Credit Ratings Q FINANCIAL UPDATE QUARTERLY REPORT OF THE U.S. SHAREHOLDER-OWNED ELECTRIC UTILITY INDUSTRY

Transcription

1 Credit Ratings Q FINANCIAL UPDATE QUARTERLY REPORT OF THE U.S. SHAREHOLDER-OWNED ELECTRIC UTILITY INDUSTRY

2 About EEI The Edison Electric Institute is the association of U.S. shareholderowned electric companies. Our members serve 95% of the ultimate customers in the shareholder-owned segment of the industry, and represent approximately 70% of the U.S. electric power industry. We also have 79 international electric companies as Affiliate members and more than 190 industry suppliers and related organizations as Associate members. About EEI s Quarterly Financial Updates EEI s quarterly financial updates present industry trend analyses and financial data covering 69 U.S. shareholder-owned electric utility companies. These 69 companies include 59 electric utility holding companies whose stocks are traded on major U.S. stock exchanges and ten electric utilities who are subsidiaries of nonutility or foreign companies. Financial updates are published for the following topics: Dividends Stock Performance Credit Ratings Construction Rate Case Summary Fuel Income Statement Balance Sheet Cash Flow Statement Business Segmentation For EEI Member Companies The EEI Finance and Accounting Division is developing current year and historical data sets that cover a wide range of industry financial and operating metrics. We look forward to serving as a resource for member companies who wish to produce customized industry financial data and trend analyses for use in: We Welcome Your Feedback EEI is interested in ensuring that our financial publications and industry data sets best address the needs of member companies and the financial community. We welcome your comments, suggestions and inquiries. Contact: Mark Agnew Director, Financial Analysis (202) , magnew@eei.org Aaron Trent Senior Financial Analyst (202) , atrent@eei.org Future EEI Finance Meetings EEI International Utility Conference March 15-17, 2009 London Hilton on Park Lane London, United Kingdom For more information about EEI Finance Meetings, please contact Debra Henry, (202) , dhenry@eei.org Investor relations studies and presentations Internal company presentations Performance benchmarking Peer group analyses Annual and quarterly reports to shareholders Edison Electric Institute 701 Pennsylvania Avenue, N.W. Washington, D.C

3 The 69 U.S. Shareholder-Owned Electric Utilities The companies listed below all serve a regulated distribution territory. Other utilities, such as transmission provider ITC Holdings, are not shown below because they do not serve a regulated distribution territory. However, their financial information is included in relevant EEI data sets, such as transmission-related construction spending. Allegheny Energy, Inc. (AYE) ALLETE, Inc. (ALE) Alliant Energy Corporation (LNT) Ameren Corporation (AEE) American Electric Power Company, Inc. (AEP) Avista Corporation (AVA) Black Hills Corporation (BKH) CenterPoint Energy, Inc. (CNP) Central Vermont Public Service Corporation (CV) CH Energy Group, Inc. (CHG) Cleco Corporation (CNL) CMS Energy Corporation (CMS) Consolidated Edison, Inc. (ED) Constellation Energy Group, Inc. (CEG) Dominion Resources, Inc. (D) DPL, Inc. (DPL) DTE Energy Company (DTE) Duke Energy Corporation (DUK) Duquesne Light Holdings, Inc. Edison International (EIX) El Paso Electric Company (EE) Empire District Electric Company (EDE) Energy East Corporation Energy Future Holdings Corp. (formerly TXU Corp.)