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Rating Action:

Moody's downgrades AES Eastern to Ba2; outlook negative

Global Credit Research - 26 Aug 2010

$486 million debt affected

New York, August 26, 2010 -- Moody's Investors Service has downgraded the rating on AES Eastern L.P.'s (AEE) $486 million of Pass-Through Trust Certificates Outstanding to Ba2 from Ba1. The outlook remains negative.

Downgrades:

..Issuer: AES Eastern Energy, L.P.

....Senior Secured Pass-Through, Downgraded to Ba2 from Ba1

RATINGS RATIONALE

The downgrade reflects the significant deterioration in the project's financial performance in the first half of 2010. In addition, a significant increase in the project's merchant market exposure and the currently weak state of the wholesale energy market in which the project operates support Moody's expectation that financial performance will remain considerably weaker than recent historical levels over the next several years. The Ba2 rating is supported by the project's relatively high level of liquidity and the conservative restricted payments test, which is expected to result in even higher levels of liquidity in the coming years. This provides the project with a valuable cushion in the event its financial performance deteriorates further than currently anticipated.

The negative outlook considers the impending maturity of the project's revolving credit facility as well as the Parent company letter of credit facility upon which it relies to satisfy counterparty collateral requirements. The rating could be downgraded further if the project and its Parent company are unable to renew or extend these facilities prior to their maturity, if the project's financial performance deteriorates more than currently anticipated such that total rent coverages are expected to fall below 1.35x for a sustained period of time, or if it traps less cash than expected over the coming years and is unable to defer or find alternative means of financing for its significant planned capital expenditures, . Given the negative outlook, the rating is unlikely to be upgraded in the near to medium term. However, the outlook could be stabilized if the credit facilities are successfully extended or renewed and the energy market in which the project operates shows signs of sustainable improvement.

Due to the decline in energy prices and the expiration of many of the project's energy hedges, non-deferrable rent coverage fell to 1.44x in first half of 2010 (total rent coverage fell to 1.37x) from 2.12x over the previous six months and a peak of 4.6x in the six months ended December 2007. As a result, the project was unable to meet its 1.7x restricted payments test (there is an additional 2.0x test at the holdco) and $13 million in excess cash flows were trapped. The restricted payments test includes a 1-year look back and a 2-year forward (both calculated for individual six-month periods. Based on this, management does not anticipate it will be able to make distributions until July 2016.

Moody's notes that the restricted payments test is very high relative to other projects, a relative credit strength. As a result, the project is expected to accumulate substantial excess cash flow over the next several years, which should provide a degree of cushion in the event markets deteriorate further than expected (but a substantial portion of which may to be utilized to finance upcoming capital expenditures). This will complement the project's already high level of liquidity provided by its six-month cash funded non-deferrable rent reserve (equal to six months debt service on the trust certificates) and its additional liquidity reserve, also sized at six months non-deferrable rent and fulfilled with a letter of credit provided by the project's Parent company.

Coverage is currently projected to drop further to 1.33x in the second half of 2010 notwithstanding a 20% forecast increase in energy revenues, partially offset by a 30% increase in variable costs. The increase in both revenues and variable costs is driven by a projected increase in capacity factors to 96% from 73%, which appears to be optimistic based upon the project's recent performance. (Between 2011 and 2014, capacity factors are expected to average 91%. While this is still somewhat aggressive in Moody's opinion, it is more reasonable than the forecast for the second half of the year.)

In the first half of 2011, the project has just 2% of its capacity hedged. It has no other energy hedges thereafter, and it has no gas hedges for the year either. This contrasts sharply with the company's hedged position prior to 2009. As recently as June 2008, it was 65% hedged through the end of 2009 and 10% hedged through 2010 and it was even more hedged in prior years. The company is reluctant to enter into hedges because of a compressed Dark Spread, implied forward curve market heat rates which are roughly 1,000 Btu/kWh below recent historical performance, regulatory uncertainty and reduced market liquidity. However, the company's reluctance may ultimately hurt it because forward gas prices for 2011 have dropped from over $7.00/mmBtu as of the beginning of 2009 to less than $5 currently.

Nevertheless, coverage is projected to rebound somewhat in 2011, but in the first half of 2012 it projected to fall below 1.0x due to costs associated with the forecasted purchase of RGGI emissions credits. Another rebound is expected in the second half of 2012, but in 2013 and 2014 coverage is projected to average just 0.67x due to significant forecasted capital expenditures. If not for the capex, projected coverage would average a considerably stronger, though still narrow, 1.35x over this time period. The capex is expected to be financed from excess cash flows that are trapped between now and 2012. Based upon management's forecast, the project will accumulate $94 million in excess cash flow over that time frame, which is nearly double the expected cash flow shortfall of $50 million in 2013 and 2014.

