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Announcement:

Moody's revises AES Puerto Rico's outlook to negative; Baa3 rating affirmed

Global Credit Research - 23 Aug 2010

$195 million debt affected

New York, August 23, 2010 -- Moody's Investors Service has affirmed the Baa3 rating on AES Puerto Rico L.P.'s (AES PR) $195 million of senior secured bonds outstanding and revised the outlook to negative. The bonds were issued on behalf of AES PR by the Puerto Rico Industrial, Tourist, Educational, Medical, and Environmental Control Facilities Financing Authority. Proceeds of the bonds were lent to AES PR to help finance the construction of its 454 megawatt (MW) coal-fired cogeneration facility. The bonds are secured by loan payments from AES Puerto Rico equal to debt service on the bonds.

The Baa3 rating reflects the cash flow stability provided by the project's power sales agreement for the full output of the plant with the Puerto Rico Electric Power Authority (PREPA, rated A3), which provides for the transfer of most fuel cost risk to the offtaker, and the essentiality of the plant to Puerto Rico's resource portfolio. The negative outlook considers the expected deterioration of the project's financial performance in the coming years, driven by steady increases in scheduled debt service, higher than expected operating and maintenance costs and capital expenditures, and operational problems related to the project's inability to achieve the heat rate performance requirements in its offtake agreement.

The rating will come under downward rating pressure unless the project is able to reduce its O&M and capex costs and improve its operating performance sufficiently to maintain a minimum of 1.5x debt service coverage going forward. 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 project successfully achieves its forecast coverage level of 1.6x in 2011 and demonstrates its ability to maintain a minimum debt service coverage ratio of 1.5x going forward.

In 2009, debt service coverage was just 1.36x, down from an average of 1.7x over the previous four years. Coverage is expected to remain slightly below 1.5x this year. Next year it is projected to rebound to 1.6x, but management forecasts that it will fall to 1.4x by 2017 and if the project is unable to achieve some of the assumed improvements upon which management's forecast is based, Moody's believes that coverage could fall as low as 1.33x.

Debt service is projected to increase to $84 million in 2017 from just $66 million in 2010, an increase of 27%. This far outstrips the increase in scheduled capacity payments from PREPA, which grow by just 8%, or $8 million, to $101 million during this period. The capacity payments account for approximately 85% of the cash flow available for debt service. As a result, management forecasts that debt service coverage will fall to 1.4x by 2017. This forecast assumes a reduction of $5 million in annual operating and maintenance expenditures (including capex) and an increase of $700,000 in the margin of variable O&M payments over related costs going forward. If they are unable to achieve these results, coverage could fall as low as 1.33x in 2017.

Between 2005 and 2008, average debt service coverage of 1.7x was only slightly below the intial forecast of 1.8x. However, cash flow available for debt service averaged just $105 million over this time period, well below the initial forecast of $128 mm. This was largely offset by lower than expected debt service, which averaged just $62 million, or $10 million lower than initially forecast.

Cash flows have been weaker than forecast at least in part because of higher than expected capital expenditures and ash management, dredging, and insurance costs, as well as under recovery of fuel costs related to the plant's inability to meet the heat rate guarantees in its power sales agreement. The financial impact of this last concern has been increasing in recent years due to steady growth in the project's fuel costs, which have risen from $21/MWh in 2005 to $35/MWh in 2009. Recent capital improvements are expected to result in an improvement in the project's heat rate and a $1 million improvement to earnings according to management. A recent renegotiation of the coal supply contract is expected to result in an additional $1.5 million boost to the bottom line. However, these improvements may be offset by an increase in the project's ash management costs that could total $5 million this year, though management hopes to bring this down to $1.3 million by 2014. Management also anticipates a $2.5-$3 million annual reduction in taxes beginning in 2016 thanks to a recently negotiated amendment to the project's tax agreement with the government that is still awaiting final approval. It is unclear whether these expected changes have been incorporated into the forecast.

The project's lower than expected debt service was due to lower than expected interest expense related to the project's term loans, of which it currently has $444 million outstanding. While less than 20% of these debt obligations by par value are fixed rate, over 80% of the project's variable rate exposure is currently hedged and less than 1% of the project's 2010 debt service requirements consist of unhedged interest expense. This figure is expected to rise to 7.25% by 2017, but it remains reasonable in Moody's opinion. As a result, Moody's believes it is highly unlikely that the project's debt service requirements, which are expected to increase considerably in coming years, will remain significantly below expectations.

The decline in debt service coverage in 2009 was largely attributable to a late payment by PREPA of $11 million. This payment was subsequently received and PREPA is now current on its payments. Adjusted for this, coverage was a considerably stronger 1.54x. While even the adjusted coverage figure remained below recent historical averages, this was primarily the result of significant one-time capital expenditures. In 2010, coverage is projected to remain slightly below 1.5x due to a significant forced outage on one of the two units that occurred this spring and lasted a month and a half together with a planned outage this fall on the other unit. This is expected to result in a $15 million reduction in capacity payments this year and a $6 million increase in O&M expense. In addition, the company incurred a approximately $3 million of capex associated with a refurbishment of its cooling tower.

The last rating action on AES Puerto Rico was on May 31, 2006 when the Baa3 rating was affirmed.

The principal methodology used in rating this issuer was Moody's Power Generation Projects, published in December 2008 and available on www.moodys.com in the Ratings Methodologies subdirectory under the Research & Ratings tab. Other methodologies and factors that may have been considered in the process of rating this issuer can also be found in the Ratings Methodologies subdirectory on Moody's website.

AES Puerto Rico, L.P. (AES PR or the project), an indirect wholly owned subsidiary of AES Corp. (B1 corporate family rating), owns and operates a 454 megawatt (MW) coal-fired cogeneration facility located on the southeastern coast of Puerto Rico. The project sells all of its firm energy and capacity pursuant to a 25-year power purchase agreement (PPA) to the Puerto Rico Electric Power Authority, a public corporation and governmental agency of the Commonwealth of Puerto Rico.

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

New York
Aaron Freedman
Vice President - Senior Analyst
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 revises AES Puerto Rico's outlook to negative; Baa3 rating affirmed
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