The URL can be used to link to this page

Home My WebLink About20090123Thies Direct.pdf-r'" 1\ /l'.""Rt.vt.. ~ r:;t) DAVID J. MEYER VICE PRESIDENT AND CHIEF COUNSEL OF REGULATORY & GOVERNENTAL AFFAIRS AVISTA CORPORATION P.O. BOX 3727 1411 EAST MISSION AVENE SPOKAE, WASHINGTON 99220-3727 TELEPHONE: (509) 495-4316FACSIMILE: (509) 495-4361 20n9 JAN 23 PH 12: 37 BEFORE THE IDAHO PUBLIC UTILITIES COMMISSION IN THE MATTER OF THE APPLICATION ) CASE NO. OF AVISTA CORPORATION FOR THE ) CASE NO. AUTHORITY TO INCREASE ITS RATES ) AND CHARGES FOR ELECTRIC AND ) NATURAL GAS SERVICE TO ELECTRIC AND ) NATURAL GAS CUSTOMERS IN THE STATE )OF IDAHO ) ) AVU-E-09-01 AVU-G-09-01 DIRECT TESTIMONY OF MAK THIES FOR AVISTA CORPORATION (ELECTRIC AND NATURAL GAS) 1 2 I. INTRODUCTION Q. Please state your name, business address, and 3 present position with Avista Corp. 4 5 A.My name is Mark Thies.My business address is 1411 East Mission Avenue, Spokane, Washington.I am 6 employed by Avista Corporation as Senior Vice President and 7 Chief Financial Officer. 8 Q.Would you please describe your education and 9 business experience? 10 A.I received Bachelor of Arts degrees in Accounting 11 and Business Administration from Saint Amrose College in 12 Davenport, Iowa, and became a Certified Public Accountant 13 14 in 1987.I have extensive experience in finance, risk managemen t ,accounting and administration wi thin the 15 utility sector, primarily in the Midwest. 16 I joined Avista in September of 2008 as Senior Vice 17 President and Chief Financial Officer (CFO).Prior to 18 joining Avista, I was Executive Vice President and CFO for 19 Black Hills Corporation, a diversified energy company, 20 providing regulated electric and natural gas service to 21 areas of South Dakota, Wyoming and Montana. I joined Black 22 Hills Corporation in 1997 upon leaving InterCoast Energy 23 Company in Des Moines, Iowa, where I was the manager of 24 accounting.Previous to that I was a senior auditor for 25 Arthur Anderson & Co. in Chicago, Illinois. Thies, Direct 1 Avista Corporation 1 Q.What is the scope of your testimony in this 2 proceeding? 3 A.i will provide a financial overview of the 4 Company and will explain the overall rate of return 5 proposed by the Company in this filing for its electric and 6 natural gas operations.The proposed rate of return is 7 derived from Avista' s long-term cost of debt and common 8 equity, weighted in proportion to the proposed capital 9 structure. 10 i will address the proposed capital structure, as well 11 as the proposed cost of debt and equity in this filing. 12 Company witness Dr. Avera will provide additional testimony 13 related to the appropriate return on equity for Avista, 14 based on the specific circumstances of the Company, 15 together with the current state of the financial markets. 16 In brief, i will provide information that shows: 17 . Avista's plans call for significant capital18 expenditure requirements for the utility over the19 next two years to assure reliability in serving 20 growth in the numer of customers and customer21 demand. Capital expenditures of approximately22 $420 million are planned for 2009-2010 for23 customer growth, investment in generation,24 transmission and distribution facilities for the25 electric utility business as well as necessary26 maintenance and replacements of our natural gas 27 utility systems. Avista needs adequate cash flow28 from operations to fund these requirements,29 together wi th access to capi tal from external30 sources under reasonable terms. 31 32 . Avista' s corporate credit rating from Standard & 33 Poor's is currently BBB- and Baa3 from Moody's.34 Avista Utilities needs to operate at a level that Thies, Direct 2 Avista Corporation 1 will support a strong investment grade corporate 2 credit rating, meaning UBBB" or UBBB+" , in order 3 to access capital markets at reasonable rates, 4 which will decrease long-term costs to customers. 5 Maintaining solid credit metrics and credit 6 ratings will also help support a stock price 7 necessary to issue equi ty to fund capital8 requirements. 9 10 . The Company has proposed an overall rate of11 return of 8.80%, including a 50.00% equity ratio12 and an 11.0% return on equity. We believe the13 11.0% provides a reasonable balance of the14 competing objectives of continuing to improve our15 financial health, and the impacts that increased16 ra tes have on our cus tomers . 1718 The Company's initiatives to carefully manage its 19 operating costs and capital expenditures are an important 20 part of improving performance, but are not sufficient 21 without revenues from the general rate request for our 22 electric and natural gas businesses in these cases. 23 Certainty of cash flows from operations can only be 24 achieved with the continued support of regulators in 25 allowing the timely recovery of costs and the ability to 26 earn a fair return on investment. 