— U.S. electric utility holding company Energy Future Holdings Corp. (EFH) and its subsidiary Energy Future Intermediate Holding Co. LLC (EFIH) have completed a debt exchange and have announced two more exchanges, one for senior unsecured EFH debt and one for senior secured EFH and EFIH debt.
— EFH subsidiary Texas Competitive Electric Holdings Co. LLC (TCEH) has announced an offer to extend the 2013 maturity of the $645 million portion of its total $2 billion senior secured revolving credit facility to 2016, after having drawn down fully on the revolver earlier in the month. The offer involves substantial incentives for takers.
— We view all of the transactions as distressed debt exchanges, given maturity extensions, payments for less than (but close to) par, payments of interest with payment-in-kind (PIK) in some cases, and other features such as changes to security, but overall because EFH is undertaking them to manage upcoming maturities from 2014 to 2017 in a market that will almost certainly not produce the cash flow to refinance them.
— We are lowering our corporate credit ratings on EFIH, TCEH, and Energy Future Competitive Holdings Co. (EFCH) to ‘CC’ from ‘CCC’ and kept the outlook negative. We left unchanged our ‘SD’ corporate credit rating on EFH, which just completed a distressed exchange and which has debt involved in the current exchange offer. There are no rating actions at all at Oncor Electric Delivery Holding Co. LLC (Oncor).
— We are also revising upward our recovery rating on the senior secured second-lien debt at EFH and EFIH to a ‘5’ from a ‘6’ after updating our valuation of distributions to EFIH from subsidiary Oncor.
On Dec. 26, 2012, Standard & Poor’s Ratings Services lowered its corporate credit ratings on EFIH, TCEH, and EFCH to ‘CC’ from ‘CCC’ and kept the negative rating outlook with the announcement of various exchanges—completed and announced—that we view as distressed.
We kept unchanged EFH’s ‘SD’ rating, reflecting another completed exchange on Dec. 21, 2012 of senior unsecured cash pay and PIK toggle notes into new debt at EFIH, and another offer to exchange the remaining balances of cash pay and PIK toggle notes into more new debt at EFIH.
We lowered to ‘CC’ from ‘B-‘ the debt related to the announced exchange of senior secured debt at EFH and EFIH: 10% senior secured notes due 2020, EFH’s 9.75% senior secured notes due 2019, and EFIH’s 9.75% senior secured notes due 2019. We lowered to ‘CC’ from ‘CCC’ our rating on TCEH’s senior secured revolving credit facilities due between 2013 and 2017, which contains the revolving credit facility involved in the distressed offer.
We lowered to ‘CC’ from ‘CCC’ our corporate credit rating on EFH subsidiary EFCH. EFCH guarantees TCEH’s senior secured debt (which includes the revolver) and so falls to ‘CC’ along with TCEH. We revised our recovery rating to ‘5’ from ‘6’ on the senior secured second-lien debt at EFH and EFIH.
This change in the recovery rating results in a change in the rating on these securities to ‘CCC-‘ from ‘CC.’ Rationale The distressed debt exchange continues EFH’s strategy to reduce debt levels and its annual interest burden through distressed exchanges and remove maturities in the years in which EFH’s subsidiary TCEH; CCC/Negative/—) approximate $20 billion coming due between 2014 and 2017.
The efforts also reflect liquidity preservation. Recent and announced exchanges of the EFH cash pay and toggle notes for new EFIH notes allow interest PIK for the next three years, preserving liquidity in a time when Oncor distributions are low to due high capital spending. The exchange of senior secured debt at EFH and EFIH into new debt at EFIH moves those lenders closer to the best value in the firm—distributions from Oncor—and into a larger pool of EFIH debt that likely adds to greater market liquidity for those lenders.
We view this exchange as distressed; although the terms given up are close to those to be received, two maturities are extended beyond original terms so we are viewing this exchange within the larger recapitalization of the firm through multiple distressed exchanges. Interestingly, at TCEH, the firm had drawn $285 million of the $2 billion revolver as of Sept. 30, 2012, but chose to draw the entire revolver down before announcing the exchange—clearly an effort to build liquidity going into the high-risk 2014 to 2017 refinance period, but potentially increasing near-term default risk if the exchange is not successful.
TCEH has noted that a holder of $425 million of the $645 million piece due in 2013 has already committed to the exchange, improving chances for success. The incentive cost to TCEH is large; takers receive as incentive new term loans equal to 52% of the amount tendered. Liquidity We view consolidated liquidity as “less than adequate” given TCEH’s large $3.8 billion term loan coming due in 2014. While we believe EFH should have sufficient liquidity to operate through 2013, it will face a sharp liquidity decline in 2014.
Furthermore, EFH does not meet several qualitative characteristics required for “adequate” liquidity, including satisfactory standing in the credit markets, prudent risk management, and the ability to absorb high impact, low probability events with limited need for refinancing. As of Sept. 30, 2012, liquidity consisted of $1.79 billion in cash and equivalents ($625 million at EFH, $858 million at EFIH, $309 million at TCEH), $1.2 billion in TCEH’s senior secured revolver not due within the next 12 months, and $265 million in TCEH’s letter of credit facility.
Significant changes have occurred recently. In its 8-K of Dec. 21, 2012, EFH reported TCEH liquidity on Dec. 21, 2012, of $1.3 billion in cash and equivalents (after the revolver drawdown) plus $114 million available in the secured letter of credit facility, for a total of $1.4 billion. TCEH noted that it would terminate its ability to draw on the letter of credit facility on Dec. 24, 2012. EFH’s liquidity is augmented by cash flow, which is somewhat predictable over the next year from Oncor and from TCEH given the large hedge position that mitigates low natural gas prices. Expected uses of cash over the next 12 months include about $550 million in capital spending and about $745 million in debt maturities, giving a liquidity sources divided by uses ratio of about 2.1x in 2013.
Following a review of the company and recovery prospects following a simulated default in 2014 when TCEH’s $3.8 billion senior secured term loan comes due, we left all recovery ratings unchanged except for our recovery rating on EFH and EFIH’s senior secured second-lien debt; we increased it to ‘5’ from ‘6’ based on our increased valuation of distributions from Oncor, following a simulated EFH-EFIH-TCEH default.
In such a default situation, we conclude that Oncor will continue to operate without interruption and will not be pulled into its parent’s insolvency. Our detailed recovery report for EFH and subsidiaries will be published shortly.
The overall outlook for credit at the companies is negative. We think more such capital re-engineering through distressed exchanges will continue because wholesale and retail electricity cash flow will remain depressed given the low power prices in the Electricity Reliability Council of Texas region in 2013 and probably more so in 2014 as the firm’s currently favorably priced natural gas hedges begin to roll off in 2013. If the EFH-EFIH and TCEH exchanges are consummated as planned, then we would lower the corporate credit ratings to ‘SD’ from ‘CC’ and shortly thereafter return to their fundamental credit level. If the exchanges are not completed, then we would revise all ratings to their fundamental credit levels. Similarly, the debt involved in a consummated exchange will also to be lowered to ‘D’ and thereafter may be returned to its fundamental credit level. We may retain the ‘D’ rating on any debt issue that we consider highly likely to be subject to further exchanges.