20170925Utah_Attachment 5.3.pdf

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JUNE 23,2017 INFRASTRUCTURE
MOODY'S
INVESTORS SERVICE
RATING Regulated Electric and Gas Utilities
METHODOLOGY
Table of Contents:This rating methodology replaces "Regulated Electric and Gas Utilities"last revised on
SUMMARY 1 December 23,2013 We have updated some outdated links and removed certain issuer-
ABOUT THE RATED UNIVERSE 3 specific informationABOUTTHISRATINGMETHODOLOGY4
DISCUSSION OF THE GRID FACTORS 6
APPENDIX A:REGULATEDELECTRIC
AND GAS UTILITIESMETHODOLOGY Summ<wyFACTORGRID29-
APPENDIX B:APPROACH TO RATINGS
WITHINAUTILITYFAMILY 35 This rating methodology explains our approach to assessing credit risk for regulated electric and gas
APPENDIX C:BRIEF DESCRIPTIONSOF Utilitiesglobally.This document does not include an exhaustive treatment of all factors that areTHETYPESOFCOMPANIESRATED
UNDERTHIS METHODOLOGY 38 reflected in our ratings but should enable the readerto understand the qualitative considerations
APPENDIXD:KEYINDUSTRY ISSUEs and financial information and ratios that are usually most important for ratings in this sector.
OVERTHE INTERMEDIATETERM 40
APPENDIX E:REGIONAL AND OTHER ...--
CONSIDERATIONS 44 This report includes a detailed rating grid which is areference tool that can be used to approximate
APPENDIX F:TREATMENTOF POWER credit profiles within the regulated electric and gas utility sector in most cases.The grid provides
PURCHASEAGREEMENTS("PPAS")46 Summarized guidance for the factors thatare generally most important in assigning ratings to
METHODS FOR ESTIMATING A Companies in the regulated electric and gas utility industry.However,the grid is a summary thatLIABILITYAMOUNTFORPPAS48
MOODY'S RELATED RESEARCH 49 does not include every rating consideration.The weights shown for each factor in the grid represent
an approximationof their importance for rating decisions but actual importance may vary
substantially.In addition,the grid in this document uses historical resultswhile ratings are based on
Analyst Contacts:our forward-looking expectations.As a result,the grid-indicatedrating is not expected to match the
NEW YORK +1.212.553.1653 actual rating of each company.
Michael G.Haggarty +1.212.553.7172
Associate Managing Director
[e-mail]
Jim Hempstead +1,212.553.4318
Managing Director-Utilities
[e-mail]
Walter Winrow +1,212.553,7943
Managing Director-Global Project and
Infrastructure Finance
[e-mail]
Jeffrey Cassella +1.212.553.1665
Vice President -Senior Analyst
[e-mail]
Natividad Martel +1.212.553.4561
Vice President -Senior Analyst
[e-mail]
»contacts continued on the last nace
i This update may not be effective in some jurisdictions until certain requirements are met.
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The grid contains four key factors that are important in our assessment for ratings in theregulated electric
and gas utility sector:
1.Regulatory Framework
2.Ability to Recover costs and Earn Returns
3.Diversification
4.Financial Strength
Some of these factors also encompass a number of sub-factors.There is also a notching factor for holding
company structuralsubordination.
This rating methodology is not intended to be an exhaustive discussion of all factors that ouranalysts
consider in assigning ratings in this sector.We note that our analysis for ratings in this sectorcovers factors
that are common across all industries such as ownership,management,liquidity,corporatelegal structure,
governance and country related risks which are not explained in detail in this document,as well as factors
that can be meaningful on a company-specific basis.Our ratings consider these and other qualitative
considerations that do not lend themselves to a transparent presentation in agrid format.The grid used for
this methodology reflects a decision to favor a relatively simpleand transparent presentation rather than a
more complex grid that might map grid-indicated ratingsmore closely to actual ratings.
Highlights of this report include:
»An overview of the rated universe
»A summary of the rating methodology
»A discussion of the key rating factors that drive ratings
»Comments on the rating methodology assumptions and limitations,including a discussionof rating
considerations that are not included in the grid
The Appendices show the full grid (Appendix A),our approach to ratings within a utility family (Appendix B),
a description of the various types of companies rated under this methodology (Appendix C),key industry
issues over the intermediate term (Appendix D),regional and other considerations(Appendix E),and
treatment of power purchase agreements (AppendixF).
This methodology describes the analytical framework used in determining credit ratings.Insome instances
our analysis is also guided by additional publications which describe our approach for analytical
considerations that are not specific to any single sector.Examples of such considerations include but are not
limited to:the assignment of short-term ratings,the relative ranking ofdifferent classes of debt and hybrid
securities,how sovereign credit quality affects non-sovereign issuers,and the assessment of credit support
from other entities.A link to documents that describe our approach to such cross-sector credit rating
methodological considerations can be found in the Related Research section of this report.
This publication does not announce
a credit rating action.For any
credit ratings referenced in this
publication,please see the ratings
tab on the issuer/entity page on
www.moodys.com for the most
updated credit rating action
information and rating history.
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About the Rated Universe
The Regulated Electric and Gas Utilities rating methodology applies to rate-regulated2electric and gas
utilities that are not Networks3.Regulated Electric and Gas Utilities are companies whose predominant45
business is the sale of electricity and/or gas or related services under arate-regulated framework,in most
cases to retail customers.Also included under this methodology arerate-regulated utilities that own
generating assets as any material part of their business,utilities whose charges orbills to customers include
a meaningful component related to the electric or gas commodity,utilitieswhose rates are regulated at a
sub-sovereign level (e.g.by provinces,states or municipalities),andcompanies providing an independent
system operator function to an electric grid.Companies rated underthis methodology are primarily rate-
regulated monopolies or,in certain circumstances,companies thatmay not be outright monopolies but
where government regulation effectively sets prices and limits competition.
This rating methodology covers regulated electric and gas utilities worldwide.These companiesare engaged
in the production,transmission,coordination,distribution and/or sale of electricityand/or natural gas,and
they are either investor owned companies,commercially oriented governmentowned companies or,in the
case of independent system operators,not-for-profit or similar entities.As detailed in Appendix C,this
methodology covers a wide variety of companies active in the sector,including vertically integrated utilities,
transmission and distribution utilities with retailcustomers and/or sub-sovereign regulation,local gas
distribution utility companies (LDCs),independentsystem operators,and regulated generation companies.
These companies may be operating companiesor holding companies.
An over-arching consideration for regulated utilities is the regulatory environment in whichthey operate.
While regulation is also a key consideration for networks,a utility's regulatory environment is in comparison
often more dynamic and more subject to political intervention.The directrelationship that a regulated
utility has with the retail customer,including billing for electric or gas supply thathas substantial price
volatility,can lead to a more politically charged rate-setting environment.Similarly,regulation at the sub-
sovereign level is often more accessible for participation by interveners,including disaffected customers and
the politicians who want their votes.Our views of regulatoryenvironments evolve over time in accordance
with our observations of regulatory,political,and judicial eventsthat affect issuers in the sector.
This methodology pertains to regulated electric and gas utilities and excludes the following typesof issuers,
which are covered by separate rating methodologies:Regulated Networks,Unregulated Utilities and Power
Companies,Public Power Utilities,Municipal joint Action Agencies,Electric Cooperatives,Regulated Water
Companies and Natural Gas Pipelines."
The Regulated Electric and Gas Utility sector is predominantly investment grade,reflecting thestability
generally conferred by regulation that typically sets prices and also limits competition,such that defaults
have been lower than in many other non-financial corporate sectors.However,the nature ofregulation can
2 Companies in many industries are regulated.We use the term rate-regulatedto distinguish companies whose rates (by which we also mean tariffs or revenues in
general)are set by regulators.
3 Regulated Electric and Gas Networks are companies whose predominantbusiness is purely the transmission and/ordistribution of electricity and/or natural gas
without involvement in the procurement or sale of electricity and/orgas;whose charges to customers thus do not include a meaningful commodity cost component;
which sell mainly (or in many cases exclusively)to non-retail customers;and which are rate-regulatedunder a nationalframework,
4 We generally consider a company to be predominantly a regulated electric and gas utility when a majority of its cash flows,prospectively and on a sustained basis,
are derived from regulated electric and gas utility businesses,Since cash flows can be volatile (such that a company might have a majority of utility cash flows
simply dueto a cyclical downturn in its non-utility businesses),we may also consider the breakdown of assets and/ordebt of a company to determine which business
is predominant.
6 A link to credit rating methodologies covering these and other sectors can be found in the Related Research section of this report.
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vary significantly from jurisdiction to jurisdiction.Most issuers at the lower end of the ratings spectrum
operate in challenging regulatory environments.
About this Rating Methodology
This report explains the rating methodology for regulated electric and gas utilities in sixsections,which are
summarized as follows:
1.Identification and Discussion of the Rating Factors in the Grid
The grid in this rating methodology focuses on four rating factors.The four factors are comprisedof sub-
factors that provide further detail:
Factor /Sub-Factor Weighting -Regulated Utilities
Broad Rating Factor Sub-FactorBroadRatingFactorsWeightingRatingSub-Factor Weighting
Regulatory Framework 25%Legislative and Judicial Underpinnings of the Regulatory 12.5%
Framework
Consistency and Predictability of Regulation 12.5%
Ability to Recover Costs 25%Timelinessof Recovery of Operating and Capital Costs 12.5%
and Earn Returns Sufficiency of Rates and Returns 12.5%
Diversification 10%Market Position 5%*
Generation and Fuel Diversity 5%**
Financial Strength,Key 40%
Financial Metrics CFO pre-WC +Interest/Interest 7.5%
CFO pre-WC /Debt 15.0%
CFO pre-WC-Dividends /Debt 10.0%
Debt/Capitalization 7.5%
Total 100%100%
Notching Adjustment
Holding Company Structural Subordination 0 to -3
*10%weightforissuers that lack generation;**0%weightfor issuers that lack generation
We explain our general approach for scoring each grid factor and show the weights used in the grid.We also
provide a rationale for why each of these grid components is meaningfulas a creditindicator.The
information used in assessing the sub-factors is generally found in or calculated frominformation in
company financial statements,derived from other observations or estimated by our analysts.6 All of the
quantitative credit metrics incorporate Moody's standard adjustments to income statement,cash flow
statement and balance sheet amounts for restructuring,impairment,off-balance sheet accounts,receivable
securitization programs,under-funded pension obligations,and recurring operating leases.'
6 For definitions of our most common ratio terms,please see "Moody's Basic Definitions for Credit Statistics,User's Guide,"a link to which may be found in the
Related Research section of this report
/Our standard adjustments are described in "Financial Statement Adjustments in the Analysis of Non-Financial Corporations".A link to this and other sector and
cross-sector credit rating methodologies can be found in the Related Research section of this report.
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Our ratings are forward-looking and reflect our expectations for future financial and operating performance.
However,historical results are helpful in understanding patterns and trends of a company's performance as
well as for peer comparisons.We utilize historical data (in most cases,an average of the last three years of
reported results)in the rating grid.However,the factors in the grid can be assessed using various time
periods.Forexample,rating committees may find it analytically useful to examine both historical and
expected future performance for periods of several years or more,or for individual twelve month periods.
After estimating or calculating each sub-factor,the outcomes for each of the sub-factors are mappedto a
broad Moody's rating category (Aaa,Aa,A,Baa,Ba,B,or Caa).
This section discusses limitations in the use of the grid to map against actual ratings,some ofthe additional
factors that are not included in the grid but can be important in determining ratings,and limitations and
assumptions that pertain to the overall rating methodology.
5.Determining the Overall Grid-Indicated Rating"
To determine the overall grid-indicated rating,we convert each of the sub-factor ratings intoa numeric
value based upon the scale below.
Aaa Aa A Baa Ba B Caa Ca
1 3 6 9 12 15 18 20
The numerical score for each sub-factor is multiplied by the weight for that sub-factor with theresults then
summed to produce a composite weighted-factor score.The composite weighted factor scoreis then
mapped back to an alphanumeric rating based on the ranges in the tablebelow.
Grid-indicated Rating
Grid-Indicated Rating Aggregate Weighted Total Factor Score
Aaa x <1.5
Aa1 1.5 sx <2.5
Aa2 2.5 sx <3.5
Aa3 3.5 sx <4.5
A1 4.5 sx <5.5
A2 5.5 sx <6.5
A3 6.5 sx <7.5
Baal 7.5 sx <8.5
Baa2 8.5sx<9.5
Baa3 9.5sx<10.5
3 in general,the grid-indicatedrating is orientedto the Corporate Family Rating (CFR)for speculative-grade issuers and the senior unsecured rating for investment-
grade issuers,For issuers that benefit from ratings uplift due to parental support,government ownership or other institutional support,the grid-indicatedrating is
oriented to the baseline credit assessment,For an explanation of baseline credit assessment,please refer to our rating methodology on government-related issuers.
Individual debt instrument ratings also factor in decisions on notching for seniority level and collateraL The documents that provide broad guidance for these
notching decisions are our rating methodologies on loss given default for speculative grade non-financial companies and for aligning corporate instrument ratings
based on differences in security and priority of claim,The link to these and other sector and cross-sector credit rating methodologies can be found in the Related
Research section of this report,
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Grid-indicated Rating
Grid-Indicated Rating Aggregate Weighted Total Factor Score
Bal 10.5 sx <11.5
Ba2 11.5 sx <12.5
Ba3 12.5 sx <13.5
B1 13.5 sx <14.5
B2 14.5 sx <15.5
B3 15.5 sx <16.5
Caal 16.5 sx <17.5
Caa2 17.5 sx <18.5
Caa3 18.5 sx <19.5
Ca x >19.5
For example,an issuer with a composite weighted factor score of 11.7 would have a Ba2grid-indicated
rating.
The Appendices present a full grid and provide additional commentary and insights on our view of credit
risks inthis industry.
Discussion of the Grid Factors
Our analysis of electric and gas utilities focuses on four broad factors:
»Regulatory Framework
»Ability to Recover Costs and Earn Returns
»Diversification
»Financial Strength
There is also a notching factor for holding company structuralsubordination.
Why it Matters
For rate-regulated utilities,which typically operate as a monopoly,the regulatory environmentand how the
utility adapts to that environment are the most important credit considerations.The regulatory
environment is comprised of two rating factors -the Regulatory Framework and its corollary factor,the
Ability to Recover Costs and Earn Returns.Broadly speaking,theRegulatory Framework is the foundation for
how all the decisions that affect utilities are made (includingthe setting of rates),as well as the
predictability and consistency of decision-making provided bythat foundation.The Ability to Recover Costs
and Earn Returns relates more directly to theactual decisions,including their timeliness and the rate-setting
outcomes.
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Utility rates are set in a political/regulatory process rather than a competitive or free-market process;thus,
the Regulatory Framework is a key determinant of the success of utility.The Regulatory Framework has
many components:the governing body and the utility legislation or decrees itenacts,the manner in which
regulators are appointed or elected,the rules and procedures promulgated by those regulators,the judiciary
that interprets the laws and rules and that arbitrates disagreements,and the manner in which the utility
manages the political and regulatory process.In many cases,utilities have experienced credit stress or
default primarily or at least secondarily because of a break-downor obstacle in the Regulatory Framework -
for instance,laws that prohibited regulators fromincluding investments in uncompleted power plants or
plants not deemed "used and useful"in rates,ora disagreement about rate-making that could not be
resolved until after the utility had defaulted onits debts.
How We Assess Legislative and Judicial Underpinnings of the Regulatory Framework for the Grid
For this sub-factor,we consider the scope,clarity,transparency,supportiveness and granularityof
utility legislation,decrees,and rules as they apply to the issuer.We also consider the strength of
the regulator's authority over rate-making and other regulatory issues affecting the utility,the
effectiveness of the judiciary or other independent body in arbitrating disputes in a disinterested
manner,and whether the utility's monopoly has meaningful or growing carve-outs.In addition,we
look at howwell developed the framework is -both how fully fleshed out the rules and regulations
are and howwell tested it is -the extent to which regulatory or judicial decisions have created a
body of precedentthat will help determine future rate-making.Since the focus of our scoring is on
each issuer,weconsider
6 In jurisdictions where utility revenues include material government subsidy payments,we consider utility
rates to be inclusive of these payments,and we thus evaluate sub-factors la,lb,2a and 2b in light of both
rates and material subsidy payments.For example,we would consider the legal and judicial underpinnings
and consistency and predictability of subsidies as well as rates.
how effective the utility is in navigating the regulatory framework -both the utility's ability toshape the
framework and adapt to it.
A utility operating in a regulatory framework that is characterized by legislation that is credit supportive of
utilities and eliminates doubt by prescribing many of the procedures that theregulators will use in
determining fair rates (which legislation may show evidence of being responsive to theneeds of the utility in
general or specific ways),a long history of transparent rate-setting,and a judiciarythat has provided ample
precedent by impartially adjudicating disagreements in a manner thataddresses ambiguities in the laws and
rules will receive higher scores in the Legislative and judicial Underpinnings sub-factor.A utility operating in
a regulatory framework that,by statute or practice,allows the regulator to arbitrarily prevent the utility
from recovering its costs or earning areasonable return on prudently incurred investments,or where
regulatory decisions may be reversed bypoliticians seeking to enhance their populist appeal will receive a
much lowerscore.
In general,we view national utility regulation as being less liable to political intervention than regulation by
state,provincial or municipal entities,so the very highest scoring in this sub-factoris reserved for this
category.However,we acknowledge that states and provinces in some countries may be larger than small
nations,such that their regulators may be equally "above-the-fray"in termsof impartial and technically-
oriented rate setting,and very high scoring may beappropriate.