27 Finally, I will provide testimony concerning the 28 Company's pension expense and its proposal for a balancing 29 account with respect to annual dollar differences between 30 cash payments and pension expense. Thies, Direct 3 Avista Corporation 1 2 3 4 5 6 7 8 9 10 11 12 A table of contents for my testimony is as follows: Description I. Introduction II. Financial Overview III. Credit Ratings IV. Cash FlowV. Capi tal Structure VI. Cost of Debt VII. Cost of Common Equity VIII. Increase in Pension Expense Page 1 4 13 27 36 37 37 40 Q.Are you sponsoring any exhibits with your direct 13 testimony? 14 15 A.Yes.I am sponsoring Exhibi t No.2, Schedules 1 and 2, which were prepared under my direction.Avista's 16 credit ratings by the three principal rating agencies are 17 sumarized on Schedule 1, and Avista' s actual capital 18 structure at December 31, 2008 and pro forma capital 19 structure at June 30, 2009 are included on Schedule 2, page 20 1, with supporting information on pages 2 through 3. 21 22 23 II. FINANCIAL OVERVIEW Q.Please provide an overview of Avista' s financial 24 situation. 25 A.The Company has made solid progress in improving 26 its financial health in recent years, as demonstrated by 27 improved financial ratios. Avista has reduced investments 28 in unregulated subsidiaries and redeployed the majority of 29 the proceeds from the sales of the unregulated subsidiaries 30 to the Utility.The Company has been able to improve its Thies, Direct 4 Avista Corporation 1 debt ratio and balance the overall debt / equity ratio by 2 paying down debt, issuing additional common stock, and 3 4 through additional retained earnings.Al though we have made progress in improving the Company's financial 5 condition, we are still not as strong as we need to be 6 given the current unrest in capital markets, which may 7 continue for some time. 8 Avista's goal is to operate at a level that will 9 support a strong corporate credit rating of BBB / BBB+, and 10 move away from the Ucliff" of the investment grade rating 11 scale. Operating at a higher rating will help reduce long- 12 term costs to customers. It will also reduce collateral 13 requirements and allow us to maintain access to more counterparties for acquisition of natural gas and14 15 16 electrici ty.We expect that a continued focus on the regulated utility,conservati ve financing strategies 17 (including the issuance of common equity) and a continued 18 supportive regulatory environment will contribute to an 19 overall improved financial situation, that will allow us to 20 move up from the current BBB- rating. 21 Q.What additional steps is the Company taking to 22 improve its financial health? 23 A.We are working to assure we have adequate funds 24 for operations, capital expenditures and debt maturities. 25 We recently acquired a new $200 million 364-day line of 26 credit from our banks at reasonable rates that has allowed Thies, Direct 5 Avista Corporation 1 us to avoid the debt capital markets at a volatile time 2 when rates are very high. In December 2008, we also 3 obtained a $30 million private placement of five-year debt 4 at favorable rates as compared to the public markets. 5 We are maintaining our original $320 million line of 6 credit, which will expire in April 2011, as well as our 7 Accounts Receivable Sales program.The Company plans to 8 obtain a portion of our capital requirements through equity 9 issuance.We also maintain an ongoing dialogue with the 10 rating agencies regarding the measures taken by the Company 11 to improve our credit rating. 12 Addi tionally,the Company is working through 13 regulatory processes to recover our costs in a timely 14 manner so that earned returns are closer to those allowed 15 by regulators in each of the states we serve. This is one 16 of the key determinants from the rating agencies' 17 standpoint when they are reviewing our overall credit 18 standing. 19 Q.In addition to having credit ratings that will 20 allow Avista to attract debt capital under reasonable 21 terms, is it also necessary to attract capital from equity 22 investors? 23 A.It is absolutely essential.Avista has two 24 primary sources of external capi tal - debt lenders and 25 equity investors. Avista currently has approximately $2.0 26 billion of net investment in place to serve its customers. Thies, Direct 6 Avista Corporation 1 Approximately half of that investment is funded by debt 2 holders,and half is funded by equi ty investors. 3 Therefore, even though there tends to be a lot of emphasis 4 on maintaining credit metrics and credit ratings that will 5 provide access to debt capi tal under reasonable terms, 6 access to equity capital is equally important. 7 Addi tional equity capital generally comes in two forms 8 retained earnings and new equi ty issuances. Retained 9 earnings represent the annual earnings (return on equity) 10 of the Company that is not paid out to investors in 11 dividends.The retained earnings are reinves ted by the 12 Company in utility plant, and other capital requirements, 13 to serve customers, which avoids the need to issue new 14 debt.Occasionally it is necessary to issue new common 15 stock to maintain the proper balance of debt and equity in 16 the capital structure, which allows Avista access to both 17 debt and equi ty markets under reasonable terms, on a 18 sustainable basis.Because of the large capital 19 requirements at Avista in the near-term, it is imperative 20 that Avista have ready-access to both the debt and equity 21 markets at reasonable costs. 