^ Entergy Corporation (ETR) Exelon Corporation (EXC) FirstEnergy Corp. (FE) FPL Group, Inc. (FPL) Great Plains Energy Incorporated (GXP) Green Mountain Power Corporation Hawaiian Electric Industries, Inc. (HE) IDACORP, Inc. (IDA) Ipalco Enterprises, Inc. Integrys Energy Group, Inc. (TEG) Kentucky Utilities ** KeySpan Corporation (KSE) Louisville Gas and Electric ** Maine & Maritimes Corporation (MAM) MDU Resources Group, Inc. (MDU) MGE Energy, Inc. (MGEE) MidAmerican Energy Company Niagra Mohawk Power Corporation NiSource Inc. (NI) Northeast Utilities (NU) NorthWestern Corporation (NWEC) NSTAR (NST) OGE Energy Corp. (OGE) Otter Tail Corporation (OTTR) Pepco Holdings, Inc. (POM) PG&E Corporation (PCG) Pinnacle West Capital Corporation (PNW) PNM Resources, Inc. (PNM) Portland General Electric Company (POR)* PPL Corporation (PPL) Progress Energy (PGN) Public Service Enterprise Group Inc. (PEG) Puget Energy, Inc. (PSD) SCANA Corporation (SCG) Sempra Energy (SRE) Sierra Pacific Resources (SRP) Southern Company (SO) TECO Energy, Inc. (TE) UIL Holdings Corporation (UIL) UniSource Energy Corporation (UNS) Unitil Corporation (UTL) Vectren Corporation (VVC) Westar Energy, Inc. (WR) Wisconsin Energy Corporation (WEC) Xcel Energy, Inc. (XEL) Note: Includes the 59 shareholder-owned electric utility holding companies plus an additional 10 electric utilities (shown in italics) that are not listed on U.S. stock exchanges for one of the following reasons i. they are a subsidiary of an independent power producer, ii. they are a subsidiary of a foreignowned company, or iii. they were acquired by an investment firm. Stock symbols are shown in parentheses. *Portland General transitioned from private ownership to become a publicly traded company on April 3, The EEI Index includes Portland General beginning on January 1, **Kentucky Utilities and Louisville Gas and Electric, both subsidiaries of E.ON AG, were added to the EEI coverage universe effective January 1, EEI s historical industry financial data now includes their results. ^TXU (now Energy Future Holdings Corp.) was acquired by the Texas Energy Future Holdings Limited Partnership (TEF) on 10/10/2007. TEF was formed by a group of investors led by Kohlberg Kravis Roberts and Texas Pacific Group to facilitate the merger.

4 Companies Listed by Category (as of 12/31/07) Please refer to the Quarterly Financial Updates webpage for previous years lists. iven the diversity of utility holding company corporate G strategies, no single company categorization approach will be useful for all EEI members and utility industry analysts. Never-theless, we believe the following classification provides an informative framework for tracking financial trends and the capital markets response to business strategies as companies depart from the traditional regulated utility model. Regulated Mostly Regulated Diversified 80%+ of total assets are regulated 50% to 80% of total assets are regulated Less than 50% of total assets are regulated Categorization of the 59 publicly traded utility holding companies is based on year-end business segmentation data presented in 10Ks, supplemented by discussions with company IR departments. Categorization of the 10 non-publicly traded companies (shown in italics) is based on estimates derived from FERC Form 1 data and information provided by parent company IR departments. The EEI Finance and Accounting Division continues to evaluate our approach to company categorization and business segmentation. In addition, we can produce customized categorization and peer group analyses in response to member company requests. We welcome comments, suggestions and feedback from EEI member companies and the financial community. Regulated (43 of 69) ALLETE, Inc. Ameren Corporation American Electric Power Company, Inc. Avista Corporation Central Vermont Public Service Corporation CH Energy Group, Inc. Cleco Corporation CMS Energy Corporation Consolidated Edison, Inc. DPL, Inc. Duquesne