20190610Thies Direct.pdf

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DAVID J. MEYER
VICE PRESIDENT AND CHIEF COI-INSEL FOR
REGULATORY & GOVERNMENTAL AFFAIRS
AVISTA CORPORATION
P.O.BOX3727
1411 EAST MISSION AVENUE
SPOKANE, WASH INGTON 99220 -37 27
TELEPHONE: [phone]
FACSIMILE: (509) 495-885 1
[e-mail]
i$19 JUt{ l0 At{
,1rJi$flffccli{fihl
BEFORE THE IDAHO PUBLIC UTILITIES COMMISSION
TN THE MATTER OF THE APPLICATION )
oF AVISTA CORPORATTON FOR THE )
AUTHORITY TO INCREASE ITS RATES )
AND CHARGES FOR ELECTRIC SERVICE )
TO ELECTRIC CUSTOMERS IN THE )
STATE OF IDAHO )
CASE NO. AVU-E-19-04
DIRECT TESTIMONY
OF
MARK T. THIES
FOR AVISTA CORPORATION
(ELECTRIC)
RECEIVED
05
SION
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o I. INTRODUCTION
2 Q. Please state your name, business address, and present position with Avista
3 Corporation.
4 A. My name is Mark T. Thies. My business address is l4l 1 East Mission Avenue,
5 Spokane, Washington. I am employed by Avista Corporation as Senior Vice President, Chief
6 Financial Officer and Treasurer.
7 Q. Would you please describe your education and business experience?
8 A. I received a Bachelor of Ars degree in 1986 with majors in Accounting and
9 Business Administration from Saint Ambrose College in Davenport, Iowa, and became a
10 Certified Public Accountant in 1987 . I have extensive experience in finance, risk
11 management, accounting and administration within the utility sector.
12 I joined Avista in September of 2008 as Senior Vice President and Chief Financial
13 Officer (CFO). Prior to joining Avista, I was Executive Vice President and CFO for Black
14 Hills Corporation, a diversified energy company, providing regulated electric and natural gas
15 service to areas of South Dakota, Wyoming and Montana. I joined Black Hills Corporation
16 in 1997 upon leaving InterCoast Energy Company in Des Moines, Iowa, where I was the
17 manager of accounting. Previous to that I was a senior auditor for Arthur Andersen & Co. in
l8 Chicago, Illinois.
19 a. What is the scope of your testimony in this proceeding?
20 A. I will provide a financial overview of Avista Corporation, as well as explain
2l our credit ratings and the Company's proposed capital structure and overall rate of return in
22 this case. Company witness Mr. McKenzie will provide additional testimony related to the
23 appropriate return on equity for Avista, based on our specific circumstances, together with the
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I current state of the financial markets. I will provide an overview of our capital expenditures
2 program, and other witnesses will provide details on what capital expenditures we are making,
3 and why they are necessary in the time frame in which they are planned.
4 ln brief, I will provide information that shows:
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o Avista's plans call for a continuation of utility capital investments in generation,
transmission and distribution systems and technology to preserve and enhance
service reliability for our customers. Capital expenditures of $405 million per year
(system) are planned for the five-year period ending December 31,2023. Avista
needs adequate cash flow from operations to fund these requirements, together
with access to capital from external sources under reasonable terms, on a
sustainable basis.
o We are proposing an overall rate of return of 7.55 percent, which includes a 50.0
percent common equity ratio, a 9.9 percent return on equity, and a cost of debt of
5.20 percent. We believe our proposed overall rate of return of 7.55 percent and
proposed capital structure provide a reasonable balance between safety and
economy.
o Avista's corporate credit rating from Standard & Poor's (S&P) is currently BBB
andBaa2 from Moody's Investors Service. Avista must operate at a level that will
support a solid investment grade corporate credit rating in order to access capital
markets at reasonable rates. A supportive regulatory environment is an important
consideration by the rating agencies when reviewing Avista. Maintaining solid
credit metrics and credit ratings will also help support a stock price necessary to
issue equity under reasonable terms to fund capital requirements.
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A table of contents for my testimony is as follows:
Description Pase
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I. Introduction
II. FinancialOverview
III. Capital ExpendituresIV. Maturing DebtV. Proposed Capital Structure and Cost of CapitalVI. Credit Ratings
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a. Are you sponsoring any exhibits with your direct testimony?
A. Yes. I am sponsoring ExhibitNo.2, Schedules I through 4. Schedule 1, page
l, includes Avista's credit ratings by S&P and Moody's. Avista's actual capital structure at
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December 31,2018, and proposed capital structure at December 31,2019, are included on
page2, with supporting information on pages 3 through 5. Confidential Schedule 2C is our
Interest Rate Risk Management Plan and Schedule 3 is a copy of Avista's Infrastructure
Investment Plan. Finally, Confidential Schedule 4C shows the Company's planned capital
expenditures and long-term debt issuances by year for2019-2023.
II. FINANCIAL OVERVIEW
a. Please provide an overview of Avista's financial situation.
