HomeMy WebLinkAbout20080403Malquist Direct.pdfDAVID J. MEYER
VICE PRESIDENT, CHIEF COUNSEL REGULATORY & GO~~ENTAL
~~i~;~S CORPORATION " Pi? - 3 Pr'112: 40
P.O. BOX 3727
1411 EAST MISSION AVENUE
SPOKAE, WASHINGTON 99220-3727
TELEPHONE: (509) 495-4316
FACSIMILE: (509) 495-4361
BEFORE THE IDAHO PUBLIC UTILITIES COMMISSION
IN THE MATTER OF THE APPLICATION ) CASE
OF AVISTA CORPORATION FOR THE ) CASE
AUTHORITY TO INCREASE ITS RATES )
AND CHAGES FOR ELECTRIC AND )
NATURAL GAS SERVICE TO ELECTRIC AN )
NATURAL GAS CUSTOMERS IN THE STATE )OF IDAHO )
)
NO. AVU-E-08-01
NO. AVU-G-08-01
DIRECT TESTIMONY
OF
MAYN K. MAQUIST
FOR AVISTA CORPORATION
(ELECTRIC AN NATURA GAS)
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I. INTRODUCTION
Q. Please state your name, business address, and
3 present position with Avista Corp.
4 A.My name is Malyn K. Malquist.My business
5 address is 1411 East Mission Avenue, Spokane, Washington.
6 i am employed by Avista Corporation as Executive Vice
7 President and Chief Financial Officer.
8 Q.Would you please describe your education and
9 business experience?
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A.I received a Bachelors degree and a Master of
Business Administration degree from Brigham Young
University.I have also attended a variety of utility
13 finance courses and leadership programs during my 25+ year
14 utility career.
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I joined Avista in September of 2002 as Senior Vice
President.In November 2002 I was named to the additional
17 position of Chief Financial Officer. I was named Executive
18 Vice President in May 2006.Prior to joining Avista, I
19 was General Manager of Truckee Meadows Water Authority in
20 Reno, Nevada, which was separated out from Sierra Pacific
21 Power Company in 2001.I was Chief Executive Officer of
22 Data Engines, Inc., a high tech company located in Reno
23 from June to October of 2000.From April 1994 to April
24 2000, I was employed by Sierra Pacific Resources, first as
25 the company's Chief Financial Officer and later as its
Malquist, Di 1
Avista Corporation
1 Chairman of the Board and Chief Executive Officer.
2 Following the merger of Sierra Pacific Resources with
3 Nevada Power Company in 1999, I became the President of
4 both Sierra Pacific Power Company and Nevada Power Company.
5 For the sixteen-year period prior to 1994, I was employed
6 by San Diego Gas & Electric Company in various positions,
7 including Treasurer and Vice President - Finance.
8 Q.What is the scope of your testimony in this
9 proceeding?
10 A.i will provide a financial overview of the
11 Company and will explain the overall rate of return
12 proposed by the Company in this filing for its electric and
13 natural gas operations.The proposed rate of return is
14 derived from Avista' s long-term cost of debt and common
15 equi ty, weighted in proportion to the proposed capital
16 structure.
17 i will address the proposed capital structure and debt
18 cost components. Company witness Dr. Avera will testify to
19 the appropriate return on equity for the Company.
20 In brief, i will provide information that shows:
21 . Avista's plans call for significant capital22 expenditure requirements for the utility over the23 next three to five years to assure reliability in24 our energy sys tems , and to keep pace wi th
25 regional growth and customer demand. Capital26 expenditures are planned for 2008-2009 of27 approximately $390 million for customer growth,28 investment in generation, transmission and29 distribution facilities for the electric utility30 business as well as necessary maintenance and
Malquist, Di 2
Avista Corporation
1 replacements of our natural gas utility systems.
2 Avista needs adequate cash flow from operations
3 to fund these requirements.
4
5 . Avista's corporate rating from Standard & Poor's
6 is currently BBB-. Avista Utilities should
7 operate at a level that will support a strong
8 investment grade credit rating, meaning "BBB+" or
9 "A-" . The Company's financial performance has
10 improved; however, we have not improved financial11 ratios to a level that would result in a strong12 investment grade credit rating.
13
14 . The Company has proposed an overall rate of15 return of 8.74%, including a 47.94% equity ratio16 and a 10.8% return on equity. We believe the17 10.8% provides a reasonable balance of the18 competing objectives of continuing to improve our19 financial health, and the impacts that increased20 rates have on our customers.
