Fitch Expects to Rate NE Energy, Inc. 'B'.

CHICAGO -- Fitch Ratings expects to assign an Issuer Default Rating (IDR) of 'B' to NE Energy, Inc. (NE Energy, or the Borrower). In addition, Fitch expects to assign issue ratings of 'BB-/Recovery Rating (RR)2' to the proposed first lien credit facilities and 'B-/RR5' to the proposed second lien credit facilities to be issued by the Borrower. The proposed first lien facilities consist of a $550 million term loan due 2013, a $100 million cash collateralized synthetic letter of credit facility due in 2013, and a $35 million revolving credit facility maturing in 2011. The proposed second lien facility consists of a $170 million term loan due six months after maturity of the first lien term loan.

NE Energy is a newly formed subsidiary of Energy Capital Partners I, LP (the Sponsor). The proposed term loans, in addition to approximately $400 million of equity, will be used to finance the Sponsor's acquisition of Northeast Utilities' non-regulated generation assets, fund required liquidity accounts, and pay transaction costs. The acquired assets consist of Mt Tom, a 146 MW coal fired facility, and Northeast Generation Company (NGC), a portfolio of primarily hydroelectric facilities totaling 1296 MW. NGC is currently encumbered with $320 million of senior secured bonds due 2026 (rated 'BBB-' by Fitch). The Mt Tom facility is not encumbered with project-level debt.

Upon completion of the acquisition, the ownership structure will essentially mirror the current organization. The assets will be operated and maintained by an affiliate service company (NE Energy Services) and the assets' output will be sold to (or in the case of Mt. Tom, dedicated to) an affiliate marketing company (NE Energy Management). The Sponsor has advised that a substantial majority of the personnel responsible for the daily operations, maintenance, management and marketing functions will be retained at acquisition. NE Energy Services' and NE Energy Management's expected scopes of business are limited to NGC and Mt Tom.

Rating Rationale

The assigned ratings reflect the limited margin of safety that is present in the Borrower's financial projections for the near term. Although it is apparent to Fitch that the projections are based on extensive analysis, Fitch believes that a high level of uncertainty remains. For example, the projected ancillary service revenues are based on the increased revenues received during just the few months subsequent to an October 2005 market change. In addition, the Sponsor is projecting annual cost reductions of approximately $10 million (net of an expected $3 million increase of certain costs) which may not be entirely achievable. To be clear, Fitch believes that the Borrower's projections are a credible outcome. However, Fitch also believes there are credible outcomes in which the annual cash flow may be insufficient to fully satisfy the annual obligations under the credit facilities. The revolving credit facility and a debt service reserve do provide additional liquidity in the event of a temporary shortfall.

The proposed credit agreement requires that the Borrower use excess cash flow to prepay the first lien term loan. The assigned ratings reflect the Borrower's near term financial profile and could be adjusted upward if the project is able to reduce meaningfully the balance of the term loan via operating cash flow.

Payment of the Borrower's direct obligations is structurally subordinated to the debt at NGC. NGC bondholders have a first mortgage claim on the assets of NGC, including the physical assets and cash accounts held at NGC. The collateral package for the Borrower's creditors includes NGC's stock, the Mt Tom asset, and cash accounts held in the Borrower's name. Although the indenture for the NGC project level bonds includes conditions that could prohibit distributions to NE Energy, including a minimum debt service coverage ratio of 1.35 (times) x, Fitch believes these conditions do not represent a relative risk to NE Energy; the level of cash flow that just barely satisfies NGC's distribution conditions is already insufficient to satisfy NE Energy's direct obligations. Accordingly, Fitch looks toward the consolidated credit metrics when assessing the Borrower's credit profile, rather than viewing the Borrower's credit facilities as the subordinated debt of NGC.

Based on the proposed credit agreement, Fitch believes the first and second lien facilities share an equal probability of default. The issue rating of the first lien facilities differs from that of the second lien facility due to the different levels of expected recovery in the event of a payment default.

