SEC lets Allegheny borrow $2 billion

Action eases credit crisis at troubled Maryland energy company

October 22, 2002|By Dan Thanh Dang | Dan Thanh Dang,SUN STAFF

A subsidiary of struggling Allegheny Energy Inc. received permission from the Securities and Exchange Commission yesterday to borrow up to $2 billion on a secured basis to shore up liquidity after defaulting on key credit agreements this month.

The Hagerstown energy company said yesterday that it is discussing with its banks borrowing about $1.3 billion to restructure its existing debt.

The restructured financing would probably be secured by power plants owned by the defaulting subsidiary, Allegheny Energy Supply.

The SEC approval provides Allegheny with breathing room after two months of turmoil that began with the dismissal of the head of its energy-trading business.

The firing was followed by a legal battle over the trading unit, a dispute with the state of California over a $4.5 billion electricity contract and credit downgrades by ratings agencies.

The downgrades forced Allegheny Energy Supply to default on several credit agreements Oct. 8, after the company declined to post additional collateral with several trading firms.

"We're pleased by the support and cooperation of the SEC for providing this approval," said Cynthia A. Shoop, Allegheny's vice president of corporate communications.

"If we're able to secure the financing with our lenders, we're hoping to be able to post the collateral and resume trading with those counterparties. For the time being, we haven't posted the collateral yet.

"We have permission to borrow up to $2 billion, but we may not choose to borrow that amount. It's too soon to tell. But we're optimistic that we can do this as quickly as possible."

Shares of Allegheny rose $1.30, or 26.5 percent, to close at $6.20 yesterday on the New York Stock Exchange.

A wave of credit downgrades has hurt several of the nation's top energy companies by forcing them to promise cash or other assets as collateral for long-term contracts.

As other troubled energy companies post similar assets as collateral to shore up their finances, banks could balk at signing new agreements, analysts said.

Bank `indigestion'

"Banks have indigestion, and rightfully so," said Craig Shere, equity analyst with Standard & Poor's Investment Advisory Services LLC.

"Banks don't want to wind up owning half the assets in this industry. They have to look at more than just the assets. They have to look at the business plan, the likelihood of default and extension in credit. While [the SEC approval] ... is positive, it doesn't [automatically] mean a timely agreement with the banks.

"Allegheny is hardly close to having won the war, but they did win the battle."

Allegheny, like other U.S. energy companies, has been hurt by troubles in the energy industry, including Enron Corp.'s collapse, the California power crisis and trading schemes.

More recently, the energy-trading unit that Allegheny bought for $490 million last year from Merrill Lynch & Co. Inc., has exacerbated those problems.

Merrill Lynch has sued Allegheny for failing to buy Merrill Lynch's remaining 2 percent stake in the trading unit, worth about $115 million.

Allegheny countered by suing Merrill Lynch for $1 billion, saying Merrill Lynch used "wash" or "round-trip" trades to artificially inflate the trading unit's revenue and trading volume, which made the business more attractive for sale.

The trading unit's hedging practices also hurt Allegheny. Shortly after Allegheny purchased the trading unit on March 16 last year, it resold an energy supply contract to power hungry California by agreeing to sell electricity at $61 per megawatt hour to the state for the next 10 years.

Allegheny had to purchase power on the wholesale market at double the $61 price to supply California, which would result in negative cash flows for the first two years of the contract, company officials said.

Cash flow problems

"Allegheny's really been hurt in terms of cash flow because of money losing hedges," Shere said. "But those money-losing hedges fall off in December. The combination of continuing hedges and the California contracts will turn to meaningful cash flow positive next year.

"No one thought [Allegheny] had a fundamental problem," said Shere, who upgraded his rating on Allegheny from "sell" to "hold," based on the SEC approval to borrow on a secured basis.

"The question was, `Can they get the liquidity?' They've got a better future if they can get through this turmoil. ... They don't have months. If this [isn't resolved] ... until February, forget it."

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