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The utility's need for ready cash trumps the cost of drawing down on its credit lines.
David M. Katz, CFO.com | US
December 16, 2008
Back in September, before the current downturn had reached a crisis point, AEP, one of the nation's biggest generators of electricity, began to draw down cash from its credit line. It was not that the company saw any particular need for the money, but rather, a need to sit "on a cushion of cash," Holly Koeppel, the company's finance chief, told CFO editors in an interview earlier this month.
Like many other companies, the utility was changing from the previous orthodoxy of keeping your cash balances lean and leveraging up your balance sheet as much as possible. Instead, AEP, once known as American Electric Power, drew down $2 billion in cash from a $3.9 billion revolving credit line that it held with a group of 27 banks. (None of the banks has more than a 10 percent stake in AEP's total bank commitments.)
In September 2008 and October 2008, respectively the company borrowed $600 million and $1.4 billion under its credit lines to buttress its cash position during what it called, in its third quarter 10-Q, "this period of market disruptions."
The reason the company drew down the money, says Koeppel, is that it had exhausted its ability to raise near-term cash in the commercial paper market. Observing the collapse of the commercial paper market in 2007, the company wanted to act to avert illiquidity this time around. As a utility with cash needs that oscillate with the seasons and weather conditions, AEP was especially aware of the need to keep electricity flowing.
The crisis has also sharpened Koeppel's sensitivity to corporate risk. While she's not exactly on a hair trigger these days, the corporation's experience as a counterparty to Enron at the time of the latter company's bankruptcy has made her aware of how quickly debtors can head south. Following is an edited version of some high points of the interview.
How has the crisis affected your ability to raise capital?
The first challenge that we faced, which I expect will be pretty persistent for the near term future, is short-term credit markets. We saw [ the commercial paper market] break down about 12 months back; based on that relatively recent experience, we anticipated that it would experience some dislocations and took proactive steps to draw on our lines of credit to cover the retirement, or funding, of that cp. I don't expect that market to open to us in any meaningful way. Fortunately our bank lines were more than adequate to bridge us over and really position us to stay out of the market--even the long-term refinancing market--for the foreseeable future. We have very few maturities coming due in '09 and in a very strong liquidity position.
We proactively drew on our lines by an amount that was adequate to cover not only the retirement of our commercial paper but also the financings that we have in queue lined up for next year. [About $120 million and $300 million, respectively, of the company's $16 billion of the company's long-term debt will mature in the rest of 2008 and 2009, respectively, AEP reported in its third-quarter 10-Q. "We intend to refinance these maturities," it said then.]
So you have retired all the commercial paper you had issued?
Yes. We have none outstanding right now.
So how are you dealing with your current cash needs?
We actually are sitting on cash balances, and not [using] the traditional strategy [of making use of as much cash as possible]. There is a negative carry, but it's good to be liquid at this time. And it's a really good spot for a utility because as you know we have pretty dramatic seasonal working capital needs. But to plan ahead and to be long cash is where we want to be right now.
Are you using the cash you've drawn from those credit lines? What's the virtue in drawing down lines of credit and paying interest on debt you're not using?
That's that negative carry. It's nice to have money in the bank, and what we did use it for was to meet the fact that we were no longer issuing commercial paper. We sized the dollar amount to provide us with enough money in the bank to pay bills that we saw coming due in the fourth quarter, to avoid planned long-term debt issuances, and to really have money on deposit for future bills that may come due. So we have a cash cushion in the bank.
But these were existing lines that you could have drawn down at any time. Was there some underlying worry about whether banks could deliver when you needed it?
At the time of the first draw, no. After Lehman, I was not worried about our principle banking relationships, but I certainly felt more comfortable knowing that I had the money in the bank and that we were very, very liquid.
We've had very strong support from our bank group. We're very grateful for the relationship and support. But I sleep better knowing that we have enough money in the bank.
Are all the 27 banks participating in your credit facility still viable?
All but Lehman, and it was in for a very modest amount. As a matter fact, in one of our facilities, another bank stepped in and took up that piece. So we have not yet had any serious consequences impacting us directly as a consequence of the Lehman failure.
What are your relationships with your banks like now?
Incredibly open and collaborative, particularly with the key banking relationships. They're reaching out to us and they're very open with us in terms of insight about the human capital side: when another round of layoffs is coming, how any relationships we have are going to be impacted. It's far more of a partner relationship than it was 12 months ago. They want to insure that if we perceive any impact on service or relationship, they're working very hard to insure a continuity and a level of support that preserves our relationship.
What are your seasonal working capital needs?
As a very large utility, we build up an inventory of fuel in advance of generating a lot of electricity to heat people's homes. Our fuel inventory balance will build up, we'll create the electricity, and ultimately send out the bills. There is a pretty substantial lag between when we invest in the inventory and when we receive payment from our customers, and that, as you would expect, shifts seasonally. It's very weather-dependent. When it's hot and air conditioning is running, there's a bigger gap than when it's relatively moderate out and we're neither heating homes nor cooling homes with electricity.
Has the crisis changed your approach to managing cash flow?
We've taken a much more granular look at the cash flows. Fortunately, we have a very good system, a pretty rigorous approach towards being able to predict the timing of cash payments, a good seasonal pattern. So we had the data we needed to size up the amount that we wanted to draw on our liquidity facilities. We drew the $2 billion dollars in anticipation of retiring the commercial paper as well as being able to fund the capital requirements that we saw over the near term, including the working capital requirement for fuel inventory. I'd sum it up by saying, Good cash management and a good handle on the relative fluctuations in cash management is more important now than ever in the past.
Have you had any writeoffs, such as goodwill-impairment charges, lately?
No. But like most major industries, we have a very large pension plan. We were at a 112 percent funded level and we have seen a significant decline in our level of funding. While we don't expect that we will see a requirement to fund our pension plan in 2009, because we'll be above the 80 percent minimum level, it is in light of the current environment likely that we will begin funding in 2010. Now that was not a writeoff, but it is a decline in asset value that will be impacting us--as we expect now, in 2010. Depending on what happens in the market, it could be 2009.
Are you sitting on any credit-default swaps?
No we're not. But we are a very substantial participant in the energy markets. We learned, probably in the school of hard knocks a bit, from the Enron experience back in 2002. We're fortunate in having a disciplined portfolio approach, managing our risk exposure to any one counterparty--including the banks.
What did you specifically learn from Enron?
Don't put all your eggs in one basket. Manage the amount of risk that could roll back onto your balance sheet. The scale of the mix of transactions needs to be managed relative to your underlying balance sheet's ability to handle the potential for collateral calls for margining and for counterparty default.
What ended up happening was that everybody that had Enron as a counterparty was left holding the bag for all those transactions. They were a pretty substantial counterparty to us. And we had many long-duration transactions with them--transactions that went for many, many years.
Have the last few months affected the way you view risk?
Yes, in one particular manner: the speed at which changes in the market can take place. You mention the credit-default-swap market. It was a wonderful tool to manage risk. We did not use it because of our internal limitations on risk exposure. We didn't need to use it to lay off risk; we chose not to enter into those types of risk. But the speed at which markets can move and the breakdown in fundamentals has caused us to be more proactive in terms of insuring that we have breathing room.