22 Q.Are the debt and equity capital markets a 23 competitive market? 24 A.Yes.Our ability to attract new capital, 25 especially equity capital, under reasonable terms is 26 dependent on our ability to offer a risk/reward opportunityThies, Direct 7 Avista Corporation 1 2 that is better than the equity investors'other alternatives.We are competing with not only other 3 utilities, but businesses in other sectors of the economy. 4 As an example,if an equity investor believes,or 5 perceives, that the risk/reward opportunity is better with 6 WalMart than with Avista, or the utility industry in 7 general, the investor will put the equity dollars in 8 WalMart stock.Demand for the stock supports the stock 9 price, which provides the opportunity to issue additional 10 stock under reasonable terms to fund capital investment 11 requirements. 12 To the extent that the equity investor holds a 13 diversified portfolio of companies that includes utilities 14 and other energy companies, we would be competing with 15 those companies to attract those equity dollars. 16 In the debt markets, utilities are the third largest 17 issuers; right behind governments and financial services. 18 Therefore, it is a very competitive market and the Company 19 must be able to attract debt investors as well as equity 20 inves tors. 21 Q.What is Avista doing to attract equity 22 investment? 23 A.Avista is carrying a capital structure that 24 provides the opportunity to have financial metrics that 25 offer a risk/reward proposition that is competitive and/or 26 attractive for equity holders. Thies, Direct 8 Avista Corporation 1 We have increased our dividend for common 2 shareholders, and have publicly stated that we intend to 3 work toward a dividend payout ratio that is comparable to 4 other utilities in the industry.This is an essential 5 element in providing a competitive risk/reward opportunity 6 for equity investors. 7 We are operating the business efficiently to keep 8 costs as low as practicable for our customers, while at the 9 same time ensuring that our energy service is reliable, and 10 results in a high level of customer satisfaction.An 11 efficient, well-run business is not only important to our 12 customers, but also to investors. 13 We are employing tracking mechanisms such as the PCA 14 and PGA, approved by the regulatory commissions, to balance 15 the risk of owning and operating the business in a manner 16 that places us in a position to offer a risk/reward 17 opportunity that is competitive with not only other 18 utilities, but with businesses in other sectors of the 19 economy. 20 We are seeking rate relief to provide timely recovery 21 of costs and earned returns closer to those allowed by 22 regulators.If we are not able to achieve a reasonable, 23 actual, earned return on our equity investment, we will not 24 be able to attract equity dollars that are absolutely 25 necessary to support this business going forward. Thies, Direct 9 Avista Corporation 1 Dr. Avera provides additional testimony related to the 2 appropriate return on equity for Avista, that would allow 3 the Company access to equi ty capi tal under reasonable 4 terms, and on a sustainable basis. 5 Q.Do you believe there are misconceptions about the 6 earnings of the Company related to the equity investment in 7 the Company? 8 A.Yes I do.I believe some of our customers 9 believe that the earnings of the Company that we report 10 publicly each quarter are uprofits" that are over and above 11 the dollars necessary to own and operate the utility, which 12 we know is simply not true.Just as we must pay interest 13 to debt holders in exchange for the use of their dollars, 14 we must also provide a return on investment for the equity 15 holder, or the equity holder will take his or her dollars 16 somewhere else. 17 i believe some do not understand that the quarterly 18 earnings or profits are the return or u interest" to the 19 shareholder, and without it we would not have the funds 20 necessary to run the business - i. e., it is, in fact, one 21 of the essential costs of owning and operating the 22 business. 23 Q.After Avista reported its earnings for the Second 24 Quarter (Q2) of 2008, it was reported in the Spokesman 25 Review newspaper that "Avista Quarterly Profits Soar." Did Thies, Direct 10 Avista Corporation 1 Avista's earnings for Q2 of 2008 exceed those authorized by 2 this Commission? 3 A.No.While earnings from utility operations did 4 improve some for Q2 2008 versus the prior year, the primary 5 reason for the improvement was that Avista Corp completed 6 the sale of Avista Energy during Q2 2007, and recorded a 7 large loss in Q2 2007 related to the operations of that 8 business.The absence of the loss in 2008, resulted in a 9 substantial improvement in reported earnings in Q2 of 2008. 10 Q.What do the quarterly and annual earnings 11 reported by Avista tell us about the earned return for 12 equity holders for 2008? 