Reliant Resources recently refinanced $6.2 billion in debt to stabilize its operations during a difficult time for the energy industry. Some critics argue these refinancings merely delay inevitable problems by increasing debt levels. Reliant extended $5.9 billion in bank debt and added a $300 million credit line. However, Reliant's CFO states the goal is to improve its credit rating by paying down debt and eventually refinancing on an unsecured basis rather than relying on bank loans. While money is available from distressed debt investors, banks continuing to roll over loans is preventing capital from circulating in the market.

1. Refinancing
Delaying the inevitable?
As Reliant Resources celebrates a $6.2 billion ref inancing deal, some in the
industry say such deals are merely postponing problems that are bound to
resurface. James Ockenden reports
eliant Resources’ landmark restructuring of the companies them- of an investment-grade company – so,
R debt restructuring high-
lights a growing trend
towards refinancing among
US energy firms. Many companies are
looking to manage their credit and cash-
selves, not just the debt they hold.
With regard to the general refinanc-
ing occurring in the industry, Miller
says: “The debt has simply not been
rationalised. Debt that was there a year
over time, we aim to address that,” he
says. “But it will take some time for us
to get down that road. We need to get
our existing refinancing paid down to a
level where we can refinance on an
flow risk by seeking new terms for the ago is still there – in fact, it is now unsecured basis.”
heavy debt they took on to finance the greater because many of the loans that
plant construction in the post-1997 were rolled over have also been Hoping for an upturn
boom years. Most of this borrowing was extended. Companies have taken an But Jacobs says business conditions in
medium-term, bank-financed money extra $300–400 million, to give them the sector have not lent themselves to
due to mature between 2003 and 2006. something to work with.” raising money in capital markets. “One
Rating agency Standard & Poor’s As for the Reliant deal, Miller says the reason we felt strongly about having a
(S&P) estimates as much $90 billion banks “did not want to touch the long tenure on this facility was that it
was financed in this way and will need company with a 10-foot pole, but to roll may be a year or two before capital
to be refinanced over the next three the loans over is the lesser of two evils markets come back in any size,” he
years. But distressed energy companies for them.” Miller calls it a short-term adds. “But we will try to be oppor-
are finding refinancing at favourable solution to a long-term problem. “It’s a tunistic and very aggressive.”
rates a major challenge, because of cosmetic solution with some bank holi- Yet Miller says the banks are doing
depressed wholesale power prices, slow day, but there’s no way professionals in exactly what traders are trained not to
growth in demand and weakened this market can earn their way out of this do. “The first thing you learn is ‘hope
investor confidence.
Mark Jacobs, chief financial officer
at Reliant says the overriding objective “Rating agencies feel that being a
of refinancing – which included the
extension of $5.9 billion debt and the secured borrower is not a characteristic
addition of a new $300 million credit
line – was to stabilise the operation.
of an investment-grade firm”
“We felt that high levels of near-term Mark Jacobs, Reliant Resources
debt would negatively impact our abil-
ity to access capital markets,” he says.
Reliant needed to maintain adequate debt problem. There’s too much debt is not your best friend’,” he says. “The
liquidity to manage the business in a and it’s way too over-leveraged.” banks are taking one big gamble on
period of stressed commodity prices, However, Reliant’s Jacobs suggests hope – hope that the market will turn
says Jacobs. “It goes without saying you that the refinancing through banks around and these assets will be worth
can’t have too much liquidity – as was using long-term maturity is not something. But that’s not what capital
shown by the dislocation in the natural intended to be the final solution. “We markets are about. When you have a
gas markets in February this year,” he do not want to continue to rely on bank loss, you accept your loss, you write it
adds. “We thought it was prudent to debt,” he says. “We are going to very off and you move on.”