In jurisdictions where utility revenues include material government subsidy payments,we consider utility rates to be inclusive of these payments,and we thus
evaluate sub-factors la,ib,2a and 2b in light of both rates and material subsidy payments For example,we would consider the legal and judicial underpinnings and
consistency and predictability of subsidies as well as rates.
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The relevant judicial system can be a major factor in the regulatory framework.This is particularly true in
litigious societies like the United States,where disagreements between the utility and its stateor municipal
regulator may eventually be adjudicated in federal district courts or even by the USSupremeCourt.In
addition,bankruptcy proceedings in the US take place in federal courts,which have at times
been able to impose rate settlement agreements on state or municipal regulators.Asa result,the range of
decisions available to state regulators may be effectively circumscribed by court precedent at the state or
federal level,which we generally view as favorable for the credit-supportiveness of the regulatory
framework.
Electric and gas utilities are generally presumed to have a strong monopoly that will continue intothe
foreseeable future,and this expectation has allowed these companies to have greater leveragethan
companies in other sectors with similar ratings.Thus,the existence of a monopoly in itself isunlikely to be a
driver of strong scoring in this sub-factor.On the other hand,a strong challenge tothe monopoly could
cause lower scoring,because the utility can only recover its costs and investmentsand service its debt if
customers purchase its services.There have some instances of incursions intoutilities'monopoly,including
municipalization,self-generation,distributed generation with net metering,or unauthorized use (beyond the
level for which the utility receives compensation in rates).Incursions that are growing significantly or having
a meaningful impact on rates for customers that remainwith the utility could have a negative impact on
scoring of this sub-factor and on factor 2 -Abilityto Recover Costs and Earn Returns.
The scoring of this sub-factor may not be the same for every utility in a particular jurisdiction.We have
observed that some utilities appear to have greater sway over the relevant utility legislationand
promulgation of rules than other utilities -even those in the same jurisdiction.The content and tone of
publicly filed documents and regulatory decisions sometimes indicates that the management teamat one
utility has better responsiveness to and credibility with its regulators or legislators thanthe management at
another utility.
While the underpinnings to the regulatory framework tend to change relatively slowly,they do evolve,and
our factor scoring will seek to reflect that evolution.For instance,a new framework willtypically become
tested over time as regulatory decisions are issued,or perhaps litigated,thereby setting abody of precedent.
Utilities may seek changes to laws in order to permit them to securitize certain costsor collect interim rates,
or a jurisdiction in which rates were previously recovered primarily in base rate proceedings may institute
riders and trackers.These changes would likely impact scoring ofsub-factor 2b -Timeliness of Recovery of
Operating and Capital Costs,but they may also besufficiently significant to indicate a change in the
regulatory underpinnings.On the negative side,a judiciarythat had formerly been independent may start to
issue decisions that indicate it is conforming itsdecisions to the expectations of an executive branch that
wants to mandate lower rates.
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Factor 1a:Legislative and Judicial Underpinnings of the Regulatory Framework (12.5%)
Aaa Aa A Baa
Utility regulation occurs under a fully developed Utility regulation occursunder a fully developed national,Utility regulation occurs under a well developed Utility regulation occurs (i)undera national,state,provincialor
framework that is national in scopebased on state or provincial framework based on legislation that national,state or provincial framework based on municipal framework based on legislation that provides the
legislation that provides the utility a nearly absolute providesthe utility an extremely strong monopoly (see note legislation that providesthe utility a verystrong utilitya strong monopoly within its serviceterritory that may
monopoly (see note 1)within its serviceterritory,an 1)within its serviceterritory,a strong assurance,subject to monopoly (see note 1)within its serviceterritory,havesome exceptions such as greater self-generation (see note
unquestioned assurancethat rateswill be set in a limited review,that rates will be set in a manner thatwill an assurance,subject to reasonableprudency 1),ageneral assurancethat,subject to prudency requirements
manner thatwill permit the utility to makeand requirements,that rateswillbe set in a manner that are mostly reasonable,rates will be set will be set in a
recoverall necessaryinvestments,an extremely high permit the utility to makeand recoverallnecessary that will permit the utility to make and recover manner that willpermitthe utility to makeand recoverall
degreeof clarity asto the manner in which utilities inve toments,a rLhiCdeegreeeof cladritLastasthe nner all necessaryinvestments,a high degreeof clarity necessaryinvestments,reasonableclarity as to the manner in
will be regulatedand prescriptive methods and as to the manner in which utilities willbe which utilities will be regulated andoverall guidance for
proceduresfor setting rates.Existingutility law is prh rcrihptivemethods and proœ res ora ot ng athea regulated,andoverall guidance for methods and methods and proceduresfor setting rates;or (ii)under a new
comprehensive andsupportive such that changesin beentimely andclearly credit supportive of the issuer ina procedures for setting rates.If there havebeen framework where independent andtransparent regulation exists
legislation are not expectedtobe necessary;or any mannerthat showsthe utility has had a strong voicein the changesin utility legislation,they have been in other sectors.If there havebeen changesin utility legislation,
changesthat haveoccurred havebeenstrongly ..mostlytimely and on the whole credit supportive they havebeencredit supportive or at least balancedfor the
supportive of utilities credit quality ingeneral and d
sacere he e an ndneen ent ud c a thhac ar a for the issuer,and the utility has had a clear voice issuer but potentially less timely,andthe utility hada voice in
sufficiently forward-looking so as to address inthe legislative process.Thereis an independent thelegislative process.Thereis either (i)an independent
problems before they occurred.There is an jud
ch orceccerdennctndinhe
n pretat
n c dysla
s d a judiciary that can arbitrate disagreements judiciary that can arbitrate disagreements betweenthe
mdependent judiciary that can arbitrate strong rule of law.We expectthese conditions to continue.between the regulator and the utility,should regulator and the utility,including access to courts at leastat
disagreements between the regulator and the utility theyoccur,mcluding access to national courts,the state or provincial level,reasonablyclearjudicial precedent
should they occur,including access to national clearjudicial precedent in the interpretation of in the interpretation of utility laws,and a generally strong rule
courts,very strongjudicial precedent in the utility law,anda strong rule of law.We expect of law;or (ii)regulation has beenapplied (underawell
interpretation of utility laws,and a strong rule of law.these conditionsto continue.developed framework)in a manner such that redress to an
We expectthese conditionsto continue.independent arbiter has not beenrequired.We expectthese
conditionstocontinue.
Ba B Caa
Utility regulation occurs (i)under a national,state,Utility regulation occurs (i)undera national,state,Utility regulation occurs(i)under a national,
provincialor municipal framework basedon provincialor municipal framework basedon legislationor state,provincialor municipal framework based
legislation or government decree that provides the government decree that provides the utility monopoly on legislation or government decreethat
utility a monopoly within its serviceterritory that is within its serviceterritory that is reasonablystrong but may providesthe utility a monopoly within its service
generally strong but may havea greater levelof haveimportant exceptions,and that,subject toprudency territory,but with little assurancethat rateswill
exceptions (see note 1),and that,subject to prudency requirements which may be stringent or at timesarbitrary,be set in a manner that will permit the utility to
requirements which may be stringent,providesa Providesmore limited or less certain assurancethat rates makeand recovernecessaryinvestments;or (ii)
generalassurance (with somewhat less certainty)willbe set in a mannerthat will permit the utility tomake under anew framework where we would expect
that rates will be set willbe set in a manner that will and recovernecessaryinvestments;or (ii)undera new unpredictable or adverseregulation,based either
permit the utility tomake and recovernecessary framework where we would expect less independent and on the jurisdiction's history of in other sectors or
investments;or (ii)under anew framework where transparent regulation,based either on the regulator's other factors.The judiciary that can arbitrate
the jurisdiction has a history ofLess independent and history in other sectorsor other factors.The judiciarythat disagreements between the regulator andthe
transparent regulation in other sectors.Either:(i)the can arbitrate disagreements between the regulator andthe utility maynot haveclear authority or is viewed
judiciary that can arbitrate disagreements between utility may not haveclearauthority or may not befully as not beingfully independent of the regulatoror
the regulator andtheutility may not haveclear independent of the regulator or other political pressure,but other political pressure.Alternately,there maybe
authority or maynot befully independent of the there is a reasonably strong ruleof law.Alternately,where no redress to an effective independent arbiter.
regulator or other politicalpressure,but there is a there is no independent arbiter,the regulation hasbeen The ability of the utility to enforce its monopoly
reasonablystrong rule of law;or (ii)where there is no applied in a manner that often requires some redressadding or prevent uncompensated usage of its system
independent arbiter,the regulation has mostly been more uncertainty to the regulatory framework.Theremay may be limited.Theremay be a risk ofcreditor-
applied in a manner such redress hasnot been be a periodic risk of creditor-unfriendlygovernment unfriendly nationalization or othersignificant
required.We expect theseconditions to continue.intervention in utility markets orrate-setting.intervention in utility marketsorrate-setting.
Note t The strength of themonopoly refers to the legal,regulatoryand practical obstacles for customersin theutility's territory toobtainservice from another provider.Examples of a weakeningof the monopolywould include theability of a city
or large user to leave the utility systemto set up their ownsystem,theextenttowhichself-generationis permitted (e.g.cogeneration)and/orencouraged (e.g.,net metering,DSM generation).At the lowerend of the ratings spectrum,the
utility's monopolymaybe challenged by pervasivetheft and unauthorizeduse.Since utilitiesare generallypresumedto be monopolies,a strong monopolypositionin itself is not sufficientfor a strong score in this sub-factor,but a weakening
of the monopolycan lowerthescore.
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How We Assess Consistency and Predictability of Regulation for theGrid
For the Consistency and Predictability sub-factor,we consider the track record of regulatorydecisions in
terms of consistency,predictability and supportiveness.We evaluate the utility's interactions in the
regulatory process as well as the overall stance of the regulator toward theutility.
In most jurisdictions,the laws and rules seek to make rate-setting a primarily technical processthat
examines costs the utility incurs and the returns on investments the utility needs to earn so it can make
investments that are required to build and maintain the utility infrastructure -power plants,electric
transmission and distribution systems,and/or natural gas distribution systems.When theprocess remains
technical and transparent such that regulators can support the financial health of the utility while balancing
their public duty to assure that reliable service is provided at a reasonable cost,and when the utility is able
to align itself with the policy initiatives of the governing jurisdiction,theutility will receive higher scores in
this sub-factor.When the process includes substantial political intervention,which could take the form of
legislators or other government officials publicallysecond-guessing regulators,dismissing regulators who
have approved unpopular rate increases,orpreventing the implementation of rate increases,or when
regulators ignore the laws/rules to deliver anoutcome that appears more politically motivated,the utility
will receive lower scores in this sub-factor.
As with the prior sub-factor,we may score different utilities in the same jurisdiction differently,based on
outcomes that are more or less supportive of credit quality over a period of time.We haveobserved that
some utilities are better able to meet the expectations of their customers and regulators,whether through
better service,greater reliability,more stable rates or simply more effective regulatory outreach and
communication.These utilities typically receive more consistent and credit supportiveoutcomes,so they
will score higher in this sub-factor.Conversely,if a utility has multiple rapid rate increases,chooses to
submit major rate increase requests during a sensitive election cycle or a severeeconomic downturn,has
chronic customer service issues,is viewed as frequently providing incomplete information to regulators,or is
tone deaf to the priorities of regulators and politicians,it mayreceive less consistent and supportive
outcomes and thus score lower in thissub-factor.
In scoring this sub-factor,we will primarily evaluate the actions of regulators,politicians and jurists rather
than their words.Nonetheless,words matter when they are an indication of future action.We seek to
differentiate between political rhetoric that is perhaps oriented toward gaining attention for the viewpoint of
the speaker and rhetoric that is indicative of future actions and trends in decision-making.
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Factor 1b:Consistency and Predictability of Regulation (12.5%)
Aaa Aa A Baa
The issuer's interaction with the regulator has led The issuer's interaction with the regulator hasa The issuer's interaction with the regulator has led The issuer's interaction with the regulator has led
to a strong,lengthy track record of predictable,led to a considerable track record of to a track record of largely predictableand to an adequate track record.The regulator is
consistent and favorable decisions.The regulator predominantly predictable and consistent consistent decisions.The regulator may be generally consistent and predictable,butthere
is highly credit supportive of the issuer and decisions.The regulator is mostly credit somewhat less credit supportive of utilities in may some evidence of inconsistency or
utilities in general.We expect these conditions supportive of utilities in generaland in almost all general,but has been quite credit supportive of unpredictability from time to time,or decisions
to continue.instances has been highly credit supportive of the the issuer in most circumstances.We expect may at times be politically charged.However,
issuer.We expect these conditions to continue.these conditions to continue.instances of less credit supportive decisions are
based on reasonable application of existing rules
and statutes and are not overly punitive.We
expect these conditions tocontinue.
Ba B Caa
We expect that regulatory decisions will We expect that regulatory decisions will be We expect that regulatory decisions will behighly
demonstrate considerable inconsistency or largely unpredictable or even somewhat arbitrary,unpredictable and frequently adverse,based
unpredictability or that decisions will be based either on the issuer's track record of either on the issuer's track record of interaction
politically charged,based either on the issuer's interaction with regulatorsor other governing with regulators or other governing bodies,or our
track record of interaction with regulatorsor bodies,or our view that decisions will move in view that decisions will move in this direction.
Other governing bodies,or our view that decisions this direction.However,we expect that the Alternately,decisions may have creditsupportivewillmoveinthisdirection.The regulatormay issuer will ultimately be able to obtain support aspects,but may often be unenforceable.Thehaveahistoryoflesscreditsupportiveregulatorywhenitencountersfinancialstress,albeit with regulator's authority may have been seriouslydecisionswithrespecttotheissuer,but we material or more extended delays.Alternately,eroded by legislative or political action.Theexpectthattheissuerwillbeabletoobtaintheregulatorisuntested,lacks a consistent track regulator may consistently ignorethe frameworksupportwhenitencountersfinancialstress,with record,or is undergoingsubstantialchange.The to the detriment of the issuer.some potentially material delays.Theregulator's regulator's authority may be erodedon frequent
authority may be erodedat times by legislativeor occasions by legislative or political action.The
political action.The regulator may not followthe regulator may more frequently ignore the
framework for some material decisions.framework in a manner detrimental to the issuer.
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Factor 2:Ability to Recover Costs and Earn Returns (25%)
Why it Matters
This rating factor examines the ability of a utility to recover its costs and earn a return over a periodof time,
including during differing market and economic conditions.While the Regulatory Framework looks at the
transparency and predictability of the rules that govern the decision-making processwith respect to utilities,
the Ability to Recover Costs and Earn Returns evaluates the regulatory elements that directly impact the
ability of the utility to generate cash flow and service its debt over time.The ability to recover prudently
incurred costs on a timely basis and to attract debt and equity capitalare crucial credit considerations.The
inability to recover costs,for instance if fuel or purchased power costs ballooned during a rate freeze period,
has been one of the greatest drivers of financial stress in this sector,as well as the cause of some utility
defaults.In a sector that is typically free cash flownegative (due to large capital expenditures and dividends)
and that routinely needs to refinance very large maturities of long-term debt,investor concerns about a lack
of timely cost recovery or the sufficiency of rates can,in an extreme scenario,strain access to capital
markets and potentially lead to insolvency of the utility (as was the case when "used and useful"
requirements threatened some utilitiesthat experienced years of delay in completing nuclear power plants
in the 1980s).While our scoring forthe Ability to Recover Costs and Earn Returns may primarily be
influenced by our assessment ofthe regulatory relationship,it can also be highly impacted by the
management and business decisions ofthe utility.
How We Assess Ability to Recover Costs and Earn Returns
The timeliness and sufficiency of rates are scored as separate sub-factors;however,they are interrelated.
Timeliness can have an impact on our view of what constitutes sufficient returns,because astrong assurance
of timely cost recovery reduces risk.Conversely,utilities may have a strong assurancethat they will earn a
full return on certain deferred costs until they are able to collect them,or their generally strong returns may
allow them to weather some rate lag on recovery ofconstruction-related capital expenditures.The
timeliness of cost recovery is particularly important in a period of rapidly rising costs.During the past five
years,utilities have benefitted from low interest rates andgenerally decreasing fuel costs and purchased
power costs,but these market conditions could easily reverse.For example,fuel is a large component of
total costs for vertically integrated utilities and for naturalgas utilities,and fuel prices are highly volatile,so
the timeliness of fuel and purchased power costrecovery is especially important.
While Factors 1 and 2 are closely inter-related,scoring of these factors will not necessarily be the same.We
have observed jurisdictions where the Regulatory Framework caused considerable credit concerns -perhaps
it was untested or going through a transition to de-regulation,but where the track recordof rate case
outcomes was quite positive,leading to a higher score in the Ability to Recover Costs and Earn Returns.
Conversely,there have been instances of strong Legislative and Judicial Underpinnings of the Regulatory
Framework where the commission has ignored the framework (which wouldaffect Consistency and
Predictability of Regulation as well as Ability to Recover Costs and Earn Returns)or has used extraordinary
measures to prevent or defer an increase that might have been justifiable from a cost perspective but would
have caused rate shock.
One might surmise that Factors 2 and 4 should be strongly correlated,since a good AbilitytoRecover Costs
and Earn Returns would normally lead to good financial metrics.However,the scoring forthe Ability to
Recover Costs and Earn Returns sub-factor places more emphasis on our expectationof timeliness and
sufficiency of rates over time,whereas financial metrics may be impacted byone-time events,market
conditions or construction cycles -trends that we believe could normalize oreven reverse.