13 A.Al though actual earnings for the calendar year 14 2008 have not yet been released, Avista has previously 15 provided uguidance" for the expected earnings for the year. 16 The current earnings guidance for Avista Utilities for 2008 17 is the range of $1.20 to $1.35 per common share. At 18 September 30, 2008 Avista had approximately 54.0 million 19 common shares outs tanding, and an equi ty inves tmen t in the 20 utility of $904 million, per our third-quarter 10-Q filed 21 with the Securities and Exchange Commission. If we were to 22 assume that Avista will see earnings in the middle of the 23 earnings guidance, at $1. 28/share, it would result in a 24 return on investment for equity holders of 7.6%.By 25 comparison, the currently authorized return on equity in 26 Idaho for Avista is 10.20%.Therefore, during 2008 we Thies, Direct 11 Avista Corporation 1 expect to earn substantially less than what we were 2 authorized to earn by the I PUC , i . e., we will not recover 3 our costs of providing service to customers, including a 4 competitive return to equity holders. 5 If we continue to fall short, it will threaten our 6 ability to obtain financing from debt and equity holders 7 under reasonable terms. 8 9 Q.What is the Company expecting to earn in 2009? A.We received additional rate relief in all three 10 states where we do business during 2008 (January 1, 2009 11 for Washington).While this provides additional cost 12 recovery, we are also continuing to experience increases in 13 costs, and increased capital investment requirements.As 14 an example, our most recent rate case in Idaho included 15 recovery of new capital investment through December 31, 16 2008, but none for 2009.What that means is, we are not 17 recovering the costs associated with the new capital 18 investment we have already made in 2009, and will continue 19 to make, until the conclusion of this rate case in mid- 20 2009. 21 Furthermore, if we do not reflect in retail rates the 22 cost of future capital that will be serving customers 23 during the period that retail rates are in place from this 24 case, we will continue to earn a lower return than what we 25 are authorized to earn. Thies, Direct 12 Avista Corporation 1 We have previously announced that we expect Avista' s 2 utility earnings for 2009 to be in the range of $1.30 to 3 4 $1.45 per share.If we again use the middle of the range ($1.38/share)for illustrative purposes,54.0 million 5 shares outstanding, and $1.0 billion of equity investment, 6 it would result in an earned return for 2009 of 7.5%, again 7 well below the authorized return of 10.2%. 8 As we process this rate filing, it is imperative that 9 we work toward recovery of the costs to provide service to 10 customers, and a meaningful opportunity to earn a return 11 closer to the allowed return, so that we can have access to 12 debt and equity capi tal under reasonable terms. 13 14 15 16 III. CREDIT RATINGS Q.How important are credit ratings for Avista? A. Utilities need ready access to capital markets in 17 all types of economic environments. I believe few, if any, 18 would have predicted the kind of financial markets we have 19 experienced the past few months.The nature of our 20 business with long-term capital projects, our obligation to 21 serve, and the potential for high volatility in fuel and 22 purchased power markets, necessitates the ability to tap 23 the financial markets under reasonable terms on a regular 24 basis. 25 In these past few months we have seen ample evidence 26 of the benefit of having a higher credit rating. As an Thies, Direct 13 Avista Corporation 1 example, in December, 2008, El Paso Electric, a BB credit, 2 issued bonds at an effective cost of 15%. 3 4 5 In the fall of 2008 we had planned to issue an additional $100 million of long-term debt.In April 2008 we issued $250 million of 10-year debt at 5.95%.In the 6 fall of 2008, however, because of the unrest in the 7 financial markets, there were times when we could not issue 8 debt at any interest rate, and when it was available, the 9 al 1 - in in teres t rates were 9. 5 % or higher. Fortuna tely , we 10 were able to negotiate the acquisition of an additional 11 credit line of $200 million for a period of 364 days, under 12 favorable terms, and avoid issuing new long-term debt at 13 these high rates - at least for now.We believe that 14 financial markets will be more stable as we move toward the 15 later part of 2009, and our financial circumstances will be 16 such that we will have access to new long-term debt at 17 reasonable rates. 18 19 Q.Yields on us Treasuries have decreased significantly over the past several months.Why have 20 interest rates for utility bonds gone up? 21 A.Although it is true that the yield on us 22 Treasuries has declined, the interest rate spreads between 23 utility bonds and Treasuries that debt holders are 24 demanding have increased dramatically due to the unrest in 25 the financial system and the economy.The following graph 26 illustrates the dramatic rise in the gap during 2008 Thies, Direct 14 Avista Corporation 1 between the yields on Treasuries and utility bonds rated 2 BBB+, BBB, and BBB- or below.The graph also illustrates 3 the significantly higher cost of debt for companies at or 4 below the lowest rung of the investment grade ladder (BBB- 5 or below), versus a credit rating of BBB, only one step 6 higher than Avista' s current rating of BBB-. 