Business & Money
FERC's ruling on cash management programs will introduce new transparency into how utilities manage their cash.
On Oct. 22, the Federal Energy Regulatory Commission (FERC) ruled that FERC-regulated entities must file their cash management agreements with the commission and notify the commission within 45 days after the end of each calendar quarter when their proprietary capital ratio drops below 30 percent, and when it subsequently returns to or exceeds 30 percent.
FERC's ruling comes in response to analysis that found "severe record keeping deficiencies" by some FERC-regulated entities. In fact, results of the investigation found: 1) cash management agreements generally were not formalized in writing; 2) the terms of programs and the interest associated with loans were not documented in writing; and 3) it was unclear whether interest had been paid to subsidiary companies by the parent companies.
This problem has led credit rating agencies like Fitch Ratings to warn that consolidated cash management accounts and failure to document fund transfers among affiliated companies as intercompany loans could be factors contributing to a U.S. bankruptcy court's decision to consolidate a solvent company in the bankruptcy proceeding of its affiliate.
Moreover, FERC's chief accountant found that utilities had $16 billion in cash management accounts at the time, and now $25.2 billion, according to a recent analysis.
The big three credit ratings agencies-Standard & Poor's, Moody's and Fitch Ratings-have taken a strong interest in this ruling, which aims to protect financial abuses such as when Enron Corp., in the weeks leading up to its bankruptcy filing, tapped its two regulated natural gas pipeline affiliates for $1 billion to stave off a liquidity crisis.
As S&P credit analyst Todd A. Shipman explains in a research note, "The FERC rule has credit rating implications in that it raises the possibility that FERC regulatory oversight could rise to a level that would support an analytical judgment that FERC-regulated entities covered by the new rule are insulated from their parents, and thus could support a ratings differential.
"The elements that determine whether regulatory insulation exists are numerous and complex. … The strongest case for regulatory insulation exist when there are tight, statutory restrictions on cash or asset transfers with real consequences for violations, coupled with active, preemptive oversight."
But Shipman doesn't believe that FERC went far enough in its order. He says FERC should have imposed a minimum common equity balance of 30 percent and a requirement that the pipeline and its parent, for example, maintain investment-grade credit ratings in cash management programs with affiliates. Shipman says that even a minimum equity balance is not particularly protective (it would not support even an investment-grade rating at a typical pipeline business risk score), but at least it would introduce credit-related discipline into the regulatory mix.
Because of this and a view that FERC oversight has been viewed as less than sufficient to justify insulation, Shipman says, "It seems clear to Standard & Poor's that the new rule falls short of providing the requisite insulation to justify any ratings separation for utilities regulated primarily by FERC."
Cash 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. In the event of a bankruptcy filing, the inter-company lender would get in line with outside creditors to pursue its claim against the bankrupt affiliate, which is most often ranked as a general unsecured claim. Fitch does believe it is possible to have some benefits of cash management centralization while avoiding the potential pitfalls. "With effective limits on the participants, shared money pools can reduce the group's costs and outside borrowing levels but still preserve distinctions in the credit of participants for ratings purposes."
Moody's: LDCs All Over The Map
Many credit ratings agencies have pointed out that, to date, many utility cash management pools are as diverse as their ratings. Some experts believe that the new FERC order, in bringing more transparency to utility cash operations, may lead to a standardization and greater clarity of the risks inherent in certain utility cash pools. This may be necessary as Moody's credit analyst Edward Tan, in a report, finds that while natural gas local distribution companies, "perform the same purchasing, storage, and distribution business throughout the country, they differ as to their methods of cash management.
"The practices vary as widely as their credit ratings, reflecting both the degree of regulatory supervision and operating guidelines as well as individual company policies and philosophies with respect to whether to separate the cash of their regulated utilities from the non-regulated affiliates and if so, the degree of their cash operation," he writes.
According to Moody's, in a group of 32 LDCs, 13 used cash money pools while 19 did not. Of these 13, seven were in a combined money pool containing utility and non-utility companies and six in separate utility and non-utility money pools. The three "A"-rated companies having one combined money pool are Washington Gas Co., National Fuel Gas Co., and Laclede Gas Co. Tan believes these companies have different mitigants in place that appear to limit the credit risk of their utilities. He notes that many state regulators do not require a strict separation of cash operating systems between the utilities and non-utility affiliates.
Most "A"-rated companies, however, appear to have taken a more pro-active approach toward ensuring the protection and separation of funds belonging to the different legal entities. Moody's, S&P, and Fitch all agree that how companies deal with their internal systems is also indicative of their operating philosophy. In fact, the approach taken by FERC-regulated utilities toward handling their cash is a factor in credit and investors' evaluation, they say.
Reference: Cash Management Programs
Cash management programs include all agreements under which funds in excess of the daily needs of the FERC-regulated entity, along with the excess funds of the entity's parent, affiliated and subsidiary companies, are concentrated, consolidated or otherwise made available for use by other entities within the corporate group. Such programs concentrate affiliates' cash assets in joint accounts for the purpose of providing financial flexibility and lowering the cost of borrowing.
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