S&P cuts NRG multiple notches to junk

Standard & Poor's downgraded NRG Energy Inc. multiple notches to junk. Ratings lowered include NRG's senior notes and convertibles securities to B+ from BBB- and NRG Northeast Generating LLC's and NRG South Central Generating LLC's senior secured bonds to BB from BBB-. NSP Financing I's trust preferreds were held steady at BB+ as were Northern States Power Co.'s first mortgage bonds at BBB+ and notes at BBB- and Xcel Energy Inc.'s preferred stock at BB+ and senior notes at BBB-. NRG's corporate credit rating was cut three notches to BB. All ratings were placed on CreditWatch with negative implications.

S&P said NRG's senior unsecured bonds were lowered to B+ to reflect their position as inferior to the secured project level debt.

S&P said the action is a consequence of its view that NRG's access to capital is severely constrained and its ability to finance the $1.5 billion acquisition of certain First Energy power plants is highly problematic given today's adverse market conditions.

The CreditWatch listing reflects primarily the existence of substantial collateral calls that are triggered by this rating downgrade, which have the potential to severely exacerbate NRG's liquidity concerns and its default risk, S&P said.

The ratings on Xcel Energy, Inc and its utilities subsidiaries are also placed on CreditWatch with negative implications, pending the outcome of negotiations concerning structural linkages to NRG, S&P added.

If Xcel Energy removes the cross-default provision in its corporate revolving credit facility and the banks forbear in exercising their rights to collateral under the NRG revolving construction facility, then NRG's rating may move to around the B+ level, reflecting its stand-alone credit quality and presumed diminished parent support. Accordingly, Xcel Energy's rating may be maintained at the current level, S&P said.

If Xcel Energy removes the cross-default provisions but the banks do not forbear in exercising their rights to collateral under the NRG revolving construction facility, then there would a risk of impending default at NRG. However, in this case, Xcel Energy's rating may be maintained at the current level, as it distances itself from its failing subsidiary, S&P continued.

If Xcel Energy is not successful in removing the cross-default provisions but the banks forbear in exercising their rights to collateral under the NRG revolving construction facility, then NRG's rating would likely remain at BB, and Xcel's ratings could fall to BB. This action would reflect the notion that the cross-default provision closely ties together the two companies' credit quality, S&P said.

If Xcel Energy is not successful in removing the cross-default provisions and the banks do not forbear in exercising their rights to collateral under the NRG revolving construction facility, then there would a risk of impending default at NRG. In this case, Xcel Energy's rating would fall to speculative grade, S&P said.

Moody's puts Stilwell on downgrade review

Moody's placed Stilwell Financial Inc.'s ratings (senior at Baa1) on review for possible downgrade, reflecting concern that Stilwell's earnings and cash flow are under pressure and this makes the firm's high leverage relative to peers a greater potential issue.

Moody's said the review will consider the negative effects the recent slide in the equity markets has had on assets under management and the resultant reduction to its earnings and cash flow. Moody's said Stilwell's assets under management have declined as a result of both market depreciation and investor redemptions.

Stilwell's ability to counter the recent reduction in assets under management in light of the firm's high concentrations in growth equity and retail-oriented products also will be scrutinized. Stilwell's ability to manage its expenses to offset a portion of its revenue declines will also be considered.

Weakening cash flow, together with the volatility in those cash flows given the firm's concentrations, makes Stilwell's high financial leverage relative to other asset managers a particular ratings concern that will be evaluated, Moody's said.

Positively, Moody's noted that Stilwell does continue to hold a substantial investment in DST Systems and that, although it would be costly, it could be monetized in order to support its debt load. Additionally, Moody's said that the company has no major debt maturities for the next several years.

S&P keeps Tyco on negative watch

Standard & Poor's said it is keeping the ratings of Tyco International Ltd. and subsidiaries on negative watch, including the two 0% convertible notes at BBB-.

Bermuda-based Tyco is a diversified company with total debt of about $26 billion.

S&P believes reports regarding a planned bankruptcy filing by Tyco are unfounded and the company hosted a teleconference to strongly refute this rumor. The same day, Tyco announced the appointment of Edward Breen, former chief operating officer of Motorola Inc., as chief executive officer.

