restructuring of the companies them-selves, not just the debt they hold.

With regard to the general refinanc-ing occurring in the industry, Millersays: “The debt has simply not beenrationalised. Debt that was there a yearago is still there – in fact, it is nowgreater because many of the loans thatwere rolled over have also beenextended. Companies have taken anextra $300–400 million, to give themsomething to work with.”

As for the Reliant deal, Miller says thebanks “did not want to touch thecompany with a 10-foot pole, but to rollthe loans over is the lesser of two evilsfor them.” Miller calls it a short-termsolution to a long-term problem. “It’s acosmetic solution with some bank holi-day, but there’s no way professionals inthis market can earn their way out of this

debt problem. There’s too much debtand it’s way too over-leveraged.”

However, Reliant’s Jacobs suggeststhat the refinancing through banksusing long-term maturity is notintended to be the final solution. “Wedo not want to continue to rely on bankdebt,” he says. “We are going to veryaggressive about getting out and refi-nancing this debt as quickly as we can.”

One reason for this assertion is thecompany’s plan to improve its creditrating. While S&P says it will not baserating decisions solely on debt outstand-ing or risks associated with refinancingenergy debt, Jacobs says until thecompany can break free of the banks, itwill not be able to return to investmentgrade. And he admits this may take time.

“Rating agencies feel that being asecured borrower is not a characteristic

of an investment-grade company – so,over time, we aim to address that,” hesays. “But it will take some time for usto get down that road. We need to getour existing refinancing paid down to alevel where we can refinance on anunsecured basis.”

Hoping for an upturnBut Jacobs says business conditions inthe sector have not lent themselves toraising money in capital markets. “Onereason we felt strongly about having along tenure on this facility was that itmay be a year or two before capitalmarkets come back in any size,” headds. “But we will try to be oppor-tunistic and very aggressive.”

Yet Miller says the banks are doingexactly what traders are trained not todo. “The first thing you learn is ‘hope

is not your best friend’,” he says. “Thebanks are taking one big gamble onhope – hope that the market will turnaround and these assets will be worthsomething. But that’s not what capitalmarkets are about. When you have aloss, you accept your loss, you write itoff and you move on.”

What’s more, the banks are causinga “logjam of commerce” by rolling overthese loans, says Miller. “If the bankshide the ball and won’t accept theirlosses, there’s no way for that money totransact,” he adds. “And the privateequity and LBO [leveraged buyout]money – which is really the only moneyavailable to the market today – will notbe able to come in.”

Steven Stolze, managing director atdebt consultants Rudden Financial inNew York, agrees money is available

Reliant Resources’ landmarkdebt restructuring high-lights a growing trendtowards refinancing among

US energy firms. Many companies arelooking to manage their credit and cash-flow risk by seeking new terms for theheavy debt they took on to finance theplant construction in the post-1997boom years. Most of this borrowing wasmedium-term, bank-financed moneydue to mature between 2003 and 2006.

Rating agency Standard & Poor’s(S&P) estimates as much $90 billionwas financed in this way and will needto be refinanced over the next threeyears. But distressed energy companiesare finding refinancing at favourablerates a major challenge, because ofdepressed wholesale power prices, slowgrowth in demand and weakenedinvestor confidence.

Mark Jacobs, chief financial officerat Reliant says the overriding objectiveof refinancing – which included theextension of $5.9 billion debt and theaddition of a new $300 million creditline – was to stabilise the operation.“We felt that high levels of near-termdebt would negatively impact our abil-ity to access capital markets,” he says.

Reliant needed to maintain adequateliquidity to manage the business in aperiod of stressed commodity prices,says Jacobs. “It goes without saying youcan’t have too much liquidity – as wasshown by the dislocation in the naturalgas markets in February this year,” headds. “We thought it was prudent tohave a bigger safety cushion.”

Hiding the ballCritics of such deals say restructuringis merely aggravating the problem.Karl Miller, senior partner at NewYork-based asset acquisition firmMiller, McConville, Christen, Hutchi-son & Waffel, is outspoken on theissue. He is doubtful about the abilityof companies such as Reliant to earnthemselves out of debt. The time hascome, Miller feels, for a significant

S2 ❚ Finance ❚ www.eprm.com

Delaying the inevitable?As Reliant Resources celebrates a $6.2 billion ref inancing deal, some in theindustry say such deals are merely postponing problems that are bound toresurface. James Ockenden reports

Refinancing

“Rating agencies feel that being asecured borrower is not a characteristicof an investment-grade firm” Mark Jacobs, Reliant Resources

have been raising private equity, andthere is a ton of money around,” saysStolze. “They have always had an inter-est in any sector that has been beatendown, and right now energy is a high-profile sector that has been beaten

down. Power is a product we have touse – it’s not going to go away, so it’san attractive opportunity.

While Miller is critical of banks“trading on hope”, Stolze says manyventure capital (VC) companies are

May ❚ Finance ❚ S3

through distressed debt investors,which he calls ‘vulture capital’ compa-nies. But unlike Miller, he envisagesgood market opportunities on thecreditor side over the coming years.

“These vulture capital companies

The refinancing involved 24 banks, with Bank of America, Barclays andDeutsche Bank taking the lead roles. Key components of thecompany’s debt before the restructuring were:

● a $2.9 billion bridge loan; ● an $800 million revolver loan [which is?] that had matured in August

2002, but on which Reliant had taken a one-year term option suchthat it fell due in August 2003;

● an $800 million revolver loan that matured in August 2004; and ● a $1.3 billion off-balance sheet synthetic lease, a construction

agency agreement used to build three new power plants, which felldue in December 2004.