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 +640bps +590bps +540 bps +490 bps +440bps +390bps +340bps +290bps +240bps +190 bps +140 bps Illustration No.1: Average Utility Bond Spread to U.S. Treasury -BBB+ -BBB -BBB-orWorse I BBB-wo.. ~ +90 bps Mar-07 May-07 Aug-07 Oc~07 Jan.QS Mar-OS Jun-OS Aug-OS No".OS 22 debt securities. Q.Please explain the credit ratings for Avista's 23 24 A.Rating agencies are independent agencies that assess risks for investors.The three mos t widely 25 recogni z ed rat ing agenc i es are Standard & Poor's ( S&P) , 26 (Moody's) and FitchRatings Thies, Direct 15 Avista Corporation Moody's Investors Service 1 (Fitch) .These rating agencies assign a credit rating to 2 companies and their securities so investors can more easily 3 understand the risks associated with investing in their 4 debt and preferred stock.Avista's credit ratings by the 5 three principal rating agencies are sumarized on page 1 of 6 Exhibi t No.2. Additionally, the following rating actions 7 occurred during 2007 and 2008: 8 a. S&P upgraded Avista' s corporate credit rating to 9 BBB- from BB+ (February 2008) and Avista's secured 10 debt rating to BBB+ from BBB- (September 2007 and11 af firmed in September 2008) . 1213 b. Moody's upgraded Avista' s corporate credit rating 14 to Baa3 from Ba1 and Avista' s secured rating to 15 Baa2 from Baa3 (December 2007) . 1617 c. Fitch upgraded Avista' s long-term issuer default18 rating to BB+ from BB and its secured debt rating 19 to BBB from BBB- (August 2007 and affirmed in20 February 2008) . 2122 As shown in Illustration No. 2 below, Avista is on the 23 lowest rung of the investment grade credit rating scale. 24 As I noted earlier, I believe it is important that we move 25 up the scale to at least a BBB or BBB+, so that we are not 26 on the edge of the investment grade cliff. Thies, Direct 16 Avista Corporation 1 2 3 4 5 6 7 8 Illustration NO.2: S&P's Distnbution of Credit Ratigs of U.S. Regulted Electnc Utities (as of 1/5/09) c 80 j 60.. ~ 40JpOzo Avista AA-A-BBB+BBB BBB-BB+ BB BB.A+A Credit Rating Q.Please explain the implications of the credit 9 ratings in terms of the Company's ability to access 10 financial markets. 11 impact investor demand andCreditratingsA. 12 expected return. More specifically, when the company issues 13 debt, the credit rating helps determine the interest rate 14 at which the debt will be issued. The credit rating also 15 determines the type of investor who will be interested in 16 purchasing the debt. For each type of investment a 17 potential investor could make, the investor looks at the 18 quality of that investment in terms of the risk they are 19 taking and the priority they would have in the event that 20 the organization experiences severe financial stress. 21 Investment risks include the likelihood that a company will 22 not meet all of its debt obligations in terms of timeliness 23 and amounts owed for principal and interest. Secured debt 24 receives the highest ratings and priority for repayment 25 and, hence, has the lowest relative risk.In challenging 26 credit markets, where investors are less likely to buy Thies, Direct 17 Avista Corporation 1 corporate bonds, a higher credit rating will attract more 2 investors, and a lower credit rating could shrink or 3 eliminate the numer of potential investors.Thus, lower 4 credit ratings may result in a company having more 5 difficul ty accessing financial markets and/or incur 6 significantly higher financing costs. 7 Q.What credit rating does Avista Corporation 8 believe is appropriate? 9 A. The move to investment grade for Avista Corp last 10 year was a significant step in improving the ability to 11 access capital at a reasonable cost.However, a credi t 12 rating at the bottom of investment grade is not appropriate 13 for Avista.In adverse conditions - whether unique to 14 Avista or by all market participants - a downgrade from 15 BBB-( investment grade)to BB+(high-yield)is 16 significantly harder to overcome than a downgrade from BBB 17 to BBB-. As Avista experienced, it took approximately six 18 years for the Company to regain its investment grade rating 19 from S&P after it was downgraded during the energy crisis. 20 The difference between investment grade and non-investment 21 grade is not only a matter of debt pricing, it can be a matter of any access at all.During the period from mid-22 23 24 September to mid-December,the credi t markets were essentially closed to non-investment grade issuers.In 25 order to be able to weather a potential downgrade, Avista 26 Utilities should operate at a level that will support a Thies, Direct 18 Avista Corporation 1 strong corporate investment grade credit rating, meaning a 2 UBBB" or an uBBB+," using S&P' s rating scale. 3 4 A solid investment grade credit rating would also allow the Company to post less collateral with 5 counterparties than would otherwise be required with a 6 lower credit rating. This results in lower costs. It also 7 increases financial flexibility since the credit line 8 capacity would not be reduced for outstanding letters of 9 credit. 