As Lights Dim in California, Banks Downplay Their Utility-Loan Risk

After a decidedly rocky year, investors have become accustomed to seeing increasing numbers of bad loans on bank balance sheets. Now, rapidly mounting problems at California utilities could darken the picture even more.

The list of banks that have already warned of weaker fourth-quarter results, including Bank of America (BAC), J.P. Morgan Chase (JPM) and UnionBanCal (UB) also are in the line of fire from troubled utilities. So is Bank One (ONE), which has had its share of credit woes in the past year.

Now people are wondering, "How much worse will it get?" Given the speed at which liquidity problems have worsened, investors and analysts alike are questioning whether the risk of utility exposure has already been priced into the bank stocks. Furthermore, investors are trying to figure out whether previously disclosed moves by some banks to shore up their loan-loss reserves included the risk of shaky utility loans.

If not, profits could be further depressed at some already stressed banks. Investors usually aren't too happy to see a bank add to reserves (which are essentially rainy day funds to cover the cost of bad loans), because it eats into profits, in addition to signaling that banks expect more problem loans ahead.

Out in Front

Bank of America leads the pack in terms of recent credit problems as well as exposure to utilities, including a $1 billion credit line it arranged for PG&E (PCG) in October, according to published reports. In early December, Bank of America warned that fourth-quarter nonperforming loans (those past due but not charged off) were expected to rise by more than 13% from the previous quarter. Nonperformers nearly doubled in the third quarter from the summer of 1999.

Kathy Shanley, fixed-income analyst with debt-rating newsletter Gimme Credit, believes the smoke hasn't necessarily cleared yet. "We would be surprised if BAC factored possible losses on its electric utility exposure into its early December outlook, since the crises had not yet fully unfolded at that time," she recently wrote.

California utility companies, especially PG&E and Edison International (EIX), have been overwhelmed by a combination of rising fuel costs and a cap on electricity prices resulting from deregulation. The 1996 deregulation law prevents companies from passing on higher wholesale rates to consumers. Amid the threat of blackouts for California residents, bankruptcy talk intensified last week as Standard & Poor's and Moody's Investor Service downgraded PG&E's debt.

As federal and state regulators met for the second time Wednesday to discuss solutions to the power crisis, conventional wisdom says the state's government isn't about to let the utility companies sink.

"The state has a vested interest in making sure these companies are financially viable. They need to make sure they still have power in the state of California," says David Stumpf, banks analyst at A.G. Edwards in St. Louis, adding, "The loss potential on these credits is different than what you might have in a commercial borrower."

No Problems Here

Banks are eager to downplay the risk factor. A Bank of America spokesman says that while the company cannot predict the future, it stands by the statement for fourth-quarter and 2001 guidance it released in December.

Bank One, which reportedly arranged a $203 million backup credit line for PG&E in October, said it couldn't comment on customer relationships, including whether the backup line has been drawn down. The bank pointed out in a recent filing that utilities aren't among the top five industries to which it has loaned money. British bank Barclays (BCS), which participated in the $203 million credit, released a statement insisting it won't need to make a provision against its exposure to PG&E.

The newly formed J.P. Morgan Chase, which has skillfully sidestepped credit issues to date, also commented publicly that it has not seen any major credit problems. The bank's Chase unit also is reported as a participant in the $1 billion credit.

Jack Rice, a spokesman for San Francisco-based UnionBanCal, says the bank has "a very modest exposure which is minimal in terms of outstanding loans." Rice also adds, "the perception of this credit has been included into our guidance for the fourth quarter. The situation won't change."

Still, Stumpf says this is one more problem added to the mix banks are already struggling with. "This isn't the only issue out there. Credit quality is under pressure, and it's going to stay under pressure in the first half of the year."

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