A. Avista has, and will continue to operate the business efficiently to keep costs
as low as practicable for our customers, while at the same time ensuring that our energy service
is reliable and our customers are satisfied. An efficient, well-run business is not only
important to our customers, but also important to investors. Our capital financing plan, and
our execution of that plan, provides a prudent capital structure and liquidity necessary for
utility operations. We initiate regulatory processes to recover our costs in a timely manner
with the goal of achieving earned returns close to those allowed by regulators in each of the
states we serve. These elements - cost management, ready access to capital and revenues that
support operations - are key determinants to the rating agencies when they are reviewing our
overall credit ratings.
a. What steps are the Company taking to maintain and improve its financial
health?
A. Avista works to assure there are adequate funds for operations, capital
expenditures and debt maturities. We obtain a portion of these funds through the issuance of
long-term debt and common equity. We actively manage risks related to the issuance of long-
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o I term debt through our interest rate risk mitigation plan and we maintain a proper balance of
2 debt and common equity through regular issuances and other transactions. The Company
3 actively manage energy resource risks and other financial uncertainties inherent in supplying
4 reliable energy services to our customers. We create financial plans and forecasts to model
5 our income, expenses and investments, providing a basis for prudent financial planning. We
6 seek timely recovery of our costs through general rate cases and other ratemaking
7 mechanisms.
8 The Company currently has a sound financial profile and it is very important for Avista
9 to maintain and enhance its financial position in order to access debt and equity financing
l0 under reasonable terms as Avista funds significant future capital investments and refinances
l1 maturing debt.
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13 III. CAPITAL EXPENDITURES
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a. What is the Company's recent history related to capital investments?
A. We are making significant capital investments in our electric generation,
transmission and distribution facilities, natural gas distribution system, and new technology to
better serve the needs of our customers. These investments are focused on, among other things,
the preservation and enhancement of safety, service reliability and the replacement of aging
infrastructure. For the period 2014 through 201 8, our capital expenditures were approximately
$400 million per year, on a system basis. While there are variations among the functional areas
targeted for investment each year, the predominant areas have included natural gas distribution
plant, electric generation, transmission and distribution facilities, new customer hookups,
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s200.0
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environmental and regulatory requirements, information technology and other supporting
functions, such as fleet services and facilities.
a. What are Avista's recent and planned capital expenditure levels?
A. Illustration No. I below summarizes the capital expenditure levels for recent
years, as well as planned expenditures through 2023.
Illustration No. 1 - Capital Bxpenditures
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2013 2014 2015 2016 2017 2018 2019 2020 2021 lAtZ 2023
Actu al Plan ned
I Environmental I Gas I Generatbn lfirowth I ET I Other t Electric T&D
The capital expenditure level is expected to remain constant at $405 million (system)
annually from 2019 through 2023.
a. Please explain how Avista identifies and prioritizes capital investments,
and why the investments are made in the time frame they are completed.
A. I will summarize why Avista is making capital investments in the time frame
they are being completed, and the process we use for identifying and prioritizing those
investments. Company witnesses Mr. Thackston, Ms. Rosentrater, and Mr. Kensok provide
more information regarding2019 pro forma capital projects included in this case. Company
witness Ms. Schuh sponsors the pro forma capital adjustment. Those witnesses address why
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they need to be done in the planned time frame, and what the risks and consequences are of
not completing the projects in that time frame.
As discussed in greater detail in Exhibit No. 2, Schedule 3, Avista's "Infrastructure
Investment Plan"" our process to identify and prioritize capital investment is designed to meet
the overall need for investment, in the appropriate time frame, in a manner that best meets the
future needs and expectations of our customers, in both the short-term and long-term. The
Company's practice has been to constrain the level of capital investment each year, such that
not all of the prioritized projects and programsl will be funded in a given year at the level
requested. Avista believes that holding capital spending below the level requested
accomplishes several important objectives, including:
o Promotes Innovation - Encourages ways to satisfy the identified investment needs in
a manner that may identify potential cost savings, defer implementation, or other
creative options or solutions.
Balances Cost and ,Ris* - Captures the customer benefits of deferring needed
investments by prudently managing the cost consequences and risks associated with
such deferrals.
EfJiciently Allocates Capital - Ensures that the highest-priority needs are adequately
funded in the most efficient and effective way.
Reduces Variobility - Moderates the magnitude of year-to-year variability to avoid
excessive rate impacts, and more efficiently optimizes the number and cost of
personnel necessary to carry out the capital projects.
Avista currently has chosen to stabilize the level of annual capital spending at what
can be described as aconstrained level of $405 million (system), in an effortto accomplish
the objectives described above.
I "Project" refers to an individual investment for a specific period of time. "Programs" represent investments
that address systemic needs that are ongoing with no recognized endpoint, such as the wood pole management
or Aldyl-A Pipe Replacement programs. For ease of reference, the term "capital project" will be used to
represent both capital projects and capital programs.
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a. As Avista removes old equipment and replaces it with new, does the
depreciation component currently included in retail rates cover the cost to replace
facilities?
A. No. The depreciation component curently included in retail rates generally
covers a very small amount of the new facilities and equipment placed into service, especially
for the long-lived assets. Avista's retail rates are cost-based, which means the prices
customers are paying today for natural gas pipe, gate stations, transformers, distribution poles,
substations, and transmission lines, among other facilities, are based on the cost to install those
facilities, in some cases,40, 50, and even 60 years ago. The costs of the same equipment and
facilities today are many times more expensive. The depreciation component built into retail
rates today is based on the much lower cost to install those facilities many years ago.