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How We Assess Timeliness of Recovery of Operating and Capital Costs for theGrid
The criteria we consider include provisions and cost recovery mechanisms for operating costs,mechanisms
that allow actual operating and/or capital expenditures to be trued-up periodicallyinto rates without having
to file a rate case (this may include formula rates,rider and trackers,or the ability to periodically adjust rates
for construction work in progress)as well as the process and timeframeof general tariff/base rate cases -
those that are fully reviewed by the regulator,generally in a public format that includes testimony of the
utility and other stakeholders and interest groups.We also look atthe track record of the utility and
regulator for timeliness.For instance,having a formula rate plan is positive,but if the actual process has
included reviews that are delayed for long periods,it may dampen the benefit to the utility.In addition,we
seek to estimate the lag between the time that a utility incurs a major construction expenditures and the
time that the utility will start to recover and/or earn a return on that expenditure.
How We Assess sufficiency of Rates and Returns for the Grid
The criteria we consider include statutory protections that assure full cost recovery and areasonable return
for the utility on its investments,the regulatory mechanisms used to determine whata reasonable return
should be,and the track record of the utility in actually recovering costs andearning returns.We examine
outcomes of rate cases/tariff reviews and compare them to the requestsubmitted by the utility,to prior rate
cases/tariff reviews for the same utility and to recent rate/tariff decisionsfor a peer group of comparable
utilities.In this context,comparable utilities are typically utilities inthe same or similar jurisdiction.In cases
where the utility is unique or nearly unique in itsjurisdiction,comparison will be made to other peers with
an adjustment for local differences,including prevailing rates of interest and returns on capital,as well as the
timeliness of rate-setting.We look atregulatory disallowances of costs or investments,with a focus on their
financial severity and also on thereasons given by the regulator,in order to assess the likelihood that such
disallowances will be repeated inthe future.
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Factor 2a:Timeliness of Recovery of Operating and Capital Costs(12.5%)
Aaa Aa A Baa
Tariff formulas and automatic cost recovery Tariff formulas and automatic cost recovery Automatic cost recovery mechanisms provide full Fuel,purchased power and all other highly variable
mechanisms provide full and highly timely mechanisms provide full and highly timely and reasonably timely recovery of fuel,purchased expenses are generally recovered through
recovery of all operating costs and essentially recovery of all operating costs and essentially powerand all other highly variable operating mechanisms incorporating delays of less than one
contemporaneousreturn on all incremental contemporaneousor near-contemporaneous expenses.Material capital investments may be year,although some rapid increases in costs may
capital investments,with statutory provisions in return on most incremental capital investments,made undertariff formulas or other rate-making be delayed longer wheresuch deferrals do not
place to precludethe possibility of challengesto with minimal challenges by regulatorsto permitting reasonably contemporaneousreturns,place financial stress on the utility.Incremental
rate increases or cost recovery mechanisms.By companies'cost assumptions.By statute and by or may be submitted underother types of filings capital investments may be recovered primarily
statute and by practice,generalrate cases are practice,generalrate cases are efficient,focused that provide recovery of cost of capital with through generalrate cases with moderate lag,
efficient,focused on an impartial review,quick,on an impartial review,of a very reasonable minimal delays.Instances of regulatory with some through tariff formulas.Alternately,
and permit inclusion of fully forward-looking duration before non-appealable interim rates can challenges that delay rate increases or cost there may be formula rates that are untested or
costs.be collected,and primarily permit inclusion of recovery are generally related to large,unexpected unclear.Potentially greatertendency for delays
forward-looking costs.increases in sizeable construction projects.By due to regulatory intervention,although this will
statute or by practice,generalrate cases are generally be limited to rates related to large
reasonably efficient,primarily focused on an capital projects or rapid increases in operating
impartial review,of a reasonable duration before costs.
rates (either permanentornon-refundable interim
rates)can be collected,and permit inclusion of
important forward-lookingcosts.
Ba B Caa
There is an expectation that fuel,purchased power The expectation that fuel,purchased poweror The expectation that fuel,purchased poweror
or other highly variable expenses will eventually other highly variable expenses will be recovered other highly variable expenses will berecovered
be recovered with delays that will not place may be subject to material delays due to second-may be subject to extensive delays due to second-
material financial stress on the utility,butthere guessing of spendingdecisions by regulatorsor guessing of spending decisions by regulators or
may be some evidence of an unwillingnessby due to political intervention.Recovery of costs due to political intervention.
regulators to make timely rate changes to address related to capital investments may be subjectto Recovery of costs related to capital investmentsvolatilityinfuel,or purchased power,or other delays that are material to the issuer,or may be may be uncertain,subject to delays that aremarket-sensitive expenses.Recovery of costs likely to discourage some important investment extensive,or that may be likely to discourage evenrelatedtocapitalinvestmentsmaybesubjecttonecessaryinvestment.delays that are somewhat lengthy,but not so
pervasive as to be expected to discourage
important investments.
Note:Tariff formulasinclude formularate plans as wellas trackers and riders relatedto capitalinvestment.
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Factor 2b:Sufficiency of Rates and Returns (12.5%)
Aaa Aa A Baa
Sufficiency of rates to cover costs and attract Rates are (and we expect will continue to be)set Rates are (and we expect will continue to be)set Rates are (and we expect will continue to be)set
capital is (and will continue to be)unquestioned.at a level that permits full cost recovery and afair at a level that generally provides full cost recovery at a level that generally provides full operating
return on all investments,with minimal challenges and a fair return on investments,with limited cost recovery and a mostly fair returnon
by regulators to companies'cost assumptions.instances of regulatory challenges and investments,but there may be somewhat more
This will translate to returns (measured in relation disallowances.In general,this will translateto instances of regulatory challenges and
to equity,total assets,rate base or regulatory returns (measured in relation to equity,total disallowances,although ultimate rate outcomes
asset value,as applicable)that are strong relative assets,rate base or regulatory asset value,as are sufficient to attract capital without difficulty.
to global peers.applicable)that are generally above average In general,this will translate to returns (measured
relative to global peers,but may at times be in relation to equity,total assets,rate base or
average.regulatory asset value,as applicable)that are
average relative to global peers,but may attimes
be somewhat belowaverage.
Ba B Caa
Rates are (and we expect will continue to be)set We expect rates will be set at a level that attimes We expect rates will be set at a level that often
at a level that generally provides recovery of most fails to provide recovery of costs other than cash fails to provide recovery of material costs,and
operating costs but return on investments may be costs,and regulatorsmay engage in somewhat recovery of cash costs may also be at risk.
less predictable,and there may be decidedly more arbitrary second-guessing of spending decisions or Regulators may engage in more arbitrary second-instances of regulatory challenges and deny rate increases relatedto fundingongoing guessing of spending decisions or deny ratedisallowances,but ultimate rate outcomesare operations based much more on politics thanon increases related to funding ongoingoperationsgenerallysufficienttoattractcapital.In general,prudency reviews.Return on investments may be based primarily on politics.Return on investments
this will translate to returns (measured in relation set at levels that discourage investment.We may be set at levels that discourage necessarytoequity,total assets,rate base or regulatory expect that rate outcomes may be difficultor maintenanceinvestment.We expect that rateassetvalue,as applicable)that are generally uncertain,negatively affecting continued access to outcomes may often be punitive or highlybelowaveragerelativetoglobalpeers,or where capital.Alternately,the tariff formula may fail to uncertain,with a markedly negative impact onallowedreturnsareaveragebutdifficulttoearn.take into account significant cost components access to capital.Alternately,the tariff formulaAlternately,the tariff formula may not take into other than cash costs,and/or remuneration of may fail to take into account significant cash costaccountallcostcomponentsand/or investments may be generally unfavorable.components,and/or remuneration of investmentsremunerationofinvestmentsmaybeunclearormaybeprimarilyunfavorable.at times unfavorable.
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Why it Matters
Diversification of overall business operations helps to mitigate the risk that economic cycles,material
changes in a single regulatory regime or commodity price movements will have a severe impact on cash flow
and credit quality of a utility.While utilities'sales volumes have lower exposure to economic recessions than
many non-financial corporate issuers,some sales components,including industrial sales,are directly
affected by economic trends that cause lower production and/or plant closures.In addition,economic
activityplays a role in the rate of customer growth in the service territoryand (absent energy efficiency and
conservation)can often impact usage per customer.Theeconomic strength or weakness of the service
territory can affect the political and regulatory environment forrate increase requests by the utility.For
utilities in areas prone to severe storms and other natural disasters,the utility's geographic diversity or
concentration can be a key determinant forcreditworthiness.
Diversity among regulatory regimes can mitigate the impact of a single unfavorable decisionaffecting one
part of the utility's footprint.
For utilities with electric generation,fuel source diversity can mitigate the impact (to the utility andto its
rate-payers)of changes in commodity prices,hydrology and water flow,and environmental orother
regulations affecting plant operations and economics.We have observed that utilities'regulatory
environments are most likely to become unfavorable during periods of rapid rate increases (whichare more
important than absolute rate levels)and that fuel diversity leads to more stable rates over time.
For that reason,fuel diversity can be important even if fuel and purchased power expenses arean automatic
pass-through to the utility's ratepayers.Changes in environmental,safety andother regulations have caused
vulnerabilities for certain technologies and fuel sources during the pastfive years.These vulnerabilities have
varied widely in different countries and have changed over time.
How We Assess Market Position for the Grid
Market position is comprised primarily of the economic diversity of the utility's service territory and the
diversity of its regulatory regimes.We also consider the diversity of utility operations(e.g.,regulated electric,
gas,water,steam)when there are material operations in more than one area.
Economic diversity is a typically a function of the population,size and breadth of the territory andthe
businesses that drive its GDP and employment.For the size of the territory,we typically considerthe
number of customers and the volumes of generation and/or throughput.For breadth,we considerthe
number of sizeable metropolitan areas served,the economic diversity and vitality in thosemetropolitan
areas,and any concentration in a particular area or industry.In our assessment,we mayconsider various
information sources.For example,in the US,information sources on the diversity andvitality of economies
of individual states and metropolitan areas may include Moody's Economy.com.Wealso look at the mix of
the utility's sales volumes among customer types,as well as the track recordof volume sales and any
notable payment patterns during economic cycles.For diversity of regulatory regimes,we typically look at
the number of regulators and the percentages of revenues and utility assets that are under the purview of
each.While the highest scores in the Market Position sub-factorare reserved for issuers regulated in
multiple jurisdictions,when there is only one regulator,we makea differentiation of regimes perceived as
having lower or highervolatility.
Issuers with multiple supportive regulatory jurisdictions,a balanced sales mix amongresidential,
commercial,industrial and governmental customers in a large service territory with a robustand diverse
economy will generally score higher in this sub-factor.An issuer with a small service territory economy that
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has a high dependence on one or two sectors,especially highly cyclical industries,will generally score lower
in this sub-factor,as will issuers with meaningful exposure toeconomic dislocations caused by natural
disasters.
For issuers that are vertically integrated utilities having a meaningful amount of generation,thissub-factor
has a weighting of 5%.For electric transmission and distribution utilities without meaningful generation and
for natural gas local distribution companies,this sub-factor has a weighting ofl0%.
How We Assess Generation and Fuel Diversity for the Grid
Criteria include the fuel type of the issuer's generation and important power purchase agreements,the
ability of the issuer economically to shift its generation and power purchases when there are changes in fuel
prices,the degree to which the utility and its rate-payers are exposed to or insulated fromchanges in
commodity prices,and exposure to challenged Source and Threatened Sources (see the explanations for
how we generally characterize these generation sources in the table below).A regulated utility's capacity mix
may not in itself be an indication of fuel diversity or the ability to shift fuels,since utilities may keep old and
inefficient plants (e.g.,natural gas boilers)to serve peak load.For this reason,we do not incorporate set
percentages reflecting an "ideal"or "sub-par"mix for capacity or even generation.In addition to looking at
a utility's generation mix to evaluate fuel diversity,we consider the efficiency of the utility's plants,their
placement on the regional dispatch curve,and the demonstrated ability/inability of the utility to shift its
generation mix in accordance with changing commodity prices.
Issuers having a balanced mix of hydro,coal,natural gas,nuclear and renewable energy as well aslow
exposure to challenged and threatened sources of generation will score more highly in this sub-factor.Issuers
that have concentration in one or two sources of generation,especially if they are threatenedor challenged
sources,will incur lower scores.
In evaluating an issuer's degree of exposure to challenged and threatened sources,we will considernot only
the existence of those plants in the utility's portfolio,but also the relevant factors thatwill determine the
impact on the utility and on its rate-payers.For instance,an issuer that has a fairlyhigh percentage of its
generation from challenged sources could be evaluated very differently if itspeer utilities face the same
magnitude of those issues than if its peers have no exposure to challengedor threatened sources.In
evaluating threatened sources,we consider the utility's progress in its planto replace those sources,its
reserve margin,the availability of purchased power capacity in the region,and the overall impact of the
replacement plan on the issuer's rates relative to its peer group.Especiallyif there are no peers in the same
jurisdiction,we also examine the extent to which the utility's generation resources plan is aligned with the
relevant government's fuel/energypolicy.
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Sub-Factor
Weighting 10%Weighting Aaa Aa A Baa
Market Position 5.00%*A very high degree of multinational Material operations in three or more Material operationsin two to three May operate undera single regulatory
and regional diversity in terms of nations or substantial geographic nations,states,provinces or regions regime viewed as having low
regulatory regimes and/or service regions providing very good diversity that provide good diversity of volatility,or where multiple
territory economies.of regulatory regimes and/or service regulatory regimes and service regulatory regimes are not viewed as
territory economies.territory economies.Alternately,providing much diversity.The service
operates within a single regulatory territory economy may have some
regime with low volatility,and the concentration and cyclicality,but is
service territory economy is robust,sufficiently resilient that it can absorb
has a very high degree of diversity and reasonably foreseeable increases in
has demonstrated resilience in utility rates.
economic cycles.
Generation and 5.00%**A high degree of diversity in terms of Very good diversification in terms of Good diversification in terms of Adequatediversification in terms of
Fuel Diversity generation and/or fuel sources such generation and/or fuel sources such generationand/or fuel sources such generation and/or fuel sources such
that the utility and rate-payers are that the utility and rate-payers are that the utility and rate-payers have that the utility and rate-payers have
well insulated from commodity price affected only minimally by only modest exposure to commodity moderate exposure to commodity
changes,no generation concentration,commodity price changes,little price changes;however,may have price changes;however,may have
and very low exposures to Challenged generation concentration,and low some concentration in a source that is some concentration in a source that is
or ThreatenedSources (see definitions exposures to Challenged or neither Challenged nor Threatened.Challenged.Exposure to Threatened
below).ThreatenedSources.Exposure to ThreatenedSources is Sources is moderate,while exposure
low.While there may be some to Challenged Sources is manageable.
exposure to Challenged Sources,it is
not a cause for concern.
Sub-Factor
Weighting Ba B Caa Definiitons
Market Position 5.00%*Operatesin a market area with Operates in a limited market area Operates in a concentrated economic ChallengedSources are generation
somewhat greater concentration and with material concentration and more service territory with pronounced plants that face higher but not
cyclicality in the service territory severe cyclicality in service territory concentration,macroeconomicrisk insurmountable economic hurdles
economy and/or exposure to storms economy such that cycles are of factors,and/or exposure to natural resultingfrom penalties or taxes on
and other natural disasters,and thus materially longerduration or disasters.their operation,or from
less resilience to absorbingreasonably reasonably foreseeable increases in environmental upgrades that are
foreseeable increases in utility rates.utility rates could present a material requiredor likely to be required.
May show somewhat greatervolatility challengeto the economy.Service Some examples are carbon-emitting
in the regulatory regime(s).territory may have geographic plants that incur carbon taxes,plants
concentration that limits its resilience that must buy emissions credits to
to storms and other natural disasters,operate,and plants that must install
or may be an emerging market.May environmental equipment to continue
show decided volatility in the to operate,in each where the
regulatory regime(s).taxes/creditslupgrades are sufficient
to have a material impact on those
plants'competitiveness relative to
other generation types or on the
utility's rates,but where the impact is
not so severe as to be likely require
plant closure.
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Generation and 5.00%**Modest diversification in generation Operateswith little diversification in Operates with high concentration in ThreatenedSources are generation
Fuel Diversity and/or fuel sources such that the generation and/or fuel sources such generationand/or fuel sources such plants that are not currently able toutilityorrate-payers have greater that the utility or rate-payers have that the utility or rate-payers have operate due to major unplanned
exposure to commodity price high exposure to commodity price exposure to commodity price shocks.outages or issues with licensing or
changes.Exposure to Challenged and changes.Exposure to Challenged and Exposure to Challenged and other regulatory compliance,and
Threatened Sources may be more ThreatenedSources may be high,and ThreatenedSources may be very high,plants that are highly likely to be
pronounced,but the utility will be accessing alternate sources may be and accessing alternate sources may requiredto de-activate,whether due
able to access alternative sources challengingand cause more financial be highly uncertain.to the effectiveness of currently
without unduefinancial stress.stress,but ultimately feasible.existing or expected rules and
regulations or due to economic
challenges.Some recent examples
would include coal fired plants in the
US that are not economicto retro-fit
to meet mercury and air toxics
standards,plants that cannot meet
the effective date of those standards,
nuclearplants in Japan that have not
been licensed to re-start after the
Fukushima Dai-ichi accident,and
nuclearplants that are requiredto be
phased out within 10 years (as is the
case in some European countries).