Light Holdings, Inc. El Paso Electric Company Empire District Electric Company Energy East Corporation Great Plains Energy Incorporated Green Mountain Power Corporation IDACORP, Inc. IPALCO Enterprises, Inc. Kentucky Utilities KeySpan Corporation Louisville Gas and Electric Maine & Maritimes Corporation MGE Energy, Inc. Niagara Mohawk Power Corporation Northeast Utilities NorthWestern Energy NSTAR PG&E Corporation Pinnacle West Capital Corporation PNM Resources, Inc. Portland General Electric Company Progress Energy Puget Energy, Inc. Sierra Pacific Resources Southern Company TECO Energy, Inc. UIL Holdings Corporation UniSource Energy Corporation Unitil Corporation Vectren Corporation Westar Energy, Inc. Wisconsin Energy Corporation Xcel Energy, Inc. Mostly Regulated (19 of 69) Alliant Energy Corporation CenterPoint Energy, Inc. Dominion Resources, Inc. DTE Energy Company Duke Energy Corporation Edison International Entergy Corporation Exelon Corporation First Energy Corp. FPL Group, Inc. Integrys Energy Group MidAmerican Energy Holdings NiSource Inc. OGE Energy Corp. Otter Tail Corporation Pepco Holdings, Inc. PPL Corporation Public Service Enterprise Group, Inc. SCANA Corporation Diversified (7 of 69) Allegheny Energy, Inc. Black Hills Corporation Constellation Energy Group, Inc. Energy Future Holdings * Hawaiian Electric Industries, Inc. MDU Resources Group, Inc. Sempra Energy Note: Based on assets at 12/31/07 * TXU (now Energy Future Holdings Corp.) was acquired by the Texas Energy Future Holdings Limited Partnership (TEF) on 10/10/2007. TEF was formed by a group of investors led by Kohlberg Kravis Roberts and Texas Pacific Group to facilitate the merger.

5 Q Credit Ratings COMMENTARY HIGHLIGHTS nthe industry s average credit rating remained at a solid BBB in 2008 for the fifth consecutive year, although the year s 50 ratings actions were well below the 100+ pace of the past four years. nregulatory relations and weakened financial metrics produced the year s 26 downgrades. Positive regulatory developments along with improved financial metrics, a focus on core utility operations and well-managed capital spending accounted for most of the year s 24 upgrades. nratings outlooks remained mostly negative for the second straight year. Seventy-two percent of outlooks/ watches were negative on December 31, 2008, as 26 negatives outnumbered ten positives. The industry s average credit rating remained at a solid BBB in 2008 for the fifth consecutive year, although the year s 50 ratings actions were well below the 110 to 121 in 2004 through 2007, the 253 in 2002, and the 300 in Regulatory relations and weakened financial metrics produced 26 downgrades 18 in the first half of the year and eight in the second half. Positive regulatory developments along with improved financial metrics, a focus on core utility operations and well-managed capital spending accounted for most of the year s 24 upgrades. Downgrades outnumbered upgrades for the first time since 2004, albeit by the narrow margin of only two. Ratings outlooks remained mostly negative for the second straight year, finishing the year at 72% negative among companies with an outlook. Management of elevated capital 1 BBB-, 21% Below BBB-, 11% Below BBB-, 18 % BBB-, 9% I. S&P I. Utility U.S. Electric Credit Ratings Output (GWh) Distribution BBB, 33% At 12/31/2007 BBB, 35% At 12/31/2005 A or higher, 8% A-, 11% BBB+, 17% A or higher, 12 % A-, 5% BBB+, 21% Below BBB-, 12 % BBB-, 20% Below BBB-, 17 % BBB-, 7% BBB, 27% BBB, 33% At 12/31/2008 A or higher, 9% A-, 9% BBB+, 23% At 12/31/2006 A or higher, 13 % A-, 6% BBB+, 23% Note: Rating applies to utility holding company entity. Source: Standard & Poor s, SNL Financial, EEI Finance Department and company annual reports.