Therefore, the depreciation component in retail rates covers only a small fraction of the annual
costs associated with the new investment in facilities.
a. How does Avista identify and prioritize its capital investments?
A. Avista's capital investments originate from the following six major
"investment drivers":
1. Respond to customer requests for new service or service enhancements;
2. Meet our customers' expectations for quality and reliability of service;3. Meet regulatory and other mandatory obligations;4. Address system performance and capacity issues;
5. Replace infrastructure at the end of its useful life based on asset condition; and6. Replace equipment that is damaged or fails, and support field operations.
An explanation of each ofthese drivers, as well as examples of specific capital projects
under these drivers, is provided in the Infrastructure Investment Plan, attached as Exhibit No.
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2, Schedule 3. A breakdown of planned investments for each driver for 2019-2023 is shown
in Illustration No. 2 below.
Illustration No. 2 - Planned Investments bv Capital Investment Driver (2019 - 2023)
Five Year lnfrastructure Plan by lnvestment Summary
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Customer
Requeste d
Custorer
Seruice (luality
& Reliability
Mandatory & Perfomame & Aset Condition Failed Plant &Compliance Capacity Operations
The process under which Avista's planned capital expenditures are identified and
prioritized is illustrated in Illustration No. 3 below.
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Illustration No. 3 - Identification and Prioritization Process
The capital projects are identified in the lower-left portion of the diagram labeled
"Business Unit Needs," and are then prioritized within each department. This prioritization
occurs with the knowledge of the continuing constraint on the capital spend level for the
Company, while at the same time the leadership of each department informs Senior
Management of both the near-term and longer-term needs that are being delayed. For the
prioritized projects, Business Cases2 are developed for each of the Capital Requests that go to
the Capital Planning Group (CPG) (as illustrated in the diagram). The CPG prioritizes the
Capital Requests across departments, such that the overall planned capital spend stays within
2 A Business Case is a summary document that defines the business problem addressed by a project or program,
along with a proposal and recommended solution. The Business Case explains why the work is necessary, and
the risks associated with not making the investment, as well as the alternatives considered, the selected
alternative and the timeline associated with the project.
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Prioritization
Capital Planning Group
Overall lnfrastructure Priority and Capital
Allocation
Not Funded
(Deferred)
Business Unit
Needs
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I the constrained spend level established by Senior Management. The highest priority Capital
2 Requests are "Funded", and a portion of the Capital Requests are "Not Funded" (Deferred),
3 as shown on the diagram. Each year, the Board Finance Committee reviews and approves the
4 first year of the rolling five-year capital investment plan. Under this Identification and
5 Prioritization Process, the capital projects are screened and prioritized twice; once within the
6 departments. and then a second time across departments within the CPG. This Identification
7 and Prioritization Process is explained in more detail in the Infrastructure Investment Plan in
8 Exhibit No. 2, Schedule 3.
9 Q. What does Avista consider in setting the overall level of capital investment
l0 each year?
I I A. A range of factors influences the level of capital investment made each year,
12 including: 1) the level of investment needed to meet safety, service and reliability objectives
13 and to further optimize our facilities;2) the degree of overall rate pressure faced by our
14 customers; 3) the variability of investments required for major projects; 4) unanticipated
l5 capital requirements, such as an unplanned outage on a large generating unit; 5) the cost of
l6 debt; and 6) the opportunity to issue equity on reasonable terms.
17 O. Why did the Company increase the level of its capital expenditures
l8 beginning in 2015?
19 A. The primary drivers that have affected Avista's level of capital investment
20 includes the business need to fund a greater portion of the departmental requests for new
2l capital investment that, in the past, have not been funded, and the need to capture investment
22 opportunities and benefits identified by our asset management programs.
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o I Q. If a project is delayed forwhatever reason, can the Company simply lower
2 the capital budget for that year rather than find another project to fund?
3 A. The continuing progress on projects in the queue is very important to avoid the
4 creation of a large "bow-wave" of investment that needs to be done in a relatively shon period
5 of time. Generally, if a project is delayed, moving the next priority project up helps to
6 alleviate that bow-wave. This reprioritization occurs within the CPG, which is charged with
7 ensuring that the total capital spend for the year stays within the constrained spending limit
8 established by the Company. The dollar amount of capital projects requested by departments
9 with the amounts approved by the Company is provided in Table No. 1 below. The dollar
l0 amounts for projects that were delayed (not approved) are also shown:
I I Table No. 1: Capital Proiect Requests/Apnrovals ($ in millions)
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Year Requested Approved Delaved 7o Capital Delayed
2017 $461 $40s $s6 l2%
201 8 $4ss $40s $50 llYo
2019 $s28 $40s $ 123 23Yo
2020 $s l6 s40s $111 22%
2021 ss0l $40s $96 lgYo
2022 s467 s40s $62 130
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As demonstrated in Table No. I above, the Company has a significant capital
investment need, as determined by Company subject matter experts. If Avista were simply
just trying to grow rate base for purposes of increasing earnings, we would not constrain
ourselves to the 5405 million capital budget level. Put another way, Avista could fully justify
increasing its capital budget to $500 million over the next several years, but it is choosing not
to in order to balance investment need with customer rate impact.