*10%weightfor issuers that lack generation **0%weight for issuers that lack generation
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Why it Matters
Electric and gas utilities are regulated,asset-based businesses characterized by large investmentsin long-
lived property,plant and equipment.Financial strength,including the ability to service debtand provide a
return to shareholders,is necessary for a utility to attract capital at a reasonable cost inorder to invest in its
generation,transmission and distribution assets,so that the utility can fulfill itsservice obligations at a
reasonable cost to rate-payers.
How We Assess it for the Grid
in comparison to companies in other non-financial corporate sectors,the financial statementsof regulated
electric and gas utilities have certain unique aspects that impact financial analysis,whichis further
complicated by disparate treatment of certain elements under US GenerallyAccepted Accounting Principles
(GAAP)versus International Financial Reporting Standards (IFRS).Regulatory accounting may permit
utilities to defer certain costs (thereby creating regulatory assets)that anon-utility corporate entity would
have to expense.For instance,a regulated utility may be able to defera substantial portion of costs related
to recovery from a storm based on the general regulatoryframework for those expenses,even if the utility
does not have a specific order to collect the expenses from ratepayers over a set period of time.A regulated
utility may be able to accrue and defer a returnon equity (in addition to capitalizing interest)for
construction-work-in-progress for an approved project based on the assumption that it will be able to
collect that deferred equity return once the assetcomes into service.For this reason,we focus more on a
utility's cash flow than on its reported netincome.
Conversely,utilities may collect certain costs in rates well ahead of the time they must be paid(for instance,
pension costs),thereby creating regulatory liabilities.Many of our metrics focus on Cash Flow from
Operations Before Changes in Working Capital (CFO Pre-WC)because,unlikeFunds from Operations (FFO),
it captures the changes in long-term regulatory assets and liabilities.
However,under IFRS the two measures are essentially the same.In general,we view changesin working
capital as less important in utility financial analysis because they are often either seasonal(for example,
power demand is generally greatest in the summer)or caused by changes in fuel pricesthat are typically a
relatively automatic pass-through to the customer.We will nonetheless examinethe impact of working
capital changes in analyzing a utility's liquidity (see Other Rating Considerations-Liquidity).
Given the long-term nature of utility assets and the often lumpy nature of their capital expenditures,it is
important to analyze both a utility's historical financial performance as well as its prospectivefuture
performance,which may be different from backward-looking measures.Scores under this factormay be
higher or lower than what might be expected from historical results,depending on our viewof expected
future performance.Multi-year periods are usuallymore representative of credit quality because utilities can
experience swings in cash flows fromone-time events,including such items as rate refunds,storm cost
deferrals that create a regulatory asset,or securitization proceeds that reduce a regulatory asset.
Nonetheless,we also look at trends in metrics for individual periods,which may influence our view of future
performance and ratings.
For this scoring grid,we have identified four key ratios that we consider the most consistently usefulin the
analysis of regulated electric and gas utilities.However,no single financial ratio canadequately convey the
relative credit strength of these highly diverse companies.Our ratings consider theoverall financial strength
of a company,and in individual cases other financial indicators may also playan important role.
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CFO Pre-WorkingCapitalPlus Interest/Interest or Cash Flow Interestcoverage
The cash flow interest coverage ratio is an indicator for a utility's ability to cover the cost ofits
borrowed capital.The numerator in the ratio calculation is the sum of CFO Pre-WC and interest
expense,and the denominator is interestexpense.
CFO Pre-Working Capital /Debt
This important metric is an indicator for the cash generating ability of a utility compared to itstotal debt.
The numerator in the ratio calculation is CFO Pre-WC,and the denominator is totaldebt.
CFO Pre-Working Capital Minus Dividends /Debt
This ratio is an indicator for financial leverage as well as an indicator of the strength of a utility'scash flow
after dividend payments are made.Dividend obligations of utilities are often substantial,quasi-permanent
outflows that can affect the ability of a utility to cover its debt obligations,and this ratio can also provide
insight into the financial policies of a utility or utility holding company.Thehigher the level of retained cash
flow relative to a utility's debt,the more cash the utility has to supportits capital expenditure program.The
numerator of this ratio is CFO Pre-WC minus dividends,andthe denominator is total debt.
Debt/Capitalization
This ratio is a traditional measure of balance sheet leverage.The numerator is total debt andthe
denominator is total capitalization.All of our ratios are calculated in accordance with our standard
adjustments'°,but we note that our definition of total capitalization includes deferred taxes in addition to
total debt,preferred stock,other hybrid securities,and common equity.Since thepresence or absence of
deferred taxes is a function of national tax policy,comparing utilities using this ratiomay be more
meaningful among utilities in the same country or in countries with similar tax policies.High debt levels in
comparison to capitalization can indicate higher interest obligations,can limit theability of a utility to raise
additional financing if needed,and can lead to leverage covenant violations in bank credit facilities or other
financing agreements".A high ratio may result from a regulatory framework that does not permit a robust
cushion of equity in the capital structure,or from a material write-offof an asset,which may not have
impacted current period cash flows but could affect future period cash flows relative to debt.
There are two sets of thresholds for three of these ratios based on the level of the issuer's business risk -the
Standard Grid and the Lower Business Risk (LBR)Grid.In our view,the different types ofutility entities
covered under this methodology (as described in Appendix E)have different levels ofbusiness risk.
Generation utilities and vertically integrated utilities generally have a higher level of business risk because
they are engaged in power generation,so we apply the Standard Grid.We viewpower generation as the
highest-risk component of the electric utility business,as generation plants are typically the most expensive
part of a utility's infrastructure (representing asset concentration risk)and are subject to the greatest risks in
both construction and operation,including the risk that incurred costs will either not be recovered in rates or
recovered with materialdelays.
Other types of utilities may have lower business risk,such that we believe that they are most appropriately
assessed using the LBR Grid,due to factors that could include a generally greater transfer of risk to
customers,very strong insulation from exposure to commodity price movements,good protection from
volumetric risks,fairly limited capex needs and low exposure to storms,major accidents and natural
so in certain circumstances,analysts may also apply specificadjustments.
"We also examine debt/capitalization ratios as defined in applicable covenants (which typically exclude deferred taxes from capitalization)relative to the covenant
threshold leveL
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disasters.For instance,we tend to view many US natural gas localdistribution companies (LDCs)and certain
US electric transmission and distribution companies (T&Ds,which lack generation but generally retain some
procurement responsibilities for customers),astypically having a lower business risk profile than their
vertically integrated peers.In cases of T&Ds that we do not view as having materially lower risk than their
vertically integrated peers,we will applythe Standard grid.This could result from a regulatory framework
that exposes them to energy supply risk,large capital expenditures for required maintenance or upgrades,a
heightened degree of exposureto catastrophic storm damage,or increased regulatory scrutiny due to poor
reliability,orother considerations.The Standard Grid will also apply to LDCs that in our view do not have
materially lower risk;for instance,due to their ownership of high pressure pipes or older systems requiring
extensive gas main replacements,where gas commodity costs are not fully recovered in areasonably
contemporaneous manner,or where the LDC is not well insulated from decliningvolumes.
The four key ratios,their weighting in the grid,and the Standard and LBR scoring thresholdsare detailed in
the following table.
Sub-
FactorWeighting40%Weighting Aaa Aa A Baa Ba B Caa
CFO pre-WC +7.50%a 8.0x 6.0x -8.0x 4.5x -6.0x 3.Ox -4.5x 2.0x -3.0x 1.Ox -2.0x <1.0x
Interest /
Interest
CFO pre-WC /15.00%Standard Grid a 40%30%-40%22%-30%13%-22%5%-13%1%-5%<1%
Debt
LowBusiness a 38%27%-38%19%-27%11%-19%5%-11%1%-5%<1%
Risk Grid
CFO pre-WC -10.00%Standard Grid a 35%25%-35%17%-25%9%-17%0%-9%(5%)-0%<(5%)
Dividends /Debt
LowBusiness a 34%23%-34%15%-23%7%-15%0%-7%(5%)-0%<(5%)
Risk Grid
Debt /7.50%Standard Grid <25%25%-35%35%-45%45%-55%55%-65%65%-75%a 75%
Capitalization
LowBusiness <29%29%-40%40%-50%50%-59%59%-67%67%-75%a 75%
Risk Grid
Notching for Structural Subordination of HoldingCompanies
Why it Matters
A typical utility company structure consists of a holding company ("HoldCo")that owns one ormore
operating subsidiaries (each an "Opco").Opcos may be regulated utilities or non-utilitycompanies.A
Holdco typically has no operations -its assets are mostly limited to its equity interests in subsidiaries,and
potentially other investments in subsidiaries that are structured as advances,debt,or even hybrid securities.
Most HoldCos present their financial statements on a consolidated basis that blurs legalconsiderations
about priority of creditors based on the legal structure of the family,and grid scoring is thus basedon
consolidated ratios.However,HoldCo creditors typically have a secondary claim on the group'scash flows
and assets after Opco creditors.We refer to this as structural subordination,because it isthe corporate legal
structure,rather than specific subordination provisions,that causes creditors at eachof the utility and non-
utility subsidiaries to have a more direct claim on the cash flows and assets oftheir respective Opco
obligors.By contrast,the debt of the HoldCo is typically serviced primarilyby dividends that are up-
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streamed by the Opcos".Under normal circumstances,these dividends are made from net income,after
payment of the Opco's interest and preferred dividends.In mostnon-financial corporate sectors where
cash often moves freely between the entities in a single issuerfamily,this distinction may have less of an
impact.However,in the regulated utility sector,barriersto movement of cash among companies in the
corporate family can be much more restrictive,depending on the regulatory framework.These barriers can
lead to significantly different probabilities ofdefault for HoldCos and Opcos.Structural subordination also
affects loss given default.Under most default'33°scenarios,an Opco's creditors will be satisfied from the
value residing at that Opco before any of the Opco's assets can be used to satisfy claims of the HoldCo's
creditors.The prevalenceof debt issuance at the Opco level is another reason that structural subordination
is usually amore serious concern in the utility sector than for investment grade issuers in other non-financial
corporate sectors.
The grids for factors 1-4 are primarily oriented to Opcos (and to some degree for HoldCoswith minimal
current structural subordination;for example,there is no current structural subordinationto debt at the
operating company if all of the utility family's debt and preferred stock is issued atthe HoldCo level,
although there is structural subordination to other liabilities at the Opco level).The additional risk from
structural subordination is addressed via a notching adjustment to bringgrid outcomes (on average)closer
to the actual ratings of HoldCos.
How We Assess It
Grid-indicated ratings of holding companies may be notched down based on structuralsubordination.The
risk factors and mitigants that impact structural subordination are varied and can be presentin different
combinations,such that a formulaic approach is not practical and case-by-caseanalyst judgment of the
interaction of all pertinent factors that may increase or decrease its importance tothe credit risk of an issuer
are essential.
Some of the potentially pertinent factors that could increase the degree and/or impact ofstructural
subordination include the following:
»Regulatory or other barriers to cash movement from OpCos to HoldCo
»Specific ring-fencing provisions
»Strict financial covenants at the Opco level
»Higher leverage at the Opco level
»Higher leverage at the HoldCo level14
»Significant dividend limitations or potential limitations at an importantOpco
»Holdco exposure to subsidiaries with high business risk or volatile cash flows
Strained liquidity at the Holdco level
»The group's investment program is primarily in businesses that are higher risk or new to the group
Some of the potentially mitigating factors that could decrease the degree and/or impact ofstructural
subordination include the following:
*The HoldCo and Opco may also have intercompany agreements,induding tax sharing agreements,that can be anothersource of cash to theHoldCo.
33 Actual priority in a default scenario will be determined by many factors,induding the corporate and bankruptcy laws of the jurisdiction,the asset value of each
Opco,specific financing terms,inter-relationshipsamong members of the family,etc
14 While higher leverage at the HoldCo does not increase structural subordinationper se,it exacerbates the impact of any structural subordination that exists
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»Substantial diversity in cash flows from a variety of utilityOpcos
»Meaningful dividends to Holdco from unlevered utility Opcos
»Dependable,meaningful dividends to Holdco from non-utilityopcos
»The group's investment program is primarily in strong utilitybusinesses
»Inter-company guarantees -however,in many jurisdictions the value of an upstreamguarantee may be
limited by certain factors,including by the value that the Opco received in exchangefor granting the
guarantee
Notching for structural subordination within the grid may range from 0 to negative 3 notches.Instances of
extreme structural subordination are relatively rare,so the grid convention doesnot accommodate wider
differences,although in the instances where we believe it is present,actualratings do reflect the full impact
of structuralsubordination.
A related issue is the relationship of ratings within a utility family with multiple operatingcompanies,and
sometimes intermediate holding companies.Some of the key issues are the same,such asthe relative
amounts of debt at the holding company level compared to the operating company level (orat one Opco
relative to another),and the degree to which operating companies have credit insulation due to regulation
or other protective factors.Appendix B has additional insights on ratings withina utility family.
Rating Methodology Assumptions,Limitations,and Other RatingConsiderations
The grid in this rating methodology represents a decision to favor simplicity that enhances transparency and
to avoid greater complexity that might enable the grid to map more closely toactual ratings.Accordingly,
the four rating factors and the notching factor in the grid do not constitutean exhaustive treatment of all of
the considerations that are important for ratings of companies inthe regulated electric and gas utility sector.
In addition,our ratings incorporate expectations forfuture performance,while the financial information that
is used in the grid inthis document is mainly historicaL In some cases,our e×pectations for future
performance may be informed by confidential information that we can't disclose.In other cases,we
estimate futureresults based upon past performance,industry trends,competitor actions or other factors.In
eithercase,predicting the future is subject to the risk of substantialinaccuracy.
Assumptions that may cause our forward-looking expectations to be incorrect includeunanticipated
changes in any of the following factors:the macroeconomic environment and general financialmarket
conditions,industry competition,disruptive technology,regulatory and legalactions.
Key rating assumptions that apply in this sector include our view that sovereign credit risk isstrongly
correlated with that of other domestic issuers,that legal priority of claim affects average recoveryon
different classes of debt,sufficiently to generally warrant differences in ratings for different debt classes of
the same issuer,and the assumption that lack of access to liquidity is a strong driver of creditrisk.
In choosing metrics for this rating methodology grid,we did not explicitly include certain important factors
that are common to all companies in any industry such as the quality and experienceof management,
assessments of corporate governance and the quality of financial reporting and information disclosure.
Therefore ranking these factors by rating category in a grid would insome cases suggest too much precision
in the relative ranking of particular issuers against all otherissuers that are rated in various industry sectors.
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Ratings may include additional factors that are difficult to quantify or that have a meaningful effectin
differentiating credit quality only in some cases,but not all.Such factors include financialcontrols,exposure
to uncertain licensing regimes and possible government interference in somecountries.
Regulatory,litigation,liquidity,technology and reputational risk as well as changes to consumerand
business spending patterns,competitor strategies and macroeconomic trends also affect ratings.While these
are important considerations,it is not possible precisely to express these in the rating methodology grid
without making the grid excessively complex and significantly lesstransparent.
Ratings may also reflect circumstances in which the weighting of a particular factor willbe substantially
different from the weighting suggested by the grid.
This variation in weighting rating considerations can also apply to factors that we choose notto represent in
the grid.For example,liquidity is a consideration frequently critical to ratings andwhich may not,in other
circumstances,have a substantial impact in discriminating between two issuerswith a similar credit profile.
As an example of the limitations,ratings can be heavily affected byextremely weak liquidity that magnifies
default risk.However,two identical companies might be rated thesame if their only differentiating feature is
that one has a good liquidity position while the other hasan extremely good liquidity position.
Other Rating Considerations
We consider other factors in addition to those discussed in this report,but in mostcases understanding the
considerations discussed herein should enable a good approximation of our viewon the credit quality of
companies in the regulated electric and gas utilities sector.Ratings considerour assessment of the quality of
management,corporate governance,financial controls,liquidity management,event risk and seasonality.
The analysis of these factors remains an integral part ofour rating process.
Liquidity and Access to Capital Markets
Liquidity analysis is a key element in the financial analysis of electric and gas utilities,and it encompasses a
company's ability to generate cash from internal sources as well as the availabilityof external sources of
financing to supplement these internal sources.Liquidity and access tofinancing are of particular
importance in this sector.Utility assets can often have a very long useful life-30,40 or even 60 years is not
uncommon,as well as high price tags.Partly as a result of constructioncycles,the utility sector has
experienced prolonged periods of negative free cash flow-essentially,the sumof its dividends and its
capital expenditures for maintenance and growth of its infrastructurefrequently exceeds cash from
operations,such that a portion of capital expenditures must routinely be debt financed.Utilities are among
the largest debt issuers in the corporate universe and typicallyrequire consistent access to the capital
markets to assure adequate sources of funding and to maintainfinancial flexibility.Substantial portions of
capex are non-discretionary (for example,maintenance,adding customers to the network,or meeting
environmental mandates),however,utilities were swift to cutor defer discretionary spending during the
2007-2009 recession.Dividends represent aquasi-permanent outlay,since utilities typically only rarely will
cut their dividend.Liquidity is also important tomeet maturing obligations,which often occur in large
chunks,and to meet collateral calls underany hedging agreements.
Due to the importance of liquidity,incorporating it as a factor with a fixed weighting in thegrid would
suggest an importance level that is often far different from the actual weight in the rating.In normal
circumstances most companies in the sector have good access to liquidity.The industry generally requires,
and for the most part has,large,syndicated,multi-year committed creditfacilities.In addition,utilities have
demonstrated strong access to capital markets,even underdifficult conditions.As a result,liquidity
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generally has not been an issue for most utilities and a utilitywith very strong liquidity may not warrant a
rating distinction compared to a utility with strongliquidity.However,when there is weakness in liquidity or
liquidity management,it can be thedominant consideration for ratings.