6 2 CREDIT RATINGS II. Credit Rating Agency Upgrades and Downgrades Positive = upgrades Negatives = downgrades Fitch Moody s Standard & Poor s Q Q Q Q Q Q1 2007Q Q Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Fitch (Up) Fitch (Down) Moody s (Up) Moody s (Down) S&P (Up) S&P (Down) Note: Data presents the number of occurrences and includes each event, even if multiple actions occurred for a single company. Source: Fitch Ratings, Moody s, Standard & Poor s III. Total Ratings Actions IV. Direction of Ratings Actions Fitch Moody's Standard & Poor's Total Note: Full year, except where noted. Source: Fitch Ratings, Moody s, Standard & Poor s 70.0% 60.0% 50.0% 40.0% 30.0% 20.0% 10.0% 0.0% % 46.4% % % % % Upgrade % Total Actions Note: Full year, except where noted. Source: Fitch Ratings, Moody s, Standard & Poor s

7 CREDIT RATINGS 3 V. S&P Utility Credit Rating Distribution by Company Category (at period end) 12/31/ /31/ /31/ /31/ /31/ /31/2008 REGULATED A or higher 6 17% 7 19% 7 19% 6 19% 5 13% 4 10% A- 5 14% 4 11% 3 8% 1 3% 2 5% 3 8% BBB+ 6 17% 7 19% 8 22% 7 22% 8 21% 7 18% BBB 6 17% 8 22% 9 25% 9 28% 10 26% 11 28% BBB- 5 14% 5 14% 3 8% 3 9% 7 18% 9 23% Below BBB- 8 22% 5 14% 6 17% 6 19% 6 16% 6 15% Total % % % % % % MOSTLY REGULATED A or higher 3 15% 2 9% 2 9% 1 4% 1 5% 1 5% A- 2 10% 1 4% 0 0% 2 9% 3 16% 4 21% BBB+ 5 25% 6 26% 6 27% 3 13% 4 21% 2 11% BBB 4 20% 7 30% 9 41% 11 48% 6 32% 9 47% BBB- 2 10% 7 30% 0 0% 1 4% 4 21% 3 16% Below BBB- 4 20% 0 0% 5 23% 5 22% 1 5% 0 0% Total % % % % % % DIVERSIFIED A or higher 0 0% 0 0% 0 0% 1 9% 0 0% 0 0% A- 2 13% 1 9% 1 9% 0 0% 1 11% 0 0% BBB+ 4 27% 3 27% 2 18% 4 36% 3 33% 2 29% BBB 5 33% 5 45% 5 45% 3 27% 2 22% 2 29% BBB- 2 13% 1 9% 2 18% 2 18% 2 22% 2 29% Below BBB- 2 13% 1 9% 1 9% 1 9% 1 11% 1 14% Total % % % % 9 100% 7 100% Note: At period end. Percentages may not total 100% due to rounding. Source: Standard & Poor s, SNL Financial, EEI Finance Department expenditure (capex) plans continues to be closely monitored by the ratings agencies. Although it has not yet impacted ratings actions, the credit crisis that erupted in late 2008 is a concern given the industry s elevated capital spending and associated capital needs. Despite Q4 s market turmoil, the quarter saw only three downgrades and all related to a merger announcement. The industry s average credit rating is based on the unweighted average of all parent company ratings. We capture upgrades and downgrades at the subsidiary level, allowing for multiple actions under a single parent holding company to count in the upgrade/downgrade data. Ratings Analysis by Company Category Table V presents the distribution of credit ratings over time for the shareholder-owned electric utilities organized into Regulated, Mostly Regulated and Diversified categories. Ratings are based on S&P long-term issuer ratings at the holding company level, with only one rating assigned per company. At December 31, 2008, the categories had the following average ratings: Regulated = BBB, Mostly Regulated = BBB/ BBB+, and Diversified = BBB-. This compares to a BBB rating for each category on December 31, These changes are due to a shift in companies among the various categories for 2008, as opposed to upgrades or downgrades within a category. Notably, the migration of Duke (A-) and

8 4 CREDIT RATINGS Dominion (BBB) to the Mostly Regulated category from the Diversified category impacted the group averages, as did the move from Mostly Regulated to Regulated by Avista (BBB-), PNM Resources (BB-) and TECO (BBB-), and Alliant s (BBB+) move from Regulated to Mostly Regulated. Handful of Companies Dominate 2008 Actions If 2008 s ratings actions (compiled at the subsidiary level) are rolled up to the parent level, four companies accounted for 63% (15 of 24) of the year s upgrades and 85% (22 of 26) of downgrades. Multiple upgrades occurred at Ameren (8), NV Energy (3), Exelon (2) and Westar (2). Multiple downgrades were seen at PNM (6), ConEd (6), Constellation (3), Exelon (3), IDACORP (2) and AEP (2). Rate Case Developments Spur Downgrades Over two-thirds of the industry s downgrades occurred during the first half of the