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Business & Money
Pool Centralization or Segregation?
Fitch Ratings' Managing Director Richard Hunter outlines in a recent report the ratings advantages and disadvantages of utilities that depend too heavily on centralized cash management pools, and contrasts them with decentralized pools. Fitch believes that there is a middle ground between the two extremes, and, if intercompany cash management and lending are practiced within a group, a number of methods can help insulate a strong affiliate's credit from the risks associated with participating in a shared money pool.
"Centralization of funding and cash management is more economic and less burdensome to administer than discrete treasury functions for each affiliate but can make it difficult to track which entity owns the funds," writes Hunter. Yet, according to Hunter, ties among associated issuers within a utility group, such as participation in a shared money pool, increase the interdependencies in the ratings of the issuer.
For example, on Sept. 30, 2003, Fitch lowered the senior unsecured rating of First Energy Corp. (FE) to "BBB-" and, at the same time, lowered the short-term ratings of three FE subsidiaries-Jersey Central Power & Light Co., Metropolitan Edison Co., and Pennsylvania Electric Co.-to the same short-term rating as their parent, "F3." The reduction in the short-term ratings reflects the subsidiaries' reliance on FE's corporate money pool or FE itself to meet any short-term funding needs and contingencies, the report says.
By contrast, at the same time, the short-term ratings of FE's Ohio Edison Co. (Ohio Edison) subsidiary was affirmed at "F2." Ohio Edison maintains its own credit facility and, therefore, is not solely dependent on money pool or parent company advances for short-term funding needs.
Another utility group with short-term funding dependencies among related issuers is Entergy Corp., according to the report. "The ratings of the regulated utility subsidiaries of Entergy consider the issuer interdependencies created by operational agreements related to generation and a shared money pool agreement. Furthermore, the regulated subsidiaries are dependent on the parent access to external liquidity," Hunter says.
While Entergy's regulated subsidiaries ratings are not currently constrained, Fitch says changes in the credit quality of one subsidiary or the parent could also affect related issuers.
These examples, according to Fitch, illustrate that the more the operational and cash management ties with affiliates or the parent company, the more an individual affiliate's credit quality will be sensitive to changes in the credit quality of its parent and associated companies.
"To address the risk of a subsidiary being solely reliant on its parent company's credit facility to minimize costs, [Fitch says] a single credit facility can be structured to include individual parent and subsidiary maximum borrowing sublimits within an umbrella. This can be an efficient means to minimize costs yet still maintain a separation of affiliates. … This type of umbrella facility enables the utility group to benefit from lower facility initiation costs and reduces the administrative burdens related to covenant compliance and documentation while preserving affiliate distinction."
Nevertheless, Hunter notes that shared money pools may cause serious problems if a weak affiliate with outstanding borrowings from the pool files bankruptcy.