Dynegy Inc. is refinancing debt and altering its corporatestructure to avoid a default, putting bondholders at a disadvantageby reducing their claims on the assets of the third-largestindependent U.S. power producer.

Dynegy is seeking $1.7 billion in new loans to replace anexisting facility on which it expects to default later thisyear.

The utility has posted four straight quarterly losses as lowpower prices and tougher capital requirements led it to considerbankruptcy earlier this year. Robert C. Flexon, named chiefexecutive officer on June 22, needs a new credit agreement becauseDynegy expects to be out of compliance with an earnings-to-interestratio requirement in its current loan package by the end of theyear, according to a May 9 regulatory filing.

“The new management team's first requirement is to getliquidity, get the new bank facilities and then once that's done togo after some of these long-dated maturities,” said Andy DeVries,an analyst at CreditSights Inc. in New York.

The proposed financing package includes term loans of $1.3billion and $400 million, the company said in a regulatory filingyesterday. Credit Suisse Group AG and Goldman Sachs Group Inc. arearranging the six-year facilities, which Dynegy expects to becompleted at the end of July.

'Asset Stripping'
Dynegy's plan adds alayer of debt senior to its bonds, whose holders are also at riskof having company holdings sold.

“The bondholders have no covenants protecting them against assetstripping,” said CreditSights' DeVries. “They caught the market offguard, and senior unsecured bondholders are saying that managementis no longer looking at the whole company as one big portfolio andthat is telling bondholders they may try to strip some assets outfrom under them.”

Neither Flexon, 52, nor Chief Financial Officer Clint Freeland,42, would comment on yesterday's filing, Millie Brinkley, a companyspokeswoman said in a telephone interview. Flexon was hired by anew board backed by the company's two largest owners, Carl Icahnand Seneca Capital, after shareholders rejected two takeoverbids.

Gas, Coal
Dynegy said it will restructureitself with one unit owning eight primarily natural gas-fired powergeneration facilities and another owning a group of six primarilycoal-fired baseload facilities, according to the filing. The $1.3billion debt will be available to the natural-gas unit, while thecoal subsidiary would get the $400 million loan, Dynegy said.

Separating debt at its natural-gas fueled plants, which havebeen running more, from its coal-burning plants, which have beenrunning less based on fuel costs, will make it easier for Dynegy tosell either unit, Brandon Blossman, a Houston-based analyst forTudor Pickering Holt & Co., said in a telephone interview.

Dynegy must increase the ratio of its earnings before interest,taxes, depreciation and amortization to interest expense to 1.6times or more by Sept. 30 to remain in compliance with its covenantand avoid default, according to the SEC filing.

It is “virtually certain that we will not be in compliance withthis covenant at some point over the next twelve months unless wereach agreement on an amendment to or replacement of the creditfacility, or obtain a waiver of its terms,” according to thecompany's 10-Q filing received May 9.

Bond Ratings
Moody's Investors Serviceassigned Dynegy a rating of Ca, 10 steps below investment grade, onMarch 28. Standard & Poor's cut its level to an equivalent CCon March 18 and said it could downgrade the company further, citingthe “near-term possibility of a bankruptcy filing” if lenders don'tagree to modify the terms of the loans.

The company's 8.375 percent bonds have fallen 12.75 cents sincetouching 87.75 cents, the highest in a year, on May 3, Trace datashow.

The extra yield investors demand to own Dynegy's $4.31 billionof bonds instead of similar-maturity Treasuries widened to 13.24percentage points on average yesterday from 11.75 on June 22, evenas spreads on high-yield debt narrowed 6 basis points over the samespan, according to Bank of America Merrill Lynch index data. Abasis point is 0.01 percentage point.

New Loans
Dynegy had $68 millionoutstanding under its term loan B due April 2013, as of March 31,according to the regulatory filing. The utility also has $850million outstanding under a term facility also due April 2013 thatis fully collateralized by $850 million of restricted cash, whichmeans current bondholders are behind $68 million in the capitalstructure. After the refinancing, they will be subordinated to thenew $1.7 billion facility.

“This structure gets them down the road a year or two, and youjust don't know how much more new debt will be ahead of you,” PeterThornton of KDP Investment Advisors in Montpelier, Vermont. said ina telephone interview. “You're going to be facing increasingstructural subordination, and in that case the recovery value justgoes down as more and more debt is layered on to those newsubsidiaries.”

Dynegy has risen 66 cents, or 11.6 percent, to $6.36 in New YorkStock Exchange composite trading since the Houston-based utilityannounced April 13 it had hired Lazard Ltd. to refinance its debt.The company reported its fourth consecutive quarterly loss on May 9as electricity prices fell from a year earlier.

Energy Prices
Falling gas prices have hurtDynegy's earnings. Gas costs set energy prices in most marketbecause plants powered by it usually provide the marginal powerneeded to meet demand. Coal is easy to store, and plants powered byit are usually slow to be turned on and off.

The first-quarter net loss was $77 million, or 64 cents a share,compared with net income of $145 million, or $1.20, a year earlier,the Houston-based company said in the May 9 statement. Sales fell41 percent to $505 million.

NRG Energy Inc. and Calpine Corp. are the two largest U.S.independent power producers.

Natural gas for May delivery rose 3 cents to $4.31 per millionBritish thermal units yesterday on the New York MercantileExchange. Natural gas futures traded at $4.405 per million Btu onDec. 31 and as high as $13.577 on July 3, 2008. Dynegy failed tohedge at that time, and it sold eight natural-gas powered plants toLS Power Group in 2009.

The spot price of Illinois coal rose 16 percent from a yearearlier to $47.80 a ton in the past quarter, trailing a 31 percentincrease in power prices in PJM Interconnection LLC, the largestU.S. power market over the same period, Bloomberg data show.Natural gas prices fell 5.2 percent, to $4.37 a million Btu, in thesame period.

'More Time'
Dynegy's loss excluding someitems such as adjustments to the value of fuel and power salescontracts probably doubled to 55 cents a share in the past quarter,the average of four estimates by analysts compiled byBloomberg.

“If this works, they've bought themselves a little more time,”said Tudor Pickering Holt's Blossman. “Presumably, the covenantlanguage in the new facilities will allow them essentially the sixyears to right the ship.”

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