And so Moody's wakes up.
Moody's Japan K.K. has downgraded to Baa1 from A1 the senior secured and long-term issuer ratings on Tokyo Electric Power Co., Inc. (TEPCO).
Moody's also downgraded the short-term rating for TEPCO's commercial paper to Prime-2 from Prime-1.
All three ratings remain on review for possible downgrade.
The downgrade reflects the significant financial obligations the company faces as it continues to address multiple challenges resulting from the March 11 earthquake and tsunami that seriously damaged several of its nuclear and thermal generating facilities, most notably its Fukushima Daiichi nuclear plant. TEPCO continues to struggle to control reactor temperature and limit radioactive leaks at the plant, problems that appear far from being resolved.
The downgrade takes into consideration the enormous costs the company will incur as it recovers from this disaster, including costs for replacement power, the building of new generation plants to replace the permanently damaged plants, and the decommissioning of the contaminated plant.
These costs will inevitably increase TEPCO's already high debt leverage and could result in substantial rate increases that its residential and industrial customers may not be able to tolerate over the near term.
These costs could lead to losses for at least the next two years if the company cannot increase the rates substantially.
Furthermore, the radiation that has already been released in and around the plant could make TEPCO liable for an unknown amount of damages incurred by local residences, businesses, and farms in the area.
Depending on the magnitude of the damages and the extent to which TEPCO is found liable, TEPCO's ability to meet these large and potentially growing obligations could be severely strained.
As a result, Moody's believes TEPCO will remain highly leveraged and unprofitable for an extended period of time and will face substantial risk regarding nuclear liability.
Although the Japanese government would typically be responsible for these claims if it determined that the March 11 events comprised an "unusually severe natural disaster", there has been no indication that the government is willing to directly absorb these costs. Recent statements from government officials appear to indicate that TEPCO may have to shoulder at least part of this liability.
The costs for replacement power are likely to be significant as a number of the damaged plants were low-cost baseload nuclear and coal units. In addition to the Fukushima Daichi nuclear plant, the company's nearby Fukushima Daini nuclear plant, as well as its Hirono and Hitachinaka thermal plants, have also suffered damage.
Much of this low-cost generation will be replaced by higher-cost LNG and oil-fired generation, which will substantially increase the company's fuel costs. Given the likelihood that the entire Fukushima Daiichi nuclear site may never be brought on line again, TEPCO's generation costs are likely to be elevated over a longer term, adding to fuel costs and putting additional pressure on customer rates.
The downgrade of TEPCO's Prime-2 short-term rating for commercial paper recognizes the severely constrained liquidity position the company faces over the near term. Although TEPCO had nearly JPY700 billion of cash on hand as of December 31, 2010, it has lost access to the equity and bond markets as the nuclear crisis has unfolded.
Although it has reportedly secured a JPY1.9 trillion loan from several of its major relationship banks, which will shore up the company's liquidity and financial viability over the near term, this will only temporarily meet cash flow needs to build new generation, pay for more expensive replacement power, and meet upcoming debt maturities.
Moody's believes that the company will require additional liquidity support from other banks, Japanese government lenders, insurance companies, or other sources, to assist it in meeting its substantial liquidity and cash flow needs, especially if it is required to provide compensation for the disaster. However, whether the banking system will extend further credit without an improvement in TEPCO's financial profile is questionable.
The result of these developments is a standalone credit profile that is not longer consistent with an investment-grade rating. The current final rating still reflects the expectation that the Japanese government will ultimately act in a way to preserve TEPCO's solvency without losses to lenders.
Moody's believes it is likely the government will consider that TEPCO's ongoing viability is critical to the reliability and integrity of the power system in the Tokyo area and that it will continue to recognize the broader financial implications of allowing a major company like TEPCO to collapse.
The ratings remain on review as the company continues to struggle to secure the Fukushima Daiichi nuclear plant reactors, and because of the substantial uncertainty about the magnitude of the company's costs and ultimate financial obligations for third-party damages. The review will focus on the company's progress in stabilizing the Fukushima Daiichi plant site, the potential amount of third-party liability costs, the costs of cleaning up and decommissioning the nuclear plant site, and indications of the form of government support for the utility.
Ratings downgraded and remaining on review for possible downgrade include:
TEPCO's senior secured rating, to Baa1 from A1
TEPCO's issuer rating, to Baa1 from A1
TEPCO's short-term rating for commercial paper, to Prime-2 from Prime-1
Moody's last rating action with respect to TEPCO was on March 18, 2011, when its long-term ratings were downgraded, and the ratings were remained for further review for downgrade.