Docket No. 0000--ER- Witness: Bruce N. Williams BEFORE THE WYOMING PUBLIC SERVICE COMMISSION ROCKY MOUNTAIN POWER Rebuttal Testimony of Bruce N. Williams September 0
Q. Are you the same Bruce N. Williams who previously submitted direct testimony in this case on behalf of Rocky Mountain Power ( RMP or the Company )? A. Yes. PURPOSE AND SUMMARY Q. What is the purpose of your rebuttal testimony? A. The purpose of my rebuttal testimony is to: 0 provide an updated cost of debt that reflects recent financing activities and updated interest rates which results in a reduced overall cost of capital in this case; respond to Office of Consumer Advocate ( OCA ) witness Mr. Anthony Ornelas proposed cost of debt; and comment on the pro forma credit metric analysis used by Wyoming Industrial Energy Consumers ( WIEC ) witness Mr. Michael Gorman to support his recommended overall rate of return. 0 Company witness Dr. Samuel C. Hadaway will address return on equity issues raised by Messrs. Gorman and Ornelas. Q. Please summarize your testimony. A. I am sponsoring a change to the cost of debt that results in a decrease to the requested rate relief in this case of approximately $0. million. Additionally, I show why Mr. Ornelas proposed cost of debt is not appropriate and should not be used by the Commission. Finally, I comment on Mr. Gorman s discussion concerning financial integrity and explain why his credit metric analysis cannot Page Rebuttal Testimony of Bruce N. Williams
be relied upon. I show that his analysis is not consistent with Standard & Poor s ( S&P s ) current methodology and assessment for the Company. Q. Are there items in which Messrs. Gorman and Ornelas are in agreement with you? A. Yes. Most significantly the parties are in agreement with the Company s recommended capital structure as discussed in my direct testimony. No party is proposing any adjustments to the capital structure replicated below: Component Percent of Total Long Term Debt. % Preferred Stock 0.0 % Common Equity. % 00.00 % 0 Mr. Gorman proposes no adjustment to the Company s cost of debt recommended in my direct testimony. WIEC Exhibit No. 00, page, lines through. UPDATED COST OF DEBT Q. Please discuss the recent financing work that the Company has completed. A. There were two significant financing activities that the Company completed earlier this year subsequent to my preparing and filing direct testimony in this case. First, during June 0, the Company completed the issuance of new long-term debt $0 million of. percent first mortgage bonds. This issuance of new long-term debt was included as a pro forma issuance in my direct testimony, which I update here to include the actual interest rate and related issuance costs. To properly reflect this financing, I have removed the pro-forma Page Rebuttal Testimony of Bruce N. Williams
financing that was in the Company s proposed cost of long-term debt and 0 0 included this new issuance. While I disagree with Mr. Ornelas proposed cost of long-term debt for other reasons, he has accurately included this recent debt issuance in his proposed cost of debt. Exhibit 0. page, line no.. Secondly, I have made a series of cost reductions related to letters of credit that the Company modified earlier this year. These letters of credit provide liquidity and credit support for certain series of the floating rate tax-exempt bond portfolio and replaced similar but higher cost letters of credit. The Company was able to negotiate new, multi-year letters of credit at more favorable pricing. As such, I have updated the cost of debt to capture these lower costs for the benefit of customers. Again, although I disagree with Mr. Ornelas proposed cost of debt for other reasons, he has accurately updated for these changes. Q. Please describe the interest rates that you updated. A. I have updated the projected rates for the Company s variable rate long-term debt. As more fully described in my direct testimony, the Company will have on average $0 million in principal amount of these variable rate securities during the test period of calendar year 0 ( Test Period ). The projected interest rate on these securities is based on forward 0-day London Interbank Offer Rate ( LIBOR ) rates at each future quarter-end spanning the test period. I have utilized current forward 0 day LIBOR rates during the Test Period and also updated the historical relationship between the interest rates on the securities and the corresponding LIBOR rates. As shown in Exhibit RMP (BNW-R) the average historical relationship for these securities is now percent of the See Exhibit RMP (BNW-) page, line no.. Page Rebuttal Testimony of Bruce N. Williams
0 corresponding 0 day LIBOR rate. In addition, Exhibit RMP (BNW-R) shows that although forward LIBOR rates during the Test Period are now lower than when my direct testimony was prepared, they are still projected to be significantly higher than current rates. The result of this update is that these securities are now expected to have an average cost of.% (including the cost of issuance and credit enhancements) during the Test Period. Importantly, the Company continues to consistently utilize the same methodology to project the costs of the securities. I will discuss later in my testimony an alternative proposed by Mr. Ornelas and why it is not appropriate. Q. What is the new cost of debt? A. As shown in Exhibit RMP (BNW-R), the updated cost of long-term debt is now.%. The Company s recently completed financings and updated interest rates have reduced the cost of debt by approximately basis points (0.0 percent). COMPANY S UPDATED OVERALL COST OF CAPITAL Q. Are you proposing a new overall cost of capital in this proceeding? A. Yes. The Company has updated the cost of long-term debt and combined with the capital structure produces an updated overall cost of capital as shown below. Updated Overall Cost of Capital Component Percent of Total Cost Weighted Average Long Term Debt. %. %. % Preferred Stock 0.0 %. % 0.00 % Common Equity. %. %.0 % 00.00 %. % The updated overall cost of capital is.%, a reduction of. basis points (0.0 percent) from the Company s direct testimony. This reduction in the Page Rebuttal Testimony of Bruce N. Williams