Our assessment of liquidity for regulated utilities involves an analysis of total sources and uses ofcash over
the next 12 months or more,as is done for all corporates.Using our financial projections ofthe utility and
our analysis of its available sources of liquidity (including an assessment of the qualityand reliability of
alternate liquidity such as committed credit facilities),we evaluate how itsprojected sources of cash (cash
from operations,cash on hand and existing committed multi-year creditfacilities)compare to its projected
uses (including all or most capital expenditures,dividends,maturities of short and long-term debt,our
projection of potential liquidity calls on financial hedges,and important issuer-specific items such as special
tax payments).We assume no access to capital marketsor additional liquidity sources,no renewal of
existing credit facilities,and no cut to dividends.We examine a company's liquidity profile under this
scenario,its ability to make adjustments to improve its liquidity position,and any dependence on liquidity
sources with lower quality and reliability.
ManagementQuality and Financial Policy
The quality of management is an important factor supporting the credit strength of a regulated utility or
utility holding company.Assessing the execution of business plans over time can be helpful in assessing
management's business strategies,policies,and philosophies and in evaluating management performance
relative to performance of competitors and our projections.A record of consistency provides us with insight
into management's likely future performance in stressed situations and can be an indicator of management's
tendency to depart significantly from its stated plans and guidelines.
We also assess financial policy (including dividend policy and planned capital expenditures)and how
management balances the potentially competing interests of shareholders,fixed income investorsand other
stakeholders.Dividends and discretionary capital expenditures are the two primary components over which
management has the greatest control in the short term.For holding companies,we consider the extent to
which management is willing stretch its payout ratio (through aggressive increases or delays in needed
decreases)in order to satisfy common shareholders.For a utility that isa subsidiary of a parent company
with several utility subsidiaries,dividends to the parent may bemore volatile depending on the cash
generation and cash needs of that utility,because parents typicallywant to assure that each utility
maintains the regulatory debt/equity ratio on which its rates have beenset.The effect we have observed is
that utility subsidiaries often pay higher dividends when they have lower capital needs and lower dividends
when they have higher capital expenditures or other cash needs.Any dividend policy that cuts into the
regulatory debt/equity ratio is a material credit negative.
Size -Natural Disasters,Customer Concentration and Construction Risks
The size and scale of a regulated utility has generally not been a major determinant of its credit strength in
the same way that it has been for most other industrial sectors.While size bringscertain economies of scale
that can somewhat affect the utility's cost structure and competitiveness,ratesare more heavily impacted
by costs related to fuel and fixed assets.Particularly in the US,we havenot observed material differences in
the success of utilities'regulatory outreach based on their size.Smaller utilities have sometimes been better
able to focus their attention on meeting the expectations of a single regulator than their multi-statepeers.
However,size can be a very important factor in our assessment of certain risks that impactratings,including
exposure to natural disasters,customer concentration (primarily to industrial customers ina single sector)
and construction risks associated with large projects.While the grid attempts to incorporate the first two of
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these into Factor 3,for some issuers these considerations may be sufficiently important that the rating
reflects a greater weight for these risks.Whileconstruction projects always carry the risk of cost over-runs
and delays,these risks are materially heightenedfor projects that are very large relative to the size of the
utility.
Interaction of Utility Ratings with Government Policies and SovereignRatings
Compared to most industrial sectors,regulated utilities are more likely to be impacted bygovernment
actions.Credit impacts can occur directly through rate regulation,and indirectly throughenergy,
environmental and tax policies.Government actions affect fuel prices,the mix of generating plants,the
certainty and timing of revenues and costs,and the likelihood that regulated utilities willexperience
financial stress.While our evolving view of the impact of such policies and the general economicand
financial climate is reflected in ratings for each utility,some considerations do not lend themselvesto
incorporation in a simple ratings grid."
A small number of regulated utilities have diversified operations that are segments within the utility
company,as opposed to the more common practice of housing such operations in one or more separate
affiliates.In general,we will seek to evaluate the other businesses that are materialin accordance with the
appropriate methodology and the rating will reflect considerations fromsuch methodologies.There may be
analytical limitations in evaluating the utility and non-utilitybusinesses when segment financial results are
not fully broken out and these may be addressed throughestimation based on available information.Since
regulated utilities are a relatively low risk business comparedto other corporate sectors,in most cases
diversified non-utility operations increase the business risk profile of a utility.Reflecting this tendency,we
note that assigned ratings are typically lower thangrid-indicated ratings for such companies.
Event Risk
We also recognize the possibility that an unexpected event could cause a sudden and sharp declinein an
issuer's fundamental creditworthiness.Typical special events include mergers and acquisitions,asset sales,
spin-offs,capital restructuring programs,litigation and shareholderdistributions.
CorporateGovernance
Among the areas of focus in corporate governance are audit committee financial expertise,the incentives
created by executive compensation packages,related party transactions,interactionswith outside auditors,
and ownership structure.
Investment and Acquisition Strategy
In our credit assessment we take into consideration management's investment strategy.Investment strategy
is benchmarked with that of the other companies in the rated universe to further verifyits consistency.
Acquisitions can strengthen a company's business.Our assessment of a company's tolerance for acquisitions
at a given rating level takes into consideration (1)management's risk appetite,including the likelihood of
further acquisitions over the medium term;(2)sharebuy-back activity;(3)the company's commitment to
specific leverage targets;and (4)the volatility of the underlying businesses,as well as that of the business
acquired.Ratings can often hold after acquisitions even if leverage temporarily climbs above normally
acceptable ranges.However,this depends on (1)the strategic fit;(2)pro-forma capitalization/leverage
*See also the cross-sector methodology "How Sovereign Credit Quality May Affect Other Ratings."A link to this and other sector and cross-sector credit rating
methodologies can be found in the Related Research section of this report
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following an acquisition;and (3)ourconfidence that credit metrics will be restored in a relatively short
timeframe.
Financial Controls
We rely on the accuracy of audited financial statements to assign and monitor ratings in thissector.Such
accuracy is only possible when companies have sufficient internal controls,includingcentralized operations,
the proper tone at the top and consistency in accounting policies and procedures.
Weaknesses in the overall financial reporting processes,financial statement restatements or delaysin
regulatory filings can be indications of a potential breakdown in internalcontrols.
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AppendixA:Regulated Electric and Gas Utilities MethodologyFactor Grid
Factor 1a:Legislative and Judicial Underpinnings of the Regulatory Framework (12.5%)
Aaa Aa A Baa
Utility regulationoccurs under a fully developed Utility regulationoccurs undera fully developednational,Utility regulationoccurs undera welldeveloped Utility regulation occurs (i)undera national,state,provincialor municipal
frameworkthat is nationalin scope based onlegislation stateor provincialframework based on legislationthat national,stateor provincialframework based on framework based on legislationthat providesthe utilitya strong monopolythatprovidestheutilityanearlyabsolutemonopoly(see providesthe utility an extremelystrong monopoly(see note Legislation that providesthe utility a verystrong within its service territory that mayhavesomeexceptionssuch as greaternote1_within its service territory,an unquestioned 1)within its service territory,a strongassurance,subjectto monopoly(see note 1)within its service territory,an self-generation(see note 1),ageneralassurance that,subjectto prudency
assurance that rates will be set in a mannerthat will permit limited review,that rates will be set in amannerthat will assurance,subjectto reasonableprudency requirementsthat are mostly reasonable,rates will be set will be set in a
the utility to makeand recover all necessary investments,permit the utility to makeand recoverall necessary requirements,that rates will be set ina mannerthat mannerthat willpermit the utility to makeand recoverall necessary
an extremelyhigh degreeofclarity as to the mannerin investments,a veryhigh degree of clarity asto the manner will permit the utility to makeandrecoverall investments,reasonableclarity as to the mannerin which utilities will be
whichutilities will be regulated and prescriptivemethods in which utilities will be regulatedand reasonably necessary investments,a high degree of clarity as to regulatedand overallguidancefor methodsand proceduresfor setting
and proceduresforsetting rates.Existing utility law is prescriptivemethodsand proceduresforsetting rates.If the mannerin whichutilities will be regulated,and rates;or(ii)undera newframeworkwhereindependentand transparent
comprehensiveandsupportivesuch that changes in therehavebeen changes in utility legislation,they have overallguidance for methodsand proceduresfor regulationexists in other sectors.If there havebeen changes in utility
legislation are notexpectedto be necessary;or any been timely and clearlycredit supportiveoftheissuer in a setting rates.If therehavebeen changes in utility legislation,they havebeen creditsupportiveor atleast balancedfor the
changes that have occurred have been stronglysupportive mannerthat shows the utility has had a strong voicein the legislation,they havebeen mostly timely and on the issuer but potentially less timely,and theutility had a voice in the
of utilitiescredit qualityin general and sufficientlyforward-process.There is an independentjudiciary thatcan arbitrate wholecreditsupportivefor the issuer,and the utility legislativeprocess.There is either (i)anindependentjudiciarythat can
lookingso as to address problemsbeforetheyoccurred.disagreementsbetweenthe regulatorand the utility,should has had a clear voicein thelegislativeprocess.There arbitrate disagreementsbetweenthe regulatorand the utility,including
There is an independentjudiciary that can arbitrate they occur includingaccess to national courts,strong is an independentjudiciarythat can arbitrate access to courtsat least at the state or provinciallevel,reasonablyclear
disagreements betweenthe regulator and theutility should judicial precedentin the interpretation of utility laws,and a disagreementsbetweenthe regulatorand the utility,judicial precedentin the interpretation of utility laws,and a generally
they occur,including access to nationalcourts,verystrong strong rule of law.We expectthese conditionstocontinue.shouldthey occur,includingaccesstonational strong rule of law;or
judicialprecedentin the interpretationof utility laws,and a courts,clear judicial precedentinthe interpretation (ii)regulationhas been applied(undera well developedframework)in astrongruleoflaw.We expecttheseconditionstocontinue.of utility law,and a strongruleof law.We expect mannersuch that redress to an independentarbiter has not been required.theseconditionsto continue We expectthese conditionstocontinue.
Ba B Caa
Utility regulationoccurs (i)undera national,state,Utility regulation occurs (i)undera national,state,Utility regulationoccurs (i)underanational,state,
provincialor municipalframeworkbased on legislation or provincialor municipalframeworkbased on legislationor provincialor municipal frameworkbased on
governmentdecree that provides the utility a monopoly governmentdecree that providestheutility monopoly legislation or governmentdecree that providesthe
within its service territory that isgenerallystrong butmay within its service territory that is reasonablystrong butmay utility a monopoly within itsserviceterritory,but
have a greater level of exceptions(seenote1),and that,haveimportant exceptions,and that,subjecttoprudency with little assurance that rates will be set in a manner
subject to prudencyrequirementswhich maybe stringent,requirementswhich may be stringent or at timesarbitrary,that will permit the utilityto makeand recover
providesa generalassurance (with somewhatless providesmorelimited or less certainassurance that rates necessary investments;or(ii)undera newframework
certainty)that rates will be set will be set in a mannerthat will be set in a mannerthat will permit the utility tomake wherewe wouldexpectunpredictableor adverse
will permitthe utilityto makeand recover necessary and recovernecessary investments;or (ii)undera new regulation,based either on thejurisdiction's history
investments;or (ii)undera new frameworkwherethe framework wherewe would expectless independentand of in other sectorsorother factors.The judiciary that
jurisdiction has a historyof less independentand transparentregulation,based either on theregulator's can arbitratedisagreementsbetweentheregulator
transparentregulationinother sectors.Either:(i)the history in other sectors or otherfactors.The judiciarythat andthe utility maynot haveclear authority or is
judiciarythat can arbitratedisagreements betweenthe can arbitrate disagreementsbetweenthe regulator andthe viewedas not being fully independentofthe
regulator and theutility maynot have clear authority or utility maynot haveclear authority or maynot be fully regulatoror other political pressure.Alternately,
maynot be fully independentof the regulatoror other independentofthe regulator or other political pressure,but theremaybe no redress to an effectiveindependentpoliticalpressure,butthere is a reasonablystrong rule of there is a reasonablystrong rule of law.Alternately,where arbiter.The ability of the utility to enforceits
law;or (ii)wherethere is no independentarbiter,the thereis no independentarbiter,theregulationhasbeen monopoly or preventuncompensatedusage of its
regulationhas mostlybeen appliedin a mannersuch appliedin a mannerthat often requires some redressadding systemmay be limited.There maybe a risk of
redress has notbeen required.We expectthese conditions moreuncertainty to the regulatoryframework.creditor-unfriendlynationalizationor othertocontinueTheremaybeaperiodicriskofcreditor-unfriendly significantintervention in utility marketsorrate-
government intervention in utility marketsorrate-setting.setting.
Note 1:The strength of themonopoly refers to the legal,regulatoryand practical obstacles for customersin the utility's territory to obtainservice fromanotherprovider.Examples of a weakeningof the monopolywould include theabilityof a
city or large user to leave the utility systemto set up their ownsystem,the extent to whichself-generationis permitted (e.g.cogeneration)and/or encouraged (e.g.,net metering,DSM generation).At the lower end of the ratings spectrum,
the utility's monopoly maybe challenged bypervasivetheft and unauthorizeduse.Since utilitiesare generallypresumedto be monopolies,a strong monopolypositionin itself is not sufficientfor a strong score in this sub-factor,buta
weakeningofthe monopolycan lowerthe score.
*10%weightfor issuers that lack generation **0%weight for issuers that lack generation
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Factor 1b:Consistency and Predictability of Regulation (12.5%)
Aaa Aa A Baa
The issuer's interaction with the regulator The issuer's interaction with the regulator has a The issuer's interaction with the The issuer's interaction with the regulator has led toan
has led to a strong,lengthy track record of led to a considerabletrack record of regulator has led to a track record of adequate track record.The regulator is generally
predictable,consistent and favorable predominantly predictable and consistent largely predictable and consistent consistent and predictable,but there may some evidence
decisions.The regulator is highly credit decisions.The regulator is mostly credit decisions.The regulator may be of inconsistency or unpredictability from time to time,or
supportive of the issuer and utilities in supportive of utilities in generaland in almost all somewhat less credit supportive of decisions may at times be politically charged.However,
general.We expect these conditions to instances has been highlycredit supportive of utilities in general,but has been quite instances of tess credit supportive decisions are based on
continue.the issuer.We expect these conditions to credit supportive of the issuerin most reasonableapplication of existing rules and statutes and
continue.circumstances.We expect these are not overly punitive.We expect these conditions to
conditions to continue.continue.
Ba B Caa
We expect that regulatory decisions will We expect that regulatory decisions will be We expect that regulatory decisions will
demonstrate considerable inconsistency or largely unpredictable or even somewhat be highly unpredictable and frequently
unpredictability or that decisions will be arbitrary,based either on the issuer's track adverse,based either on the issuer'strack
politically charged,based either on the record of interaction with regulators or other record of interaction with regulators or
issuer's track record of interaction with governing bodies,or our view that decisions will other governing bodies,or our view that
regulatorsor other governing bodies,or our move in this direction.However,we expect that decisions will move in this direction.
view that decisions will move in this the issuer will ultimately be ableto obtain Alternately,decisions may have creditdirection.The regulator may have a history support when it encounters financial stress,supportive aspects,but may often beoflesscreditsupportiveregulatorydecisionsalbeitwithmaterialormoreextendeddelaysunenforceable.The regulator's authoritywithrespecttotheissuer,but we expect that Alternately,the regulator is untested,lacks a may have been seriously eroded bytheissuerwillbeabletoobtainsupportconsistenttrackrecord,or is undergoing legislative or political action.Thewhenitencountersfinancialstress,with substantial change.The regulator's authority regulator may consistently ignore thesomepotentiallymaterialdelays.The may be erodedon frequent occasions by frameworkto the detriment of the issuer.regulator's authority may be erodedat times legislative or politicalaction.The regulator may
by legislative or political action.The more frequently ignorethe framework in aregulatormaynotfollowtheframeworkformannerdetrimentaltotheissuer.
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Factor 2a:Timeliness of Recovery of Operating and Capital Costs (12.5%)
Aaa Aa A Baa
Tariff formulas and automatic cost recovery Tariff formulas and automatic cost recovery Automatic cost recovery mechanisms provide Fuel,purchased power and all other highlyvariable
mechanisms provide full and highly timely mechanisms provide full and highly timely full and reasonablytimely recovery of fuel,expenses are generally recovered through mechanisms
recovery of all operating costs and recovery of all operating costs and essentially purchased power and all other highly variable incorporating delays of less thanone year,although
essentially contemporaneous return on all contemporaneous or near-contemporaneous operating expenses.Material capital some rapid increases in costs maybe delayed longer
incremental capital investments,with return on most incremental capital investments may be made under tariff where such deferrals do not place financial stress on the
statutory provisions in place to preclude the investments,with minimalchallenges by formulas or otherrate-making permitting utility.Incremental capital investments may be
possibility of challengesto rate increases or regulators to companies'cost assumptions.By reasonablycontemporaneous returns,or may recovered primarily through general rate cases with
cost recovery mechanisms.By statute and statute and by practice,generalrate cases are be submitted underother types of filings that moderate lag,withsome through tariff formulas.
by practice,generalrate casesare efficient,efficient,focused on an impartial review,of a provide recovery of cost of capital with minimal Alternately,there may be formula rates that are
focused on an impartial review,quick,and very reasonableduration before non-delays.Instances of regulatory challengesthat untested orunclear.
permit inclusion of fully forward -looking appealable interim rates can be collected,and delay rate increases or cost recovery are Potentially greater tendency for delays due tocosts.primarily permit inclusion of forward-looking generally related to large,unexpected increases regulatory intervention,although this willgenerally becosts.in sizeable construction projects.By statute or limited to rates related to large capital projects or rapid
by practice,generalrate cases are reasonably increases in operating costs.efficient,primarily focused on an impartial
review,of a reasonableduration before rates
(either permanent or non-refundable interim
rates)can be collected,and permit inclusion of
important forward -lookingcosts.