10 11 Financially healthy utilities have lower financing costs which, in turn, benefit customers.In addition, 12 financially healthy utilities are better able to invest in 13 the needed infrastructure over time to serve their 14 customers, and to withstand the challenges and risks facing 15 the industry. 16 Q.What financial metrics are used by the rating 17 agencies to establish credit ratings? 18 A.S&P modified its electric and natural gas utility 19 rankings in November 2007 to conform to the ubusiness 20 risk/financial risk" matrix used by their corporate ratings 21 group.The change by S&P was designed to present their 22 rating conclusions in a clear and standardized manner 23 across all corporate sectors. 24 S&P's financial ratio benchmarks used to rate 25 companies such as Avista are set forth in Illustration No. 26 3 below. Thies, Direct 19 Avista Corporation 1 Illustration No.3: Standard & Poor's Financial Risk Indicative Ratios. US Utilties 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 12 Month End 9/30108 Ratios: Avista Adjusted*17.6 3.4 53.7 * Calculated as of 9/30108 based on last known S&P methodology 2 3 4 5 The ratios above are utilized to determine the financial risk profile.Currently, Avista is in the uAggressive" category.The financial risk category along 6 with the business risk profile (Avista is in the Strong 7 category) is then utilized in Illustration No. 4 below to 8 S&P currently has Avista' sdetermine a company's rating. 9 corporate credit rating as a BBB-, as indicated in the 10 following illustration. 11 Illustration No.4: 12 Standard & Poor's Business Risk 1 Financial Risk Matrix 13 14 15 16 17 18 Financial Risk Profile Highly Business Risk Profile Minimal Modest Intermediate Aggressive leveraged Excellent AA 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- Thies, Direct 20 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, uFunds 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, uFunds 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 statements of the Company? 24 A.Yes. Rating agencies make adjustments to debt to 25 factor in off-balance sheet commitments (for example, the 26 accounts receivable program, purchased power agreements and Thies, Direct 21 Avista Corporation 1 the unfunded status of pension and other post-retirement 2 benefits) that negatively impact the ratios.S&P has 3 historically made adjustments to Avista' s debt totaling 4 approximately $226 million related to the accounts 5 receivable program, purchased power and post-retirement 6 benefits.The adjusted financial ratios for Avista are 7 included in Illustration No. 3 above. 8 Q.Where does Avista fall within those coverage 9 ratios? 10 A.Avista's cash flow ratios have improved as a 11 result of the refinancing of the high cost debt that 12 matured in June 2008.S&P and Moody's took this into 13 account when they upgraded Avista in December 2007 and 14 February 2008. Progress in increasing the cash flow ratios 15 in recent years has been slower than anticipated due to 16 below normal stream flows affecting hydro generation, 17 higher thermal fuel costs than the amount included in rates 18 and the resulting inability to eliminate electric deferral 19 balances, and higher capital expenditures that require cash 20 up front before we can recover the costs from customers. 21 Each has an impact on the Company by reducing the amount of 22 available cash flow from operations, requiring external 23 financing and ultimately resulting in higher debt and lower 24 25 cash flow ratios.In fact, S&P stated the following in a January 2008 research report on Pacific Northwest 26 Hydrology: Thies, Direct 22 Avista Corporation 1 We find that Avista and Idaho Power, which are 2 comparably sized companies, face the most 3 substantial risk (related to hydro power) despite 4 their peAs and cost update mechanisms. 1 5 6 Additionally, S&P stated the following in its February 2008 7 research update of Avista Corporation: 8 The Company's financial performance will continue 9 to be significantly affected by hydro conditions10 and gas prices. And the Company's key utility11 risk going forward is its exposure to high-cost12 replacement power, particularly in low water13 years. 2 1415 In order to improve the cash flow ratios, Avista must 16 reduce its total debt balances and increase its available 17 funds from operations.Although the Company has continued 18 to work towards paying down its total debt, the negative 19 impacts to cash flow caused by below-normal hydroelectric 20 generation and volatility of wholesale electric market 21 prices and natural gas prices in recent years, has 22 adversely affected Avista' s progress in improving the cash 23 flow ratios. 24 Q.Do the rating agencies look at any other factors 25 when evaluating a company's credit quality? 