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Reign of the Bond Kings
Ronald M. Barone, managing director for utilities, energy, and project finance at Standard & Poor's, says the industry's credit issues really go back five years, to when utilities wanted access to more capital, to fund non-regulated generation projects and generally to expand operations to take advantage of deregulating markets.
"They said it was going to be energy-related, mid-stream operations," Barone recounts. "It would be non-regulated generation and debt financed. 'Don't worry,' they said, 'we know it's more [debt], but the cash flows will come.' Five years is a long time to wait. Basically the rope we gave them to have the opportunity, there is not much rope left to it because they have turned that rope into a noose.
"This is a pre-Enron phenomenon. It all has to do with companies fail[ing] miserably in their approach to deregulating in terms of maintaining credit quality," says Barone. He points out that his firm was downgrading energy companies as early as the fourth quarter of 1999, as well as downgrading more than upgrading in 2000.
But industry observers point out it was not until the Enron debacle that ratings agencies felt compelled to downgrade below investment grade.
"Yes," Barone admits, "we felt they were investment grade last year. We always pointed out their challenge. If you look at almost every outlook statement, we mention in every case that due to growing non-regulated operations, the company's challenge was to maintain and improve cash flow coverage to measure the added business risk. While they were stable outlooks and investment grade, we always pointed out those risks. Again, [we gave] the companies the opportunity to improve upon themselves to enact their strategy."
Richard Hunter, managing director for global power at Fitch Ratings, suggests that ratings agencies gave energy merchants a long rope at first, and only later reined them in:
"The difference between this year and last year was that last year there was a far greater willingness for banks and other capital markets to grant what was really a new industry an enormous amount of access to the banks and capital markets.
"There was a lot of leeway granted to those companies. Some of the expansion plans were a little over ambitious. Some of them relied on favorable projections. There is a growing realization that power is a commodity and it was logical to expect a cycle," he adds.
Hunter concedes that it could well have been that the banks, the companies, and to some extent the agencies underestimated what point of the cycle the industry was at when ratings were being handed out to, effectively, new entities.
"I think Enron has focused people's attention very much on seeing what exactly in the trading business is generating money. I think for a long time there was an idea that the trading business was going to generate money because it existed."
Furthermore, Hunter believes there were a lot of management teams throughout the industry that were not used to gaining returns on capital in a competitive environment. Just the opposite-they were used to gaining returns