THE POWER PLANTS OF AT LEAST FIVE UTILITIES IN NEW England and California get swapped this year for more than $5.3 billion. And happily, those holding bonds on the plants will be given cash for their coupons.
These utilities (see sidebar, "Going Once, Going Twice¼ Sold!") can expect their credit ratings to remain firm or even jump (em although that's debated by analysts. Such improved ratings may surprise market observers led to believe that loss of utility collateral would hurt investment grades.
That plant sales have exceeded book value certainly hasn't hurt expectations for firm credit ratings. The extra cash makes it easier for investor-owned utilities to get around restrictive bond indentures that guarantee bond security, analysts and utility executives say. Meanwhile, because the IOUs are left with solid portfolios of transmission and distribution assets, such utilities are viewed as good risks.
No credit-rating agency seems to have a formula yet, however, for evaluating credit-worthiness of what soon may be "non-generating" utilities. Some say no recipe is needed.
Paying Down Debt
Utility executives and analysts report unanimously that the IOUs plan to retire the debt once the sales are approved and closed.
Bob Seega, investor relations director for New England Electric System, sees direct effects on those holding bonds of New England Power Co., the NEES company that auctioned about $1.6 billion in generating assets. The utility's First Mortgage bonds carry staggered maturities, from short-term to 30 years.
"This constitutes, under our indenture, a sale of substantially all the property of New England Power Co," Seega says. Therefore the sale makes the utility's indenture null and void.
That means for all outstanding debt, cash is put up with the mortgage trustee. The cash covers payment of the interest on the bonds until they are either called or matured. At the end of maturity, bondholders receive their principal payment, just as they would if the company had kept the bonds outstanding.
"It isn't the case that you're leaving the bondholders with a leaky ship of state," says M. Douglas Dunn of Milbank, Tweed, Hadley & McCloy. "They're getting, in fact, cash and more."
"The only tricky part is if the bonds are callable before maturity," Seega says. "The issue there with the fixed-income analyst is: 'Are you going to call those bonds at a premium price or at a par call?'"
In some cases, special circumstances allow a company to call bonds at par, or face, value. That won't be the case at NEES, however.
"When we defease the indenture, we will pay the general redemption price or a premium price for those couple of series that are callable prior to maturity," Seega says. "In the case of defeasance, you get 100 percent of your money¼ The bondholders get made completely whole."
The plan has been filed with the mortgage trustee and trustee's counsel. "It's really what's required under our indenture," Seega says. "Utility indentures tend to have some similarities, but they all can be a little unique."
The NEES sale only puts a small dent in its $5-billion asset base.
At Pacific 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 Emily Eisenlohr, a Moody's senior electric utility analyst. "We certainly look at a lot of quantitative data for doing ratings. But within this environment in particular, we need to look at the regulatory environment within the state and what ongoing mechanisms will affect the rating of the utility. Usually the asset sales are part of the solution, the transition, but they're not the whole story."
But Sabatelle says the U.K. offers one model analysts could look at (em also Australia. "We've rated there," he says, adding that it's fair to say distribution and transmission companies could withstand higher levels of debt than integrated utility companies.
Under the "new" business, cash flows are predictable. Competition shouldn't affect the business for some time. "They'll be cash cows, frankly," the analyst says. "The real risk for investors will be how the utility replaces the earnings that they will have lost from the sale of their generating assets."
Brian M. Youngberg, analyst at Duff & Phelps Credit Rating Co., says there's no model at his firm to evaluate the divested utilities.
"The number of calculations will kind of remain the same," Youngberg says. "We'll probably just kind of look at them from a different perspective. Will a T&D company be more comparable to a gas distribution company?"
Youngberg says it will be more difficult in the future to compare companies quantitatively because each company will be so different. That's why analysts will look at overall business risk profiles and the qualitative aspects of the company (em where they're going, how they're doing competitively and if they still are in generation.
Grading on the Curve
At Fitch, Fetter insists that auctions probably won't substantially influence bond ratings anytime soon. But for those companies buying generation, there's more risk. A company like PG&E, for instance, whose affiliate (U.S. Generating Co.) is getting into unregulated power production on the East Coast, will be scrutinized.