Ba B Caa
There is an expectation that fuel,purchased The expectation that fuel,purchased power or The expectation that fuel,purchased power or
power or other highly variable expenses will other highly variable expenses will be other highly variable expenses will be recovered
eventually be recovered with delays that recovered may be subject to material delays may be subject to extensive delays due to
will not place material financial stress on due to second-guessingof spendingdecisions second-guessingof spendingdecisions by
the utility,but there may be some evidence by regulators or dueto political intervention.regulators or dueto political intervention.
of an unwillingness by regulatorsto make Recovery of costs relatedto capital Recovery of costs relatedto capital investments
timely rate changes to address volatility in investments may be subject to delays that are may be uncertain,subjectto delays that are
fuel,or purchased power,or other market-material to the issuer,or may be likely to extensive,or that may be likelytodiscourage
sensitive expenses.Recovery of costs discouragesome important investment.even necessary investment.
related to capital investments may be
subject to delays thatare somewhat
lengthy,but not so pervasive as to be
expected to discourage important
investments.
Note:Tariff formulasinclude formularate plans as wellas trackers and riders related to capitalinvestment.
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Factor 2b:Sufficiency of Rates and Returns (12.5%)
Aaa Aa A Baa
Sufficiency of rates to cover costs and Rates are (and we expect will continue to be)Rates are (and we expect will continue Rates are (and we expect will continue to be)set at a level that
attract capital is (and will continue to be)setat a level that permits full cost recovery and to be)set at a level that generally generally provides full operating cost recovery and a mostly fair
unquestioned.afair return on all investments,with minimal provides full cost recovery and a fair return on investments,but there may be somewhat more
challenges by regulators to companies'cost return on investments,with limited instances of regulatory challengesand disallowances,although
assumptions.This will translate to returns instances of regulatory challenges and ultimate rate outcomes aresufficient to attract capital without
(measured in relationto equity,total assets,disallowances.difficulty.In general,this will translate to returns (measured in
rate base or regulatory asset value,as in general,this will translate to returns relation to equity,total assets,rate base or regulatory asset
applicable)that are strong relativeto global (measured in relation to equity,total value,as applicable)that are average relative to global peers,but
peers assets,rate base or regulatory asset may at times be somewhat below average.
value,as applicable)that are generally
above average relative to global peers,
but mayat times be average.
Ba B Caa
Rates are (and we expect will continue to We expect rates will be set at a level that at We expect rates will be set at a level
be)set at a level that generally provides times fails to provide recovery of costs other that often fails to provide recovery of
recoveryof most operating costs but return than cash costs,and regulators may engage in material costs,and recovery of cash
on investments may be less predictable,and somewhat arbitrary second-guessingof costs may also be at risk.Regulators
there may be decidedly more instances of spendingdecisionsor deny rate increases may engage in more arbitrary second-
regulatory challenges and disallowances,related to funding ongoing operations based guessing of spendingdecisions or deny
but ultimate rate outcomes are generally much more on politics than on prudency rate increases relatedto funding
sufficient to attract capitaL In general,this reviews.Return on investments may be set at ongoing operations based primarily on
will translate to returns (measured in levels that discourageinvestment.Weexpect politics.Return on investments may be
relation to equity,total assets,rate base or that rate outcomes may be difficult or set at levels that discouragenecessary
regulatory asset value,as applicable)that uncertain,negatively affecting continued maintenance investment.We expect
are generally belowaverage relative to access tocapital.that rate outcomes may often be
global peers,or whereallowed returns are Alternately,the tariff formula may fail to take Punitive or highly uncertain,with a
average but difficult to earn.into account significant cost components other markedly negative impact on access to
Alternately,the tariff formula may not take than cash costs,and/or remuneration of capital.Alternately,the tariff formula
into account all cost components and/or investments may be generallyunfavorable.may fail to take into account significant
remuneration of investments may be cash cost components,and/or
unclearor at times unfavorable.remuneration of investments may be
primarily unfavorable.
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Factor 3:Diversification (10%)
Sub-Factor
Weighting 10%Weighting Aaa Aa A Baa
Market Position 5%*A very high degreeof multinational Material operations in three or Material operations in two to three nations,states,May operate under a single regulatory regime viewed as having low
and regional diversity in terms of more nations or substantial provinces or regions that provide good diversity of volatility,or where multiple regulatory regimes are not viewed as
regulatory regimes and/or service geographic regions providing very regulatory regimesand service territory economies.providing much diversity.Theservice territory economy may have
territory economies.good diversity of regulatory Alternately,operates withina single regulatory some concentration and cyclicality,but is sufficiently resilient that it
regimes and/or service territory regime with low volatility,and the serviceterritory can absorb reasonably foreseeable increasesin utility rates.
economies.economy is robust,has a very high degree of
diversity and has demonstrated resilience in
economic cycles.
Generation and 5%**A high degree of diversity in terms of Very good diversification in terms Good diversification in terms ofgeneration and/or Adequate diversification in terms of generation and/or fuel sources
Fuel Diversity generation and/or fuel sources such of generation and/or fuel sources fuel sources such that the utility and rate-payers suchthat the utility and rate-payers havemoderate exposure to
that the utility and rate-payers are such that the utility and rate-haveonly modest exposureto commodity price commodity price changes;however,may havesome concentrationwellinsulatedfromcommoditypricepayersareaffectedonlyminimallychanges;however,may havesome concentration in in a source that is Challenged.Exposureto Threatened Sourcesis
changes,no generation bycommodity pricechanges,little a source that is neither Challenged norThreatened.moderate,while exposureto Challenged Sources is manageable.
concentration,and very low generation concentration,and low Exposureto Threatened Sourcesis low.While thereexposurestoChallengedorexposurestochallengedormaybesomeexposuretoChallengedSources,it isThreatenedSources(see definitions Threatened Sources not a causefor concern.below).
Sub-Factor
Weighting Ba B Caa Definitions
Market Position 5%*Operates in a market areawith Operates in a limited market area Operates in a concentrated economicservice Challenged Sourcesare generation plants that facehigher but not
somewhat greater concentration and with material concentration and territory with pronounced concentration,insurmountable economic hurdles resulting from penalties or taxes
cyclicality in the service territory moresevere cyclicality in service macroeconomic risk factors,and/or exposure to ontheir operation,or from environmental upgradesthat are
economy and/or exposureto storms territory economy such that cycles natural disasters.required or likely tobe required.Some examples are carbon-
andother natural disasters,andthus are of materially longer duration or emitting plants that incur carbontaxes,plants that must buy
less resilience to absorbing reasonably foreseeable increasesin emissions credits to operate,and plants that must install
reasonably foreseeable increasesin utility ratescould presenta environmental equipment to continue to operate,in eachwherethe
utility rates.May show somewhat material challenge to the economy.taxes/creditslupgrades are sufficient to havea material impact on
greater volatility in the regulatory Serviceterritory may have those plants'competitiveness relative to other generation types or
regime(s).geographic concentration that on theutility's rates,but where the impact is not so severeas to be
limits its resilienceto storms and likely require plant closure.
other natural disasters,or may be
an emerging market.Mayshow
decided volatility in the regulatory
regime(s).
Generation and 5%**Modest diversification in generation Operates with little diversification Operates with high concentration in generation Threatened Sourcesare generation plants that are not currently
Fuel Diversity and/or fuelsources such that the in generation and/or fuel sources and/or fuel sourcessuch thatthe utility or rate-ableto operate due to major unplanned outages or issues with
utility or rate-payers havegreater suchthat the utility or rate-payers payers haveexposureto commodity priceshocks.licensing orother regulatory compliance,and plants that are highly
exposure to commodity price havehigh exposure to commodity Exposureto Challenged and Threatened Sources likely to be required tode-activate,whether due to the
changes.Exposureto Challenged and price changes.Exposureto maybe very high,andaccessingattemate sources effectiveness of currently existing orexpected rules and regulations
Threatened Sourcesmay be more Challenged andThreatened may be highly uncertain.or dueto economic challenges.Some recentexamples would
pronounced,but the utility will be Sourcesmay be high,andaccessing include coal fired plants in the US that are not economic to retro-fit
able to access alternative sources alternate sourcesmay be to meet mercury and air toxics standards,plants that cannot meet
withoutundue financialstress.challengingand causemore theeffective date of those standards,nuclear plants in Japanthat
financial stress,but ultimately havenot beenlicensed to re-start after the Fukushima Dai-ichi
feasible.accident,and nuclear plants thatare required to be phased out
within 10 years (as is the case in someEuropeancountries).
*10%weightfor issuers that lack generation **0%weightfor issuers that lack generation
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Factor 4:Financial Strength
Sub-Factor
Weighting 40%Weighting Aaa Aa A Baa Ba B Caa
CFO pre-WC +Interest /7.5%a 8x 6x -8x 4.5x -6x 3x -4.5x 2x -3x 1x -2x <1x
interest
Standard Grid a 40%30%-40%22%-30%13%-22%5%-13%1%-5%<1%
CFO pre-WC /Debt 15%
Low Business Risk Grid a 38%27%-38%19%-27%11%-19%5%-11%1%-5%<1%
Standard Grid a 35%25%-35%17%-25%9%-17%0%-9%(5%)-0%<(5%)
CFO pre-WC -Dividends /Debt 10%
Low Business Risk Grid a 34%23%-34%15%-23%7%-15%0%-7%(5%)-0%<(5%)
Standard Grid <25%25%-35%35%-45%45%-55%55%-65%65%-75%a 75%
Debt /Capitalization 7.5%
Low Business Risk Grid <29%29%-40%40%-50%50%-59%59%-67%67%-75%a 75%
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AppendixB:Approach to Ratings within a UtilityFamily
Typical Composition ofa Utility Family
A typical utility company structure consists of a holding company ("HoldCo")that owns one ormore
operating subsidiaries (each an "Opco").Opcos may be regulated utilities or non-utilitycompanies.
Financing of these entities varies by region,in part due to the regulatory framework.A Holdco typically has
no operations -its assets are mostly limited to its equity interests in subsidiaries,and potentially other
investments in subsidiaries or minority interests in other companies.However,in certain cases there may be
material operations at the HoldCo level.Financing can occur primarilyat the Opco level,primarily at the
HoldCo level,or at both HoldCo and Opcos in varyingproportions.When a Holdco has multiple utility
Opcos,they will often be located in different regulatory jurisdictions.A HoldCo may have both levered and
unlevered opCos.
General Approach to a Utility Family
In our analysis,we generally consider the stand-alone credit profile of an Opco and the creditprofile of its
ultimate parent HoldCo (and any intermediate HoldCos),as wellas the profile of the family asa whole,
while acknowledging that these elements can have cross-family credit implications invarying degrees,
principally based on the regulatory framework of the Opcos and the financing model(which has often
developed in response to the regulatoryframework).
In addition to considering individual Opcos under this (or another applicable)methodology,we typicallyl614
approach a HoldCo rating by assessing the qualitative and quantitative factors inthis methodology for the
consolidated entity and each of its utility subsidiaries.Ratings of individual entities in the issuer family may
be pulled up or down based on the interrelationships amongthe companies in the family and their relative
credit strength.
In considering how closely aligned or how differentiated ratings should be among members of autility
family,we assess a variety of factors,including:
»Regulatory or other barriers to cash movement among Opcos and from Opcos toHoldco
»Differentiation of the regulatory frameworks of the variousopcos
»Specific ring-fencing provisions at particularopcos
»Financing arrangements -for instance,each Opco may have its own financing arrangements,or the
sole liquidity facility may be at the parent;there may be a liquidity pool among certain butnot all
members of the family;certain members of the family may better be able to withstanda temporary
hiatus of external liquidity or access to capitalmarkets
»Financial covenants and the extent to which an Event of Default by one Opco limitsavailability of
liquidity to another member of the family
»The extent to which higher leverage at one entity increases default risk for other members of the family
»An entity's exposure to or insulation from an affiliate with high businessrisk
»Structural features or other limitations in financing agreements that restrict movements of funds,
investments,provision of guarantees or collateral,etc.
See paragraph at the end of this section for approaches to Hybrid HoldCos.
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»The relative size and financial significance of any particular Opco to the Holdco and thefamily
See also those factors noted in Notching for Structural Subordination of Holding Companies.
Our approach to a Hybrid HoldCo (see definition in Appendix C)depends in part on theimportance of its
non-utility operations and the availability of information on individual businesses.If the businesses are
material and their individual results are fully broken out in financial disclosures,we may be able to assess
each material business individually by reference to the relevant Moody's methodologies to arrive at a
composite assessment for the combined businesses.If non-utility operations are material but are not broken
out in financial disclosures,we may look at theconsolidated entity under more than one methodology.
When non-utility operations are less material but couldstill impact the overall credit profile,the difference
in business risks and our estimation of their impacton financial performance will be qualitatively
incorporated in the rating.
Higher Barriers to Cash Movement with Financing Predominantlyat theOpCos
Where higher barriers to cash movement exist on an OpCo or Opcos due the regulatoryframework or debt
structural features,ratings among family members are likely to be more differentiated.For instance,for
utility families with Opcos in the US,where regulatory barriers to free cashmovement are relatively high,
greater importance is generally placed on the stand-alone credit profile ofthe Opco.
Our observation of major defaults and bankruptcies in the US sector generally corroborates a viewthat
regulation creates a degree of separateness of default probability.For instance,PortlandGeneral Electric
(Baal RUR-up)did not default on its securities,even though its then-parent Enron Corp.entered bankruptcy
proceedings.When Entergy New Orleans (Ba2 stable)entered intobankruptcy,the ratings of its affiliates
and parent Entergy Corporation (Baa3 stable)were unaffected.PG&ECorporation (Baal stable)did not
enter bankruptcy proceedings despite bankruptcies of two major subsidiaries -Pacific Gas &Electric
Company (A3 stable)in 2001 and National Energy Group in 2003.
The degree of separateness may be greater or smaller and is assessed on a case by case basis,because
situational considerations are important.One area we consider is financing arrangements.For instance,
there will tend to be greater differentiation if each member of a family has its own bankcredit facilities and
difficulties experienced by one entity would not trigger events of default for other entities.While the
existence of a money pool might appear to reduce separateness betweenthe participants,there may be
regulatory barriers within money pools that preserve separateness.For instance,non-utility entities may
have access to the pool only as a borrower,only as a lender,andeven the utility entities may have
regulatory limits on their borrowings from the pool or their credit exposures to other pool members.If the
only source of external liquidity for a money poolis borrowings by the HoldCo under its bank credit facilities,
there would be less separateness,especially if the utilities were expected to depend on that liquidity source.
However,the ability of an Opcoto finance itself by accessing capital markets must also be considered.
Inter-company tax agreementscan also have an impact on our view of how separate the risks of defaultare.
For a HoldCo,the greater the regulatory,economic,and geographic diversity of its Opcos,thegreater its
potential separation from the default probability of any individual subsidiary.Conversely,ifa HoldCo's
actions have made it clear that the HoldCo will provide support for an Opcoencountering some financial
stress (for instance,due to delays and/or cost over-runs on a majorconstruction project),we would be likely
to perceive lessseparateness.
Even where high barriers to cash movement exist,onerous leverage at a parent company may not only give
rise to greater notching for structural subordination at the parent,it may also pressure an Opco's rating,
especially when there is a clear dependence on an Opco's cash flow to service parent debt.
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While most of the regulatory barriers to cash movement are very real,they are notabsolute.Furthermore,
while it is not usually in the interest of an insolvent parent or its creditors to bringan operating utility into a
bankruptcy proceeding,such an occurrence is notimpossible.
The greatest separateness occurs where strong regulatory insulation is supplemented by effectivering-
fencing provisions that fully separate the management and operations of the Opco from the rest ofthe
family and limit the parent's ability to cause the Opco to commence bankruptcy proceedings as well as
limiting dividends and cash transfers.Typically,most entities in US utility families(including HoldCos and
Opcos)are rated within 3 notches of each other.However,it is possible for the HoldCo and Opcos in a
family to have much wider notching due to the combination of regulatory imperatives and strong ring-
fencing that includes a significant minority shareholder who must agree to important corporate decisions,
including a voluntary bankruptcy filing.
Lower Barriers to Cash Movement with Financing Predominantly at theOpCos
Our approach to rating issuers within a family where there are lower regulatory barriers to movement of
cash from OpCos to HoldCos (e.g.,many parts of Asia and Europe)places greater emphasis onthe credit
profile of the consolidated group.Individual Opcos are considered based on their individual characteristics
and their importance to the family,and their assigned ratings are typically banded closely around the
consolidated credit profile of the group due to the expectation that cash willtransit relatively freely among
family entities.
Some utilities may have Opcos in jurisdictions where cash movement among certain familymembers is
more restricted by the regulatory framework,while cash movement from and/or among Opcosin other
jurisdictions is less restricted.In these situations,Opcos with more restrictions may varymore widely from
the consolidated credit profile while those with fewer restrictions may be moretightly banded around the
other entities in the corporate family group.
