The $64,000 question on nearly every big bank's earnings call this past week was the one about exposure to California utilities. Analysts are increasingly concerned that banks will be left holding the bag on some substantial loans to troubled power providers.
In the past week alone, the situation has become increasingly dire as rolling, or scheduled, blackouts hit the electricity-poor state and major power providers default on debt payments. Friday,
Southern California Edison
defaulted on $32 million of commercial paper that matured Thursday. (Companies often use commercial paper to fund day-to-day operations.) Wednesday,
and its subsidiary defaulted on a combined $76 million in commercial paper.
That's pretty grim news for the banks that are on the hook to the struggling utilities for outstanding loans, especially given that a number of banks are already burdened by major credit issues. Banks have largely been downplaying the risk, saying the loans have already been factored into the credit outlook, or expressing confidence that the government won't let such huge utilities go belly-up. In some cases it's a combination of both. But it is hard to believe that bankruptcy filings from Edison and PG&E won't have some impact on exposed banks.
Bank of America
, for instance, which
met lowered earnings expectations on Tuesday, has already seen net charge-offs for troubled loans more than double from year-ago levels, to $1.1 billion in the fourth quarter. The bank led a $1 billion line of credit to PG&E in October.
During its conference call, Bank of America said its exposure to utilities around the world totaled $5 billion. The bank said California was "a small portion" of that exposure, even as it admitted being exposed to three of the major power companies. The bank said it was comfortable with its guidance overall, which has not changed since a December earnings warning.
Too Big to Fail?
Some analysts think at least some of that risk outlook assumes a government bailout, should things get bad enough. "It's hard to believe the government would let these things fail," says Jim Mitchell, banks analyst at
. (He rates Bank of America a hold and his firm has no underwriting relationship with the bank.) "I think
Bank of America can't believe it either."
But Steven Fetter, managing director of the global power group at debt rating agency
, says, "I haven't seen any positive signs that would lead me to believe
the utilities are going to be saved, and time is running out." He adds that a bailout would be prohibitively expensive for the state.
Additionally, there is a debt food chain of sorts with respect to recovering the money an institution has lent. For instance, the utilities have "first mortgage" bonds, those that are secured by real estate such as power plants. Holders of those bonds will be paid in a bankruptcy before holders of unsecured debt, such as commercial paper. Thus, Fetter expects holders of first-mortgage debt to be made "relatively substantially whole" in case of a reorganization. "But as you get deeper into the preferred
shares and commercial paper," it gets much harder to recover the money, he says. And given that PG&E and Edison together have racked up at least $12 billion in losses, the list of repayments is sure to be long.
Other banks with known exposure to the utilities include
J.P. Morgan Chase
, which, along with Bank of America, is thought to be one of the biggest lenders to the California utilities.
In its earnings presentation on Wednesday, J.P. Morgan said its guidance for 2001, which provides for a "moderate" but unspecified increase in nonperforming loans, includes its current view on utilities. The banks said it has "longstanding relationships with major companies out there," but could not comment on specific names. J.P. Morgan Chase also said it expects a "prompt, politically driven resolution" to the problem and added that its involvement is both in line with the industry and its capacity to handle risk.
, which has already warned of sharply lower fourth-quarter earnings and higher loan losses, will report earnings on Monday and will likely be quizzed about its level of exposure. Last week, a spokesman characterized the bank's exposure as small and said it had been included in previous guidance. He added that the situation would not change.
, which this week surprised the market with an
unexpected fourth-quarter loss instead of a profit, is also on the hook. Amid serious existing problems with troubled loans, Bank One said its exposure was small but then conceded it had loans of "several hundred million dollars" -- far from small by even the largest bank's standards.