A Surge in Downgrades for Power Companies
Rating activity was overwhelmingly negative for U.S. utilities (electric, gas, pipeline, and water) in this year's turbulent third quarter, with several companies experiencing numerous downgrades. Since July 1, 2002, there have been 57 downgrades among holding companies and operating subsidiaries, compared with just eight upgrades (three of which relate to Northern Natural Gas Co.). For the same period in 2001, there were only nine downgrades and five upgrades.
The torrid pace of the previous six months (78 downgrades and six upgrades) continued in the third quarter, as did the steep credit decline that began in 2001, when Standard & Poor's recorded 81 downgrades and 29 upgrades. In addition, the third quarter witnessed many new CreditWatch listings and outlook revisions, most of which were negative.
Although U.S. power industry creditworthiness began to weaken before 2001, the California energy crisis and the Enron Corp. bankruptcy hastened the negative trend. The erosion can be traced mainly to:
• Weakening financial profiles
• Loss of investor confidence that has affected liquidity and financing flexibility
• Heightened business risk derived from more investment outside the traditional regulated utility business, particularly unregulated generation and energy trading and marketing
• Capital and corporate restructuring efforts
• Regulatory difficulties
• Mergers and acquisitions
These trends, in turn, reflect companies' strategies to deal with an increasingly uncertain and competitive market, while also seeking to enhance shareholder value. In just 12 months, the number of companies rated 'A' and above has significantly declined, while the number of firms rated 'BBB' and below has risen substantially. In this regard, about 49% of the industry now falls in the 'BBB' category rating, while a full 11% are rated below investment grade, including five companies that are rated 'D', compared with 40% and 5%, respectively, at the end of September 2001.
The decline in the 'A' and 'AA' rating category has been precipitous, with just 40% of the industry carrying ratings of 'A' and above, versus 55% one year earlier.
Notably, although the average rating for the power sector as a whole has slipped to 'BBB+', companies that continue to emphasize a vertically integrated structure are hanging onto an 'A-' average. But utility holding companies that have ventured too far afield from their core competencies have suffered weakening market capitalization and, in many instances, rating downgrades.
Despite the large number of rating downgrades and ongoing negative pressures on utility credit quality, the sector remains solidly investment grade. This is in line with the large percentage of companies (86%) that have average or above-average business profiles.
At the end of September 2002, just 48% of all utility rating outlooks were stable, compared with nearly 60% just one year ago. The decline is attributable mainly to the substantial increase in ratings that carry negative outlooks or are listed on CreditWatch. The percentage of outlooks that are negative has reached a high 31%, continuing to strongly overshadow positive outlooks, which stand at just 3%. This results mostly from a proliferation of higher-risk business strategies, constrained access to capital markets due to investor skepticism over accounting practices and disclosure, investigations on various regulatory levels, weak competitive positioning, and an anemic wholesale power market. The remaining 18% of companies are on CreditWatch: 84% carry a negative listing, 9% positive, and 7% developing (which indicates that a rating may be raised, lowered, or remain unchanged). These percentages suggest that frequent rating changes will continue.
From Standard & Poor's CreditWire