2122 The Company's initiatives to carefully manage its
23 operating costs and capital expenditures are an important
24 part of improving performance, but are not sufficient
25 without revenues from the general rate request for our
26 electric and natural gas businesses in these cases.
27 Certainty of cash flows from operations can only be
28 achieved with the continued support of regulators in
29 allowing the timely recovery of costs and the ability to
30 earn a fair return on inves tment .
31 Q.Are you sponsoring any exhibits with your direct
32 testimony?
33 A.Yes.I am sponsoring Exhibit No. 2 pages 1
34 through 4, which were prepared under my direction.
35 Avista' s credit ratings by the three principal rating
36 agencies are sumarized on page 1, and Avista' s actual
Malquist, Di 3
Avista Corporation
1 capital structure at December 31, 2007 and pro forma
2 capital structure at Decemer 31, 2008 are included on page
3 2, with supporting information on pages 3 through 4.
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II. FINANCIAL OVERVIEW
Q.Please provide an overview of Avista' s financial
7 situation.
8 A.The Company has made solid progress in improving
9 its financial health in recent years. The Company has been
10 able to reduce outstanding debt, refinance debt at lower
11 rates and improve cash flows from operations, resulting in
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improved financial ratios.Additionally, Avista has
reduced investments in unregula ted subsidiaries and
14 redeployed the majority of the proceeds from the sales of
15 the unregulated subsidiaries to the utility.The Company
16 has been able to improve its debt ratio and balance the
17 overall debt / equity ratio by paying down debt and issuing
18 additional common stock.
19 Al though we have made progress in improving the
20 Company's financial condition, we are still not as strong
21 as we need to be. Avista' s goal is to operate at a level
22 that will support a strong credit rating of BBB+ / A-.
23 Operating at this level will help reduce long-term costs to
customers.We expect that a continued focus on the24
25 regulated utility,conservative financing strategies
Malquist, Di 4
Avista Corporation
1 (including the issuance of common equity) and a continued
2 supportive regulatory environment will contribute to an
3 overall improved financial situation.
4 Q.What additional steps is the Company taking to
5 improve its financial health in the future?
6 A.We are working to assure we have adequate funds
7 for operations, capital expenditures and debt maturities,
8 through lines of credit with our banks and maintaining
9 adequate access to the capital markets.We have worked
10 with our banks to insure that we have adequate liquidity
11 through the availability of our credit facility on the most
12 economic basis possible.Additionally, the Company plans
13 to obtain a portion of our capital requirements through
14 equi ty issuance. We also maintain an ongoing dialogue with
15 the rating agencies regarding the measures being taken by
16 the Company to improve our credit rating.
17 Addi tionally,the Company is working through
18 regulatory processes to recover our costs in a timely
19 manner so that earned returns are closer to those allowed
20 by regulators in each of the states we serve. This is one
21 of the key determinants from the rating agencies'
22 standpoint when they are reviewing our overall credit
23 rating.
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Malquist, Di 5
Avista Corporation
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III. CREDIT RATINGS
Q.Please explain the credit ratings for Avista's
3 debt and other securities.
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5
Rating agencies are independent agencies thatA.
assess risks for investors.The three most widely
6 recognized rating agencies are Standard & Poor's (S&P),
7
8
Moody's Investors Service and FitchRatings(Moody's)
(Fitch) .These rating agencies assign a credit rating to
9 companies and their securities so investors can more easily
10 understand the risks associated with investing in their
11 debt and preferred stock.
12 Avista' s credit ratings by the three principal rating
13 agencies are sumarized on page 1 of Exhibit NO.2.
14 Addi tionally, the following rating actions occurred during
15
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2007 and 2008:
a. S&P upgraded Avista's corporate credit rating to
BBB- from BB+ (February 2008) and Avista's secured
debt rating to BBB+ from BBB- (September 2007).
b. Moody's upgraded Avista's corporate credit ratingto Baa3 from Ba1 and Avista' s secured rating to
Baa2 from Baa3 (December 2007) .
c. Fitch upgraded Avista's long-term issuer default
rating to BB+ from BB and its secured debt ratingto BBB from BBB- (August 2007 and affirmed in
February 2008) .
Q. Please explain the implications of these ratings
30 (in terms of the Company's ability to access financial
31 markets) .
