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Reign of the Bond Kings
S&P, Moody's, and Fitch tell why credit issues now rule the energy sector.
This year saw energy companies forced to make some grim choices-issuing new stock in falling markets, angering investors with dividend cutbacks, selling prized assets at fire sale prices. Some blame it on the rating agencies-the bond kings-who imposed tougher credit standards after the fall of Enron.
Various cash-strapped companies might even have faced bankruptcy if not for those 11th-hour, cash-raising measures, given the combination of falling credit ratings, a general collapse in the stock market and power prices, troubles with creditors, and government inquiries from the SEC and FERC.
Now, most see Dynegy's sale of its Northern Natural Gas Pipeline to MidAmerican as a stroke of luck-given the shortage of potential buyers-even if the $928 million sales price fell $600 million short of what Dynegy had paid initially. That's because the sale avoided a destructive downgrade during a debt refinancing, which surely would have set the dominoes in motion. Such an event could have allowed commercial banks to change the terms of credit lines, demanding more collateral.
Standard & Poor's reported in late August that "the biggest cloud facing the industry over the next 18 to 24 months is an estimated $30 billion of mini-perm debt that needs to be refinanced in the bank and capital markets." But most bankers now do not believe that energy companies will be able to find as much as $30 billion in financing-this year or next-as credit has become scarce. Not in recent memory has the industry seen so many credit downgrades, so quickly, or so often (see Bond Chart, p. 28). That means some tough decisions will have to be made.
Of course, it is no surprise that some have criticized the credit rating agencies themselves, saying they are responsible for intensifying the credit crisis for being so reactionary.
"I understand the outcome and behavior on a human basis," said one investment banker, speaking of the ratings agencies.
"[It's] a reaction to tread conservatively after having made a mistake on being too liberal, in respect to giving too much credit for underlying merchant growth that wasn't provable and didn't actually materialize."
These downgrades have shaken the market's confidence in the ability of the rating agencies to understand complex structures in a changing environment, says another banker. Furthermore, many executives charge that ratings agencies have not been even-handed or consistent in their approach to rating energy companies since last year.
"What are they doing internally that they weren't doing before?" asks yet another banker.
Yet according to a report issued in late August by Merrill Lynch, the ratings agencies haven't been doing anything differently than in previous economic downturns. In its study of ratings changes in high-yield securities, Merrill found that the bulk of downgrades in all periods could be explained by overall economic conditions. Only about 18 percent of the changes could be attributable to other factors, including inconsistencies in ratings as the agencies become more lenient or stricter in their analyses, according to the Merrill report. So, who is right?