New York, June 5, 2003 — Moody’s Investors Service upgraded the debt ratings of The Williams Companies (TWC) and its subsidiaries.
TWC’s senior implied rating has been raised to B2 from B3 and its senior unsecured ratings to B3 from Caa1. Moody’s changed the rating outlook to developing from negative. While a number of disclosures have been made, Moody’s concludes that certain events and markets must coincide for the management to meet its financial plan, and that only the passage of time will demonstrate the degree of its precision. Failure of TWC to meet its financial plan, including asset sales and margin calls as estimated, could result in a downgrade.
These rating actions follow an assessment of TWC’s financing plan, including the recent repayment of $1.2 billion in principal and interest of its E&P subsidiary Williams Production RMT Company’s (RMT, formerly known as Barrett Resources Corporation) secured loan (RMT loan) prior to its maturity through recent and currently ongoing capital market debt offerings and the replacement of its existing secured credit facilities with a $800 million cash-collateralized credit facility.
The company plans to use this new facility, together with a large cash balance (the company will have over $2 billion of cash pro forma these transactions) and asset sale proceeds to provide for liquidity needs over the coming year, including using it as a reserve for a $1.4 billion debt maturity in 2004. Moody’s rating actions assume that TWC will complete this financing plan.
TWC’s ratings reflect significant risks: 1) wide and unpredictable swings in the working capital needs of its marketing and trading (EM&T) segment, whose large losses and cash outflows account for much of TWC’s negative cash flow from operations; 2) large net losses resulting in negative free cash flow; 3) a debt level that remains stubbornly high (over $13 billion, despite $2 billion of debt reduced since the beginning of 2002) and weak capitalization (equity has decreased almost as much as the debt since the beginning of 2002); and 4) the winding down of its asset sale program, and the expectation that there will be less cash going forward from asset sales to supplement shortfalls in operating cash flow.
TWC is turning from asset sales to capital market debt issuances to fund cash shortfalls. While favorable high-yield capital markets are currently allowing TWC to raise capital and to supplement its liquidity, TWC may need to seek further asset sales or other sources of cash, if it fails to meet its financial plan and the capital markets turn less receptive.
The upgrades reflect the improvement in liquidity position expected from the above-mentioned financing plan and other imminent transactions which will:
1) eliminate a large and imminent liquidity hurdle posed by the large RMT loan maturity and diminish the risk of insolvency for TWC;
2) release hard assets that secure its existing liquidity facilities, so that TWC’s debt will be largely unsecured (except for the $500 million reserves-backed debt at RMT, $27 million of Transco Energy’s 9-7/8% notes, and non-recourse project financings, altogether totaling 4% of consolidated debt) and its assets largely unencumbered (TWC estimates that its encumberable assets total $5 to $6 billion under its indentures);
3) afford TWC greater financial flexibility as a result of being released from highly restrictive covenants under its existing liquidity facilities (such as the required application of asset sale proceeds toward repaying structured financings — which were recently paid off — and required trapping of certain amounts of cash); and
4) lower its very high interest expense to levels more in line with the current low market rates.
The developing outlook reflects the rapidly evolving state of the company and its ongoing cash deficits. TWC remains in flux and difficult to forecast even for short periods as it continues to sell numerous assets, some large and significant to the company.
This will continue to result in unusual gains and losses, possibly including charges from further asset impairments, to continue to buffet its financial results as businesses are discontinued and sold. It may be a while before we see stabilization and a discernible base line for recurring financial performance, so that there is more certainty in assessing whether the company can turn and stay cash flow positive.
The largest variable in TWC’s financial performance and liquidity is EM&T’s working capital needs. Moody’s will monitor how closely EM&T’s future margin needs track currently estimated ranges in future price environments. Volatility in the current gas price environment as well as possible price spikes during the winter of 2003/2004 will provide stress tests to EM&T’s models.
Factors that could firm the rating or outlook in the future would include TWC’s demonstrating its ability to turn positive its recurring operating cash flows and to establish an unequivocal turnaround; increased transparency in EM&T’s liquidity demands and any permanent decline in the amplitude of their fluctuations; and certainty to its repayment of the $1.4 billion of 9.25% notes that mature in March 2004.