Malquist, Di 6
Avista Corporation
1 A.For each type of investment a potential investor
2 could make, the investor looks at the quality of that
3 investment in terms of the risk they are taking and the
4 priority they would have in the event that the organization
5 experiences severe financial stress.Investment risks
6 include the likelihood that a company will not meet all of
7 its debt obligations in terms of timeliness and amounts
8 owed for principal and interest. Secured debt receives the
9 highest ratings and priority for repayment and, hence, has
10 the lowest relative risk.Thus, lower credit ratings may
11 result in a company having more difficulty accessing
12 financial markets and/or increased financing costs.
13 Q.What risks are facing Avista and the utility
14 sector that may have an impact on companies' credit
15 ratings?
16 A.Among the risk factors are the level and
17 volatility of wholesale electric market prices and natural
18 gas prices for fuel costs, liquidity in the wholesale
19 market (fewer counterparties and tighter credit
20 restrictions), recoverability of natural gas and power
21 costs,streamflow and weather conditions,changes in
22 legislative and governmental regulations, relicensing hydro
23 proj ects, rising construction and raw material costs and
24 access to capital markets at a reasonable cost.
Malquist, Di 7
Avista Corporation
1
2
Higher capital expendi tures for environmental
compliance,new generation and transmission and
3 distribution facilities are also impacting the utility
4 sector.The significant need for capital expenditures
5 causes increased competi tion for financial capital.
6 Regulation supporting the full and timely recovery of
7 prudently incurred costs is critical to the utility sector,
8 including Avista.
9 Q.What credit rating does Avista Utilities believe
10 is appropriate?
11 A.Avista Utilities should operate at a level that
12 will support a strong investment grade credit rating,
13 meaning a "BBB+" or an "A-," using S&P's rating scale. In
14 fact, S&P stated in its November 2007 U.S. Utilities and
15 Power Commentary that "About 68% of the companies in the
16 industry carry a 'BBB' category rating (BB+, BB, and BB-)
17 and 24% are rated 'A-' and above.
"1 Ratios required to
18 support this level of credit rating are included in Table 1
19 below.
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21
Financially healthy utilities have lower financing
costs which, in turn, benefits customers.In addition,
22 financially healthy utilities are better able to invest in
23 the needed infrastructure over time to serve their
i Stadard and Poor's, u.s. Utilities And Power Commentary, November 2007
Malquist, Di 8
Avista Corporation
1 customers, and to withstand the challenges and risks facing
2 the industry.
3 Q.Why is it important to have a strong investment
4 grade credit rating?
5 A.A utility is a capital-intensive business and, as
6 such, needs to have ready access to capital markets under
7
8
reasonable terms.Access is more difficult and more
expensive for lower rated companies.As new financing is
9 required in the future to finance utility plant additions,
10 new customer additions, and debt maturities, the cost of
11 new and replacement debt will be higher for lower rated
12 issuers.
13 The lower credit rating also requires the Company to
14 post more collateral with counterparties than would
15
16
otherwise be required with a higher credit rating.This
resul ts in increased costs.It also reduces financial
17 flexibility since we must always maintain a certain amount
18 of capacity under our credit line for letters of credit.
19 Q.Wht credit rating ratios are used by the rating
20 agencies?
21 A.S&P modified its electric and gas utility
22 rankings in November 2007 to conform to the "business
23 risk/financial risk" matrix used by their corporate ratings
24 group.The change by S&P was designed to present their
Malquist, Di 9
Avista Corporation
1 rating conclusions in a clear and standardized manner
2 across all corporate sectors.
3 S&P's financial ratio benchmarks used to rate
4 companies such as Avista are set forth below:
5 Table 1
Standard & Poor's Financial Risk Indicative Ratios - US Utilties
6
7
8
9
FFO/Debt (%)FFO/lnterest (x)Debt Ratio (%)
Modest 40 - 60 4.0 - 6.0 25 - 40
Intermediate 25 - 45 3.0 - 4.5 35 - 50
Aggressive 10 - 30 2.0 - 3.5 45 - 60
Highly leveraged Below 15 2.5 or less Over 50
December 31, 2007 Ratios:
Avista Unadjusted 14.0 2.9 53.8
Avista Adjusted 13.3 2.8 58.7
The ratios above are utilized to determine the
financial risk profile.Currently, Avistais in the
"Aggressive" category.The financial risk category along
10 with the business risk profile (Avista is in the Strong
11 category) is then utilized in the matrix below to determine
12 a company's rating.S&P currently has Avista' s corporate
13 credit rating as a BBB-, as indicated in the table below.