year and were mostly prompted by rate case developments and the ratings agencies perception of strained regulatory relations in some cases. Consolidated Edison and PNM Resources led all companies with six downgrades each in the year s first half, followed by American Electric Power and IDACORP, with two each. Consolidated Edison (ConEd) and two of its subsidiaries were downgraded by both Fitch and S&P in March following rate case activity with the New York Public Service Commission (NYPSC). Fitch lowered the ratings of the parent company and subsidiary Consolidated Edison of New York (CECONY) from A to BBB+, a two-notch drop. The company s Orange and Rockland Utilities subsidiary was downgraded from A to A-. The ConEd and CECONY downgrades reflected projected cash flow credit measures (such as debt to operating cash flow and cash flow interest coverage) consistent with Fitch s BBB rating given the relatively high forecast capital expenditures from CECONY s business and cash flow comprise over 90% of the ConEd group s consolidated business and cash flow. Raising capital to fund the utility s more than $2 billion annual capex budget may be more difficult as a result of the relatively low 9.1% return on equity (ROE) authorized by the NYPSC and the uncertainty from the commission s announced investigation of $1.6 billion of capital spending in S&P downgraded ConEd and the same two subsidiaries on March 25, each from A to A-. S&P commented that the downgrades reflected expectations that ConEd s financial measures would be commensurate with an A- rating after NYPSC s rate order for CECONY became effective in April. Key factors cited by S&P were ConEd s debt leverage, cash flow and recovery of capital expenditures. S&P went on to say that ConEd s regulatory relations will likely be a key factor driving any future rating actions. VI. Credit Ratings Scales Investment Grade Moody s S&P Fitch Aaa AAA AAA Aa1 AA+ AA+ Aa2 AA AA Aa3 AA- AA- A1 A+ A+ A2 A A A3 A- A- Baa1 BBB+ BBB+ Baa2 BBB BBB Baa3 BBB- BBB- Speculative Grade Moody s S&P Fitch Ba1 BB+ BB+ Ba2 BB BB Ba3 BB- BB- B1 B+ B+ B2 B B B3 B- B- Caa1 CCC+ CCC+ Caa2 CCC CCC Caa3 CCC- CCC- Ca CC CC C C C Default Moody s S&P Fitch Source: Fitch Ratings, Moody s, Standard & Poor s C D D In March, Fitch downgraded PNM Resources and its subsidiaries Public Service Company of New Mexico and Texas New Mexico Power Company from BBB- to BB+, placing all three companies just below investment grade. According to Fitch, the lower ratings reflect operating challenges at PNM along with the company s credit metrics and business risk profile. A major concern was the prospect for approval of PNM s request for a rate increase along with a fuel-adjustment clause that would allow recovery of higher

9 CREDIT RATINGS 5 fuel and purchased power costs. In April, Moody s downgraded Public Service Company of New Mexico from Baa2 to Baa3, the lowest notch of investment-grade status. The downgrade followed a decision by the New Mexico Public Regulation Commission to authorize an approximate $35 million (about 6%) increase in PSNM s base electric retail rates. The authorized increase was less than half of the base rate increase requested and less than 25% of the company s estimated total requested increase, including the impact of a fuel adjustment clause. In May, Standard & Poor s lowered the ratings of PNM Resources and both subsidiaries to speculative grade, from BBB- to BB-. According to S&P, the ratings action reflected operational challenges coupled with a deterioration in financial metrics and protracted proceedings with regulators. Other Downgrades Seven of the industry s eight downgrades in the second half of 2008 reflected unique circumstances at three companies. Constellation Energy and its Baltimore Gas and Electric subsidiary were each downgraded by S&P on August 13 from BBB+ to BBB. The lower ratings related to Constellation s energy trading business and its disclosure of incremental downgrade collateral requirements. S&P referred to potential collateral calls in the event of Constellation s downgrade to speculative grade. Fitch also lowered its rating