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AppendixC:Brief Descriptions of the Types of Companies Rated Under This
Methodology
The following describes the principal categories of companies rated under this methodology:
Vertically Integrated Utility:Vertically integrated utilities are regulated electric or combination utilities (see
below)that own generation,distribution and (in most cases)electric transmissionassets.Vertically
integrated utilities are generally engaged in all aspects of the electricity business.They build power plants,
procure fuel,generate power,build and maintain the electric grid that deliverspower from a group of power
plants to end-users (including high and low voltage lines,transformersand substations),and generally meet
all of the electric needs of the customers in a specific geographicarea (also called a service territory).The
rates or tariffs for all of these monopolistic activities are set bythe relevant regulatory authority.
Transmission &Distribution Utility:Transmission &Distribution utilities (T&Ds)typically operate in
deregulated markets where generation is provided under a competitive framework.T&Ds ownand operate
the electric grid that transmits and/or distributes electricity within a specific state or region.
T&Ds provide electrical transportation and distribution services to carry electricity from powerplants and
transmission lines to retail,commercial,and industrial customers.T&Ds are typically responsible for billing
customers for electric delivery and/or supply,and most have an obligation to providea standard supply or
provider-of-last-resort (POLR)service to customers that have not switched toa competitive supplier.These
factors distinguish T&Ds from Networks,whose customers are retail electric suppliers and/or other
electricity companies.In a smaller number of cases,T&Ds rated under this methodology may not have an
obligation to provide POLR services,but are regulated in sub-sovereign jurisdictions.The rates or tariffs for
these monopolistic T&D activities are set bythe relevant regulatory authority.
Local Gas Distribution Company:Distribution is the final step in delivering natural gas to customers.While
some large industrial,commercial,and electric generation customers receive natural gasdirectly from high
capacity pipelines that carry gas from gas producing basins to areas where gas isconsumed,most other
users receive natural gas from their local gas utility,also called a local distributioncompany (LDC).LDCs are
regulated utilities involved in the delivery of natural gas to consumers withina specific geographic area.
Specifically,LDCs typically transport natural gas from delivery pointslocated on large-diameter pipelines
(that usually operate at fairly high pressure)to households and businesses through thousands of miles of
small-diameter distribution pipe (that usually operate at fairlylow pressure).LDCs are typically responsible
for billing customers for gas delivery and/or supply,and most also have the responsibility to procure gas for
at least some of their customers,although insome markets gas supply to all customers is on a competitive
basis.These factors distinguish LDCs from gas networks,whose customers are retail gas suppliers and/or
other natural gas companies.The ratesor tariffs for these monopolistic activities are set by the relevant
regulatoryauthority.
Integrated Gas Utility:Integrated gas regulated utilities are regulated utilities that deliver gas to all end
users in a particular service territory by sourcing the commodity;operating transport infrastructure that
often combines high pressure pipelines with low pressure distribution systems and,in somecases,gas
storage,re-gasification or other related facilities;and performing other supply-related activities,such as
customer billing and metering.The rates or tariffs for the totality of these activities are setby the relevant
regulatory authority.Many integrated gas utilities are national inscope.
Combination Utility:Combination utilities are those that combine an LDC or Integrated Gas Utility with
either a vertically integrated utility or a T&D utility.The rates or tariffs for thesemonopolistic activities are
set by the relevant regulatory authority.
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Regulated Generation Utility:Regulated generation utilities (Regulated Gencos)are utilities that almost
exclusively have generation assets,but their activities are generally regulated like thoseof vertically
integrated utilities.In the US,this means that the purchasers of their output (typically other investor-
owned,municipal or cooperative utilities)pay a regulated rate based on the total allowedcosts of the
Regulated Genco,including a return on equity based on a capital structure designated bythe regulator
(primarily FERC).Companies that have been included in this group include certain generation companies
(including in Korea and China)that are not rate regulated in the usual senseof recovering costs plus a
regulated rate of return on either equity or asset value.Instead,we have looked at a combination of
governmental action with respect to setting feed-in tariffs and directives on how much generation will be
built (or not built)in combination with a generally high degree of government ownership,and we have
concluded that these companies are currently best rated under this methodology.Future evolution in our
view of the operating and/or regulatory environmentof these companies could lead us to conclude that
they may be more appropriately rated under arelated methodology (for example,Unregulated Utilities and
Power Companies).
Independent System Operator:An Independent System Operator (ISO)is an organization formed in certain
regional electricity markets to act as the sole chief coordinator of an electric grid.In theareas where an ISO
is established,it coordinates,controls and monitors the operation of the electricalpower system to assure
that electric supply and demand are balanced at all times,and,to the extentpossible,that electric demand
is met with the lowest-cost sources.ISOs seek to assure adequatetransmission and generation resources,
usually by identifying new transmission needs and planning for ageneration reserve margin above expected
peak demand.In regions where generation is competitive,they also seek to establish rules that foster a fair
and open marketplace,and they may conductprice-setting auctions for energy and/or capacity.The
generation resources that an ISO coordinates may belongto vertically integrated utilities or to independent
power producers.ISOs may not be rate-regulated in the traditional sense,but fall under governmental
oversight.All participants in the regional gridare required to pay a fee or tariff (often volumetric)to the ISO
that is designed to recover its costs,including costs of investment in systems and equipment needed to
fulfill their function.ISOs maybe for profit or not-for-profit entities.
In the US,most ISos were formed at the direction or recommendation of the Federal Energy Regulatory
Commission (FERC),but the ISO that operates solely in Texas falls understate jurisdiction.Some US ISOs
also perform certain additional functions such that they are designatedas Regional Transmission
Organizations (or RTOs).
Transmission-Only Utility:Transmission-only utilities are solely focused on owning and operating
transmission assets.The transmission lines these utilities own are typically high-voltage andallow energy
producers to transport electric power over long distances from where it is generated (or received)to the
transmission or distribution system of a T&D or vertically integrated utility.Unlike most of the other utilities
rated under this methodology,transmission-only utilities primarilyprovide services to other utilities and
ISOs.Transmission-only utilities in most parts of the world otherthan the US have been rated under the
Regulated Networks methodology.
Utility Holding Company (Utility HoldCo):As detailed in Appendix B,regulated electric and gas utilities are
often part of corporate families under a parent holding company.The operating subsidiaries of Utility
Holdcos are overwhelmingly regulated electric and gas utilities.
Hybrid Holding Company (Hybrid HoldCo):Some utility families contain a mix of regulated electric and gas
utilities and other types of companies,but the regulated electric and gasutilities represent the majority of
the consolidated cash flows,assets and debt.The parent company is thusa Hybrid HoldCo.
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AppendixD:Key IndustryIssues Over the Intermediate Term
As highly regulated monopolistic entities,regulated utilities continually face political and regulatory risk,and
managing these risks through effective outreach to key customers as wellas key political and regulatory
decision-makers is,or at least should be,a core competency of companies in this sector.However,largerwaves
of change in the political,regulatory or economic environment have the potential to cause substantial changes
in the level of risk experienced by utilities and their investors in somewhat unpredictable ways.
One of the more universal risks faced by utilities currently is the compression of allowed returns.A longperiod
of globally low interest rates,held down by monetary stimulus policies,has generally benefittedutilities,since
reductions in allowed returns have been slower than reductions in incurred capital costs.Essentially all
regulated utilities face a ratcheting down of allowed and/or earned returns.More difficult topredict is how
regulators will respond when monetary stimulus reverses,and how well utilitieswill farewhen fixed income
investors require higher interest rates and equity investors require higher total returnsand growth prospects.
The following global snapshot highlights that regulatory frameworks evolve over time.On an overall basis in
the US over the past several years,we have noted some incremental positive regulatory trends,including
greater use of formula rates,trackers and riders,and (primarily for natural gas utilities)de-coupling of returns
from volumetric sales.In Canada,the framework has historically been viewed as predictable and
stable,which has helped offset somewhat lower levels of equity in the capital structure,but the compressionof
returns has been relatively steep in recent years.In Japan,the regulatory authorities are working throughthe
challenges presented by the decision to shut down virtually all of the country's nuclear generationcapacity,
leading to uncertainty regarding the extent to which increased costs will be reflected in rate increases
sufficient to permit returns on capital to return to prior levels.China's regulatory frameworkhas continued to
evolve,with fairly low transparency and some time-to-time shifts in favored versus less-favoredgeneration
sources balanced by an overall state policy of assuring sustainability of the sector,adequate supply of electricity
and affordability to the general public.Singapore and Hong Kong have fairly well developedand supportive
regulatory frameworks despite a trend towards lower returns,whereas Malaysia,Korea andThailandhave been
moving towards a more transparent regulatory framework.The Philippines is in theprocess of deregulating its
power market,while Indian power utilities continue to grapple with structuralchallenges.In Latin America,
there is a wide dispersion among frameworks,ranging from the more stable,longestablished and predictable
framework in Chile to the decidedly unpredictable framework in Argentina.Generally,as Latin American
economies have evolved to more stable economic policies,regulatory frameworks for utilities have also shown
greater stability and predictability.
All of the other issues discussed in this section have a regulatory/politicalcomponent,either as the driver of
change or in reaction to changes in economic environments and market factors.
Economic and Financial MarketConditions
As regulated monopolies,electric and gas utilities have generally been quite resistant to unsettled economic
and financial market conditions for several reasons.Unlike many companies that facedirect market-based
competition,their rates do not decrease when demand decreases.The elasticityof demand for electricity
and gas is much lower than for most products in the consumereconomy.
When financial markets are volatile,utilities often have greater capital market access than industrial
companies in competitive sectors,as was the case in the 2007-2009 recession.However,regulated electric
and gas utilities are by no means immune to a protracted or severerecession.
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Severe economic malaise can negatively affect utility credit profiles in several ways.Fallingdemandfor
electricity or natural gas may negatively impact margins and debt service protection measures,especially
when rates are designed such that a substantial portion of fixed costs is in theoryrecovered through
volumetric charges.The decrease in demand in the 2007-2009 recession was notable in comparison to prior
recessions,especially in the residential sector.Poor economic conditions can make it more difficult for
regulators to approve needed rate increases or provide timely cost recovery for utilities,resulting in higher
cost deferrals and longer regulatory lag.Finally,recessions can coincide with a lack of confidence in the
utility sector that impacts access to capital markets for a period of time.For instance,in the Great
Depression and (to a lesser extent)in the 2001 recession,accessfor some issuers was curtailed due to the
sector's generally higher leverage than other corporatesectors,combined with a concerns over a lack of
transparency in financialreporting.
Fuel Price Volatility and the Global Impact of Shale Gas
The ability of most utilities to pass through their fuel costs to end users may insulate a utility from exposure
to price volatility of these fuels,but it does not insulate consumers.Consumers and regulators complained
vociferously about utility rates during the run-up in hydro-carbon pricesin 2005-2008 (oil,natural gas and,
to a lesser extent,coal).The steep decline in US natural gasprices since 2009,caused in large part by the
development of shale gas and shale oil resources,has beena material benefit to US utilities,because many
have been able to pass through substantial baserate increases during a period when all-in rates were
declining.Shale hydro-carbons have also had a positive impact,albeit one that is less immediate and direct,
on non-US utilities.In much ofthe eastern hemisphere,natural gas prices under long-term contracts have
generally been tied to oil prices,but utilities and other industrial users have started to have some success in
negotiating tode-link natural gas from oil.In addition,increasing US production of oil has had a noticeable
impacton world oil prices,generally benefitting oil and gas users.
Not all utilities will benefit equally.Utilities that have locked in natural gas under high-priced long-term
contracts that they cannot re-negotiate are negatively impacted if they cannot pass throughtheir full
contracted cost of gas,or if the high costs cause customer dissatisfaction and regulatory backlash.Utilities
with large coal fleets or utilities constructing nuclear power plants may also face negative impacts on their
regulatory environment,since their customers will benefit less from lower naturalgas prices.
Distributed Generation Versus the Central Station Paradigm
The regulation and the financing of electric utilities are based on the premise that the currentmodel under
which electricity is generated and distributed to customers will continue essentiallyunchanged for many
decades to come.This model,called the central station paradigm (because electricityis generated in large,
centrally located plants and distributed to a large number of customers,who mayin fact be hundreds of
miles away),has been in place since the early part of the 20th century.The model has worked because the
economies of scale inherent to very large power plants has more than offset the cost and inefficiency
(through power losses)inherent to maintaining a grid for transmittingand distributing electricity to end
users.
Despite rate structures that only allow recovery of invested capital over many decades (up to 60 years),
utilities can attract capital because investors assume that rates will continue to be collected for atleast that
long a period.Regulators and politicians assume that taxes and regulatory charges levied on electricity usage
will be paid by a broad swath of residences and businesses and will not materially discourage usage of
electricity in a way that would decrease the amount of taxes collected.A corollary assumption is that the
number of customers taking electricity from the system during that period will continue to be high enough
such that rates will be reasonable and generally more attractive thanother alternatives.In the event that
consumers were to switch en masse to alternate sources of generatingor receiving power (for instance
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distributed generation),rates for remaining customers would eithernot cover the utility's costs,or rates
would need to be increased so much that more customers maybe incentivized to leave the system.This
scenario has been experienced in the regulated US copperwire telephone business,where rates have
increased quite dramatically for users who have not switchedto digital or wireless telephone service.While
this scenario continues to be unlikely for theelectricity sector,distributed generation,especially from solar
panels,has made inroads in certainregions.
Distributed generation is any retail-scale generation,differentiated from self-generation,which generally
describes a large industrial plant that builds its own reasonably large conventional power plant to meet its
own needs.While some residential property owners that install distributed generation may choose to sever
their connection to the local utility,most choose to remainconnected,generating power into the grid when
it is both feasible and economic to do so,and taking powerfrom the grid at other times.Distributed
generation is currently concentrated in roof-top photovoltaicsolar panels,which have benefitted from
varying levels of tax incentives in differentjurisdictions.
Regulatory treatment has also varied,but some rate structures that seek to incentivize distributed renewable
energy are decidedly credit negative for utilities,in particular netmetering.
Under net metering,a customer receives a credit from the utility for all of its generation at the full(or nearly
full)retail rate and pays only for power taken,also at the retail rate,resulting in amaterially reduced
monthly bill relative to a customer with no distributed generation.The distributed generation customer has
no obligation to generate any particular amount of power,so the utility must stand ready to generate and
deliver that customer's full power needs at all times.Since most utility costs,including the fixed costs of
financing and maintaining generation and delivery systems,are currentlycollected through volumetric rates,
a customer owning distributed generation effectively transfers a portion of the utility's costs of serving that
customer to other customers with higher net usage,notablyto customers that do not own distributed
generation.The higher costs may incentivize more customers to install solar panels,thereby shifting the
utility's fixed costs to an even smaller group ofrate-payers.California is an example of a state employing net
solar metering in its rate structure,whereas inNew Jersey,which has the second largest residential solar
program in the US,utilities buy power at aprice closer to their blended cost of generation,which is much
lower than the retailrate.
To date,solar generation and net metering have not had a material credit impact on any utilities,but ratings
could be negatively impacted if the programs were to grow and if rate structures werenot amended so that
each customer's monthly bill more closely approximated the cost of servingthat customer.
In our current view,the possibility that there will be a widespread movement of electricutility customers to
sever themselves from the grid is remote.However,we acknowledge thatnew technologies,such as the
development of commercially viable fuel cells and/or distributedelectric storage,could disrupt materially
the central station paradigm and the credit quality of theutility sector.
Nuclear Issues
Utilities with nuclear generation face unique safety,regulatory,and operational issues.Thenuclear disaster
at FukushimaDaiichi had a severely negative credit impact on its owner,Tokyo Electric Power Company,
Incorporated,as well as all the nuclear utilities in the country.Japan previously generated about 30%of its
power from 50 reactors,but all are currently either idled orshut down,and utilities in the country face
materially higher costs of replacement power,a creditnegative.
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Fukushima Daiichi also had global consequences.Germany's response was to require that all nuclear power
plants in the country be shut by 2022.Switzerland opted for a phase-out by 2031.(Most European nuclear
plants are owned by companies rated under other the Unregulated Utilitiesand Power Companies
methodology.)Even in countries where the regulatory response was more moderate,increased regulatory
scrutiny has raised operating costs,a credit negative,especially inthe US,where low natural gas prices have
rendered certain primarily smaller nuclear plantsuneconomic.Nonetheless,we view robust and independent
nuclear safety regulation asa credit-positive for the industry.
Other general issues for nuclear operators include higher costs and lower reliability related tothe increasing
age of the fleet.In 2013,Duke Energy Florida,Inc.decided to shut permanently Crystal River Unit 3 after it
determined that a de-lamination (or separation)inthe concrete of the outer wall of the containment
building was uneconomic to repair.San Onofre Nuclear Generating Station was closed permanently in 2013
after its owners,including Southern California Edison Company (A3,RUR-up)and San Diego Gas &Electric
Company (A2,RUR-up),decided not to pursue a re-start in light of operating defects in two steam
generators that had been replaced in 2010 and 2011.
Korea Hydro and Nuclear Power Company Limited and its parent,Korea Electric Power Corporation,faced a
scandal related to alleged corruption and acceptanceof falsified safety documents provided by its parts
suppliers for nuclear plants.Korean prosecutors'widening probe into KHNP'suse of substandard parts at
many of its 23 nuclear power plantscaused three plants to be shut down temporarily.
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AppendixE:Regional and Other Considerations
In most regions,our approach to notching between different debt classes of the same regulatedutility issuer
follows the guidance in the publication "Updated Summary Guidance for Notching Bonds,Preferred Stocks
and Hybrid Securities of Corporate Issuers,"including a onenotch differential between senior secured and
senior unsecured debt."However,in most cases we havetwo notches between the first mortgage bonds
and senior unsecured debt of regulated electric and gas utilities in the US.