14 Table 2
Standard & Poor's Business Risk I Financial Risk Matrix
Financial Risk Profile
Highly
Business Risk Profile Minimal Modest Intermediate Aggressive leveraged
Excellent AM AA A BBB BB
Strong AA A A-BBB-BB-
Satisfactory A BBB+BBB BB+B+
Weak BBB BBB-BB+BB.B
Vulnerable BB B+B+B B-
15
Malquist, Di 10
Avista Corporation
1 The other rating agencies (Moody's and Fitch) use a
2 similar methodology to analyze and determine utility credit
3 ratings.
4 Q.Please describe how these ratios are calculated
5 and what they mean?
6 A.The first ratio, "Funds from operations/total
7 debt (%)", calculates the amount of cash from operations as
8 a percent of total debt. The ratio indicates the company's
9 ability to fund debt obligations. The second ratio, "Funds
10 from operations/interest coverage (x)", calculates the
11 amount of cash from operations that is available to cover
12 interest requirements.This ratio indicates how well a
13 company's earnings can cover interest payments on its debt.
14 The third ratio, "Total debt/total capital (%)", is the
15 amount of debt in our total capital structure.The ratio
16 is an indication of the extent to which the company is
17 using debt to finance its operations.S&P looks at many
18 other financial ratios; however, these are the three most
19 important ratios they use when analyzing our financial
20 profile.
21 Q.Do rating agencies make adjustments to the
22 financial ratios that are calculated directly from the
23 financial statemnts of the Company?
24 A.Yes. Rating agencies make adjustments to debt to
25 factor in off-balance sheet commitments (for example, the
Malquist, Di 11
Avista Corporation
1 accounts receivable program, purchased power agreements and
2 the unfunded status of pension and other post-retirement
3 benefits) that negatively impact the ratios.S&P has
4 historically made adjustments to Avista' s debt totaling
5 approximately $226 million related to the accounts
6 receivable program, purchased power and post-retirement
7 benefits.The adjusted financial ratios for Avista are
8 included in Table 1 above.
9 Q.Where does Avista fall within those coverage
10 ratios?
11 A.Avista's cash flow ratios lag primarily because
12 of high cost debt that is outstanding.The cash flow
13 ratios should improve as the 2008 debt maturities are
14 refinanced.S&P and Moody's took this into account when
15 they upgraded Avista in Decemer 2007 and February 2008.
16 Progress in increasing the cash flow ratios has been slower
17 than anticipated due to below normal stream flows affecting
18 hydro generation, higher thermal fuel costs than the amount
19 included in rates and resulting inability to eliminate
20 electric deferral balances, and higher capital expenditures
21 that require cash up front before we can recover the costs
22 from customers.Each has an impact on the Company by
23 reducing the amount of available cash flow from operations,
24 requiring external financing and ultimately resulting in
25 higher debt and lower cash flow ratios.In fact, S&P
Malquis t, Di 12
Avista Corporation
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stated the following in a January 2008 research report on
Pacific Northwest Hydrology:
We find that Avista and Idaho Power, which are
comparably sized companies, face the most
substantial risk (related to hydro power) despite
their PC As and cost update mechanisms. 2
Additionally, S&P stated the following in its February 2008
research update of Avista Corporation:
The Company's financial performance will continue
to be significantly affected by hydro conditions
and gas prices. And the Company's key utility
risk going forward is its exposure to high-cost
replacement power, particularly in low water
3years.
In order to improve the cash flow ratios, Avista must
reduce its total debt balances and increase its available
19 funds from operations. Although the Company has continued
20 to work towards paying down its total debt, the negative
21 impacts to cash flow caused by below-normal hydroelectric
22 generation and volatility of wholesale electric market
23 prices and natural gas prices in recent years, has
24 adversely affected Avista' s progress in improving the cash
25 flow ratios.
26 Do the rating agencies look at any other factorsQ.
27 when evaluating a company's credit quality?
28
29
Yes, they also look at a numer of qualitativeA.
factors.The rating agencies evaluate the company's
2 Standard and Poor's, Pacifc Northwest Hydrology and Its Impact on Investor-Owned Utilties' Credit
Quality, Januar 2008
Malquist, Di 13
Avista Corporation
1 resource picture, the competitive environment in which we
2 operate, the regulatory environment including the timely
3 recovery and certainty of recovery of costs, quality of
4 management and financial policy.Therefore, while the
5 ratios are utilized in their quantitative evaluation of a
6 company, they are not the only factors that are taken into
7 account.
