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Rating Action:

Moody's confirms Verizon Communications at A3; outlook negative

29 Oct 2008
Moody's confirms Verizon Communications at A3; outlook negative

Approximately $45 Billion of Long-term Debt Affected

New York, October 29, 2008 -- Moody's Investors Service confirmed the A3 senior unsecured rating of Verizon Communications (VZ) based on Moody's assessment that the cash flows generated by Verizon Wireless (VZW) will continue to grow at a healthy rate despite the U.S. economic downturn. We anticipate that, especially over the next two years, the bulk of this cash will be directed to Verizon Communications as VZW quickly repays an inter-company loan. The pending acquisition of Alltel will increase leverage quite significantly. However, the cash flows generated by Verizon Wireless, in combination with our expectation that future share repurchases will be limited, should allow Verizon Communications to meet its various obligations and investment needs and reduce debt.

"Cash flows from Verizon's wireless business have been strong, and we expect that to continue despite the soft economy," said Dennis Saputo, Moody's Senior Vice President. "The strength of the wireless business offers substantial support to the rating, and helps offset challenges in some of the wireline subsidiaries."

Moody's also lowered the ratings of 4 wireline-operating companies because we expect their financial profiles to remain under pressure as a result of intense competition, combined with the high, albeit declining, costs of the FiOS project. In addition, Moody's confirmed the ratings of 9 Verizon wireline subsidiaries based on the expectation that the parent company will continue to provide a level of support that enables the credit profiles at these companies to remain close to current levels.

The outlook for Verizon and all its subsidiaries is negative. "The negative outlook reflects execution risks associated with Verizon's plan to reduce its leverage to a level that is commensurate with the A3 rating following the Alltel acquisition amid a weakening economy", commented Saputo. In addition, the company faces very large financing needs related to the acquisition during a period of difficult market conditions. The parent company's existing $6 billion revolver matures in September 2009, the remaining financing for the Alltel acquisition (estimated at about $21 billion) is uncommitted and a little over $7 billion of debt matures in the next twelve months.

These actions complete the ratings review of Verizon and its subsidiaries initiated on June 6, 2008 when Verizon announced that its 55% owned subsidiary, Verizon Wireless, planned to acquire Alltel for about $28.1 billion in cash and assumed debt. Moody's is in the process of evaluating Verizon Wireless and will be assigning a rating to the company shortly. The review of Alltel's debt ratings, initiated at the same time, remains ongoing pending greater assurance that the transaction will close as expected.

The complete list of rating actions follows at the end of this press release.

Further Rationale for Confirmation of Verizon Communications Ratings

The confirmation of the parent company's A3 rating reflects Moody's assessment that the free cash flows generated by Verizon Wireless will continue to grow at a healthy pace, despite a slowing economy, as the company benefits from economies of scale, the high operating leverage inherent in its business model and synergies resulting from its acquisition of Alltel.

Moody's believes that VZW's state-of-the-art network supports excellent service quality, a strong brand reputation, and allows the company to successfully introduce new and enhanced service offerings, leading to above-average revenue growth and below-average churn rates. These factors, when coupled with an efficient cost structure are expected to lead to steadily improving earnings and cash flows which will should allow Verizon Wireless to steadily reduce the significant amount of debt incurred in the acquisition of Alltel.

Moody's anticipates that, especially over the next two years, the bulk of the excess cash flow generated by VZW will be upstreamed to Verizon Communications, enabling the parent to meet it various obligations (including common stock dividends, debt service and taxes) and invest in its wireline operations without incurring additional debt. The A3 rating anticipates that parent company share repurchases will be limited until the consolidated entity restores its balance sheet to targeted levels of about 1.8 times Debt to EBITDA (Moody's adjusted for proportionate consolidation of Verizon Wireless).

There are several challenges confronting Verizon Communications. Although we expect VZW's contribution to Verizon's proportionate earnings and cash flow to continue increasing from about 43% today, a weakening economy may preclude the company from reducing debt levels as quickly as initially expected. Wireless subscriber growth is slowing as penetration increases toward 100% (from about 85% today) and competition remains fierce. Switching costs are low and pricing power is limited. Finally, it is unclear whether expanding data usage will continue to offset pricing pressure on voice services and sustain recent wireless ARPU growth, especially if the U.S. economy weakens more than expected and if the downturn becomes protracted.

"On the wireline side, overall business risk is still increasing with accelerating line losses and the shift in the company's asset base and investment needs toward highly competitive and capital-intensive business segments like video, broadband and corporate data", Saputo added. The margins on these products are significantly lower than the margins on traditional voice services.

A reconfiguration of VZW's ownership structure is not factored into the current ratings. A potential buyout of Vodafone's 45% stake in VZW could have significant rating implications for the ratings of VZ, its operating subsidiaries and VZW, depending on how the takeout is financed.

