Moody's Investors Service

While authorizing Nashville Gas Co. to increase rates by $4.417 million, the Tennessee Regulatory Authority has modified its existing policy on the treatment of advertising expenses in gas rate cases.

The authority abandoned a past policy limiting advertising recovery to 0.5 percent of the company's gross revenues. It also ordered a 50-50 sharing between ratepayers and shareholders. It granted, however, the LDC's request for full recovery of both payroll and nonpayroll "sales promotion" costs, rejecting allegations the costs should be treated as advertising expenses.

Wall Street loves stranded costs. No kidding. For stockbrokers and underwriters accustomed to selling utility issues to widows and orphans, the prospect of asset-backed financing opens a whole new world. I'm talking here about "securitizing" stranded costs.

In a securitization, a trust takes beneficial title to utility assets (tangible or intangible) that have lost their value in the market, and sells "transition bonds" to a new set of investors, funneling the bond sales proceeds back to the utility and to its equity investors. Who pays the coupon? Why, it's the customer of course.

NIPSCO has agreed

to acquire IWC Resources Corp., the parent of Indianapolis Water Co., for $288 million, prompting a look at credit ratings.

In response to the agreement, Moody's Investors Service is considering a ratings downgrade of IWC ('A1' senior secured). Moody's also confirmed the ratings of NIPSCO Industries, Inc. ('baa3' preferred stock) and its operating subsidiary, Northern Indiana Public Service Co. ('A2' senior secured).

Each assumes a vertical breakup, but watch out for securitization.

It can prove difficult to detect any overt difference of opinion among financial credit rating agencies. That appears to be the case in today's electric utility industry, where Moody's, Duff & Phelps, and Standard & Poor's each predicts that a breakup of the vertically integrated utility is now virtually inevitable. The result, they say, will leave us with an industry made up of disaggregated high-risk power generators, and lower-risk companies engaged in transmission, distribution, and other related services.

How a sample electric company could reduce risk of loss by upgrading performance to industry benchmarks. Competition in electric generation will expose utility costs that exceed those of alternative suppliers. Roughly speaking, these above-market ("transition") costs should track the difference between the new market price and the embedded cost set by traditional cost-of-service regulation.

The problem has attracted no shortage of proposals.

Moody's Investors Service has confirmed the debt ratings of California's three largest IOUs (em Pacific Gas and Electric Co. (PGE: Sr. Secured A2), San Diego Gas and Electric Co. (SDG&E: Sr. Secured A1), and Southern California Edison Co. (SCE: Sr. Secured A2) (em following passage of AB 1890, the California legislature's restructuring bill.

Moody's says that legislative endorsement of stranded-cost recovery is a favorable development for utility creditors, but notes that ultimate recovery depends on regulatory approval.

A Moody's Investors Service report, Moody's Assesses Risk in Utility Combinations and Spin-Offs, finds that mergers and acquisitions (M&A) do not mitigate the higher business risk posed by electric deregulation. The report also claims that financial risk only declines to the extent that management uses merger-related savings to reduce leverage.

Utilities pursue mergers to boost shareholder returns; regulators approve mergers to secure benefits for customers, such as lower rates. Bondholders run a distant third.

So the Federal Energy Regulatory Commission (FERC) won't break up the electric utility industry. But it may happen anyway (em if not at the FERC's direction, then perhaps under pressure from state regulators who, some say, are threatening to link stranded-cost recovery to vertical disaggregation.

What would a breakup mean for bonds and bondholders?

As we reported last month ("New Corporate Structures Place Bondholders at Risk," May 1, 1996, p.

Moody's Investors Service has confirmed the credit ratings of Duke Power Co. (DP) despite the utility's decision to repurchase up to $1 billion in stock by 2000. Moody's expects DP to maintain its 'Aa2' senior secured bond rating. DP management intends to repurchase the stock while allowing a gradual increase in the retained earnings cushion. The program was designed to absorb the substantial cash inflow caused by the reversal of the Catawba power plant purchased-capacity levelization in 1996 and by the utility's declining capital expenditure needs.

Investors are taking stock

of utility exposure to price competition.The utility trade press and even the general financial press have featured the views of regulators, utility executives, legislators, and various consumer advocates on the stranded-cost question. Stranded costs easily represent the most contentious issue facing the electric industry as it moves to an era of competition.