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o a. What is driving the investment in utility plant in Idaho?
A. The increase in overall costs to serve customers is driven primarily by the
continuing need to replace and upgrade the facilities and technology we use every day to serve
our customers. Specifically, Idaho "gross" plant additions through December 31,2019,
increases plant in-service by approximately S93 million, as compared to what is currently
embedded in base retail rates. Ms. Schuh sponsors the restating and pro forma capital
adjustments which incorporate the effects of these capital investments in the determination of
the Company's proposed revenue requirements. Other Company witnesses, (i.e. Mr.
Thackston regarding production assets, Ms. Rosentrater regarding transmission, distribution
and general assets, and Mr. Kensok regarding the costs associated with Avista's IS/IT
projects) provide more information regarding the 2019 pro forma capital projects included in
this case, describing the need for and timing of these capital projects. These investments
reflect, among otherthings, replacement and maintenance of Avista's utility system and to
sustain reliability, safety, and service to customers.
IV. MATURING DEBT
a. How is Avista affected by maturing debt obligations from 2019 through
2023?
A. Beginning in2019 through 2023,the Company is obligated to repay maturing
long-term debt totaling $a05.5 million. Table No. 2 below shows the Company's maturing
long-term debt from 20 1 9 through 2023 . Within this forward looking five-year period, a large
concentration - 5250 million - matures within the second quarter of 2022.
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o 1 Table No.2
Avista Corp
l,ong-Term Deh Maturities, 201 9-2023
Maturity Year Princiml Amount Coumn Rate Date Issued Maturitv Date
2019 $90,000,000 5.450o/o 11t1812004 1211t2019
2020 $52.000.000 3.890o/o t2/20/2010 12t20t2020
202t
2022 $250.000.000 5.125%9t2212019 4t1t2022
2023
$s.500.000 7.530o/o 5t6t 1993 515t2023
$r.000.000 7.54U/o 5t7t 1993 515t2023
$7.000.000 7.18V/o 8t12fi93 &fiU2023
Total $405500,000
These debt obligations originated as early as 1993 and their original terms were
between 10 and 30 years. These maturing obligations represent 23 percent of the Company's
long-term debt outstanding at the end of 2018, which is a significant portion of our capital
structure. It will be necessary for Avista to be in a favorable financial position to complete the
expected debt refinancing, while also obtaining debt and equity to fund capital expenditures
each year.
a. What are the Company's expected long-term debt issuances through
2023?
A. To provide adequate funding for the significant capital expenditures noted in
Section III above and to repay maturing long-term debt, we are forecasting the issuance of
long-term debt in each yearthrough 2023. We plan to issue $165 million in2019. Issuances
planned for 2020 through 2023 are provided in Exhibit No. 2, Confidential Schedule 4C.
a. Has Avista considered recalling of debt to take advantage of current low
long-term interest rates?
A. Yes. However, the recall provisions of debt issued require penalties (make-
whole provisions) that exceed the value gained from current market interest rates. As
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o discussed later in my testimony, Avista has an Interest Rate Risk Management Plan for
issuance of long-term debt that includes hedging a portion of future issuance through interest
rate swaps.
a. Are there other debt obligations that the Company must consider?
A. Yes. In addition to long-term debt, the Company's $400 million revolving
credit facility expires in April 2021. The Company relies on this credit facility to provide,
among other things, funding to cover daily and month-to-month variations in cash flows,
interim funding for capital expenditures, and credit support in the form of cash and letters of
credit that are required for energy resources commitments and other contractual obligations.
Our credit facility was amended in May 2016, which extended the expiration date to April 18,
2021, and reduced interest rates and fees.
The Company expects to initiate the renewal or replacement of the credit facility
before the existing arrangement expires. Any outstanding balances borrowed under the
revolving credit facility become due and payable when the facility expires. A strong financial
position will be necessary to gain access to a new or renewed revolving credit facility prior to
expiration of the existing facility.
V. PROPOSED CAPITAL STRUCTURE AND COST OF CAPITAL
a. What capital structure and rate of return does the Company request in
this proceeding?
A. Our requested capital structure is 50.0 percent debt and 50.0 percent equity
with arequested overall rate of return in this proceeding of 7.55 percent, as shown in Table
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No. 3 below. The requested capital structure is consistent with that currently authorized (per
Case No. AVU-E-17-01).
Table No.3
AVISTA CORPORATION
Proposed Cost of Capital
December3l,2019
Proposed
Structure
Cost
Component
Weighted
Cost
Total L,ong-term Debt 50.0%s.20%2.60%
Comnrcn Equrty 50.00 9.90%4.950
Total t00%7.550h
a. Why is the Company planning to maintain an equity ratio at this level?
A. Maintaining a 50 percent common equity ratio, excluding short-term debt, has
several benefits for customers. We are dependent on raising funds in capital markets
throughout all business cycles. These cycles include times of contraction and expansion. A
solid financial profile will assist us in accessing debt capital markets on reasonable terms in
both favorable financial markets and when there are disruptions in the financial markets.
Additionally, this common equity ratio solidifies our current credit ratings and our
long-term goal is to move our Standard & Poor's corporate credit rating from BBB to BBB+.