Rationale for Ratings Actions on the Wireline Operating Companies

Verizon New York

"The rating of Verizon New York was confirmed at Baa3 because of the significant amount of support that this subsidiary receives from its parent company --- an indication of its strategic importance to Verizon", according to Dennis Saputo. While Verizon has not taken a dividend from VZ-NY for several years, in May 2007 Verizon reclassified $2.0B of VZ-New York's intercompany debt to equity. In addition, access line losses appear to have moderated (dropping from 10.8% in 2006 to 9.8% in 2007) and the company's annual revenue decline has slowed to less than 5% for the first time in four years.

Nevertheless, intense competition, a very high cost structure, a difficult regulatory environment and a very weak balance sheet make it unlikely that the company will be able to significantly strengthen its credit metrics materially over the next few years. Moody's expects that Verizon New York's free cash flow will remain under considerable pressure for some time, given the likelihood that access line losses will continue to drive lower revenues, that much of the company's cost structure is fixed, and that it faces the expense of a significant network upgrade in its largest market, New York City. A relatively significantly under funded pension obligation also puts pressure on the rating. Consequently, Verizon New York is likely to remain the lowest rated of the Verizon wireline subsidiaries for quite some time.

Verizon New England

Moody's downgraded the senior unsecured long-term debt rating of Verizon New England, Inc. (VZ-NE) to Baa2 from Baa1 because we believe that the financial profile of VZ-NE will continue to be negatively impacted by strong competition, a high cost structure and the expenses associated with ongoing fiber deployment (the project is expected to be completed in 2010).

Competitive inroads and the investment associated with the FiOS network upgrade have had only a modest impact on VZ-NE's leverage profile over the last few years because of the actions taken by Verizon to support VZ-NE's balance sheet. Access lines and revenues have declined about 8% and 2%, respectively in each of the last two years and EBITDA margins have gone from over 38% in 2005 to just over 34% in 2007 (Moody's adjusted). Debt to EBITDA increased to 3.0x over the same period.

Earlier this year Fairpoint Communications merged with Verizon Maine, Verizon New Hampshire, and Verizon Vermont in a reverse Morris Trust transaction. The transaction closed on March 31, 2008. In order to offset the loss of a portion of the earnings and cash flows from these three states, a little over $500 million of VZ-NE's debt was paid down and reduced through an internal exchange. Nevertheless, Moody's believes that this transaction will increase VZ-NE's Debt to EBITDA ratio by about 60 basis points since the amount of debt reduction was only modestly higher than the loss of EBITDA.

Verizon Pennsylvania, Verizon New Jersey, and Verizon Maryland

The ratings of Verizon New Jersey, Verizon Pennsylvania, and Verizon Maryland were all lowered to Baa1 from A3 because we believe that competitive challenges in those states will remain intense. Access line losses in all 3 states continued to increase in 2007, margins at all three companies continue to steadily decline and investment spending has increased materially in the last couple of years. Our rating action incorporates Moody's belief that these companies are more likely to rely on parent company support given their challenging competitive environments and relatively significant investment needs. Consequently, their leverage ratios are likely to remain among the highest in the Verizon family.

Verizon Virginia

The senior unsecured debt rating of Verizon Virginia was confirmed at Baa1 despite currently having one of the stronger balance sheets and higher operating margins in the complex because we believe that cable competition in the company's service territory will intensify materially in the near future. Therefore, we expect access line loss rates (which at 6.9% in 2007 were below the rated Verizon operating company average of about 8.3%) to increase quickly and lead to margin erosion and pressure on operating cash flows. Capital spending has been above average over the last few years (in part due to the region's high growth) and we expect it will remain elevated. Consequently, we believe that the company's leverage metrics will deteriorate modestly from current levels. At 51.9% the company's EBITDA margin was well above the average for the rated ILECs of 37.6% and Debt to EBITDA at 1.7 times was below the rated ILEC average of 2.7 times (all ratios Moody's adjusted for the twelve months ended June 30, 2008).

Verizon California, Verizon Delaware, Verizon North, Verizon Northwest, and Verizon West Virginia

Moody's has confirmed the A3 senior unsecured ratings of Verizon California, Verizon Delaware and Verizon Northwest as the rating agency expects these companies to maintain their healthy cash flows and moderate leverage over the rating horizon. Moody's expects EBITDA margins for these three companies to remain strong and the level of competition in their markets to remain stable in the near-term, especially in Delaware and California, which already face intense competition but where greater FiOS deployment is expected to moderate subscriber losses to cable competition.

Moody's has also confirmed the A3 senior unsecured debt ratings of Verizon West Virginia and Verizon North. While capital investment has remained well below average at both these companies, competitive challenges have also been slow to develop although recent line losses at Verizon North indicate that competition is accelerating in that region. However, EBITDA margins are over 60% at Verizon North and its Debt to EBITDA ratio is 1.4 times, both metrics the best of the Verizon operating companies. Consequently, Moody's anticipates that the company will be able to sustain its strong credit profile in the face of increasing competition.

