Credit analyst: Avoid Reliant Energy until new bank line, unit spinoff

By Ronda Fears

Nashville, Tenn., Aug. 1 - Carol Levenson, director of research at Gimme Credit, said she wouldn't consider Reliant Energy bonds until it renegotiates its bank debt and completes its spin-off of Reliant Resources.

"Both Reliant Energy and Reliant Resources swore up and down the Reliant Resources spinoff is not contingent upon bank negotiations or tapping the bond market," Levenson said in a report Thursday, noting that Reliant Energy recently received a brief extension on its $4.7 billion in credit facilities.

"But surely Reliant Energy wouldn't, or couldn't, spin off a company facing an imminent liquidity crisis of this magnitude. Obviously Reliant Resources paper is to be shunned, but we wouldn't consider Reliant Energy bonds either until the bank debt is renegotiated and the spinoff is a done deal."

Reliant Resources (Ba3/BBB-) ratings were downgraded Wednesday, the analyst noted.

"Moody's meted out a stunning three-notch downgrade and left Reliant Resources under review for further downgrade. S&P followed with a modest one-notch downgrade with a continuing negative review, but left Reliant Resources' investment grade status intact," Levenson said.

"As with any company in this sector, the downgrade itself is news and can become a self-fulfilling prophecy as both business and capital markets access dry up."

Moody's also downgraded parent, Reliant Energy (Baa2/BBB+) from Baa1 to Baa2 and left it under review for further downgrade. S&P, however, affirmed Reliant Energy based on its expectation Reliant Resources will be spun off in the next few months.

"Nobody can accuse the rating agencies of following the stock market in this case, as the stocks of both Reliant Energy and Reliant Resources rallied big-time after the companies reported their second quarter earnings earlier this week, although we didn't see much to cheer about," Levenson said.

"Thanks to a fortuitous disclosure of round-trip trades at Reliant Resources, some bond investors were spared the ensuing misery when the company's maiden bond deal was pulled [in May]."

The trouble ahead for Reliant Resources seemed obvious, she said, "but our warnings mainly concerned the parent, as we worried the already-delayed spinoff of the unregulated businesses might hit a snag, leaving Reliant Energy with a huge liquidity headache as well as elevated business and financial risk."

Although the spin-off has received all the necessary approvals, she said the big question mark pertains to a successful refinancing of maturing bank debt at both Reliant Energy and Reliant Resources.

"This is bound to be even more problematic after yesterday's rating actions," Levenson said.

"Reliant Resources said the maximum collateral it needs to post, assuming a downgrade to junk by both major rating agencies, is $1.3 billion, and it's already put up $400 million. It's a big number - the biggest we've seen yet, in fact - but the company says it has $1.2 billion in unrestricted cash and available bank lines, sufficient cash to meet these requirements."

But as observed with Reliant Resources' peers, the analyst said, "it's not just a question of coming up with the collateral - it seems next to impossible to operate profitably or to hedge risk adequately while carrying junk ratings."

"That's why everywhere you look in this sector junk credits are looking for higher-rated partners to support their trading operations," Levenson said.

Reliant Resources has the added burden of a complex capital structure and some $5.5 billion in short-term debt as of March 2002, the analyst said, noting that neither Reliant Resources nor Reliant Energy presented investors with balance sheet or cash flow information for the June quarter.

"Even in yesterday's conference call after the downgrade, Reliant Resources was vague about its debt position and maturities and seemed to have no Plan B in case its bankers prove reluctant to refinance its debt in the next few months," Levenson said.

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