Wider notching differentials between debt classes may also be appropriate in speculativegrade.Additional
insights for speculative grade issuers are provided in the publication "Loss Given Defaultfor Speculative-
Grade Companies.""
First mortgage bond holders in the US generally benefit from a first lien on most of the fixedassets used to
provide utility service,including such assets as generating stations,transmission lines,distribution lines,
switching stations and substations,and gas distribution facilities,as well as a lienon franchise agreements.In
our view,the critical nature of these assets to the issuers and tothe communities they serve has been a
major factor that has led to very high recovery rates for this class of debt in situations of default,thereby
justifying a two notch uplift.The combination of the breadthof assets pledged and the bankruptcy-tested
recovery experience has been unique to theUS.
In some cases,there is only a one notch differential between US first mortgage bonds and thesenior
unsecured rating.For instance,this is likely when the pledged property is not considered critical
infrastructure for the region,or if the mortgage is materially weakened by carve-outs,lien releasesor similar
creditor-unfriendly terms.
The use of securitization,a financing technique utilizing a discrete revenue stream (typically relatedto
recovery of specifically defined expenses)that is dedicated to servicing specific securitization debt,has
primarily been used in the US,where it has been quite pervasive in the past two decades.Thefirst
generation of securitization bonds were primarily related to recovery of the negative difference between the
market value of utilities'generation assets and their book value when certain states switched to competitive
electric supply markets and utilities sold their generation (so-called stranded costs).This technique was
then used for significant storm costs (especially hurricanes)and was eventually broadened to include
environmental related expenditures,deferred fuel costs,or even deferred miscellaneous expenses.States
that have implemented securitization frameworks include Arkansas,California,Connecticut,Illinois,
Louisiana,Maryland,Massachusetts,Mississippi,NewHampshire,New Jersey,Ohio,Pennsylvania,Texas and
West Virginia.In its simplest form,asecuritization isolates and dedicates a stream of cash flow into a
separate special purpose entity (SPE).The SPEuses that stream of revenue and cash flow to provide annual
debt service for the securitized debtinstrument.Securitization is typically underpinned by specific
legislation to segregate the securitization revenues from the utility's revenues to assure their continued
collection,and the details of the enabling legislation may vary from state to state.The utility benefits
from the securitization because it receives an immediate source of cash (although it gives up the
opportunity to earn a return onthe corresponding asset),and ratepayers benefit because the cost of the
A link to this and other sector and cross-sector credit rating methodologiescan be found in the Related Research section of this report.
A link to this and other sector and cross-sector credit rating rnethodologiescan be found in the Related Research section of this report,
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securitized debt is lower than the utility's cost of debt and much lower than its all-in cost of capital,
which reduces therevenue requirement associated with the cost recovery.
In the presentation of US securitization debt in published financial ratios,we make ourown assessment of
the appropriate credit representation but in most cases follows the accounting inaudited statements under
US Generally Accepted Accounting Principles (GAAP),which in turn considers the terms of enabling
legislation.As a result,accounting treatment may vary.In most statesutilities have been required to
consolidate securitization debt under GAAP,even though it is technicallynon-recourse.
In general,we view securitization debt of utilities as being on-credit debt,in part because the rates
associated with it reduce the utility's headroom to increase rates for other purposes while keeping all-in
rates affordable to customers.Thus,where accounting treatment is off balance sheet,we seek to adjust the
company's ratios by including the securitization debt and related revenues for our analysis.Where the
securitized debt is on balance sheet,our credit analysis also considers the significance of ratiosthat exclude
securitization debt and related revenues.Since securitization debt amortizes mortgage-style,including it
makes ratios look worse in early years (when most of the revenue collected goes topay interest)and better
in later years (when most of the revenue collected goes to payprincipal).
Strong levels of government ownership in Asia Pacific (ex-Japan)provide rating uplift
Strong levels of government ownership have dominated the credit profiles of utilities in Asia Pacific
(excluding Japan),generally leading to ratings that are a number of notches above the Baselinecredit
Assessment.Regulated electric and gas utilities with significant government ownership are ratedusing this
methodology in conjunction with the joint Default Analysis approach in our methodology for Government-
Related Issuers.
Our ratings for large corporate entities in Japan reflect the unique nature of the country'ssupport system,
and they are higher than they would otherwise be if such support were disregarded.Thisis reflected in the
tendency for ratings of Japanese utilities to be higher than their grid implied ratings.However,even for large
prominent companies,our ratings consider that support will not be endless and is less likely to be provided
when a companyhas questionable viability rather than being in need of temporary liquidityassistance.
A link to this and other sector and cross-sector credit rating rnethodologiescan be found in the Related Research section of this report.
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AppendixF:Treatment of Power Purchase Agreements ("PPAs")
Although many utilities own and operate power stations,some have entered into PPAs to source electricity
from third parties to satisfy retail demand.The motivation for these PPAs may be oneor more of the
following:to outsource operating risks to parties more skilled in power station operation,to provide
certainty of supply,to reduce balance sheet debt,to fix the cost of power,or to complywith regulatory
mandates regarding power sourcing,including renewable portfolio standards.While we regard PPAs that
reduce operating or financial risk as a credit positive,some aspects of PPAs may negatively affect the credit
of utilities.The most conservative treatment would be to treat a PPA as a debt obligation of the utility as,by
paying the capacity charge,the utility is effectively providingthe funds to service the debt associated with
the power station.At the other end of the continuum,the financial obligations of the utility could also be
regarded as an ongoing operating cost,with no long-term capital component recognized.
Under most PPAs,a utility is obliged to pay a capacity charge to the power station owner (whichmay be
another utility or an Independent Power Producer -IPP);this charge typically covers a portionof the IPP's
fixed costs in relation to the power available to the utility.These fixed payments usually help to cover the
IPP's debt service and are made irrespective of whether the utility calls on the IPPto generate and deliver
power.When the utility requires generation,a further energy charge,to cover the variable costs of the IPP,
will also typically be paid by the utility.Some other similar arrangements are characterized as tolling
agreements,or long-term supply contracts,but most have similar featuresto PPAs and are thus we analyze
them as PPAs.
PPAs are recognized qualitativelyto be a future use of cash whether or not theyare
treated as debt-like obligations in financialratios
The starting point of our analysis is the issuer's audited financial statements -we consider whether the
utility's accountants determine that the PPA should be treated as a debt equivalent,a capitalizedlease,an
operating lease,or in some other manner.PPAs have a wide variety of operational and financial terms,and it
is our understanding that accountants are required to have a very granular view intothe particular
contractual arrangements in order to account for these PPAs in compliance with applicable accounting rules
and standards.However,accounting treatment for PPAs may not be entirely consistent across US GAAP,
IFRS or other accounting frameworks.In addition,we may considerthat factors not incorporated into the
accounting treatment may be relevant (which may include the scale of PPA payments,their regulatory
treatment including cost recovery mechanisms,or other factorsthat create financial or operational risk for
the utility that is greater,in our estimation,than the benefits received).When the accounting treatment of
a PPA is a debt or lease equivalent (such that itis reported on the balance sheet,or disclosed as an operating
lease and thus included in our adjusteddebt calculation),we generally do not makeadjustments to remove
the PPA from the balancesheet.
However,in relevant circumstances we consider making adjustments that impute a debt equivalentto PPAs
that are off-balance sheet for accounting purposes.
Regardless of whether we consider that a PPA warrants or does not warrant treatment as adebt obligation,
we assess the totality of the impact of the PPA on the issuer's probability of default.Costs of a PPA that
cannot be recovered in retail rates creates material risk,especially if they also cannotbe recovered through
market sales of power.
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PPAs have a wide variety of financial and regulatory characteristics,and each particularcircumstance may be
treated differently by Moody's.Factors which determine where on the continuumwe treat a particular PPA
include the following:
»Risk management:An overarching principle is that PPAs have normally been used by utilities as a risk
management tool and we recognize that this is the fundamental reason for theirexistence.Thus,we
will not automatically penalize utilities for entering into contracts for the purposeof reducing risk
associated with power price and availability.Rather,we will look at theaggregate commercial position,
evaluating the risk to a utility's purchase and supply obligations.Inaddition,PPAs are similar to other
long-term supply contracts used by other industries and their treatment should not therefore be
fundamentally different from that of other contracts of a similarnature.
»Pass-through capability:Some utilities have the ability to pass through the cost ofpurchasing power
under PPAs to their customers.As a result,the utility takes no risk that the cost of power is greater than
the retail price it will receive.Accordingly we regard these PPA obligationsas operating costs with no
long-term debt-like attributes.PPAs with no pass-through ability havea greater risk profile for utilities.
In some markets,the ability to pass through costs of a PPAis enshrined in the regulatory framework,
and in others can be dictated by market dynamics.Asa market becomes more competitive or if
regulatory support for cost recovery deteriorates,the ability to pass through costs may decrease and,as
circumstances change,our treatmentof PPA obligations will alter accordingly.
»Price considerations:The price of power paid by a utility under a PPA can be substantiallyabove or
below the market price of electricity.A below-market price will motivate the utility topurchase power
from the IPP in excess of its retail requirements,and to sell excess electricity in thespot market.This
can be a significant source of cash flow for some utilities.On the otherhand,utilities that are
compelled to pay capacity payments to IPPs when they have no demand forthe power or at an above-
market price may suffer a financial burden if they do not get full recoveryin retail rates.We will focus
particularly on PPAs that have mark-to-market losses,which typically indicates that they have a
material impact on the utility's cashflow.
»Excess Reserve Capacity:In some jurisdictions there is substantial reserve capacity and thusa significant
probability that the electricity available to a utility under PPAs will not be requiredby the market.This
increases the risk to the utility that capacity payments will need to bemade when there is no demand
for the power.We may determine that all of a utility's PPAsrepresent excess capacity,or that a portion
of PPAs are needed for the utility's supply obligations plusa normal reserve margin,while the remaining
portion represents excess capacity.In the lattercase,we may impute debt to specific PPAs that are
excess or take a proportional approach to allof the utility's PPAs.
»Risk-sharing:Utilities that own power plants bear the associated operational,fuel procurement and
other risks.These must be balanced against the financial and liquidity risk of contractingfor the
purchase of power under a PPA.We will examine on a case-by case basis the relative credit risk
associated with PPAs in comparison to plantownership.
»Purchase requirements:Some PPAs are structured with either options or requirementsto purchase the
asset at the end of the PPA term.If the utility has an economicallymeaningful requirement to purchase,
we would most likely consider it to be a debt obligation.In mostsuch cases,the obligation would
already receive on-balance sheet treatment under relevantaccounting standards.
»Default provisions:In most cases,the remedies for default under a PPA do notinclude acceleration of
amounts due,and in many cases PPAs would not be considered as debt ina bankruptcy scenario and
could potentially be cancelled.Thus,PPAs may not materiallyincrease Loss Given Default for the utility.
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In addition,PPAs are not typically considered debt forcross-default provisions under a utility's debt
and liquidity arrangements.However,the existenceof non-standard default provisions that are debt-
like would have a large impact on our treatment ofa PPA.In addition,payments due under PPAs are
senior unsecured obligations,and any inability of the utility to make them materially increases default
risk.
Each of these factors will be considered by our analysts and a decision will be made as tothe importance of
the PPA to the risk analysis of the utility.
Methodsfor estimating a liability amount for PPAs
According to the weighting and importance of the PPA to each utility and the level of disclosure,we may
approximate a debt obligation equivalent for PPAs using one or more of the methods discussed below.In
each case we look holistically at the PPA's credit impact on the utility,including the ability to pass through
costs and curtail payments,the materiality of the PPA obligation tothe overall business risk and cash flows
of the utility,operational constraints that the PPA imposes,the maturity of the PPA obligation,the impact
of purchased power on market-based power sales (ifany)that the utility will engage in,and our view of
future market conditions andvolatility.
»Operating Cost:If a utility enters into a PPA for the purpose of providing an assured supplyand there is
reasonable assurance that regulators will allow the costs to be recovered in regulated rates,we may
view the PPA as being most akin to an operating cost.Provided that theaccounting treatment for the
PPA is,in this circumstance,off-balance sheet,we will most likely makeno adjustment to bring the
obligation onto the utility's balancesheet.
»Annual Obligation x 6:In some situations,the PPA obligation may be estimated by multiplying the
annual payments by a factor of six (in most cases).This method is sometimes used inthe capitalization
of operating leases.This method may be used as an approximation wherethe analyst determines that
the obligation is significant but cannot otherwise be quantifiedotherwise due to limited information.
»Net Present Value:Where the analyst has sufficient information,we may add the NPVof the stream of
PPA payments to the debt obligations of the utility.The discount rate used will be our estimate of the
cost of capital of the utility.
»Debt Look-Through:In some circumstances,where the debt incurred by the IPP is directly related to the
off-taking utility,there may be reason to allocate the entire debt (or aproportional part related to share
of power dedicated to the utility)of the IPP to that of theutility.
»Mark-to-Market:In situations in which we believe that the PPA prices exceed the market price and thus
will create an ongoing liability for the utility,we may use a netmark-to-market method,in which the
NPV of the utility's future out-of-the-money net payments will be addedto its total debt obligations.
»Consolidation:In some instances where the IPP is wholly dedicated to the utility,it maybe appropriate
to consolidate the debt and cash flows of the IPP with that of the utility.If theutility purchases only a
portion of the power from the IPP,then that proportion of debt mightbe consolidated with the utility.
If we have determined to impute debt to a PPA for which the accounting treatment is noton-balance sheet,
we will in some circumstances use more than one method to estimate the debtequivalent obligations
imposed by the PPA,and compare results.If circumstances (including regulatory treatment or market
conditions)change over time,the approach that is used may alsovary.
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Moody's Related Research
The credit ratings assigned in this sector are primarily determined by this credit ratingmethodology.Certain
broad methodological considerations (described in one or more credit rating methodologies)may also be
relevant to the determination of credit ratings of issuersand instruments in this sector.Potentially related
sector and cross-sector credit ratingmethodologies can be found here.
For data summarizing the historical robustness and predictive power of credit ratings assigned using this
credit rating methodology,see link.
Please refer to Moody's Rating Symbols &Definitions,which is available here,for further information.
Definitions of Moody's most common ratio terms can be found in "Moody's Basic Definitions for Credit
Statistics,User's Guide",accessible via this ljnk.
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»contacts continuedfrompage 7
Analyst Contacts:
BUENOS AIRES +54.11.5129.2600
Daniela Cuan +54.11.5129.2617
Vice President -Senior Analyst
[e-mail]
TORONTO +1.416.214.1635
Gavin MacFarlane +1.416.2143864
Vice President -Senior Credit Officer
[e-mail]
LONDON +44.20.7772.5454
Douglas Segars +44.20.7772.1584
Managing Director -Infrastructure Finance
douglas,segars@moodys com
Helen Francis +44.20.7772.5422
Vice President -Senior creditOfficer
[e-mail]
HONG KONG [phone]
Vivian Tsang +852375.81538
Associate Managing Director
[e-mail]
SINGAPORE +65.6398.8308
Ray Tay +65.6398.8306
Vice President -Senior Credit Officer
[e-mail]
TOKYO +813.5408.4100
Mihoko Manabe +81354.084.033
Associate Managing Director
[e-mail]
Mariko Semetko +81354.084.209
Vice President -Senior Credit Officer
[e-mail]
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Report Number:1072530
Author Production Associate
Michael G.Haggarty Masaki Shiomi
©2017 Moody'sCorporation,Moody's InvestorsService,Inc.,Moody'sAnalytics,Inc.and/or their licensors and affiliates (collectively,"MOODY'S").All rights reserved.
CREDIT RATINGS ISSUED BY MOODY'S INVESTORS SERVICE,INC.AND ITS RATINGS AFFILIATES ("MIS")ARE MOODY'S CURRENTOPINIONSOF THE RELATIVE FUTURE
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To theextent permitted by law,MOODY'S and its directors,officers,employees,agents,representatives,licensors and suppliers disclaim liability for anydirector compensatorylosses or
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Additionalterms for Australiaonly:Anypublicationinto Australiaof this documentis pursuantto the AustralianFinancial Services License of MOODY'S affiliate,Moody's InvestorsService
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Additionalterms for Japan only:Moody'sjapanK.K.("MJKK")is a wholly-owned credit rating agency subsidiaryof Moody'sGroupJapan G.K.,which is wholly-owned byMoody's Overseas
Holdings Inc.,a wholly-owned subsidiaryof MCO.Moody'sSF japan K.K.("MSFj")is a wholly-owned credit rating agencysubsidiaryof MjKK.MSFJ is nota Nationally Recognized Statistical
Rating Organization ("NRSRO").Therefore,creditratings assigned by MSFJ are Non-NRSRO Credit Ratings.Non-NRSRO Credit Ratings are assigned by an entity that is not a NRSRO and,
consequently,the rated obligationwill not qualifyfor certaintypesof treatment underLJ.S.laws.MJKK and MSFJ are credit rating agencies registered with theJapan Financial Services Agency
and their registrationnumbersare FSA Commissioner(Ratings)No.2 and 3 respectively.
MjKK or MSFJ (as applicable)herebydisclose that most issuers of debtsecurities (including corporate and municipal bonds,debentures,notes and commercialpaper)and preferredstockrated
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MjKK and MSFJ also maintain policies and procedurestoaddress Japanese regulatoryrequirements.
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51 JUNE 23,2017 RATING METHODOLOGY:REGULATED ELECTRIC AND GAS UTIUTIES
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