of Constellation Energy on August 19 from BBB+ to BBB, citing the significant volatility and business risk in the company s commodity energy business and the expansion of its global commodity business segment relative to other less volatile components of its business portfolio. In other Q3 activity, S&P downgraded Otter Tail by two notches in September, from BBB+ to BBB-. S&P related the downgrade to the company s growing interest in non-utility businesses and to expected credit measures that are more consistent with a BBB- rating, specifically the cash flow at Otter Tail s unregulated Varistar subsidiary. Varistar s businesses include plastic pipe manufacturing, healthcare operations, metal manufacturing and food processing. In October, S&P downgraded Exelon Corp. and subsidiaries Exelon Generation and PECO Energy, based on Exelon s announced acquisition of NRG Energy in an allstock offer. All three companies fell from BBB+ to BBB and, along with subsidiary Commonwealth Edison, were placed on Credit Watch Negative status. According to S&P, by proposing a transaction with a merchant power generation company that has a significantly weaker business profile than Exelon, Exelon has shown a willingness to increase its own business profile and has relaxed its policy of limiting debt to levels commensurate with a BBB+ rating. Upgrades Driven by Positive Regulatory Relations The majority of 2008 s 24 upgrades were due to positive regulatory developments, with many citing a specific rate case. In the second half of the year, two-thirds of the upgrades (10 of 15) related to favorable regulatory developments in Illinois. In September, S&P upgraded four Ameren subsidiaries [Central Illinois Light (CILCO), Central Illinois Public Service (CIPS), CILCORP, and Illinois Power] and Exelon subsidiary Commonwealth Edison. All jumped two notches from BB to BBB-. The moves reflected S&P s expectation that Illinois regulatory and political environment will remain reasonably supportive of investment-grade credit quality in pending rate cases. Illinois Commerce Commission administrative law judges endorsed electric and gas delivery service rate increases of $163.5 million, nearly 80% of the revised amount sought by the Ameren utilities. Unlike the rate increases sought in that became highly politicized, these saw little controversy. In October, Fitch upgraded the same four Ameren utilities from BB+ to BBB, citing an expected positive financial impact from electric and gas rate case decisions. Both CILCO and CIPS were granted electric and gas rate increases effective October 1, 2008, which Fitch expects will improve credit quality measures to a level supportive of the new ratings. The ratings also recognize the reduction in business risk that resulted from the 2007 Illinois Settlement Agreement, which affirmed the Illinois utilities right to recover purchased power costs in rates. Also in October, Moody s upgraded Commonwealth Edison from Ba1 to Baa3, reflecting its assessment of the company s distribution rate case in September. In December, S&P raised the rating of UniSource subsidiary Tucson Electric Power (TEP) from BB to BB+ in reaction to the Arizona Corporate Commission s approval of TEP s rate case settlement. S&P cited the re-regulation of TEP s generation operations, which should allow the company to better match revenues with expenses. Positive regulatory relations and stronger financial metrics prompted four upgrades in Q2. In May, S&P upgraded Sierra Pacific Resource (which changed its name in September 2008 to NV Energy ) and its Nevada Power and Sierra Pacific Power subsidiaries, citing the substantial progress made by the parent company to secure additional generating resources, hedge market exposures, reduce leverage and manage regulatory risk by working with the Nevada utility commission and legislature on timely cost recovery. NV Energy has made steady progress in reducing its dependence on the volatile wholesale power market through a large power plant construction and power acquisition program and a hedging policy that mitigates 75% of market fluctuations in advance of expected loads.