8 Q.How important is the regulatory environment in
9 which a Company operates?
10 A.The regulatory environment in which a company
11 operates is a major qualitative factor in determining a
12 company's creditworthiness.Moody's stated the following
13 regarding Avista's regulatory environment in a Decemer
14 2007 credit ratings report:
15 Moody's is assuming that the company i s regulators16 in its washington, Idaho, and Oregon17 jurisdictions will continue to support timely and18 adequate recovery of, and return on, the capital19 investments through decisions in future general20 rate cases that we expect will be filed on a21 regular basis. 4
2223 Additionally, in a January 2008 article published by
24 S&P entitled "Top Ten US Electric Utility Credit Issues for
25 2008 and Beyond", S&P stated that "Recovering in a timely
26 manner federally and/or state mandated compliance costs is
3 Stadard and Poor's, Avista Corp's Corporate Credit Rating Raised One Notch to BBB-, Februar 2008
4 Moody's Investor Servce, Moody's Upgrades Avista Corp (December 20,2007)
Malquist, Di 14
Avista Corporation
1 paramount to preserving credit quality for regulated
2 electric utili ties. "5
3 Due to the maj or capi tal expendi tures planned by
4 Avista, the continued supportive regulatory environment
5 will be important to Avista's financial health.
6 Additionally, although Avista has electric and natural gas
7 tracking mechanisms (PCA and PGA) to provide recovery of
8 the majority of the variability in commodity costs, these
9 changes in costs must be financed until the costs are
10 recovered from customers.Investors and rating agencies
11 are concerned about regulatory lag and cost-recovery
12 related to these items.
13
14
15
iV. CASH FLOW
Q.What are the Company's sources of funding capital
16 requirements?
17 A.The Company utilizes cash flow from operations,
18 long-term debt and common stock issuances to fund its
19 capi tal expendi tures .Additionally, on an interim basis,
20 the Company utilizes its credit facility to fund capital
21 expenditures until longer-term financing can be obtained.
22 Q.What are the Company's near-term capital
23 requirements?
S Stadad and Poor's, Top Ten US Electric Utilty Credit Issues for 2008 and Beyond, Janua 2008
Malquist, Di 15
Avista Corporation
1 A.As a combination electric and natural gas
2 utility, over the next few years, capital will be required
3 for customer growth, investment in generation, transmission
4 and distribution facilities for the electric utility
5 business, as well as necessary maintenance and replacements
6 of our natural gas systems.
7 The amount of capital expenditures planned for 2008-
8 2009 is approximately $390 million. For 2008 alone, these
9 costs equate to a total of $190 million.Total net rate
10 base at Decemer 31, 2007 was $1.7 billion for the total
11 Company;therefore,these planned capi tal additions
12 represent substantial new investments. A few of the major
13 capital expenditure items on a system basis for 2008
14 include $46 million for electric transmission and
15 distribution upgrades, $43 million for electric and natural
16 gas customer growth, $21 million for natural gas system
17 upgrades, $9 million for environmental (associated with the
18 Spokane River relicensing and the 2001 Clark Fork River
19 license implementation issues), $26 million for generation
20 upgrades, and $15 million for Jackson Prairie capacity and
21 deliverability expansions.
22 Q.What are the Company's long-term capital
23 requirements?
24 A.Avista's integrated Resource Plan has identified
25 the potential need for the Company to finance significant
Malquist, Di 16
Avista Corporation
1 expendi tures for electric facilities.The preferred
2 strategy outlined in our 2007 Integrated Resource Plan
3 included total expenditures of $1.25 billion by 2018,
4 including investment in wind resources and upgrades at
5 hydroelectric stations.
6
7
Major capital expenditures are a normal part of
utility operations.Customers are added to the service
8 area, roads are relocated and require existing facilities
9 to be moved, and facilities continue to wear out and need
10 replacement. These and other requirements create the need
11 for significant capital expenditures each year.We are
12 seeing significant increases in the costs of materials,
13
14
including the cost of steel,cement,asphalt,and
transformers.Access to capital at reasonable rates is
15 dependent upon the Company maintaining a strong capital
16 structure, sufficient interest coverage, and investment
17 grade credit ratings.