A rating of BBB+ would be consistent with the natural gas and electric industry average,
which I will further explain later in my testimony. We rely on credit ratings in order to access
capital markets on reasonable terms. Moving further away from non-investment grade (BB+;
provides more stability for the Company, which is also beneficial for customers. We believe
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the proposed 50 percent equity appropriately balances safety and economy for customers, and
is consistent with that currently authorized for our Idaho jurisdiction.
a. How does Avista's requested 4.95 percent weighted cost of equity compare
with the weighted cost of equity recently requested by electric and natural gas utilities
in other j urisdictions?
A. As shown in Illustration No. 4, Avista proposed weighted average cost of
equity of 4.95 percent is in-line with other utilities authorized weighted average cost of equity,
and that our present weighted average cost of equity is at the lower end of actual, commission-
authorized values:
Illustration No.4
2018 Comm ission-Authorized \\'eighted Average Cost of Equity'
6.O%
5 ff/o
4 tr/o
3 U/o
2.U/o
1.@/o
O.@/o
Avista Idaho
Curent 4.75%
Avista Idaho
Pronosed 4 957n
00
Source: S&PGlobal,"RRARegulatoryFocus,MajorRateCaseDecisions,January-December20l8,"(Jan.3l,20l9).
Weighted Cost of Equity = 4glh.rized Retum on Equity + Common Equity to Total Capital.
Excludes decision that did not speciry both an ROE and a common equity ratio, where the capital structure contains cost-fiee items
or tax credit balances, duplicate cases, and limited issue rider cases.
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o I If the Commission simply carries over our existing ROE of 9.5 percent and 50 percent
2 equity component, the weighted cost of equity would only be 4.75 percent. In fact, Avista's
3 proposed weighted cost of equity is very close to the midpoint.
4 Q. In attracting capital under reasonable terms, is it necessary to attract
5 capital from both debt and equity investors?
6 A. Yes, it is absolutely essential. As a publicly traded company we have two
7 primary sources of external capital: debt and equity investors. As of December 3 I , 20 I 8, we
8 had approximately $3.6 billion of debt and equity. Approximately half of our capital structure
9 is funded by debt holders and the other half is funded by equity investors and retained
10 earnings. Rating agencies and potential debt investors tend to place significant emphasis on
I I maintaining strong financial metrics and credit ratings that support access to debt capital
l2 markets under reasonable terms. Leverage - or the extent that a company uses debt in lieu of
l3 equity in its capital structure - is a key credit metric and, therefore, access to equity capital
14 markets is critically important to long-term debt investors. This emphasis on financial metrics
15 and credit ratings is shared by equity investors who also focus on cash flows, capital structure
16 and liquidity, much like debt investors.
17 The level of common equity in our capital structure can have a direct impact on
18 investors' decisions. A balanced capital structure allows us access to both debt and equity
19 markets under reasonable terms on a sustainable basis. Being able to choose specific financing
20 methods at any given time also allows the Company to take advantage of better choices that
21 may prevail as the relative advantages of debt or equity markets can ebb and flow at different
22 times.
23 a. Are the debt and equity markets competitive markets?
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Avista Corporation
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o I A. Yes. Our ability to attract new capital, especially equity capital, under
2 reasonable terms is dependent on our ability to offer a risk/reward opportunity that is equal to
3 or better than investors' other alternatives. We are competing with not only other utilities but
4 also with businesses in other sectors ofthe economy. Demand for our stock supports our stock
5 price, which provides us the opportunity to issue additional shares under reasonable terms to
6 fund capital investment requirements.
7 Q. What is Avista doing to attract equity investment?
8 A. We are requesting a capital structure that provides us the opportunity to have
9 financial metrics that offer a risk/reward proposition that is competitive and attractive for
l0 equity holders. We have steadily increased our dividend for common shareholders over the
11 past several years, which is an essential element in providing a competitive risk/reward
12 opportunity for equity investors.
13 Tracking mechanisms, such as the Fixed Cost Adjustment, the Power Cost Adjustment
14 and the Purchased Gas Adjustment approved by the IPUC, and similar mechanisms approved
l5 by Avista's other regulatory commissions, help balance the risk of owning and operating the
16 business in a manner that places us in a position to offer a risk/reward opportunity that is
17 competitive with not only other utilities, but with businesses in other sectors of the economy.
l8 a. Has Avista prepared an exhibit that includes the components of Avista's
19 requested rate ofreturn of7.55 percent?
20 A. Yes. ExhibitNo.2, Schedule l, page 2 shows the components of Avista's
21 requested rate of return of 7.55 percent.
22 a. What is the Company's overall cost of debt, and how does it compare to
23 itshistorically-approvedcost?
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Avista Corporation
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A. Our requested overall cost of debt is 5.20 percent. The authorized cost of debt
has trended downward for Avista from 2010 to 2016, with an uptick in 2017 and2018 due to
low-cost debt that rolled off in 2016, as shown in Illustration No. 5 below.
Illustration No.5
a. Please explain why Avista's cost of long-term debt is trending down.
A. There has been a general decline in interest rates over the past decade. At the
same time Avista has issued new debt to fund capital expenditures and to replace higher cost
debt maturing, which has caused the Company's overall cost of debt to decrease. We.have
been prudently managing our interest rate risk in anticipation of these periodic debt issuances,
which has involved fixed rate long-term debt with varying maturities, and executing forward
starting interest rate swaps to mitigate interest rate risk on a portion of the future maturing
debt and our overall forecasted debt issuances.