Primary Credit Strengths

--The assets represent minimal technology risk, as the facilities have been in operation for many years and a pattern of performance has been established. Additionally, hydroelectric assets incorporate inherently low-risk technology due to the absence of harsh temperatures and pressures.

--The assets are generally low cost sources of power and are located in a market that is not expected to be plagued by surplus capacity.

--The Northfield Mountain pumped storage facility is acknowledged to be a highly valuable asset to the region's reliability, and a major provider of ancillary services.

--Financial hedges eliminate market price exposure for approximately 95% of the portfolio's energy production (excluding pumped storage) through 2011.

--The current framework of the installed capacity market is expected to result in a significant stream of revenues during the life of the term loans. Favorably, capacity prices through May, 2010 are highly certain due to regulatory rulings and participant consents.

Primary Credit Concerns

--The absence of historical financial performance that is consistent with the future operating environment, particularly for Northfield Mountain, lends a degree of uncertainty to the accuracy of the revenue projections. Favorably, the historical technical performance and operating costs are known and are consistent with projections.

--Certain projected revenue streams are based on recent market developments that might not be sustainable over the long term.

--The first and second lien facilities are, by structure, deeply subordinated to project-level indebtedness of NGC. Although Fitch does not believe this subordination is particularly detrimental to the timely payment of the facilities, recovery in the event of a default will be quite significantly dampened.

Financial Summary

The Sponsor's financial projections rely on various assumptions regarding the gross margin earned from the operation of the Northfield Mountain pumped storage facility, energy produced by the assets other than pumped storage and sold under financial hedges, ancillary service revenue attributed primarily to Northfield Mountain, and revenue earned by all the facilities in the forward capacity market. In the Sponsor's base case, the assets generate cash available for consolidated debt service of approximately $133 million in 2007 increasing to $183 million by 2010 and tapering to $163 million by 2013. The consolidated debt service of the Borrower and NGC totals approximately $106 million in 2007, declining over time depending on the pace at which mandatory prepayments of excess cash flow are achieved. In the Sponsor base case, approximately $86 million of the first lien term loan remains outstanding at maturity.

In an attempt to approximate the minimum financial performance that should be achievable over the long term (Fitch's base case), Fitch incorporated somewhat conservative assumptions that reduce cash flows by approximately $23 million in 2007 increasing to a reduction of $80 million by 2013. In order to simulate the portfolio's performance during a single year of extreme downturns in the market and energy production (i.e. low hydrology, forced outages), Fitch imposed additional assumptions that resulted in an incremental reduction of approximately $30 million to $40 million. In Fitch's base case, cash flow is adequate to pay mandatory debt service in all years, while the outstanding balance of the first lien term loan is approximately $423 million at maturity. In Fitch's one year stress scenario, cash flow is insufficient to fully pay the Borrower's direct obligations in any year in which the stress is assumed to occur. Notably, cash flow would be more than sufficient to pay the debt service at NGC and satisfy the NGC distribution conditions.

Fitch's Recovery Ratings (RR), introduced in 2005, are a relative indicator of creditor recovery on a given obligation in the event of a default. Recovery Rating analysis provides a framework for expected recoveries in the event of a bankruptcy scenario and is not meant to be a predictor of when or if a default will occur. Recovery Ratings (RR) are assigned to corporate issuers that have an Issuer Default Rating (IDR) of 'B+' or below. A broad overview of Fitch's RR methodology as it relates to specific sectors, including a Case Study webcast, can be found at http://www.fitchratings.com/recovery.

Fitch's rating definitions and the terms of use of such ratings are available on the agency's public site, www.fitchratings.com. Published ratings, criteria and methodologies are available from this site, at all times. Fitch's code of conduct, confidentiality, conflicts of interest, affiliate firewall, compliance and other relevant policies and procedures are also available from the 'Code of Conduct' section of this site.