S&P views the appointment of Breen, who is generally well-regarded, as a positive development.

Tyco began the quarter with more than $7 billion in cash following the recent IPO of its commercial finance subsidiary, The CIT Group. Management intends to use a significant portion of this to reduce debt.

The company has recently repurchased $300 million of public debt in the open market and plans to repurchase an additional $2 billion in the current quarter.

During the next 18 months, the company will have public and bank debt maturities totaling about $6.8 billion, plus the potential put of the convertibles totaling about $5.9 billion. Tyco has the option to satisfy $2.3 billion of the latter amount in common stock at the February 2003 put date. However, it may choose not to do so because at the current low common share price, this would cause significant dilution.

Operating results for the quarter ended June 30 were broadly in line with expectations, S&P said.

However, free cash flow of $657 million was below management's initial estimate of $900 million to $1.1 billion. This was primarily due to tighter payment terms from suppliers that reduced operating cash flow by more than $300 million.

Although revenues increased sequentially in all electronics end markets for the first time in about two years, market conditions in this segment remain weak. Operating margins, roughly half of levels from a year ago, are expected to continue declining in the current quarter due to pricing pressure.

During the quarter, Tyco took impairment, restructuring, and other unusual charges totaling $955 million pretax, of which about $180 million are cash charges. As of June 30, Tyco's debt to capital was about 49%, which is below the 52.5% maximum permitted by its bank credit agreements.

This provides a cushion for any meaningful additional charges, even before expected debt reduction, S&P said.

The watch will be resolved based on how management addresses the gap between cash balances plus free cash flow, expected to total about $2.5 billion in the current fiscal year, and obligations coming due in the next 18 months.

This gap could be bridged through a combination of successful negotiation of new bank credit facilities, selling additional assets and accessing the public capital markets.

S&P added that it will also will continue to monitor developments in connection with the ongoing investigations by the Manhattan District Attorney's office and the SEC of alleged tax evasion by Tyco's former CEO, as well as corporate governance issues.

The ratings could be lowered if debt is not reduced meaningfully in the near term, the company does not address in a timely manner obligations coming due late in calendar-year 2003, or if there are further negative developments in connection with regulatory or law enforcement agency investigations.

Tyco should have sufficient liquidity to repay amounts outstanding under accounts receivable securitizations, currently about $540 million, which might become due as a result of recent rating downgrades.

These include accounts receivable securitization programs, $530 million outstanding as of March 31, ¥30 billion ($225 million) of notes due 2030, partly offset by proceeds expected from the potential termination of various interest rate swaps.

Depending on the company's future capital structure, including the possibility that security could be granted or other developments could cause structural subordination, the ratings on debt obligations in the investment-grade category could be lowered even if the corporate credit rating remains unchanged.

S&P revises IKON outlook to stable

Standard & Poor's revised the outlook on IKON Office Solutions Inc. and related entities to stable from negative, reflecting stabilized operating performance and a moderately leveraged financial profile.

The ratings were affirmed, including the 5% convertible due 2007 at BB+.

IKON has a strong, but not leading, market position, offset by highly competitive conditions in the office products and solutions market, S&P said. A significant base of recurring service and supplies revenues adds some stability to IKON's revenue profile.

Growth in the mature, global office copier market is expected to be pressured in the near term by economic weakness and competitive pricing conditions. IKON's longer-term growth prospects will be driven by its strategic emphasis on document management solutions and services.

S&P expects ongoing margin pressure and uncertain economic and industry conditions to limit significant operating performance improvement in the near term. EBITDA margins, adjusted for capitalized operating leases and captive finance operations, are expected to be above 6%, with EBITDA coverage of interest in excess of 5 times.

IKON's core operations continue to generate free operating cash flow.

Additional funding requirements, dependent upon net growth in equipment sales financing, have been moderate, due to lack of revenue growth. Debt maturities for parent company IKON Office Solutions are moderate.

IOS Capital has significant near-term debt maturities, which are largely offset by finance receivables. Availability under a $300 million IKON credit facility and IOS Capital asset-backed conduits provide adequate financial flexibility.

Downside ratings protection is provided by stabilized profitability levels, a moderately leveraged financial profile and consistent free cash flow generation.

The potential for rating improvement is limited by highly competitive industry conditions and return levels that are weak for the rating.