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Avista Corporation
Avista's ldaho Jurisdiction
Historically Approved Cost of Debt
7.OO%
6.50%
6.00%
5.50%
5.OO%
6.60%
6.O1%
2010 20L3 20t6 20t7 2018 2020 Proposed
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o I There is a decrease in the proposed cost of debt for the 2020 rate year, as compared to
2 2018 authorized, due in part to the maturity of $272.5 million of debt with an average coupon
3 of 6.93%oand an effective yield of 8.425% during 2018.
4 From2014 through 2018 the Company issued $800 million in long-term debt. The
5 weighted average coupon interest rate of these issuances is 4.11%o, which does not include
6 hedge transactions. These issuances have varying maturities ranging from 30 years to 35
7 years. Our most recent issuance was funded on May 22,2018. This issuance of $375 million
8 of first mortgage bonds with a thirty-year maturity was completed at a coupon rate of 4.35o/o.
9 On the same day as the debt was priced, $275 million of interest rate swaps were settled. These
l0 swaps were entered into at various times in accordance with the Company's Interest Rate Risk
I I Management Plan. The effective cost of this debt is 4.874yo, including the issuance costs and
12 the cost of settled interest rate hedges. In May and June of 201 8, we had debt maturities that
I 3 totaled 5272.5 million with average yield of approxim ately 8.42Yo. This reduced our overall
14 cost of debt from 2018 to 2019 as shown in Illustration No. 5.
15 We have continued to issue debt with varying maturities to balance the cost of debt
16 and the weighted average maturity. This practice has provided us with the ability to take
17 advantage of historically low rates. The Company's credit ratings have supported reasonable
18 demand for Avista debt by potential investors. We have further enhanced credit quality and
l9 reduced interest cost by issuing debt that is secured by first mortgage bonds.
20 a. What is the Company doing to mitigate interest rate risk related to future
2l long-term debt issuances?
22 A. As mentioned earlier, we are forecasting $405 million (system) in capital
23 expenditures per year over the next five years. Additionally, we have $405.5 million of debt
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Avista Corporation
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o I maturing during a similar timeframe. This results in a significant need for the issuance of
2 long-term debt, while maintaining an appropriate capital structure.
3 We usually rely on short-term debt as interim financing for capital expenditures, with
4 issuances of long-term debt in larger transactions approximately once ayear. As a result, we
5 access long-term debt capital markets on limited occasions, so our exposure to prevailing
6 long-term interest rates can occur all at once rather than across market cycles. To mitigate
7 interest rate risks, we hedge the rates for a portion offorecasted debt issuances over several
8 years leading up to the date we anticipate each issuance.
9 Over time, we have issued debt with varying maturities to balance the cost of debt and
l0 the weighted average maturity. This practice has provided us with the ability to take
I I advantage of historically low rates on both the short end and long end of the yield curve.
12 There are a number of factors that should be taken into consideration in choosing the
13 term of new debt issuances. For example, in the current interest rate environment where the
14 interest rate spread for 30-year and 1O-year terms is relatively narrow (i.e. presently there is a
15 low premium for 30-year debt versus lO-year debt), supports increased reliance on longer-
16 term debt.
l7 In addition, the average life of plant assets for Avista exceeds 30 years. A 30-year
18 term for debt is a closer match to the average life of the underlying assets that are being
19 financed. Decisions on the term of the debt are generally made closer to the time that new
20 debt is issued. Based on information available today, although the Company will consider
21 some amount of 10-year debt in 2019, the issuances will likely be heavily weighted toward a
22 30-year term, due in large part to the matching of the financing to the life of the assets being
23 financed, and the narrow rate spread for 30-year vs 10-year terms.
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Avista Corporation
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I The Company's credit ratings have supported reasonable demand for Avista debt by
2 potential investors. We have further enhanced credit quality and reduced interest cost by
3 issuing debt that is secured by first mortgage bonds.
4 Q. Does the Company have guidelines regarding its interest rate risk
5 management?
6 A. Yes. The Company's "lnterest Rate Risk Management Plan", attached as
7 Exhibit No. 2, Confidential Schedule 2C, is designed to provide a certain level of stability to
8 future cash flows and the associated retail rates related to future interest rate variability. The
9 Plan provides guidelines for hedging a portion of interest rate risk with financial derivative
l0 instruments. We settle these hedge transactions for cash simultaneously when a related new
l1 fixed-rate debt issuance is priced in the market. The settlement proceeds (which may be
12 positive or negative) are amortized over the life of the new debt issuance.
13 The Interest Rate Risk Management Plan provides that hedge transactions are executed
14 solely to reduce interest rate uncertainty on future debt that is included in the Company's five-
l5 year forecast.3 The hedge transactions do not involve speculation about the movement of
16 future interest rates.
17 a. Before discussing more recent changes to the Company's Interest Rate
l8 Risk Management Plan, were the hedges that are included in the Company's cost of debt
l9 in this filing consistent with the same hedging plan that the Company operated under in
20 its last general rate case?
21 A. Yes. The hedges included in this filing were entered into a manner that is
22 consistent with the Company's Interest Rate Risk Management Plan in effect in Case Nos.
