S&P Sees Improvement, but Finds Refinancing Challenges Ahead for Merchant Sector

A few of the formerly strong energy merchants, in particular Allegheny Energy Inc. and Edison Mission Energy, remain loan-challenged through 2003, and 2004 may be a challenge for many others, according to an updated review by Standard & Poor's (S&P) issued on Thursday.

Overall, the total amount of refinancing needs for the energy merchant sector has significantly decreased in the past year, mostly driven by many companies successfully pushing out maturities past 2006, and others able to pay down debt through asset sales, said S&P credit analyst Arleen Spangler.

However, challenges remain through this year and well into 2004, she said. Allegheny Energy has $280 million coming due in December, representing 4% of total capitalization, and Edison Mission Energy's debt, with $911 million due in December at its Edison Mission Midwest Holdings subsidiary, represents 10% of its total capitalization. Others facing "large" refinancing deadlines in 2003 are Duke Energy Corp., The Williams Cos. Inc. and American Electric Power Co. Inc.

The report updates S&P's list of 23 energy merchants most at risk and the magnitude of refinancing. The credit ratings agency first compiled the research in November 2002 and updated its figures in April. For this report, Spangler focused on companies particularly challenged in 2004. She also reviewed the credit outlook for the group.

The total amount of refinancing due through 2006 has fallen to about $47 billion from more than $90 billion, said Spangler. Many have extended their maturities by allowing their lenders to take sufficient collateral to cover the loans. Others have tapped high-yield markets. And speculative-grade markets, typically open only for short periods, attracted many seven- and 10-year investors.

Still, "2004 may be a challenge for Calpine Corp., TXU Corp., Williams, Aquila Inc., and Edison Mission Energy because the maturities represent a relatively large portion of total capitalization," she said. "As we've observed over the past year, some of these companies will likely attract capital successfully by selling assets or refinancing in the high-yield market." However, Spangler said many of the companies already have collateralized all of their financings.

"It is noteworthy that all but three of the companies in the original survey attained refinancing in 2003. This may not be the case in 2004 if lenders tire of the grim outlook for merchant generation and/or no longer believe their loans are adequately secured."

The refinancings, she said, are only "interim steps until these companies can appropriately reshape their capital structure to reflect a business model with a large component of volatile cash flows. Because regulatory uncertainty and depressed market conditions continue, companies without a sustainable business model will find it difficult to survive the next round of refinancing, either in 2004 or beyond."

And despite the progress so far, S&P "does not foresee much improvement in the companies, which are still carrying significant leverage, facing an overbuilt, illiquid power market, and [getting] uncertain cash flows from the asset base. The strategy of both borrower and lender appears to be to ride out this difficult period and wait for the energy markets to improve. If this does not occur by the time many of the refinanced loans come up for renewal, there may be more failures."

Spangler added that credit trends, as measured by ratio analysis for the group, remain weak. For the 12 months ended June 30, 2003, consolidated leverage for the group averaged 73%, while funds from operations-to-total debt averaged 11%.

To learn more about the report, visit S&P's RatingsDirect at www.standardandpoors.com.

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