S&P ups Key Energy to BB

Standard & Poor's raised the corporate credit rating on Key Energy Services Inc. to BB from BB-, following the merger with Q Services Inc. The outlook is stable.

Key is a leading onshore services provider to the petroleum industry with about $470 million of debt.

The new ratings reflect an enhanced financial position and a commitment to capital structure improvement, S&P said.

The Q Services transaction was financed with $146 million of equity and the assumption of $75 million of debt for a total of $221 million.

Key has demonstrated a greater degree of resiliency in the recent industry downturn, compared with the 1999 downturn, although stronger oil prices in this most recent slowdown in the North American oilfield services industry likely have cushioned financial results.

Further, Key has steadfastly applied excess cash flow to debt-reduction bringing total debt, pro forma for the Q Services acquisition, to slightly below 40% of total capital. Management has publicly stated that it intends to continue its debt reduction initiatives, targeting a 25% debt-to-capital ratio over the next two years.

Key is expected to post adequate credit measures for the rating category.

Assuming a modest upturn in oilfield services demand in the second half of 2002, EBITDA interest coverage should range between 4.5 times and 5.0 times in fiscal year 2003.

EBITDA to interest plus capital expenditures should be above 1.5 times, however, Key has the flexibility to significantly scale back its capital spending.

Liquidity is strong, with cash on hand, significant availability on the company's $150 million secured credit facility, and no near-term maturities.

The stable outlook reflects expectations that Key will continue to pursue conservative financial policies. S&P expects the company will continue its debt reduction program and finance any further growth initiatives in a measured manner.

S&P revises AOL outlook to negative

Standard & Poor's revised the outlook for AOL Time Warner Inc. to negative from stable. All ratings were affirmed, including the 0% convertible due 2019 at BBB.

Also, S&P assigned a BBB+ rating to the company's $10 billion credit facility.

The outlook revision reflects management's recent redirection of earnings expectations toward the lower end of its 2002 5% to 9% EBITDA range, and in particular, the disappointing 27% decline in America Online EBITDA for the June quarter from a year ago.

S&P is concerned that weaker-than-expected operating performance at the AOL business unit may persist as a result of deteriorating advertising sales and could result in weaker credit measures.

Also, the decline in America Online EBITDA places a burden on the Time Warner divisions to deliver performance that will meet earnings targets.

Traditional advertising channels are in the early stages of a weak recovery. Greater concern surrounds the timeframe for a recovery in Internet spending.

In addition, the SEC inquiry announced by the company adds to recent investor uncertainty and could consume significant management time and attention as it strives to stabilize operating performance.

S&P said it regards recent management restructuring actions as positive considerations supporting the rating.

The ratings reflects solid operating performance in remaining business units, strong market positions, diversified operations, a moderate financial profile and adequate liquidity.

These factors are only partially offset by concerns associated with deteriorating financial performance of its AOL division and the still-unknown impact of a restructuring of the TWE partnership with AT&T Corp. on its credit profile.

Credit measures are somewhat stretched for the current rating level, however.

S&P has indicated an expectation of 3 times debt to EBITDA as a target level for the current rating.

Debt levels climbed by almost 25% in the first half of 2002 from 2001, while EBITDA is likely to only modestly improve in 2002.

Debt to EBITDA for the last 12 months ended June 30 was about 3.2 times. Debt plus AOL Europe preferred, operating leases, guarantees, and securitization debt to EBITDA plus rent in is the 3.6 times to 3.7 times range. EBITDA to gross interest coverage is estimated in the 4.5 times area.

The company has about $7 billion of unused capacity under committed credit facilities and a healthy margin of compliance with its credit agreement covenant of 4.5 times debt to EBITDA, which does not require stepdowns.

The new credit facility includes a $6 billion, five-year revolving credit and a $4 billion, 364-day revolving credit, with a two-year term-out option.

Additional adjustments to earnings guidance, including indications of further weakness at the America Online unit, incremental debt incurrence beyond working capital needs, or other unexpected developments could result in a rating action.

The negative outlook includes no assumptions regarding a TWE restructuring. While ratings currently are affirmed, the extent of negative pressures are not likely to exceed one rating notch, or a BBB rating.

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