Western Conference of Public Service Commissioners

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Western Conference of Public Service Commissioners

• The U.S. Power Sector
• A Credit Perspective
• Laura Schumacher

June 2005
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Todays Agenda

• Moodys Investors Service
• Credit Outlook for U.S. Power
• Key Regulatory Issues
• Ratings Process
• Concluding Remarks
• Question Answer

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Western Conference of Public Service Commissioners

• Moodys Investors Service

June 2005
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Moodys In The Past

• Founded in 1909 by John Moody
• The first credit rating agency
• Original development of rating scales
• Founded to provide investors with information on
  US railroads

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Moody's Rating Scale
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Moodys Today

• Offices in 18 countries around the world
• Over 1000 analysts, covering every industry,
  government level, as well as structured and
  infrastructure finance
• Over 200,000 debt obligations rated globally and
• Ratings cover Corporations, Financial
  Institutions, Governments and Structured
  Transactions
• 13 senior utility analysts in New York, with a
  total staff of 24. Analytical teams also in
  Toronto, London, Tokyo and Sydney

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Moodys Role In The Global Capital Markets

• Provide independent and objective assessment of
  credit risk - opinion
• Provide comprehensive coverage and global
  consistency
• Facilitate credit transparency
• Enhance efficiency and liquidity

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Western Conference of Public Service Commissioners

• Credit Outlook for Power in the U.S.

June 2005
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Rating Trends in 2005

• The Rating Outlook is Stable For the Sector
• Credit Conditions Stabilized in 2004
• 2005 Year-to-Date Twice as Many Issuer Families
  Upgraded Than Downgraded
• Fewer Issuers Are Under Review
• Most Reviews Are For Possible Upgrade
• However, More Issuers Have a Negative Outlook
  Than a Positive Outlook

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Some Key Rating Drivers

• Lingering Resolution of Underperforming
  Investments
• Focus on Regulated Operations is Supportive For
  Credit Quality and Stability
• Balance Sheet Improvement Trend Has Largely Ended
• Increasing Costs and Increasing Capital Spending
  Will Result In More Rate Filings
• Continued Pressure For Increased Shareholder
  Rewards

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Recent Rate Case Trends

• Most Rate Case Outcomes Have Been Supportive
• Some Rulings for Guaranteed Recovery on Capital
  Investments, Including Forward Looking Spending
• Increases Havent Yet Alarmed Ratepayers
  Environmental Capital Spending Has an Apple Pie
  Quality

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Western Conference of Public Service Commissioners

• Regulatory Issues as Drivers of Utility Ratings

June 2005
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Regulatory Issues Affecting U.S. Utilities

• State Regulation Less Predictable than National
  Regulation
• Substantial Diversity of Regulatory Regimes and
  Models
• Holding Company Structures Limit Regulatory
  Oversight
• Overlapping or Unclear Regulatory Jurisdiction

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The Current U.S. Regulatory Environment

• Deregulation Initiatives Stalled In Most States
  Is Re-regulation Possible?
• Transition/Market Development Periods Coming to
  an End
• Rate Freezes Expiring
• Interest Rates Rising
• Constructive Regulation Critical To Execution Of
  Back To Basics Strategy

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Greater Potential For Unpredictable Rate Case
Outcomes?

• Dramatic Increase in Rate Reviews to as Much as
  40 Billion by Some Estimates
• Volume Likely to Remain High for Several Years
• Few Utilities Or Commissions Have Experienced
  Full Rate Case in Recent Years
• Will Regulators, Legislators, or Customers Limit
  Recovery of Costs?
• More Utilities Seeking Legislative Support for
  Large Spending Needs

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Key Drivers Of Rate Case Filings

• Rising Environmental Expenditures
• Higher Fuel and Power Supply Costs
• Infrastructure/Reliability Concerns
• Increasing OM/Pension/Healthcare Costs
• Utility Ratings Generally Higher Where Regulatory
  Framework Supports Timely Recovery of These Costs

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Western Conference of Public Service Commissioners

• Rating Methodology Global Regulated Electric
  Utilities

June 2005
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Rating Methodology Global Regulated Electric
Utilities
Objective To Provide More Insight on the
Weighting of Key Qualitative and Quantitative
Rating Factors for Electric Utilities

• Over 100 companies included
• - Americas 55
• - Asia/Pacific 27
• - Europe 34
• Issuer families that operate in the regulated
  electricity business.