The new structure has removed the synthetic lease facility. Jacobssays the company wanted to extend payment of this $1.3 billionbeyond 2004. And since this facility had a guarantee attached throughholding company Reliant, the company felt it was limited its ability tocreate collateral in the broader restructuring. “So we decided to foldthat in,” says Jacobs.

As for the main chunk of new debt – the $5.9 billion – there aretwo components. Term loans account for $3.8 billion, with maturity

due in March 2007; and a $2.1 billion revolver loan – also due inMarch 2007 – completes the deal. The company has a mandatoryprincipal repayment of $500 million due on March 15, 2006. Butsignificantly, Reliant has no other significant maturities beforeOctober 2005, on any of its debt.

That said, the company has worked with its bankers to setcumulative pay-off targets, which, if not met, will lead to penalties.“We developed this concept with the lead banks to meet their desire to get paid back as quickly as possible on the one hand, buton the other without leaving us in a position where we did not havethe amortisation.”

If Reliant has not reduced its debt on the $5.9 billion by $500 millionby May 14, 2004, the banks will charge an extra $60 million – 50 basispoints (bp) – in fees.

If Reliant has not hit its cumulative pay-off target of $1 billion – thatis, $500 million on top of the May 2004 target – by May 2005, thecompany will pay an additional 75bp and 2% of the fully diluted sharesof the company.

Finally, the May 2006 cumulative target is $2 billion, which if not metwill see additional fees of 1% and the company will grant warrants foranother 2% of the fully diluted shares.

The terms of the Reliant deal

Ready cash:

venture capital

firms are ready to

offer investment

to energy firms

“Do they decide to wait for three years,keep the entity going so they can get80 cents on their dollar back? Or dothey write it down now, get 30 centsand say ‘I’m happy, I’m out of it’?”

Bleak outlookBut S&P says the banks will be the onlyfriends to energy companies in theshort term. In a report released at theend of 2002, the agency says: “The

assumption by most of the companiesand their lenders was that the debtwould be refinanced in the broad capi-tal markets in the future.

“Unfortunately, the future is here,and the outlook is bleak,” it adds. “Thedebt capital that once flowed freely hasall but dried up.”

Banking relationships have thusbecome paramount to energy compa-nies, says S&P (see table), and thebanks have no choice but to roll matu-rities over in order to prevent defaultor bankruptcy filings. Avoiding bank-ruptcies – and potentially being leftholding assets – is a key considerationfor banks, which have not traditionallybeen willing to own power generationassets (see pages S10–S11).

So two schools of thought seem tobe emerging. There are those, such asMiller, who say enough is enough, andradical restructuring and widespreadbankruptcies are the only solution tothe industry’s woes.

Others are holding out for moretime, hoping the market will recover inthe next couple of years and that assetswill start to perform as they weredesigned to during the constructionboom of the late 1990s.

With the first wave of near-term debtrefinancing only just starting, it is tooearly to judge the success of the ‘waitand see’ approach. Certainly, Stolze isnot convinced there will be a break-through in prices.

“Power prices over the next 10 yearsare looking pretty flat – there’s not a lotof growth,” he says. “But then you havegas prices out-accelerating electricityprices. How radically do you thinkthat’s going to change?” EPRM

buying distressed debt on “gut feel” –and that they may do well out of it.

“A large number of these VCcompanies are buying debt at, say, 27cents on the dollar. That’s a steepreduction in face value,” he says.“They’re taking the credit risk, theyhaven’t had the opportunity to do duediligence, they can’t see the numbers,the revenue streams.”

Gut instinct“Your risk is that the value isn’t eventhe 27 cents, and you’re doing all ofthis on the basis of public information,usually not even that,” says Stolze.“But a lot of these guys are doing thison gut instinct. They’re saying, ‘If Ican get 50 cents and double mymoney, I’m happy.”

Some VCs will buy debt at 30 cents,hold it for 90 days or six months andsell it on at 45 cents, he says. Anotherstrategy, says Stolze, is to buy the debtat 30 cents, take equity and control inthe company and build it up.

However, the banks are not ashappy holding debt, he says – acontrasting view to Miller’s. “Thebanks are in it for 100% – they loanedthe full value of that debt,” says Stolze.

S4 ❚ Finance ❚ www.eprm.com

Refinancing

Karl Miller of

Miller, McConville,

Christen,

Hutchison &

Waffel: “the banks

are taking one big

gamble on hope”

Funded bank Bank maturities exposure maturing as % of total debt

in 2003–2006 maturities, Company Rating Outlook ($ millions) 2003–2006American Electric Power BBB+ Stable 1,244 16AES Corp B+ Watch negative 2,483 47Allegheny Energy BB Watch negative 1,040 46Aquila BBB– Negative 356 36Black Hills Corp BBB Stable 558 99Calpine Corp BB Negative 5,500 75CMS Energy BB Negative 2,740 69Constellation Energy Group A– Stable 296 19Dominion Resources BBB+ Stable 640 10Duke Energy A Stable 2,350 27Dynegy B+ Watch negative 1,900 64El Paso Corp BBB+ Watch negative 920 17Edison Mission Energy BBB- Watch negative 1,838 100Entergy BBB Stable 950 36Mirant BB Negative 3,614 71PG&E National Energy Group B– Watch negative 2,458 91NRG Energy D – 4,287 92PPL BBB Negative 248 16Public Service Enterprise Group BBB Stable 833 27Teco Energy BBB Watch negative 340 59TXU BBB Negative 1,094 13Williams Companies B+ Watch negative 2,000 32Total 37,570 mean 48

Source: Standard & Poor’s, November 2002

Energy company ratings, bank exposures and total debt maturities