3 The Interest Rate Risk Management Plan also provides for the Company to hedge interest rate risk beyond the
five-year horizon in some situations.
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Avista Corporation
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o 1 AVU-E/G-17-01 and were approved by the Commission. The Company has executed interest
2 rate swaps, for purposes of reducing interest rate risk for our customers as early as 2004 and
3 has been fully transparent in communicating its interest rate hedging activities. The settlement
4 values, either losses or gains, of the interest rate swaps have been clearly included as a
5 component of cost of debt in previous filings and this filing.
6 Q. Has the Company made any recent changes to the Interest Rate Risk
7 Management Plan?
8 A. Yes. On January,l,20l9, the Company added a Risk Responsive Hedging
9 componentto its existing Interest Rate Risk Management Plan. The Risk Responsive Hedging
l0 component employs Value at Risk (VaR) calculations to fufther monitor and respond to
I I dramatic interest rate volatility for unhedged forecasted debt issuances. Risk Responsive
l2 Hedging is in effect for the two forward calendar year's debt issuances. In conjunction with
l3 implementing this new component, the Company reduced the Minimum Hedge Ratio for its
14 existing Dynamic Window Hedging component to 40Yo. The Company believes that Risk
l5 Responsive Hedging is an additional protection for customers against extreme market swings
16 associated with the interest rate market. The Company has executed one hedge under the new
17 plan as a result of a lower control limit price trigger. However, the hedge executed was not a
l8 Risk Responsive Hedge.
19 a. Did the Company communicate this plan change with Commission Staff?
20 A. Yes. On November 20,2018, Avista met with Commission Staff and provided
2l an overview of the changes made to the Interest Rate Risk Management Plan.
22 a. Turning now to return on equity (*ROE'), the Company is requesting a
23 9.9" ROB. Please explain why the Company believes this is reasonable.
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Avista Corporation
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o A. We agree with the analyses presented by Mr. McKenzie which demonstrate
that the proposed 9.9 percent ROE, together with the proposed equity layer of 50.0olo, would
properly balance safety and economy for customers, provide Avista with an opportunity to
earn a fair and reasonable return, and provide access to capital markets under reasonable terms
and on a sustainable basis. Please see the direct testimony of Mr. McKenzie for his support
of a 9.9 percent ROE.
VI. CREDIT RATINGS
a. Please describe Avista's credit facility.
A. Avista has a five-year credit facility in the amount of $400 million with a
maturity date of April18,2021. The credit facility involves participation by ten banks. This
credit facility was originally established in 2011, amended in April 2014, and extended in
May 2016. Our credit facility provides the ability to take out or repay short-term debt based
on day-to-day liquidity needs and to have letters of credit issued on the Company's behalf.
The Company pays fees under three price elements in the agreement: 1) a facility fee to
maintain the right to draw on the credit facility at any time, 2) interest on amounts borrowed,
and 3) fees for letters of credit.
The Company may request letters of credit (LCs) underwritten by the participating
banks and established for the benefit of counterparties to Avista. LCs are often used as
collateral when required for energy resources forward commitments, forward swap
transactions to hedge interest rate risk on future long-term debt, and other contractual or legal
requirements that involve the Company. The maximum amount available for LCs is $200
million. The amount available for cash borrowing out of the overall $400 million credit
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Avista Corporation
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o facility is reduced by the amount of LCs outstanding. Table No. 4 below summarizes the rates
paid to maintain and use the credit facility.
Table No. 4 - Credit Facility Fees (2014 Second Amendment to the 2011 Avista
Corporation Credit Agreement)
Pricing Level Facility Fee Eurodollar
Margin (l)ABR Margin
(2)
LC Participation
Fee
I o.o750A 0.675Yr 0.000%O.675Yo
II O.lOOYI 0.775"/,0.000%0.775Y"
III 0.l25yo o.87syo 0.000%O.875Yo
IV 0.175%;"o.950y"0.000%0.950y"
v o.200Yo l.o50y"o.o500h l.o50y"
VI 0.250y"1.2500A 0.250yo 1.250yo
Borrowing may be either of two types of short-term loans at the Company's discretion:
( I ) Borrowing with a Eurodollar-based interest rate requires three days notice. Interest
rate is based on the London interbank offered rate (LIBOR) plus a margin.(2) Borrowing under the alternative borrowing rate (ABR) may be completed on the day
requested. ABR interest rate is the prime rate set by the administrative agent bank
plus a tnargin.
The Pricing Level and associated rates that we are charged is based upon our
underlying credit ratings, as well as the security supporting the borrowings. Our current rates
are based upon Pricing Level III, which became effective in December 2018 based on the
Company's downgraded credit rating by Moody's. We achieve this Pricing Level by securing
the credit facility with First Mortgage Bonds. If we did not secure this credit facility with
First Mortgage Bonds, the costs would be based on Pricing Level IV, which would increase
costs to customers. There are also upfront costs paid for setting up the credit facility (i.e. legal
arrangement, bank commitments) that are amortized over the term of the credit facility.
a. How important are credit ratings for Avista?
