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Utilities Earn an A+ for Power Plant Auctions

Fortnightly Magazine - February 15 1998

Gas & Electric, spokesman Bill Sessa says the primary purpose of his company's auction revenue also will be to pay down debt over the next four years.

An official at San Diego Gas & Electric calls the bond buy-back there a "decapitalization."

SDG&E must meet two main requirements as part of its First Mortgage Bond indenture. One, it must have a proper unpledged-property ratio to debt. Two, to issue new debt, it must meet a minimum interest-coverage requirement; earnings must equal or exceed 2.5 times the interest on outstanding liabilities.

Earning Extra Credit

The credit analysts, for the most part, seem as happy as the utility executives when it comes to auction proceeds paying down obligations. Certainly, to the extent that generation assets are being sold above book value, it solidifies ratings for a company. But will ratings improve?

A.J. Sabatelle, senior analyst at Moody's Investor Service Inc., says his firm increased ratings on two of the three California utilities from A to A1. Southern California Edison and Pacific Gas & Electric now join San Diego Gas & Electric as A1-rated utilities. SCE and SDG&E claim positive outlooks; there's a stable outlook on PG&E. Once they go through their auctions, collect the proceeds and complete the debt securitization required by regulators, it's possible the utilities could earn higher ratings, Sabatelle says.

But Steven M. Fetter of Fitch IBCA Inc. shares a different perspective.

"In this environment, it's hard for ratings to go up," Fetter says. "But to the extent there's some uncertainty with regard to the level of a bond rating as we move toward competition, to the extent that a company gets out of generation¼ and especially to the extent that they get above book value, we would feel more comfortable with the existing rating. I don't see a lot of upgrades in this environment."

Fetter believes these utilities, now essentially T&D companies, would be evaluated under traditional, regulated-return, low-risk models.

"It would be the old model with probably a little less risk because even in the old model with a regulated return, generation still had a certain degree of risk factored in," he says. "To the extent that you pull generation away completely, we view T&D as a relatively stable business."

Rating agencies are sure to give a lot of weight to quality management with strategic vision in coming years. "When management meets with us, we don't have one strategic view we expect them to adhere to," Fetter says. "We listen to what they're thinking and make an assessment as to whether it holds together in the new environment."

Sabatelle says the California utilities selling generation are better positioned as long as the auction proceeds are used to retire debt.

"None of the companies have come out and said they're going to take the proceeds and use them for something other than that," he says. "That would be problematic. We view retiring debt as a positive development."

Yet he and a colleague also say there's no Moody's model to rate these "new utility animals."

"We really don't have formulas," says