While EBITDA margins are lower at Verizon West Virginia, competition is expected to remain relatively subdued over the near-term (access line losses were 7% in 2007) which should enable the company to sustain a strong credit profile (Debt to EBITDA is 1.4 times).

GTE Southwest and Verizon Florida

The senior secured debt ratings of GTE Southwest and the senior unsecured debt rating of Verizon Florida were confirmed at Baa1 because we expect the operating performance of both companies to stabilize in the near-term. Both companies were among the first to modernize their networks by deploying fiber to homes. While the rate of access line loss continued to increase during 2007 at Verizon Florida (in part, we believe due to housing problems), we note that the rate of decline slowed at GTE Southwest for the second year in a row and revenue growth at that company accelerated to over 3.5% in 2007.

Parent Support of Wireline Subsidiaries

For several years now, Verizon has taken steps to support the credit profile of its operating telephone companies. During this period, the wireline subs have not issued any external debt while their individual funding needs have been provided via inter-company loans from the parent. In addition, Verizon has taken steps to keep the level of total debt at each of the individual operating subs relatively flat, mainly by restricting and, in some cases eliminating the amount of dividends that the subs upstream. Nevertheless, average leverage ratios have increased steadily over the last three years, mainly because of earnings pressures as high margin legacy voice revenues are replaced by lower margin revenue streams and high investment requirements.

Although Moody's continues to be concerned with the operating performance of some of Verizon's wireline operating subsidiaries and we continue to have our doubts about the ultimate return prospects of the FiOS investment, we recognize that FiOS costs are coming down, deployment is on schedule, the product is meeting with good customer acceptance, and that thus far, the products penetration appears to have an inverse relationship with the number of line losses in some markets.

Most importantly, we believe that Verizon's overall financing policies of its wireline subsidiaries indicates relatively strong parental support for these subsidiaries, consequently, we give these subsidiaries, several notches of rating lift from the ratings that would result from their individual, stand-alone credit quality.

Moody's believes that at least over the next 12 to 18 months, the financial profile of most Verizon operating telephone subsidiaries will continue to be pressured by strong competition and the expenses and capital requirements associated with ongoing fiber deployment (the project is expected to be completed in 2010). However, we believe that significant previous network investment and additional cost reduction initiatives should slowly enable most of these companies to begin to stabilize their operating performance. While we expect that the earnings and cash flow generating capacity of the group, as a whole, will remain pressured through at least the middle of 2009, we believe that dividends to the parent will be limited such that leverage metrics at these subsidiaries, as a group, stabilize at about 3.0 times Debt to EBITDA, Moody's adjusted. For FYE 2007 and LTM to June 30, 2008, the average Moody's adjusted Debt to EBITDA ratio for Verizon's rated wireline operating subsidiaries was 2.7 times.

Complete list of rating actions:

Ratings confirmed are:

Verizon Communications: senior unsecured, A3

NYNEX Corporation: senior unsecured, A3

GTE Corporation: senior unsecured, Baa1

Verizon Delaware, Inc.: debentures, A3

Verizon West Virginia, Inc.: debentures, A3

Verizon North, Inc.: debentures, A3

Verizon Northwest, Inc.: debentures, A3

Verizon California, Inc.: debentures, A3

Verizon Virginia, Inc.: notes and debentures, Baa1

Verizon Florida, Inc.: debentures, Baa1

GTE Southwest, Inc.: first mortgage bonds, Baa1

Verizon New York, Inc.: notes and debentures, Baa3

Ratings downgraded are:

Verizon New England, Inc.: notes and debentures, to Baa2 from Baa1

Verizon New Jersey, Inc.: debentures, to Baa1 from A3

Verizon Pennsylvania, Inc.: debentures, to Baa1 from A3

Verizon Maryland, Inc.: debentures, to Baa1 from A3

Ratings remaining on review for possible upgrade:

Alltel Corporation:

$2.3 billion Senior Unsecured Notes -- Caa1, LGD 6 (95%)

$1.0 billion Senior Unsecured Toggle Notes -- Caa1 LGD 5 (79%)

Corporate Family Rating -- B2

Probability of Default Rating -- B2

Alltel Communications:

$14.0 billion Senior Secured Term Loan B due 2015 -- Ba3, LGD2 (27%)

$1.5 billion Senior Secured Revolving Credit Facility due 2013 - Ba3, LGD2 (27%)

$7.7 billion Senior Unsecured Committed Bridge Facility -- Caa1, LGD 5 (79%)

Please refer to Moodys.com for additional research.

Headquartered in New York City, Verizon Communications Inc. is the second largest telecommunications provider in the United States delivering broadband and other wireline and wireless communication services to residential, business, government and wholesale customers. Verizon Wireless, headquartered in Basking Ridge, NJ is a joint venture between Verizon Communications, which owns 55%, and Vodafone, which owns the remainder. Headquartered in Little Rock, Arkansas, ALLTEL Corporation operates the nation's largest wireless network (by geography).

New York
Dennis Saputo
Senior Vice President
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

New York
Alexandra S. Parker
Managing Director
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

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