10 6 CREDIT RATINGS In June, Moody s upgraded ALLETE to Baa1 from Baa2 due to the company s focus on growth opportunities primarily within its existing energy business, its wellcapitalized balance sheet, robust financial metrics, supportive regulatory environment and sound liquidity profile. Moody s had stated that a venture outside ALLETE s core business could have weakened its credit profile and increased business risk. Upgrades Tied to Effective Capex Management Fitch assigned three upgrades in Q3 that related to effective capex management. Fitch upgraded Pacific Gas & Electric (PG&E) in July from BBB+ to A-, expressing confidence in the company s ability to manage its large capex program, which is expected to average $3.3 billion per year through Fitch said that the new rating assumes PG&E can recover fuel and power supply costs on a timely basis. Other factors cited in the upgrade included pre-approval of construction spending, regulatory balancing accounts, forwardlooking test years, and Fitch s expectation of a continued balanced use of debt and equity by PG&E, similar to the company s current capital structure. On August 25, Fitch upgraded Westar Energy and subsidiary Kansas Gas & Electric to investment-grade status, from BB+ to BBB-. Fitch cited Westar s conservative management, strategic focus on credit quality, and growth opportunities through investment in its Kansas-based electric utility as factors in the decision. Although Fitch said that Westar s large capex program is subject to execution and regulatory risk, it believes these risks are manageable given Westar s flexible capex strategy and a significantly improved regulatory environment in Kansas since 2002, when new management adopted the current utility-focused business strategy. Recovery mechanisms adopted in recent years in Kansas include pre-approval of planned investment projects, recovery of construction-work-in-progress (CWIP), and riders to pass through environmental and FERCapproved transmission investments. Fitch believes these mechanisms will mitigate regulatory lag and increase the likelihood of timely recovery of capital investments in rates. Westar s capex program, projected to average more than $800 million annually during , emphasizes infrastructure investment, new transmission, environmental upgrades and wind and natural-gas fired peaking generation. Fitch expects the program will be funded with a balanced mix of debt and equity, and that the plan is consistent with Kansas state energy policy goals. Core Focus and Improved Financials Drive Q1 Upgrades In February, S&P upgraded Avista Corp. to investment grade, from BB+ to BBB-, citing the company s general rate case settlement in Washington and the sale of Avista Energy as major factors in the upgrade. Avista had previously emphasized the importance of an investment-grade rating, and said it will continue to work on strengthening its financial condition as it makes further investments in utility infrastructure, including hydro generation plant enhancements and its transmission and distribution systems. Company strategy is focused on its core electric and gas utility businesses in the Pacific Northwest. Avista finalized the divestiture of its energy marketing and resource management subsidiary, Avista Energy, in July 2007, and has improved regulatory mechanisms in Washington and Idaho that allow it to recover rising power costs. S&P upgraded NorthWestern Energy in March, citing a steady improvement in the company s financial profile as well as the paring of its non-regulated operations. S&P also noted that NorthWestern has shown a commitment to focus on regulated utility operations, including managing regulatory risk and resolving pending litigation. In July 2007, NorthWestern announced the termination of its proposed merger with Babcock & Brown Infrastructure after resistance from the Montana Public Service Commission. In March, Fitch raised TECO Energy s rating from BB+ to BBB-. The upgrade reflects TECO s leverage reduction resulting from the pay-down of debt with proceeds from the $405 million sale of TECO s barge operations, along with earlier debt reduction. Additionally, TECO reduced business risk over the past few years through sales of non-regulated operations and a focus of its Florida utility operations. Fitch commented on TECO s strong liquidity position and the fact that there is no long-term debt maturing at the parent holding company in 2008 and 2009, as the company has extended the average life of its debt through refinancing. Other Q upgrades include S&P s upgrade of Aquila from B+ to BB- and Moody s upgrade of AEP subsidiary Appalachian Power from Baa3 to Baa2. Focus Remains on Elevated Capex Rising capex and the accompanying debt have become more frequently cited as a concern by the ratings agencies. This growing trend was noticeable as 2007 progressed and continued throughout Whether in the form of a downgrade, a negative outlook/watch, or a general comment on future concerns, the ratings agencies have noted the impact of high and rising capital spending and the associated debt on key credit metrics. As noted earlier, well-managed capital spending programs have generated upgrades and positive comments for some companies. Industry-wide capex began to rise in 2005, which saw the first significant full-year increase since the industry s competitive generation build-out peaked in 2001 ($56.8 billion was spent on capex in 2001). The $77.8 billion spent during the 12 months ended September 30, 2008 was $37.6

