Is the second shoe of another bankruptcy filing in the energy merchant sector about to drop? No doubt it’s a question on the minds of a lot of energy industry executives after Xcel Energy last Monday said that there is a “substantial likelihood” that its NRG Energy unit will be the subject of a bankruptcy proceeding and Reliant Resources warned that it may need to pursue Chapter 11 if it can’t cobble together financing deals on acceptable terms.

Both merchant energy companies, NRG and Reliant Resources, have recently been spun off by their parent companies, which are attempting to bolster their own credit picture.

Reliant last month successfully refinanced three syndicated bank credit facilities for Orion Power Holdings Inc., Orion Power MidWest LP and Orion Power New York LP. The refinancings, which total $1.57 billion in commitments, provide a three-year extension of maturities. Interest rate swaps totaling $950 million related to Orion Power MidWest and Orion Power New York were also extended.

But Reliant, spun off by what is now called Centerpoint Energy, is not out of the woods just yet. The company still needs to refinance its debt by February 2003 when a $2.9 million bank loan matures. The company plans to negotiate a “global refinancing” for holding company debt, which totals $5.9 billion, including a synthetic lease, an analyst with Standard & Poor’s recently noted.

“If we are unable to complete the necessary future refinancings on acceptable terms and conditions, given the magnitude of the refinancings, we may be forced to consider a reorganization under the protection of bankruptcy laws,” Reliant said in its most recent quarterly report filed at the Securities and Exchange Commission (SEC).

Shares of Reliant on Monday were pounded mercilessly by investors after news of the bankruptcy possibility hit the wires. The stock finished the trading session off by just over 12% to close at $1.83 per share, but had recovered some ground by the end of the week. Shares of the company were trading hands at $2.20 early Friday afternoon.

A recent S&P report examining refinancing challenges facing merchants said that Reliant Resources is “particularly at risk given that its refinancing need is significant at 44% of overall capitalization.” The report compared the magnitude of refinancings for the next four years as a percent of total capitalization and as a percent of total debt outstanding (calculated as of June 30, 2002) for the 10 largest exposures. “Reliant’s future is highly dependent on its banking relationships, and the willingness of the banks to refinance on acceptable terms,” S&P said.

The ratings agency also said that for maturities due in 2003, companies most at risk are Reliant Resources, American Electric Power Co. Inc. Dynegy Inc. and PG&E NEG. “Again, the calculation is based on consolidated totals, and for certain companies the debt to be refinanced is at non-recourse subsidiaries. Noteworthy is Reliant, which has 85% of its total debt due in 2003. This is more than twice the amount, as a percent of total debt, of any other company’s refinancing needs.”

More recently, S&P last Thursday lowered the corporate credit ratings of Reliant Resources and related entities to “B+” from “BB+”, pending the refinancing of holding company debt and credit facilities of $5.9 billion, including a $1.4 billion synthetic lease. The CreditWatch listing was revised to “developing” from “negative.” RRI’s outstanding debt totals $7.5 billion, including off-balance sheet debt equivalents of $1.8 billion, as of Sept. 30, said the agency.

S&P also lowered the ratings for subsidiaries Reliant Energy Mid-Atlantic Power Holdings LLC (REMA) and Orion Power Holdings, as well as Reliant Energy Power Generation Benelux BV (REPGB).

“While Standard & Poor’s continues to believe that Reliant Resources has a strong likelihood of executing its refinancing plans, its lack of ability to cite strong commitments from its banks prior to the maturity of the $2.9 billion bank facility in February 2003, puts heightened stress on the company’s rating,” said S&P credit analyst Cheryl Richer.

Meanwhile, the specter of bankruptcy continues to loom over NRG, Xcel acknowledged in its 10Q filing made at the SEC on Monday. The filing notes that NRG submitted a restructuring plan on Nov. 4 to its various lenders, bondholders and other creditor groups.

Xcel also disclosed a write-down of its $2.9 billion investment in its power trading and generation unit. Xcel declared a loss of $5.22 a share in the third quarter stemming from the action. Excluding charges, Xcel’s recurring operating EPS were $0.44, including the previously announced $0.49 from regulated operations and a net loss of $0.05 from Xcel’s various other non-regulated businesses.

“Whether NRG does or does not reach a consensual arrangement with NRG’s creditors, there is a substantial likelihood that NRG will be the subject of a bankruptcy proceeding,” Xcel said in the 10Q filing. “If an agreement were reached with NRG’s creditors on a restructuring plan, it is expected that NRG would commence a Chapter 11 bankruptcy case and immediately seek approval of a prenegotiated plan of reorganization.”

Xcel said that absent an agreement with NRG’s creditor and the continued forbearance by such creditors, the generator “will be subject to substantial doubt as to its ability to continue as a going concern and will likely be the subject of a voluntary or involuntary bankruptcy proceeding.”