0 0 overall cost of capital is estimated to reduce the revenue requirement in this case by approximately $0. million. Mr. Steven R. McDougal provides the final revenue requirement calculation with all of the rebuttal adjustments. REPLY TO OCA S PROPOSED COST OF DEBT Q. What is OCA s proposed cost of debt? A. Mr. Ornelas is proposing a cost of debt of.% at OCA Exhibit 0. page, line. Q. Do you agree with Mr. Ornelas s recommendation? If not, why not? A. No. While our respective costs of debt are relatively close, there is one significant and important difference. That difference is how to set the interest rate on the Company s variable rate debt. As I explained in my direct testimony and earlier in my rebuttal testimony, the Company s method of determining the variable interest rates during the Test Period has been used consistently when determining the cost of debt in previous Wyoming general rate cases and in the Company s other jurisdictions. Mr. Ornelas would deviate from that consistent practice and proposes utilizing the cost of the variable rate securities on June, 0. There are at least two significant issues with Mr. Ornelas s proposal. First, Mr. Ornelas s arbitrary cost determination date is outside the Test Period in this case and approximately months prior to the end of the Test Period (December, 0). The Company s method exclusively uses the short-term interest rate during the Test Period. Secondly, by using historical June 0 rates, Mr. Ornelas is precluding Page Rebuttal Testimony of Bruce N. Williams
0 the Company from the opportunity to recover increases in short-term interest rates that are widely expected by the financial markets. Currently, it is very difficult to find a financial publication that doesn t expect the Federal Reserve to start raising its target for short-term rates. Market prognosticators are largely debating the timing of the first increase by the Federal Reserve, and not if rates will increase. Mr. Ornelas s view that the Federal Reserve is unlikely to begin to increase interest rates is not the view of most market participants and cost-of-capital witnesses, including Mr. Gorman or Dr. Hadaway. WIEC S FINANCIAL INTEGRITY MODELS AND RATIOS Q. Please comment on Mr. Gorman s testimony concerning financial integrity and his credit metric analysis. A. Mr. Gorman s analysis is fatally flawed and cannot be relied upon to verify claims that his proposed rate of return ( ROR ) would support the Company s credit ratings. First, Mr. Gorman s model does not include any of the financing costs associated with construction work in progress ( CWIP ). The Company must finance the costs of assets while they are under construction and the Company incurs interest expense on the debt portion of these financings. To compensate the Company, there is an allowance for funds used during construction ( AFUDC ) Mr. Gorman cites Blue Chip Financial Forecasts projected 0 year Treasury bond yield of.0% vs. the current 0-year Treasury bond yield of.%. WIEC Exhibit No. 00 page, lines through. Dr. Hadaway discusses the expectation for shorter-term rates to increase significantly more relative to long-term rates in Direct Testimony, page - Table and in rebuttal testimony as shown in Exhibit RMP (SCH-R). Mr. Gorman s conclusion that ratings would not change is unclear. Mr. Gorman argues that certain ratios would support an investment grade credit rating. See WIEC Exhibit No. 00 page lines through 0. This leaves open the possibility of a multi-step downgrade from the Company s current bond ratings although ultimately still retaining an investment grade credit rating. Page Rebuttal Testimony of Bruce N. Williams
0 that is a non-cash offset to interest expense. As AFUDC is non-cash, it is not included in the rating agencies determination of earnings before interest, taxes, depreciation and amortization ( EBITDA ) or funds from operations ( FFO ). However, the debt and corresponding interest costs on the financings are real and are included in the rating agencies credit ratio analysis. By ignoring the financing cost of CWIP, Mr. Gorman s models have understated debt and interest expense, thereby producing erroneously high debt and interest coverage ratios. Further, Mr. Gorman does not include the full amount of adjustments that S&P makes when it assessed the Company s creditworthiness. The result is that Mr. Gorman has included less than one-quarter of the amount of S&P s debt adjustments. Q. Which specific rating agency adjustments does Mr. Gorman omit from his analysis? A. The table below lists each debt adjustment that S&P made at December, 0 and compares those amounts to what Mr. Gorman has included in his credit metrics in WIEC Exhibit No. 00. page of. For purposes of this rebuttal testimony, I am focusing on the more significant adjustments. I do not address the adjustment related to preferred stock due to the immaterial amount that remains outstanding. Page Rebuttal Testimony of Bruce N. Williams
0 As can be seen in the table, Mr. Gorman has correctly included S&P s adjustments related only to operating leases and purchase power agreements but omitted the balance of S&P s debt adjustments. The result is that Mr. Gorman s credit analysis model ignores $ million of debt adjustments that S&P included in its credit analysis. For all of these reasons, Mr. Gorman s credit metric analysis is unreliable. Mr. Gorman s conclusion that his proposed overall ROR will produce financial results that support the Company s credit ratings is unsubstantiated. Q. Does this conclude your rebuttal testimony? A. Yes. Page Rebuttal Testimony of Bruce N. Williams