18 Q.What are the Company's near-term plans related to
19 its debt?
20
21
A.The Company plans to issue up to $350 million of
secured, fixed rate bonds during 2008.The proceeds from
22 the issuance of the securities will be utilized to fund
23 debt maturities and repay funds borrowed under our credit
24 facility. The Company has $318 million of debt maturing in
25 2008 and capital expenditures of approximately $190 million
Malquist, Di 17
Avista Corporation
1 during 2008. The proposed 2008 issuance of debt securities
2 has been reflected in the chart below.
Debt Maturities by Year (pro forma)
as of December 31,2008
$50
-
-
I -..~
$300
$250
$200
$150
$100
$0
09 10 11 12 13 14 15 16 17 18 19 20 21 22 ~.~~~u~~~~~~~~u~
3
4
. Long-term debt outtanding C Propoed 2008 debt l&uanc
In addition to the $318 million of debt maturities in
5 2008, we have $83.7 million of Pollution Control Bonds
6 ($66.7 million with a maturity date of October 2032 and
7 $17.0 million with a maturity date of March 2034) that are
8 subj ect to remarketing on December 30, 2008.These bonds
9 are puttable at the option of the security holders on
10 December 30, 2008.If the bonds cannot be remarketed on
11 that date, we will be required to purchase the outstanding
12 bonds.In addition, we have $25 million of Medium-Term
13 Notes with a maturity date of June 2028 that are puttable
14 at the option of the security holders in June 2008.
Malquist, Di 18
Avista Corporation
1 Q.The debt maturities graph above reflects a
2 proposed 2008 debt issuance of $250 million maturing in
3 2018. Why is the Company proposing such a large maturity
4 in one year?
5 A.Avista has had discussions with various
6 investment bankers regarding our proposed 2008 debt
7 issuances.The investment bankers have indicated that
8 investors are charging a premium for debt issuance
9 transactions that are not "index eligible" ,due to
10 volatilities that have occurred in the market over the past
11
12
year.A debt issuance must be at least $250 million in
order to be index eligible.The investment bankers have
13 indicated that the premium could range from 10 - 15 bps,
14 which is $250,000 to $375,000 annually.Due to the
15 significance of the premium, Avista believes it would be
16 beneficial to customers to issue debt that is index
17 eligible. Additionally, based upon the projected growth of
18 Avista, the maturity will be much smaller by the time the
19 debt issuance is required to be refinanced, on a relative
20 basis. Avista will continue to monitor the capital markets
21 and balance the impact of debt issuances on the maturity
22 graph and the cost of debt as well as the impact to
23 customers and rates.
Malquist, Di 19
Avista Corporation
1 Q.Has the Company taken any steps to address the
2 uncertainty related to interest rate exposure for the
3 significant debt maturities it faces in 2008?
4 A.Yes, it has. As a result of the historically low
5 interest rate environment that existed in 2004, the Company
6 entered into two forward-starting interest rate swaps
7 totaling $125 million or almost 46% of the June 1, 2008
8 debt maturity. The swaps have contract terms of ten years
9 beginning in 2008.These agreements secured a fixed rate
10 for a significant portion of the total future interest
11 rate. These agreements only lock in a portion of Avista' s
12 credit spread. The swaps will be cash settled on the same
13 day we issue new debt securities to fund the June 1, 2008
14 maturity.
15 Q.What other financing activities did the Company
16 complete in 2004 through 2007 that will lower its interest
17 costs?
18 A.The Company completed the following financing
19 activities from 2004 through 2007 that lowered interest
20 costs:
21 Table 3
Description of Securities Amount (in
Issued milions)Rate Life
Trust Preferred Stock:
April 2004 $60 6.50%5
First Mortoaoe Bonds:
Novem ber 2004 $90 5.45%15
November 2005 $150 6.25%30
December 2006 $150 5.70%30.5
Malquist, Di 20
Avista Corporation
1
2
The financing activity described in Table 3 above has
had a direct impact on the Company's debt costs.Cost of
3 total debt has decreased from 8.68% at Decemer 31, 2003 to
4 7.91% at Decemer 31, 2007.The cost of debt should
5 decrease significantly once the 2008 debt maturities are
6 refinanced, as evidenced by the pro forma cost of debt of
7 6.84% as of December 31, 2008 reflected in this filing.