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Rating Methodology Global Regulated Electric
Utilities
Ratings Are Concentrated in the A/Baa Categories
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Financing Costs are Impacted by Ratings
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Rating Methodology
Regulated Electric Utility Ratings Reflect Key
Credit Factors

• Extent of Companys Exposure to Unregulated
  Businesses
• Riskiness of Unregulated Businesses
• Supportiveness of Regulatory Framework
• These Three Factors Combined Determine the
  Companys Overall Qualitative Business Risk
• Broad Mapping of Ratings by Business Risk and Key
  Financial Metrics

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Rating Methodology Qualitative Factors
Assessment of the Risk of the Unregulated Business

• High Business Risk Merchant generation in very
  competitive markets, high cost, or not
  contracted speculative energy trading other
  non-core investments
• Medium Business Risk Merchant generation in
  less competitive markets or low cost affiliated
  generation supply businesses non-speculative
  energy trading
• Low Business Risk Unregulated generation
  contracted to creditworthy counterparties or well
  insulated from competition energy businesses
  related to core utility

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Rating Methodology Qualitative Factors
Supportiveness of Regulatory Environment (SRE)

• SRE 1 Fully developed regulatory framework,
  long track record of predictability and
  stability, very high expectation of timely
  recovery of costs investments
• SRE 2 Fully developed regulatory framework,
  high expectation of timely recovery of costs
  investments
• SRE 3 Well developed regulatory framework,
  evidence of inconsistency or unpredictability,
  lower assurance of timely recovery of cost
  investments
• SRE 4 Regulatory framework still developing,
  unclear, undergoing change, or has an
  unpredictable history

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Rating Methodology Qualitative Factors
State Level Regulatory Considerations

• Cost Recovery Provisions
• Transition Periods and Rate Caps
• Status of Deregulation/Retail Access
• Incentive or Performance Based Rates (Earnings
  Sharing)
• Ring-Fencing Provisions

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Rating Methodology Qualitative Factors
Non-specific Utility Risk Factors Also Assessed

• Adequacy of liquidity arrangements
• Quality of corporate governance
• Quality of management experience, appetite for
  risk, ability to fulfill companys stated
  strategy
• Event risk the probability of a change to
  companys financial position, business risk, or
  regulatory and political operating environment
• Off-balance sheet risks

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Rating Methodology Qualitative Factors
Concluding Observations on Qualitative Factors

• Analysis of qualitative factors determines how
  stable and predictable the cashflows of the
  company should be
• Lowest business risk wholly regulated
  activities in supportive regulatory framework
• Highest business risk significant exposure to
  higher risk non-regulated businesses
• Companies with a lower business risk can have
  weaker financial metrics than those with higher
  business risk for the same rating category

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Rating Methodology Quantitative Factors
Key Ratios

• Moodys Particularly Emphasizes 4 Core Ratios for
  the Regulated Electric Utility Sector
• - FFO/Adjusted Debt
• - FFO/Interest Expense
• - RCF/Adjusted Debt
• - Adjusted Debt/Total Capitalization

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Rating Methodology Quantitative Factors
Guide to Key Ratios by Business Risk Category
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Rating Methodology Global Regulated Electric
Utilities
Limitations of Mapping to Ratios

• Ratings are Prospective and Incorporate Use of
  Confidential Projections
• Global Categories Can Be Fairly Broad
• Year Over Year Volatility in the Numbers

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Legal Entities Within a Family

• Ratings tend to map better to quantitative
  consolidated family credit metrics
• Ratings of operating companies can be influenced
  by
• Amount of holding company debt
• Size of non-regulated activity
• Degree of interdependence among parent sub and
  between operating subs
• Regulatory ring-fencing and other forms of legal
  separateness are important factors

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Western Conference of Public Service Commissioners

• Concluding Remarks

June 2005
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Summary

• Regulation is a key factor in determining credit
  ratings.
• Increased importance as companies exit rate
  freeze periods and undertake necessary capital
  spending programs.
• Credit supportive regulation includes mechanisms
  that assure the timely recovery of costs.
• Cash flow is a more important component of
  financial metrics than book earnings.
• Ratings represent our opinion of credit quality.

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• Q A