Weighing progress toward completion of the Enron Bankruptcy case, Moody’s Investors Service last week assigned a speculative grade B1 senior secured rating to Transwestern Pipeline Co.’s $400 million term loan, a B1 senior implied rating, subject to review of final documentation, and said the outlook is positive.

Moody’s noted the recent formation of CrossCountry Energy, LLC, the new intermediate holding company that will own Transwestern. Enron’s equity interest in Transwestern and certain other pipeline holdings were transferred, free and clear of all liens and claims, into CrossCountry.

The ratings agency said it based its “positive outlook” on the expectation the court will ratify Enron’s Plan of Reorganization (POR), scheduled currently for June 2004, which outlines the plan for the spin-off (see NGI, July 14, 2003). “Confirmation of the POR in substantially its current form could result in upgrades of Transwestern’s ratings,” Moody’s said.

Under the POR, Enron indemnifies CrossCountry against bankruptcy-related liabilities relating to taxes, employee benefits, and certain performance guarantees. “This restructuring helps to bring the bankruptcy one step closer to the eventual liquidation of Enron through the spin-off of CrossCountry from Enron, either by distribution of CrossCountry stock to creditors (the initial round of distributions which could occur as early as the first half of 2005) or by sale of CrossCountry to a third party,” Moody’s said.

But, it could be a long way from here to there. Although the Securities and Exchange Commission has approved the POR, court approval is not assured (see NGI, March 15). “It is our understanding that many claims against Enron’s bankruptcy estate remain unresolved and could remain so for many years. The complexity of this bankruptcy and the diversity of interests involved could result in further litigation, appeals, delays, and further amendments to the POR.

“Delay in these proceedings would keep Transwestern under Enron’s control and prolong the risk of substantive consolidation and other means by which Transwestern could become involved in Enron’s bankruptcy. It would also result in higher costs, both operational and financial, for Transwestern,” Moody’s said.

It also remains to be seen what financial profile CrossCountry will have once it separates from Enron. Also, if CrossCountry is sold to a third party rather than spun off to creditors, then there is the buyer’s credit risk, based on financing of the acquisition.

Transwestern is not a debtor in the bankruptcy proceeding. It is, however, a creditor. The pipeline made $785 million in intercompany loans to Enron. While the company expects to recover its Enron claims, Moody’s said “the ultimate timing of any recoveries is highly uncertain.” The rating agency therefore did not include the loan recovery in its analysis.

Transwestern, on a stand-alone basis, “has a stable credit profile as a solidly capitalized regulated gas pipeline,” Moody’s said noting (1) the pipeline’s low business risk, with the majority of its revenues generated by demand charges, much of it under long-term contracts under regulated tariffs; (2) its ability to generate significant free cash flows; (3) increasing demand in both its consuming (particularly in the Southwest) and production areas (the San Juan Basin, and indirectly, the Rockies); 5) a customer base dominated by investment-grade utilities and producers; and 6) a competitive edge in its ability to flow bi-directionally that gives shippers access to both the San Juan and Permian Basins.

On the other side, there are risks, including: “1) exposure to the cyclicality in California, the pipeline’s primary consuming market; 2) the uncertainties posed by the rate filing required in November 2006; 3) the expiration of its contract with Southern California Gas Co. in October 2005 that accounts for over a quarter of its revenues; 4) higher than historic pre-bankruptcy operating costs.”

Transwestern needs favorable action to increase rates to recover its costs, and Moody’s notes it is facing increased competition from the expansion of the Kern River Gas Transmission pipeline and, in the future, from numerous proposed pipeline and LNG projects that could push competitive rates down.

Taking into account the impact of Enron’s bankruptcy on Transwestern, Moody’s notes regulatory restrictions by FERC and the SEC on transference of any further funds to Enron and the prohibition in new bank agreements on advances to affiliates and on issuing dividends until Transwestern is investment grade.

Excluding the Enron tie-in, Moody’s expects Transwestern to display financial performance about average for its gas pipeline peer group. “Maintenance capex is modest (about $16 million annually), well within its internally generated cash flow (2003 unaudited cash flow from operations was $85 million), leaving substantial free cash flow for debt repayment or reinvestment in expansion projects. The only debt Transwestern will have will be the new bank loans, which require minimal principal payments. The company’s free cash flow position reduces the need for any incremental debt, absent a major expansion program, and the company should remain well within its bank covenants. Debt-to-capital is about 52% and should be manageable under the 55% limit under its bank covenants.”

The B1 rating assigned to the term loan is contingent upon satisfactory review of final documentation. The loan will be used to repay existing bank debt outstanding of $436 million. New credit facilities include the $400 million five-year secured term loan expiring in April 2009 and a $150 million four-year secured revolving credit facility expiring in April 2008. Part of the loans will help fund the $150 million San Juan expansion, which Transwestern is proposing to build by mid-2005.

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