Fitch Ratings says that increased spreads on bond issues recently placed by European utilities will negatively impact interest coverage ratios. However, the negative consequences of increased borrowing costs will be partially mitigated by a "portfolio effect", as a number of utilities have large portfolios of outstanding bonds spread across different maturities, many of which were issued at a time when pricing was substantially lower than in current market conditions.

For these companies, the increase in average costs of debt has been minimal so far, and will not have a major impact on coverage ratios. This may change though if the current pricing environment is sustained in the medium term, causing large portions of outstanding debt to be refinanced at more expensive levels.

"The increased costs of borrowing recorded over the last two quarters of 2008 will particularly result in a deterioration of coverage ratios of those utilities which increased their leverage, or which had sizeable debt maturities, during 2008," says Jacek Kawalczewski, Associate Director in Fitch's Energy, Utilities and Regulation team.

Fitch notes that utilities have been among the first to take advantage of windows of opportunity to issue in what is an intermittently open bond market, supported by the sector's stable cash flow generating characteristics and generally solid investment grade ratings. However, the current challenging credit market environment has pushed the pricing for the highest-rated European energy companies up to approximately 200 basis points (bp) for 5-year maturities, and around 300 bp for 10-year maturities, based on recent issuance. This is a substantial difference compared to the 2007 September and October 5-year bonds issued by E.ON AG ('A+'/Outlook Negative) and CEZ, a.s. ('A-'(A minus)/Outlook Stable), both priced at around 60 bp, and to E.ON's 12-year issue placed at 110 bp in April 2008.

Fitch believes that increased borrowing costs together with the slowdown in consumption that is likely to characterise a number of recessionary European economies in 2009 might cause utility companies to revise their sizeable investment plans, as certain projects or acquisitions may no longer meet minimum hurdle rates and the strain on existing assets becomes less pronounced. Therefore, as confirmed by a number of already revised business plans, total industry capex could be scaled back, given the discretionary nature of many projects, whilst others might be delayed or suspended. Utilities with flexible investment plans should therefore be able to at least partially offset the negative implications on their financial profiles of weakened credit market conditions by reduced capex spending.

In the last two weeks several European utilities have accessed the bond market with the total issuance amount reaching almost EUR10bn, including Electricite de France ('AA-' (AA minus)/Outlook RWN) and RWE AG ('A+'/Outlook Negative). Both utility groups raised EUR2bn respectively. This was followed by German issuers EnBW AG and E.ON AG, Spain's Iberdrola ('A'/Outlook Negative) and Sweden's Vattenfall AB ('A+'/Outlook Negative).

Fitch believes highly rated European utilities are well placed to take advantage of potential further capital market issuance opportunities, particularly in the case of frequent-issuers who have already been active in recent months, such as E.ON, which has issued more than EUR18bn since September 2007 and Electricite de France, which has placed bonds on the European market four times during 2008. However, the agency will closely monitor the funding efforts of utilities with sizeable near-term refinancing needs, such as Enel SpA ('A-'(A minus)/Outlook Negative), which has some EUR14bn of debt maturing in 2010. Furthermore, Fitch will monitor the trade-off that individual entities make between increased financing costs related to new borrowings and their commitment to ease pressure on refinancing to be done in 2009 and 2010. Entities that are willing to compromise their liquidity profiles by postponing issuance in anticipation of a potential reduction in borrowing costs are likely to see their ratings negatively affected.