While the current market forward implied heat rate for 2011 is just over 7,000, the financial forecast assumes an average market heat rate of nearly 8,000 for the same period. This is roughly equal to the average heat rate over the twelve months through June 30. From 2012 to 2014, the average heat rate is forecast to drop to 7,250. Natural gas prices are projected to increase steadily from around $4.75/mmBtu currently to $7 by 2014. As a result, peak period power prices are projected to increase from $38/MWh in the second half of 2010 to over $50/MWh by 2014.

Market implied heat rates declined slightly in the first six months of this year after increasing considerably in 2009, to an average of about 8,100 Btu/kWh compared to just 7,000 in 2008. However, this reflected the fact that gas was displacing coal in the dispatch stack during certain periods as a result of the decline in gas prices coupled with an increase in coal prices, coupled with the adverse impact of high gas prices on heat rates during periods when coal was on the margin in 2008. Reflecting the drop in demand for power together with low gas prices, the 365 day rolling average around the clock price for energy in the region in which the project is located had fallen to just $33/MWh as of the end of June from $47/MWh a year earlier and around $60/MWh the year before that. Dark spreads were further compressed by a 25% increase in market coal prices since 2009, though the project is attempting to mitigate this by maximizing its fuel flexibility. As a result, the project's capacity factor has declined considerably, to just 55% in 2009 from 80% the previous year and 85% in 2007. While management estimates that the capacity factor would have been as high as 70% were it not for a significant outage at its largest facility, this still represents a significant decrease from the previous year. Average capacity factors remained roughly the same in the first five months of 2010.

Both AES Eastern's $75 million working capital facility and its parent's $350 million letter of credit facility (used to fulfill the project's collateral posting requirements) expire on July 2, 2011. The company is currently in negotiations to extend or replace them. It hopes to have the negotiations concluded by the end of the year. The Parent LC facility is used to satisfy the project's collateral posting requirements. Partly because of the impending maturity of this facility, the project has been unable to enter into longer term energy and gas hedges. Because of the deterioration in energy markets, however, management no longer feels it requires such a large facility so it may downsize it in conjunction with the renewal or extension. As of June 30 , 2010, there were a total of $49.4 million in letters of credit written under these two facilities, including $30 million for the additional liquidity reserve.

The last rating action on the company's debt occurred on September 30, 2009 when the outlook was revised to negative.

The principal methodology used in rating AES Eastern Energy, L.P. was Power Generation Projects rating methodology published in December 2008. Other methodologies and factors that may have been considered in the process of rating this issuer can also be found on Moody's website.

AES Eastern operates a portfolio of four coal-fired power plants with a total of 1,166 MWs of baseload generating capacity in western New York. The portfolio includes facilities at Somerset (675 MW) and Cayuga (303 MW), which are leased from independent owner trusts, in addition to smaller and older units at Westover (84 MW) and Greenidge (104 MW), which are owned by subsidiaries of AEE. All four plants participate in the NYISO's wholesale energy and capacity markets on a merchant basis. Somerset and Cayuga, which have historically been among the lowest cost assets in western and central New York, generate the large majority of the portfolio's cash flows. AES Eastern is a wholly owned subsidiary of AES NY, LLC and AES NY2, LLC, which are, in turn, both wholly owned subsidiaries of AES Corporation (B1 corporate family rating). The Pass Through Certificates secured by lease payments from AEE (senior unsecured obligations of AEE payable from all of AEE's cash flows, including those generated by the AEE-owned plants), in addition to liens on the Somerset and Cayuga facilities.

REGULATORY DISCLOSURES

Information sources used to prepare the credit rating are the following: parties involved in the ratings and public information.

Moody's Investors Service considers the quality of information available on the issuer or obligation satisfactory for the purposes of maintaining a credit rating.

Moody's Investors Service adopts all necessary measures so that the information it uses in assigning a credit rating is of sufficient quality and from reliable sources; however, Moody's Investors Service does not and cannot in every instance independently verify, audit or validate information received in the rating process.

Please see ratings tab on the issuer/entity page on Moodys.com for the last rating action and the rating history.

The date on which some Credit Ratings were first released goes back to a time before Moody's Investors Service's Credit Ratings were fully digitized and accurate data may not be available. Consequently, Moody's Investors Service provides a date that it believes is the most reliable and accurate based on the information that is available to it. Please see the ratings disclosure page on our website www.moodys.com for further information.

Please see the Credit Policy page on Moodys.com for the methodologies used in determining ratings, further information on the meaning of each rating category and the definition of default and recovery.

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

New York
Chee Mee Hu
MD - Project Finance
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Moody's Investors Service
250 Greenwich Street
New York, NY 10007
USA

Moody's downgrades AES Eastern to Ba2; outlook negative
No Related Data.
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