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The Path Forward

In the wake of the banking crisis, utilities lead the way to financial stability.

Fortnightly Magazine - October 2008

assets. And as cap-ex budgets have grown, companies have seen their free cash flow fall into negative numbers.

This trend seemed likely to continue for the foreseeable future—but then the week of September 15 occurred, paralyzing the capital markets and casting serious doubt on many of the assumptions built into utility companies’ cap-ex plans. In the most worrisome scenarios, the industry could put the brakes on all discretionary cap-ex, stopping the Big Build just as it got going. While unlikely, this could happen if the capital markets seize up the way they did in mid-September, when the financial markets were gripped in fear and money-market traders stopped buying even commercial paper, the bread and butter of U.S. corporate finance. 3

“In that situation, everybody is petrified to do anything,” Rollins says. “There might be a flight to quality, but how do you define quality in that type of market?”

Assuming such a seize-up doesn’t happen again—at least not for any prolonged period—the definition of “quality” will continue to include energy and utility companies with good credit ratings.

“Financials have just gotten hammered, but in a flight to quality there’s a lot of demand for utility paper,” says Andrew Redinger, managing director and head of the utility and alternative energy group at KeyBanc Capital Markets. “The market is just dislocated right now.”

As long as the market remains dislocated, accessing capital will be more difficult and expensive, even for high-quality issuers. Terms for bank debt, for example, already were costly and restrictive before September 15, with 3- and 5-year loans almost disappearing and 364-day loans prevailing among the few transactions that were happening. After the September crisis, banks seem unlikely to cut their rates or relax terms any time soon, and raising capital in public markets for debt and equity likely will become more challenging too, as companies’ ratings come under stress and investors demand a higher risk premium.

“Increasing volatility will result in capital becoming more expensive,” Nastro says. “The market will differentiate issuers based on credit qulity, potential to generate cash flow, and regulatory relationships. And new issue windows will become narrower, so companies must be ready to go to market when those windows are open.”

This is particularly true for equity markets, which were whipsawed violently by unfolding events in financial markets. Companies that brought significant equity to the market before the crisis set in—such as Xcel Energy, which finished selling 15 million shares on September 15, and another 2.25 million on September 18—looked like geniuses compared to others who were scrambling for cash in a panicked market.

“It makes sense to pre-fund as much as possible, on your terms rather than having terms forced on you,” says Tim Kingston, a managing director with Goldman Sachs and head of the firm’s power and utility investment banking group. “Forward thinking CEOs have learned that lesson and are pre-funding a significant portion of their capital requirements.”

How big those capital requirements might turn out to be, however, will depend on multiple factors—including the economy’s growth rate.

Some forecasts call for $1 trillion