8 Q.What is the status of the Company's line of
9 credit secured by first mortgage bonds and its accounts
10 receivable program?
11 A.The Company has a $320 million line of credit
12 that expires in April 2011. The Company has the option of
13 increasing the line by $100 million (up to $420 million) at
14 any time during the term of the agreement, subj ect to
15 additional fees and obtaining bank commitments.The
16 agreement includes the option to release the first mortgage
17 bond security when the Company has an investment grade
18 credit rating.Additionally, the Company has an $85
19 million accounts receivable funding program that expires in
20 March 2009. This demonstrates increased confidence by our
21 banks in Avista's financial condition.
22 The facilities have been sized to allow the Company to
23 fund at least one year of capital expenditures, plus
24 required working capital and counterparty collateral
Malquist, Di 21
Avista Corporation
1 requirements to assure flexibility given both the volatile
2 financial markets and volatile energy commodity prices.
3 Many purchases of natural gas, or contracts for
4 pipeline capacity to provide natural gas transportation,
5 require collateral, and/or prepayments, based upon the
6 Company's credit rating.Upgrades to Avista' s credit
7 ratings during 2007 and 2008 have reduced the amount of
8 collateral required to be posted with counterparties. If
9 Avista is upgraded above its current credit ratings, the
10 collateral requirements are expected to decrease, resulting
11 in reduced borrowing cos ts .The line of credit and
12 accounts receivable program are our primary sources of
13 immediate cash for borrowing to meet these needs and for
14 supporting the use of letters of credit. A line of credit
15 is required to manage daily cash flow since the timing of
16 cash receipts versus cash disbursements is never totally
17 balanced.
18 Q.Wht are Avista's plans regarding comon equity
19 and why is this important?
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21
A.Avista will continue to monitor the common equity
ratio of its capital structure.We will continuously
22 assess the need to issue additional common equi ty based
23 upon our overall capital structure. Avista entered into a
24 sales agency agreement in December 2006 to issue up to two
25 million shares of our common stock from time to time.
Malquist, Di 22
Avista Corporation
1 During the second half of 2008, we are planning to issue
2 common stock under this sales agency agreement in order to
3 maintain our equity ratio at an appropriate level.It is
4 important to the rating agencies who rate the Company's
5 securi ties, and hence an important component of the
6 Company's cost of doing business, for Avista to maintain a
7 balanced debt/equity ratio in order to minimize the risk of
8 default on required debt interest payments.Avista is
9 committed to maintaining an appropriate level of equity to
10 support a strong credit rating.
11 Q.What are Avista's plans regarding preferred
12 equity and other financing structures (for exale hybrid
13 instruents)?
14 A.Avista does not have any preferred equity or
15 other financing structures outstanding at December 31,
16 2007.Currently, Avista does not plan to issue preferred
17 equity or other financing structures. Avista will continue
18 to evaluate the appropriateness of preferred equity and
19 other financing structures within its overall capital
20 structure.
21
22
23
V. CAPITAL STRUCTU
Q.Please explain the capital structure proposed by
24 Avista in this case.
Malquist, Di 23
Avista Corporation
1 A.Avista's current capital structure consists of a
2 blend of long-term debt and common equity necessary to
3 support the assets and operating capital of the Company.
4 The proportionate shares of Avista Corp.'s actual capital
5 structure on December 31, 2007, are shown on page 2 of
6 Exhibit NO.2. A pro forma capital structure is also shown
7 on page 2 in the Exhibit, which reflects expected changes
8 for the period ending December 31, 2008.Supporting
9 workpapers provide additional details related to these
10 adjustments on pages 3 through 4.
11 The rate of return to be applied to rate base in this
12 proceeding is equal to the weighted average cost of
13 capital, taking into account the pro forma adjusting items.
14 As shown on page 2 of Exhibit No.2, Avista Utilities is
15 proposing an overall rate of return of 8.74%.
16
17
18
19
20
VI. COST OF DEBT
Q.How have you deter.ined the cost of debt?
A.Cost of debt in the Company's proposed capital
structure includes long-term debt.As shown on page 2 of
21 Exhibit No.2, the actual weighted average cost of long-
22 term debt outstanding on December 31, 2007 was 7.91%. The
23 size and mix of debt changes over time based upon the
24 actual financing completed. We have made certain pro forma
25 adjustments to update the debt cost through Decemer 31,
Malquist, Di 24
Avista Corporation
1 2008 to 6.84%.Pro forma adjustments to long-term debt
2 reflect expected maturities of outstanding debt and the
3 issuance of new debt to fund those maturities.The pro
4 forma weighted cost of long-term debt was reduced from
5 4.17% to 3.56%.
