On Oct. 14, 2002, Standard & Poor's lowered its long-term corporate credit rating on U.S.-based power utility TXU Corp. (TXU) and its U.S. and Australian subsidiaries to triple-'B' from triple-'B'-plus.
At the same time, the long-term corporate credit ratings on TXU Europe Ltd. and its European subsidiaries (TXU Europe) were lowered to single-'B'-plus from triple-'B'-minus. The outlook on TXU Corp. and its U.S. and Australian subsidiaries remains negative, and the ratings on TXU Europe remain on CreditWatch with negative implications, where they were placed on Oct. 10, 2002. The short-term 'A-3' corporate credit ratings on U.K.-based subsidiary The Energy Group Ltd. have been withdrawn. The commercial paper rating on the U.S. and Australian subsidiaries is affirmed at 'A-2'.
The rating action on TXU Corp. follows a material deterioration in the company's credit quality in 2002, due primarily to weak performance in the U.K. business, which has never provided any dividends to the parent. The weakness in TXU Corp.'s European operations has applied added pressure to its financial profile, which has been very weak for the triple-'B'-plus rating in the past few years.
Management has communicated its intent to shore up the company's financial profile in the short term to avoid further ratings downgrades, however. Standard & Poor's notes that firms faced with similar challenges have cut or significantly reduced their common dividend, limited discretionary capital expenditures significantly, and disposed of assets that are no longer considered strategic to financial goals. Furthermore, TXU Corp. will reduce debt by using cash flow and converting existing securities to common stock, as well as by securitizing $1.3 billion of regulatory assets and converting additional debt to equity. Most importantly, the financial resources of TXU Corp. will not be diverted to propping up TXU Europe. The outlook on TXU Corp., however, will remain negative until the company successfully executes short-term steps to stabilize the financial profile at the triple-'B' level.
At present, the triple-'B' corporate credit rating derives support from TXU Corp.'s strong liquidity position. About $2 billion of annual funds from operations covers annual mandatory capital expenditures of $600 million-$ 700 million, leaving a significant amount of cash available for other uses, including debt reduction. Short-term liquidity requirements are met by $2.4 billion of bank credit at TXU U.S. Holdings Co., a $138 million liquidity facility at TXU Australia Holdings (Partnership) L.P. (TXU Australia), and a $500 million facility at TXU Corp. The cross-default to TXU Europe on the $500 million facility has been removed.
The rating action on TXU Europe follows the earlier downgrade on Oct. 10, 2002. The rating action on TXU Europe is a direct result of the actions taken by TXU Corp. in recent days to protect its own creditworthiness. Management has stated that it will not, as it previously anticipated, infuse additional equity into TXU Europe. The lack of this equity infusion of up to $700 million, combined with the contingent liquidity requirements triggered by the noninvestment-grade rating, makes TXU Europe's liquidity position extremely tenuous.
TXU Europe has cash reserves of about 200 million pounds ($312 million), an undrawn bank facility of 300 million pounds, and no debt maturities within the next three years. The noninvestment-grade rating, however, makes drawing on the bank facility unlikely, and TXU Europe is now required to post collateral for trading counterparties currently estimated at 110 million pounds and, possibly, collateral for energy distribution and transmission purposes of about 75 million pounds. Several other debt and trading instruments also have rating triggers, although it remains to be seen whether these will be exercised and how TXU Europe will deal with them.
The negative CreditWatch status reflects the immediate liquidity concerns at TXU Europe. If the position deteriorates further, a negative rating action is likely in the short term. There is the potential, however, for the liquidity pressures to be partially or temporarily alleviated as the banks, bondholders, and energy contract counterparties consider their options and incentives. The situation with TXU Europe's liquidity and counterparty dealings is evolving rapidly and further announcements can be expected in the near future.
The ratings on TXU Australia and its wholly owned subsidiary, TXU Electricity Ltd., remain closely aligned to those of TXU Corp. The strength of the underlying creditworthiness of TXU Australia and the ongoing willingness of TXU Corp. to support its Australian subsidiaries mean that it is appropriate to equate the ratings. From Standard & Poor's CreditWire