Holding companies and utilities generally are protected from the gambles taken by their subsidiaries or affiliates, say Sabatelle and Youngberg.
Sabatelle says holding company investors are vulnerable because of the holding company's debt. Like Fetter, he says success comes down to company strategy, and international forays. As for unregulated ventures...
"I think it's fair to say utilities in general haven't had a terribly strong track record in diversifying into other non-regulated businesses," Sabatelle says. "So the only fly in this ointment is the reinvestment risk."
Youngberg, who analyzes Southern California Edison, among other utilities, suggests a utility is separated somewhat from risk by affiliates. "It's kind of an exclusive (em what they do outside SoCalEd, it's kind of like there's a firewall between the two," he says.
Dan Scotto of Bear Stearns Securities Corp. says since the auctions returned prices above book value, analysts have been sent back to the drawing board to re-examine impacts on credit ratings.
"There are people saying we'll have discounts to book value and how will those be handled by regulators?" he says. "And it sort of created some regulatory risk here that needed to be resolved. But as it's turning out, there's not regulatory risk.
"The cash exodus of utilities from the generating portion of the business is clearly a 'credit positive' event. We're actually calling for net upgrades."
Like Sabatelle, he says auctions have prompted credit rating agencies to allow more debt-to-capital and less cash flow protection.
Scotto says he sees utility bonds continuing to be paid off through auctions and credit ratings heading up. "It's really that simple." F
Joseph F. Schuler Jr. is senior associate editor at Public Utilities Fortnightly.
Going Once, Going Twice¼ Sold!
Power plant auctions in the works.
NEW ENGLAND ELECTRIC SYSTEM should complete this year a $1.59 billion deal announced last August with U.S.
Generating Co., a PG&E Corp. subsidiary. USGen beat 25 bidders for 18 fossil and hydro plants and 1,100 megawatts of power purchase contracts, more than 5,000 MW in all. Book value: $1.1 billion.
SOUTHERN CALIFORNIA EDISON sold 10 gas-fired plants, 7,532 MW of combined power, on Nov. 24, for $1.1 billion (em 2.65 times above the $421 million book value. Four buyers (em AES Corp., Houston Industries Power Generation, NRG Energy Inc./Destec Energy Inc. and Thermo Ecotek Corp. (em beat out 40 bidders.
NIAGARA MOHAWK POWER CORP. plans to auction its fossil fuel and hydroelectric generating plants as part of its competition plan, PowerChoice. The divestiture scheme proposes a schedule for offers to be accepted as early as April. Winning bids would be announced mid-1998. The utility's 72 hydroelectric plants will be auctioned in two packages.
NORTHEAST UTILITIES will auction its non-nuclear generation in Massachusetts as the state opens to competition. It may form an affiliate to bid on the plants. NU has 1,500 MW of generating assets in the state. It hasn't decided whether to auction its New Hampshire generation as part of a restructuring plan there.
PACIFIC GAS & ELECTRIC sold three generating plants Nov. 18 to Duke Energy Power Services Inc. for $501 million. The plants' capacity: 2,645 MW. CPUC approval was expected before last month. A closing was set before March 31. Book value: $380 million. PG&E's second auction of its remaining fossil fuel and geothermal power plants will be held this year. These assets have a generating capacity of 4,718 MW. Book value: $750 million.
BOSTON EDISON will sell its non-nuclear generation, 12 oil and gas-fired plants, for $536 million to Sithe Energies Inc. That's $86 million more than book value. A closing was set for early 1998.
SAN DIEGO GAS & ELECTRIC'S auction will be held mid-year, with closing expected by year end. Some 2,400 MW of generation assets and long-term power contracts will go up to bid. Included, too, will be a 20 percent interest in the San Onofre Nuclear Generating Station. It will be the first nuclear asset auctioned, and a "non-operator" asset at that. Book value for the fossil generation is $250 million, with SONGS valued at $650 million.
UNITIL CORP./FITCHBURG GAS AND ELECTRIC LIGHT CO. expect to have a short list of bidders by March 30 on about 24 MW in joint-owned generating assets, 38 MW in purchased power agreements and a 26 MW oil-fired gas turbine unit. Auction results should be announced by Sept. 1, with regulatory approvals expected by the end of the year. Book value of the assets was set at $12.5 million.
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