November 7, 2002 — Moody’s Investors Service downgraded the ratings of Allegheny Energy Inc., including its senior unsecured debt to B1 from Ba1.
Moody’s also downgraded the ratings of subsidiaries Allegheny Energy Supply, Monongahela Power, Potomac Edison, West Penn Power, Allegheny Generating Company, and the rating of Allegheny Energy Supply Statutory Trust 2001. The ratings of Allegheny and its subsidiaries remain under review for possible further downgrade.
The ratings of the following issuers were downgraded and remain under review for further downgrade:
* Allegheny, senior unsecured to B1 from Ba1
* Allegheny Energy Supply, senior unsecured and issuer rating to B1 from Ba2
* Allegheny Generating Company, senior unsecured to B1 from Ba2
* Allegheny Energy Supply Statutory Trust 2001, senior secured to B1 from Ba2
* Monongahela Power Company, senior secured to Baa3 from A3, senior unsecured debt and issuer rating to Ba1 from Baa1, preferred stock to Ba3 from Baa3, commercial paper to Not Prime from Prime-2
* Potomac Edison Company, senior secured to Baa3 from A3, senior unsecured debt and issuer rating to Ba1 from Baa1, commercial paper to Not Prime from Prime-2
* West Penn Power Company, senior unsecured and issuer rating to Baa1 from A1, commercial paper to Prime-2 from Prime-1
* Mountaineer Gas Company, commercial paper to Not Prime from Prime-2
None of these issuers have outstanding commercial paper.
These rating actions reflect:
(1) limited financial flexibility and deterioration in cash flow and earnings,
(2) cash from operations which, absent substantial operating improvement, fails to cover capital spending and dividends even allowing for a recent 50% dividend reduction
(3) poor near term prospects for merchant power prices and the poor returns generated on substantial investments in that area,
(4) potential default under its credit agreements requiring ongoing waivers or cures by November 29th and the need to extend its $70 million bilateral line of credit that expires on November 30th,
(5) uncertainties regarding the delay in filing the company’s financial statements, and
(6) the need to sell assets in order to bolster liquidity.
The deterioration in Allegheny’s financial performance reflects weak wholesale power markets, problems with its energy trading activities, and declines at its regulated utilities due to operating difficulties attributable to unplanned equipment outages and adverse weather conditions. Allegheny substantially increased its generating presence in the Midwest through the acquisition of three power plants in 2001. Margins in the Midwest have since declined due to substantial excess generating capacity and Moody’s does not expect market conditions in this region to improve for at least the next 1-2 years.
Allegheny’s energy trading activities have consumed cash particularly due to hedging arrangements that were intended to protect against the company’s exposure under a contract to sell power to the California Department of Water Resources (CWDR). Furthermore, the state of California has challenged the terms of the $4 billion CDWR contract prompting Allegheny to appeal to the FERC for an expedited ruling.
Allegheny’s financial flexibility is limited. Its cash position is modest and waivers that cure certain technical defaults on its credit facilities expire on November 29th. Moreover, a $70 million funded bilateral line of credit expires on November 30th. The company also faces claims for cash collateral from trading counter-parties. Merrill Lynch demanded payment for $115 million in September in connection with an agreement to repurchase its remaining ownership in Allegheny Energy Supply. This demand is presently being litigated.
The downgrade of Allegheny’s regulated utility subsidiaries reflects the potential for increased pressure to support the cash needs of the parent, and diminished financial flexibility of the family of companies. Moody’s also notes that the renegotiated provider of last resort (POLR) contracts between Allegheny Energy Supply and the utility companies have resulted in an increase in costs for the electric utilities.
The continuing review of Allegheny and its affiliates will focus on:
(1) prospective cash flow generation and asset sales in relation to cash needs for debt service and capital spending,
(2) the implications of uncertainties of financial reporting and any concomitant restatements and possible asset write-downs
(3) the ability of the utility subsidiaries to obtain their own credit lines, and
(4) the probable outcome of negotiations with lenders, who will likely request collateral as a condition to continued waivers or extensions of maturity.
Headquartered in Hagerstown, MD, Allegheny Energy, Inc. is an integrated energy company that owns various regulated and unregulated subsidiaries engaged in generation and distribution of electricity, and other businesses. Its utility subsidiaries deliver electricity to customers in Maryland, Ohio, Pennsylvania, Virginia, and West Virginia, and natural gas to customers in West Virginia.