11 CREDIT RATINGS 7 billion, or 94%, above the $40.2 billion spent during the 12- month period that ended on September 30, 2004, the cyclical low following the competitive generation build-out. Industry-wide capex grew 15% to $69.1 billion in 2007 over the $59.9 billion spent in Measured on a trailing 12-month basis, capital expenditures have risen each of the last 16 quarter-ending periods, reflecting the industry s increased spending on environmental compliance, transmission and distribution upgrades, and generation capacity. Based on data collected by EEI in the summer of 2008, the industry s total capex was projected to be $86.5 billion in 2008 and approximately $84 billion in both 2009 and Due to the worsening of the financial crisis in Q4 2008, about two-thirds of companies made downward revisions to 2009 projections, with the aggregate industry decrease exceeding 10%. Similar downward revisions are expected for 2010, although details have not yet been released by many companies. Even with these significant revisions, capex levels remain high by historical standards. Debt Costs Rise in Financial Crisis Although utility credit ratings have yet to be impacted by the economy-wide financial crisis, the industry is feeling the impact of the crisis. Based on data compiled by EEI, average bond spreads for utilities relative to 10-year U.S. Treasuries more than doubled from an average of 231 basis points (bps) in the third quarter of 2008 to 484 bps in Q The comparison is more pronounced relative to precrisis periods, as spreads averaged 160 bps in Q4 2007, 103 bps in Q and 76 basis points in Q (Utility bonds with maturities ranging from 8.5 to 11.5 years were used in the study). Bond spreads were fairly consistent from 2004 through the first half of 2007, ranging within a band of bps before climbing in the second half of 2007as global credit markets began to show strains, and then soaring in Q along with global bond spreads. Some of the spread widening was due to a drop in 10- year Treasury yields during the fourth quarter from 3.83% on September 30 to just above 2% by mid-december. The drop was accompanied, however, by an increase in utilities borrowing costs. The average coupon rate for electric utilities 10-year bond offerings rose to 8.2% in Q4 2008, the highest level in at least five years. In comparison, the average for new issues in Q3, Q2 and Q were 6.2%, 6.1% and 5.7% respectively. This sharp spike softened at the beginning of 2009, with coupons averaging 6.7% through January 27. While electric utilities with a regulated framework have generally been able to complete bond offerings throughout the crisis, access to long-term capital has become a challenge for some power companies with a nonregulated focus. Ratings Outlooks Mostly Negative Seventy-two percent of outlooks/watches were negative on December 31, 2008, as 26 negative outlooks/watches outnumbered ten positive ones. This compares with 63% on September 30, 73% on June 30, 76% on March 31, and 65% at the close of This measure was predominantly negative throughout Two companies with pending mergers/acquisitions Puget Energy (to be acquired by Macquarie Infrastructure Partners) and Exelon Corp. (acquiring NRG Energy) were among those with a Watch Negative status from at least one of the three major ratings agencies at the end of Q4. Energy East (acquired by Iberdrola on September 17), Great Plains Energy and Black Hills Corporation (both completed separate acquisitions of Aquila on July 14) changed from a negative to a stable outlook during the third quarter, based on their completed mergers. Although Mid- American Energy s merger with Constellation Energy was cancelled on December 18, both companies continued to have a Watch Negative status from S&P at year end. The deal was terminated in favor of an agreement with French energy company EDF Group. EDF will purchase 49.99% of Constellation Energy Nuclear Group, a subsidiary that owns Calvert Cliffs Nuclear Power Plant, for $4.5 billion, structured as a new joint venture between the two companies. Going forward, the timely recovery of fuel costs and elevated capital expenditures remain cash flow challenges for many utilities, and the impact of industry consolidation continues to be an influence on ratings outlooks.