have a bigger safety cushion.” aggressive about getting out and refi- What’s more, the banks are causing
nancing this debt as quickly as we can.” a “logjam of commerce” by rolling over
Hiding the ball One reason for this assertion is the these loans, says Miller. “If the banks
Critics of such deals say restructuring company’s plan to improve its credit hide the ball and won’t accept their
is merely aggravating the problem. rating. While S&P says it will not base losses, there’s no way for that money to
Karl Miller, senior partner at New rating decisions solely on debt outstand- transact,” he adds. “And the private
York-based asset acquisition firm ing or risks associated with refinancing equity and LBO [leveraged buyout]
Miller, McConville, Christen, Hutchi- energy debt, Jacobs says until the money – which is really the only money
son & Waffel, is outspoken on the company can break free of the banks, it available to the market today – will not
issue. He is doubtful about the ability will not be able to return to investment be able to come in.”
of companies such as Reliant to earn grade. And he admits this may take time. Steven Stolze, managing director at
themselves out of debt. The time has “Rating agencies feel that being a debt consultants Rudden Financial in
come, Miller feels, for a significant secured borrower is not a characteristic New York, agrees money is available
S2 ❚ Finance ❚ www.eprm.com

2. through distressed debt investors, Ready cash: have been raising private equity, and down. Power is a product we have to
which he calls ‘vulture capital’ compa- venture capital there is a ton of money around,” says use – it’s not going to go away, so it’s
nies. But unlike Miller, he envisages firms are ready to Stolze. “They have always had an inter- an attractive opportunity.
good market opportunities on the offer investment est in any sector that has been beaten While Miller is critical of banks
creditor side over the coming years. to energy firms down, and right now energy is a high- “trading on hope”, Stolze says many
“These vulture capital companies profile sector that has been beaten venture capital (VC) companies are
The terms of the Reliant deal
The refinancing involved 24 banks, with Bank of America, Barclays and due in March 2007; and a $2.1 billion revolver loan – also due in
Deutsche Bank taking the lead roles. Key components of the March 2007 – completes the deal. The company has a mandatory
company’s debt before the restructuring were: principal repayment of $500 million due on March 15, 2006. But
significantly, Reliant has no other significant maturities before
● a $2.9 billion bridge loan; October 2005, on any of its debt.
● an $800 million revolver loan [which is?] that had matured in August That said, the company has worked with its bankers to set
2002, but on which Reliant had taken a one-year term option such cumulative pay-off targets, which, if not met, will lead to penalties.
that it fell due in August 2003; “We developed this concept with the lead banks to meet their
● an $800 million revolver loan that matured in August 2004; and desire to get paid back as quickly as possible on the one hand, but
● a $1.3 billion off-balance sheet synthetic lease, a construction on the other without leaving us in a position where we did not have
agency agreement used to build three new power plants, which fell the amortisation.”
due in December 2004. If Reliant has not reduced its debt on the $5.9 billion by $500 million
by May 14, 2004, the banks will charge an extra $60 million – 50 basis
The new structure has removed the synthetic lease facility. Jacobs points (bp) – in fees.
says the company wanted to extend payment of this $1.3 billion If Reliant has not hit its cumulative pay-off target of $1 billion – that
beyond 2004. And since this facility had a guarantee attached through is, $500 million on top of the May 2004 target – by May 2005, the
holding company Reliant, the company felt it was limited its ability to company will pay an additional 75bp and 2% of the fully diluted shares
create collateral in the broader restructuring. “So we decided to fold of the company.
that in,” says Jacobs. Finally, the May 2006 cumulative target is $2 billion, which if not met
As for the main chunk of new debt – the $5.9 billion – there are will see additional fees of 1% and the company will grant warrants for
two components. Term loans account for $3.8 billion, with maturity another 2% of the fully diluted shares.
May ❚ Finance ❚ S3

3. Refinancing
buying distressed debt on “gut feel” –
and that they may do well out of it.
“A large number of these VC
companies are buying debt at, say, 27
cents on the dollar. That’s a steep
reduction in face value,” he says.