Factors that could cause a downgrade include the failure to achieve operating results forecasted; failure to execute the proposed financing plan; lack of success in selling remaining assets identified for sale near expected values; higher than estimated margin calls, adequate assurances, and prepayments; the deterioration of results at EM&T; and materialization of any large legal or regulatory contingencies that have not already been settled or revealed at this time.
TWC has yet to demonstrate its ability to post positive cash flow from operations and to achieve a measure of repeatability in its overall financial results. Although its gas pipeline (37% of 1Q03 operating income), E&P (50%), and midstream (44%) businesses provide a measure of predictability, their earnings are more than offset by the large and highly variable losses of EM&T. Although EM&T’s power business has been deemed non-core, the business is proving difficult to divest, given the depressed conditions in the power market and long tenors remaining on its tolling contracts. These tolling contracts require about $400 million of demand payments a year, which is not fully offset (70% hedged) by revenues from the load-serving contracts that hedge them.
Of the roughly $1 billion in liquidity and working capital used by EM&T, half is used in its power business and the other half for E&P, midstream, and its remaining petroleum businesses. These needs come from EM&T marketing products and services on behalf of those segments and managing the company’s price risk management. Margins, prepayments, and adequate assurances can vary depending on commodity prices and requirements of TWC’s counterparties.
While changes in margins outstanding appear to have lessened since last summer, they could still be potentially large. Assuming a one-year holding period and very high gas prices, TWC estimates that incremental margins would be about $400 million, not including additional cash outflows from prepayments and adequate assurances. This number would be in addition to over $400 million of margins currently outstanding.
In the quarter ended March 31, 2003, TWC’s results, while improved from the same quarter the prior year, were still very weak. The company generated a negative $103 million of cash flow from operating activities against capital expenditures and investments of roughly $250 million. The company has substantial leverage, with over $13 billion of debt on its balance sheet, $8 billion of various obligations off balance sheet (mostly the undiscounted future payments under tolling agreements, gross of the offsetting load-serving contracts, and some operating leases), and common equity of $4 billion. The ratio of operating income to interest accrued was 0.6 times.
The following ratings have been upgraded with a developing outlook. Moody’s raised TWC’s senior implied rating to B2 from B3 and its senior unsecured ratings to B3 from Caa1. Moody’s also assigned a B3 senior unsecured rating to TWC’s proposed notes. The rating on the company’s secured revolver is raised to B1 from B3 and will be withdrawn, once the proposed new facility is put in place. TWC’s pipeline subsidiaries’ senior unsecured ratings are upgraded to B1 from B3. The ratings of RMT have been upgraded, with secured term loan rating raised to B1 from B2, senior implied rating to B2 from B3, and senior unsecured debt to B3 from Caa1. RMT’s Caa1 issuer rating is withdrawn.
The Williams Companies, Inc. — Senior implied rating from B3 to B2, senior unsecured issuer rating from Caa1 to B3, senior secured revolving credit facility from B3 to B1, senior unsecured debt from Caa1 to B3, senior unsecured/subordinated/preferred shelf from (P)Caa1/(P)Caa3/(P)Ca to (P)B3/(P)Caa2/(P)Caa3;
Williams Capital I — Trust preferred stock from Caa3 to Caa2, trust preferred shelf from (P)Caa3 to (P)Caa2;
Williams Capital II — Trust preferred shelf from (P)Caa3 to (P)Caa2;
MAPCO Inc. – Senior unsecured debt from Caa1 to B3;
Northwest Pipeline Corporation – Senior unsecured debt from B3 to B1, senior unsecured shelf from (P)B3 to (P)B1;
Transco Energy Company — Senior secured from B3 to B1;
Transcontinental Gas Pipe Line Corporation – Senior unsecured debt from B3 to B1, senior unsecured shelf from (P)B3 to (P)B1;
Williams Production RMT Company (formerly known as Barrett Resources Corporation) – Secured term loan from B2 to B1, senior implied rating from B3 to B2, senior unsecured debt and issuer ratings from Caa1 to B3.
Headquartered in Tulsa, Oklahoma, the Williams Companies, Inc. is a diversified energy services company.