26 A.Yes. In addition to financial ratios and metrics, 27 rating agencies also look at a numer of qualitative 28 factors which directly or indirectly may affect a company's 29 cash flow. These factors include: i Standard and Poor's, Pacific Northwest Hydrology and Its Impact on Investor-Owned Utili ties' Credi t Quali ty , January 2008 2 Standard and Poor's, Avista Corp's Corporate Credi t Rating Raised One Notch to BBB-, February 2008 Thies, Direct 23 Avista Corporation 1 .Regulation 2 .Markets 3 .Operations 4 .Competi ti veness, and 5 .Management 6 In evaluating these factors, the rating agencies look 7 for regulatory actions that are supportive of cost recovery 8 and that eliminate or minimize volatility of cash flows. 9 They also consider the strength and growth of the economy 10 in our service territory, operations' ability to control 11 cos ts , whether our service is competi ti ve,and the 12 effectiveness of management. 13 Therefore, while the ratios are utilized in their 14 quantitative evaluation of a company, they are not the only 15 factors that are taken into account. 16 Q.What risks are Avista and the utility sector 17 facing that may impact credit ratings? 18 A.Avista's credit ratings are impacted by risks 19 that could negatively affect the company's cash flows. 20 These risks include, but are not limited to, the level and 21 volatility of wholesale electric market prices and natural 22 gas prices for fuel costs, liquidity in the wholesale 23 market (fewer counterparties and tighter credit 24 restrictions), recoverability of natural gas and power 25 costs, stream flow and weather conditions, changes in Thies, Direct 24 Avista Corporation 1 legislative and governmental regulations, relicensing hydro 2 proj ects, rising construction and raw material costs, 3 customers' ability to timely pay their bills, and access to 4 capital markets at a reasonable cost. 5 Credit ratings for the utility sector are also 6 adversely impacted by large capital expendi tures for 7 environmental compliance, and the need for new generation 8 and transmission and distribution facilities.The utility 9 sector is in a cycle of significant capital spending, which 10 will likely be funded by large issuances of debt and 11 equity.This increases the competition for financial 12 capital at a time when the average utility credit rating is 13 just above investment grade. 14 Given the downturn in the economy and the tightened 15 credit markets, the rating agencies are keeping closer tabs 16 on all companies in order to make sure there is sufficient 17 liquidity in case the credit markets are inaccessible. Not 18 having sufficient sources of cash for potential cash 19 requirements could prompt a credit rating downgrade. 20 The increased capi tal spending needs and resulting 21 increased debt issuances make regulation supporting the 22 full and timely recovery of prudently incurred costs even 23 more critical to the utility sector than in previous years. 24 Q.How important is the regulatory environment in 25 which a Company operates? Thies, Direct 25 Avista Corporation 1 A.The regulatory environment in which a company 2 operates is a major qualitative factor in determining a 3 company's credi tworthiness .Moody's stated the following 4 regarding Avista' s regulatory environment in a December 5 2008 credit ratings report: 6 UAvista benefits from credit supportive7 ratemaking practices in all three of its 8 jurisdictions, which include periodic mechanisms 9 to account for variations in the power and10 natural gas costs incurred as compared to the11 levels included in rates." However, Moody's also12 pointed out that uFailure to obtain adequate and13 timely support for recovery of and return on core 14 utility investments through pending and expected15 future regulatory proceedings, or any unexpected16 material deviation from the back-to-basics17 strategy, are among the more important factors 18 that could have negative rating implications. "3 1920 Additionally, in a January 2008 article published by 21 S&P entitled uTop Ten US Electric Utility Credit Issues for 22 2008 and Beyond", S&P stated that uRecovering in a timely 23 manner federally and/or state mandated compliance costs is 24 paramount to preserving credit quality for regulated 25 electric utili ties. "4 26 Due to the maj or capi tal expenditures planned by 27 Avista, the continued supportive regulatory environment 28 will be critical to Avista's financial health. 29 Additionally, although Avista has electric and natural gas 30 tracking mechanisms (PCA and PGA) to provide recovery of 3 Moody's Investor Service, Moody's Upgrades Avista Corp (Decemer 3, 2008) 4 Standard and Poor's, Top Ten US Electric Utility Credit Issues for 2008 and Beyond, January 2008 Thies, Direct 26 Avista Corporation 1 the majority of the variability in commodity costs, these 2 changes in costs must be financed until the costs are 3 recovered from customers.Investors and rating agencies 4 are concerned about regulatory lag and cost-recovery 5 related to these items. 6 Q.How do you expect the rating agencies will view 7 the Company's proposed change in the PCA mechanism from a 8 "90%/10%" to a "95%/5%" sharing? 