“They’re taking the credit risk, they
haven’t had the opportunity to do due
diligence, they can’t see the numbers,
the revenue streams.”
Gut instinct
“Your risk is that the value isn’t even
the 27 cents, and you’re doing all of
this on the basis of public information,
usually not even that,” says Stolze.
“But a lot of these guys are doing this
on gut instinct. They’re saying, ‘If I
can get 50 cents and double my
money, I’m happy.”
Some VCs will buy debt at 30 cents, Karl Miller of “Do they decide to wait for three years, assumption by most of the companies
hold it for 90 days or six months and Miller, McConville, keep the entity going so they can get and their lenders was that the debt
sell it on at 45 cents, he says. Another Christen, 80 cents on their dollar back? Or do would be refinanced in the broad capi-
strategy, says Stolze, is to buy the debt Hutchison & they write it down now, get 30 cents tal markets in the future.
at 30 cents, take equity and control in Waffel: “the banks and say ‘I’m happy, I’m out of it’?” “Unfortunately, the future is here,
the company and build it up. are taking one big and the outlook is bleak,” it adds. “The
However, the banks are not as gamble on hope” Bleak outlook debt capital that once flowed freely has
happy holding debt, he says – a But S&P says the banks will be the only all but dried up.”
contrasting view to Miller’s. “The friends to energy companies in the Banking relationships have thus
banks are in it for 100% – they loaned short term. In a report released at the become paramount to energy compa-
the full value of that debt,” says Stolze. end of 2002, the agency says: “The nies, says S&P (see table), and the
banks have no choice but to roll matu-
Energy company ratings, bank exposures and total debt maturities rities over in order to prevent default
or bankruptcy filings. Avoiding bank-
Funded bank Bank maturities ruptcies – and potentially being left
exposure maturing as % of total debt holding assets – is a key consideration
in 2003–2006 maturities, for banks, which have not traditionally
Company Rating Outlook ($ millions) 2003–2006 been willing to own power generation
American Electric Power BBB+ Stable 1,244 16 assets (see pages S10–S11).
AES Corp B+ Watch negative 2,483 47 So two schools of thought seem to
Allegheny Energy BB Watch negative 1,040 46 be emerging. There are those, such as
Aquila BBB– Negative 356 36 Miller, who say enough is enough, and
Black Hills Corp BBB Stable 558 99 radical restructuring and widespread
Calpine Corp BB Negative 5,500 75 bankruptcies are the only solution to
CMS Energy BB Negative 2,740 69 the industry’s woes.
Constellation Energy Group A– Stable 296 19 Others are holding out for more
Dominion Resources BBB+ Stable 640 10 time, hoping the market will recover in
Duke Energy A Stable 2,350 27 the next couple of years and that assets
Dynegy B+ Watch negative 1,900 64 will start to perform as they were
El Paso Corp BBB+ Watch negative 920 17 designed to during the construction
Edison Mission Energy BBB- Watch negative 1,838 100 boom of the late 1990s.
Entergy BBB Stable 950 36 With the first wave of near-term debt
Mirant BB Negative 3,614 71 refinancing only just starting, it is too
PG&E National Energy Group B– Watch negative 2,458 91 early to judge the success of the ‘wait
NRG Energy D – 4,287 92 and see’ approach. Certainly, Stolze is
PPL BBB Negative 248 16 not convinced there will be a break-
Public Service Enterprise Group BBB Stable 833 27 through in prices.
Teco Energy BBB Watch negative 340 59 “Power prices over the next 10 years
TXU BBB Negative 1,094 13 are looking pretty flat – there’s not a lot
Williams Companies B+ Watch negative 2,000 32 of growth,” he says. “But then you have
Total 37,570 mean 48 gas prices out-accelerating electricity
Source: Standard & Poor’s, November 2002
prices. How radically do you think
that’s going to change?” EPRM
S4 ❚ Finance ❚ www.eprm.com