6
7
8
VII. COST OF COMMON EQUITY
Q.What rate of return on commn equity is the
9 company proposing in this proceeding?
10 A.The company is proposing a 10.8% return on common
11 equity (ROE), which is within the lower end of Dr. Avera's
12 recommended range of required return on equi ty . Dr. Avera
13 testifies to analyses related to the cost of common equity
14 with an ROE range of 10.7% to 12.2%. In his testimony Dr.
15 Avera states that:
16 Considering investors' expectations for17 capi tal markets and the need to support18 financial integrity and fund crucial19 capital investment even under adverse20 circumstances, I concluded that Avista' s21 requested ROE of 10.8% percent is22 reasonable. (P. 5, L. 19-23)
23
24 Q. Dr. Avera suggests an ROE range of 10.7% to
25 12.2%. Why is Avista requesting an ROE on the lower end of
26 the range?
27 A.As I have testified, Avista has made solid
28 progress towards improving its financial health. If Avista
29 can earn a 10.8% ROE in 2009, I believe the financial
Malquist, Di 25
Avista Corporation
1 condi tion would continue to improve and would further
2 strengthen the credit ratings ratios.
3 Furthermore,as the Company has worked toward
4 improving its financial condition over the last several
5 years, it has done so with the customer in mind. Avista is
6 attempting to balance the ability to continue to improve
7 our financial health and access capital markets under
8 reasonable terms with the impacts that increased retail
9 rates have on its customers.In this case, although we
10 believe an ROE greater than 10.8% is supported and is
11 warranted, we also believe the 10.8% provides a reasonable
12 balance of the competing objectives.
13 Q.Please sumrize the proposed capital structure
14 and the cost components for debt and common equity.
15 A.As also shown on page 2 of Exhibit No.2, the
16 following table shows the capital structure and cost
17 components proposed by the Company.
18
19
20
21
Malquist, Di 26
Avista Corporation
1 Q.
2 testimony?
3 A.
Does
Yes.
that conclude your pre-filed direct
Malquist, Di 27
Avista Corporation
RECEive
DAVID J. MEYER
VICE PRESIDENT, GENERA COUNSEL,
GOVERNENTAL AFFAIRS
AVISTA CORPORATION
P.O. BOX 3727
1411 EAST MISSION AVENUE
SPOKA, WASHINGTON 99220-3727
TELEPHONE: (509) 495-4316
FACSIMILE: (509) 495-8851
ZODS APR-3
REGULATORY &,
BEFORE THE IDAHO PUBLIC UTILITIES COMMISSION
IN THE MATTER OF THE APPLICATION ) CASE NO. AVU-E-08-01
OF AVISTA CORPORATION FOR THE ) CASE NO. AVU-G-08-01
AUTHORITY TO INCREASE ITS RATES )
AN CHAGES FOR ELECTRIC AN )
NATURA GAS SERVICE TO ELECTRIC ) EXHIBIT NO. 2
AND NATURAL GAS CUSTOMERS IN THE )STATE OF IDAHO ) MALYN K. MAQUIST
)
FOR AVISTA CORPORATION
(ELECTRIC AN NATURAL GAS)
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4
AVISTA CORPORATION
Capital Structure and Overall Rate of Retum
PROFORM
Cost of Capital as of Percent of
December 31, 2008 Amount Total Capital Cost Component
Long-Ter Debt $1,075,800,000 52.06%6.84%3.56%
10.80%1(1 )Common Equity 990,683,000 47.94%5.18%
TOTAL $2,066,483,000 100.00%I 8.74%~
(1) Proposed Retu on Common Equity - See Avera testimony
See supporting documentation
All costs are shown before tax
Assumptions
1. Stared with 12-31-2007 actual
2. Proforma though 12-31-2008
3. The forecasted equity and debt numbers come from forecast DEC6 model ru
4. Equity is adjusted for Other Comprehensive Income and capital stock expense of$21,921,000
5. Forecasted issuance of$12.5 milion of additional equity though different company programs
Exhibit NO.2
Case No. AVU-E-08-01 and AVU-G-08-01
M. Malquist, Avista Corporation
Page 2 of4
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