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o A. Utilities require ready access to capital markets in all types of economic
environments. The capital intensive nature of our business, with energy supply and delivery
dependent on costly long-term projects to fulfill our obligation to serve customers,
necessitates the ability to obtain funding from the financial markets under reasonable terms at
regular intervals. In order to have this ability, investors need to understand the risks related
to any of their investments. Financial commitments by our investors generally stretch for
many years - even decades - and the potential for volatility in costs (arising from energy
commodities, natural disasters and other causes) is a key concern to them. To help investors
assess the creditworthiness of a company, nationally recognized statistical rating
organizations (rating agencies) developed their own standardized ratings scales, otherwise
known as credit ratings. These credit ratings indicate the creditworthiness of a company and
assist investors in determining if they want to invest in a company and its comparative level
of risk compared to other investment choices.
a. Please summarize the credit ratings for Avista.
A. Avista's credit ratings, assigned by Standard & Poor's (S&P) and Moody's
Investor Service (Moody's) are as follows:
S&P Moody's
Senior Secured Debt A.A3
Senior Unsecured Debt BBB Baa2
Outlook Stable Stable
Additional information on our credit ratings has been provided on page 1 of Exhibit
No. 2, Schedule 1.
a. Please explain the implications of the credit ratings in terms of the
Company's ability to access capital markets.
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o I A. Credit ratings impact investor demand and expected returns. More
2 specifically, when we issue debt, the credit rating can affect the determination of the interest
3 rate at which the debt will be issued. The credit rating can also affect the type of investor who
4 will be interested in purchasing the debt. For each type of investment a potential investor
5 could make, the investor looks at the quality of that investment in terms of the risk they are
6 taking and the priority they would have for payment of principal and interest in the event that
7 the organization experiences severe financial stress. Investment risks include, but are not
8 limited to, liquidity risk, market risk, operational risk, regulatory risk, and credit risk. These
9 risks are considered by S&P, Moody's and investors in assessing our creditworthiness.
l0 In challenging credit markets, where investors are less likely to buy corporate bonds
l1 (as opposed to U.S. Government bonds), a stronger credit rating will attract more investors,
12 and a weaker credit rating could reduce or eliminate the number of potential investors. Thus,
13 weaker credit ratings may result in a company having more difficulty accessing capital
14 markets and/or incurring higher costs when accessing capital.
l5 a. What credit rating does Avista believe is appropriate?
16 A. Avista's current S&P corporate credit rating is BBB. We believe operating at
17 a corporate credit rating level (senior unsecured) of BBB gives us the ability to continue to
18 attract investors and to achieve competitive debt pricing. Although a corporate credit rating
19 of BBB is a strong investment-grade credit rating, we continue to target a credit rating of
20 BBB+ which is comparable with other US utilities providing both electricity and natural gas.
21 As shown in Illustration No. 6, credit ratings for U.S. Regulated Combined Gas and Electric
22 Utilities are highly concentrated at A- or BBB+.
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Avista Corporation
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o 1 lllustration No.6
We expect that a continued focus on the regulated utility, conservative financing
strategies and a supportive regulatory environment will contribute toward an upgrade to a
BBB+ corporate credit rating for Avista. Operating with a BBB+ credit rating would likely
attract additional investors, lower our debt pricing for future financings, and make us more
competitive with other utilities. In addition, financially healthy utilities are better able to
invest in the required infrastructure over time to serve their customers, and to withstand the
challenges facing the industry and potential financial market disruptions.
a. How important is the regulatory environment in which the Company
operates?
A. A key component of a continued long-term sound financial profile is the ability
to receive timely recovery of capital additions and expenses, so the Company can earn its
authorized return. When regulatory mechanisms do not respond to changing cost factors, the
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Avista Corporation
BBB (Avlste)BB+ and lower
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SAP'r Dl-trlbutlon ol Corporatc Credlt RatlngaU.S, Ga5 and Electrlc Utiliti€sA. of February 2O19
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o I level of return can move substantially below the authorized level. This creates financial
2 weakness and concern in financial markets about the long-term stability of the Company.
3 Both Moody's and S&P cite the regulatory environment in which a regulated utility
4 operates as the dominant qualitative factor to determine a company's creditworthiness.
5 Moody's rating methodology is based on four primary factors. Two of those factors - a
6 utility's "regulatory framework" and its "ability to recover costs and earn returns" - make up
7 50% of Moody's rating methodologya.
8 For its part, S&P states the followings:
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Regulation is the most critical aspect that underlies regulated integrated
utilities' creditworthiness. Regulatory decisions can profoundly affect financial
performance. Our assessment of the regulatory environments in which a utility
operates is guided by certain principles, most prominently consistency and
predictability, as well as efficiency and timeliness. For a regulatory process to
be considered supportive of credit quality, it must limit uncertainty in the
recovery of a utility's investment. They must also eliminate, or at least greatly
reduce, the issue of rate-case lag, especially when a utility engages in a sizable
capital expenditure program.
19 Because of the major capital expenditures planned by Avista and future maturities of
20 long-term debt, continuing support from our regulators is essential in maintaining our current
21 credit rating.
22 a. Does this conclude your pre-filed direct testimony?
23 A. Yes.
a Moody's Investors Service, Rating Methodology: Regulated Electric and Gas Utilities, Jtrne 23,2017.
5 Standard and Poor's, Key Credit Factors: Business and Financial Risks in the Investor-owned Utility Industry,
March 2010.
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Avista Corporation
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