Citing the lack of a prenegotiated plan of reorganization, such a scenario would be expected to take an extended period of time to be resolved and may involve claims against Xcel under the “equitable doctrine” of substantive consolidation. The doctrine allows a bankruptcy court to disregard the separateness of related entities, to consolidate and pool the entities’ assets and liabilities and treat them as though held and incurred by one entity. Xcel noted that this doctrine is the “exception to the rule,” especially in cases where one of the companies involved is not in bankruptcy.

“Xcel Energy believes that any effort to substantively consolidate Xcel Energy with NRG would be without merit,” the company said in the quarterly filing. But Xcel said that it is possible that NRG or its creditors could attempt to advance such claims should an NRG bankruptcy proceeding occur, particularly in the absence of a prenegotiated plan of reorganization. Xcel “cannot be certain how a bankruptcy court would resolve the issue.”

Xcel earlier this month said that NRG had not filed for Chapter 11 and had no imminent plans to file for bankruptcy protection. The official statement from Xcel followed reports in editions of the Wall Street Journal that NRG had presented a plan to its lenders under which the Minneapolis-based generator would file for bankruptcy protection.

Meanwhile, Williams Capital Group Analyst Christopher Ellinghaus last week said that a Chapter 11 bankruptcy filing by financially prostrate NRG Energy “now appears imminent.” Ellinghaus predicted the bankruptcy filing in a research report on Xcel issued on Tuesday.

“It appears that negotiations on billions of NRG debt are coming to a head,” wrote Ellinghaus. He noted that on Nov. 8, some of NRG’s corporate lenders demanded the immediate payment of $1.1 billion in debt. The administrative agent of the lending group, Credit Suisse First Boston, issued the acceleration notice.

The analyst pointed out that the Nov. 15 deadline for providing additional cash collateral at NRG has passed “and it is difficult to imagine that NRG’s creditors’ patience is not waning.” Ellinghaus also said that it is “hard to imagine that the demands of the lending group were unrelated to recent rumors that an NRG bankruptcy filing is forthcoming, and the banks appear to be preserving the full extent of their creditor rights.”

Xcel management suggested that the action will not affect NRG’s ongoing restructuring efforts, “but that is also difficult to imagine,” wrote Ellinghaus. The bank debt in question is NRG’s construction revolver financing facility.

In addition, the analyst pointed out that NRG has failed to make a multitude of interest and principal payments under various credit agreements and bond covenants and is in default on a plethora of credits. “The defaults further suggest that an NRG bankruptcy is imminent,” said Ellinghaus. “Why make debt payments just prior to a bankruptcy filing?”

The analyst said that at this point, a bankruptcy filing would be favorable “in terms of resolving a massive uncertainty, and the potential benefits of deconsolidating NRG are considerable.”

Things got gloomier for NRG on Thursday. NRG South Central Generating LLC, a subsidiary of NRG, said that it has received a notice of acceleration from bondholders to pay off approximately $750 million in debt immediately. On behalf of bondholders, the bond trustee served notice that the 8.962% senior secured series A-1 bonds due 2016 and its 9.479% senior secured series B-1 bonds due 2024 are “immediately due and payable.”

Based on talks with bondholders, NRG said it is the company’s understanding that the bond trustee issued the acceleration notice to preserve certain rights. NRG said it continues negotiations with bondholders.

“We will continue to work with our lenders toward an overall restructuring of NRG’s debt,” said Richard C. Kelly, NRG president. “We do not believe that the NRG South Central Generating bondholders’ action will negatively affect the course of those discussions.”

The acceleration notice was issued after NRG South Central Generating defaulted by not making approximately $47 million in combined principal and interest payments due Sept. 15 on the two bond issuances, and did not make the required payments before the 15-day grace period expired.

In related news, Xcel said late Thursday that it has closed on the sale of $230 million of convertible senior notes, which includes the issuance of $30 million associated with a 15% over-allotment option granted to the initial purchasers. The senior notes have a coupon of 7.5%, mature in 2007 and are convertible into shares of the company’s common stock at a conversion price of $12.33.

The company said a portion of the net proceeds from the sale will be used to redeem the $100 million principal amount of 8% convertible senior notes issued on Nov. 8. Xcel said the remaining net proceeds will go towards general corporate purposes, including working capital.

On Tuesday, Standard & Poor’s Ratings Services (S&P) assigned its ‘BBB-‘ rating to Xcel’s convertible senior notes due 2007. The rating was placed on CreditWatch with developing implications. The rating agency added that Xcel’s ‘BBB’ corporate credit rating is also on CreditWatch with developing implications, “meaning that the rating could be lowered, raised, or stay the same” depending on the outcome of creditor negotiations at NRG.

“It is not known what the implications would be for Xcel if negotiations fail and NRG files for bankruptcy,” S&P said in a note. “There are strong legal arguments against substantive consolidation of the utilities, and by extension, the holding company, into an NRG bankruptcy. However, until the outcome of the negotiations is clear, Xcel’s ratings will remain on CreditWatch.”

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