9 A.I believe the rating agencies will view the 10 Company's proposal favorably. In a report issued by S&P on 11 January 14, 2009 relating to the approval by the IPUC on a 12 similar change in Idaho Power's PCA, they stated US&P said 13 today that improvements to Idaho Power Company's annual PCA 14 mechanism supports credit quality but will have no 15 immediate impact on credit ratings."The changes are 16 expected to reduce the under-collection of power costs and 17 reduce cashflow volatility. 18 19 20 iV. CASH FLOW Q.What are the Comany's sources to fund capital 21 requirements? 22 A.The Company utilizes cash flow from operations, 23 long-term debt and common stock issuances to fund its 24 capi tal expendi tures .Additionally, on an interim basis, 25 the Company utilizes its credit facilities to fund working Thies, Direct 27 Avista Corporation 1 capital needs and capital expenditures until longer-term 2 financing can be obtained. 3 Q.What are the Company's near-term capital 4 requirements? 5 A.As a combination electric and natural gas 6 utility, over the next few years, capital will be required 7 for customer growth, investment in generation, transmission 8 and distribution facilities for the electric utility 9 business, as well as necessary maintenance and replacements 10 of our natural gas systems. 11 The amount of capital expenditures planned for 2009- 12 2010 is approximately $420 million. For 2009 alone, these 13 costs equate to a total of $210 million. Total ratebase at 14 November 30, 2008 was $1.9 billion for the total Company; 15 therefore,these planned capital additions represent 16 substantial new investments given the relative size of the 17 Company. A few of the major capital expenditure items on a 18 system basis for 2009 include $60 million for electric 19 transmission and distribution upgrades, $20 million for 20 natural gas system upgrades, $10 million for environmental 21 (associated with the Spokane River relicensing and the 2001 22 Clark Fork River license implementation issues) ,and $30 23 million for generation upgrades. 24 Q.What are the Company's long-term capital 25 requirements? Thies, Direct 28 Avista Corporation 1 A.Avista's Integrated Resource Plan has identified 2 the potential need for the Company to finance significant 3 expendi tures for electric facilities.The preferred 4 strategy outlined in our 2007 Integrated Resource Plan 5 included total expenditures of $1.25 billion by 2018, 6 including investment in wind resources and upgrades at 7 hydroelectric stations. 8 9 Maj or capi tal expendi tures are a normal part of utility operations.Customers are added to the service 10 area, roads are relocated and require existing facilities 11 to be moved, and facilities continue to wear out and need 12 13 replacement.These and other requirements create the need for significant capital expenditures each year.We saw 14 significant increases in the costs of raw materials over 15 the past year, which our suppliers are continuing to pass 16 through to us in the pricing of their finished products. 17 Access to capital at reasonable rates is dependent upon the 18 Company maintaining a strong capital structure, sufficient 19 interest coverage, and investment grade credit ratings. 20 Q.What are the Company's near-term plans related to 21 its debt? 22 A.During 2008 the Company issued $250 million of 23 secured debt in April but, as explained earlier, chose not 24 to go forward with a planned issuance of $100 million in 25 long-term debt in September due to unfavorable conditions 26 in the debt capi tal markets.The Company instead sought Thies, Direct 29 Avista Corporation 1 out and was able to establish a second bank line of credit 2 in the amount of $200 million for 364 days to ensure 3 continued adequate liquidity. The Company was also offered 4 and accepted a private placement of $30 million of First 5 Mortgage Bond secured 5-year debt. 6 7 The Company currently plans to issue up to $150 million of secured, fixed rate bonds during 2009.The 8 proceeds from the issuance of the securities will be 9 utilized to fund capital expenditures and repay funds 10 borrowed under our credit facilities.The Company has no 11 long-term debt scheduled to mature in 2009; however, it has 12 an option to redeem $61.9 million of Trust Preferred 13 Securities in March 2009. 14 Illustration No. 5 below shows the amount of debt 15 maturities for Avista each year: Thies, Direct 30 Avista Corporation 1 Illustration No.5: 2 Debt Maturities by Year proforma December 31, 2009 10 $50 23% 21% 17%_. 13% - 6% 5%6% ---_.------_.._.~---------~---~-_._----------- i 2% :.i i 3 $30 4 $250 5 6 $200 7 $150 8 $100 9 11 $0 12 09 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 . Long-term debt outtai~fI Propoed 2009 debt issunc 13 14 Q.Has the Company taken any steps to address the 15 uncertainty related to interest rate exposure for the 16 planned debt issuance in 2009? 17 A.Yes.The Company recently entered into four 18 forward-starting interest rate swaps for a total of $100 19 million as a hedge on a portion of the interest payments on 20 the long-term debt we are planning to issue in 2009. The 21 Company is continuing to analyze the possibility of 22 entering into additional transactions in order to lock in 23 the interest rate on a greater portion of the debt at a 24 time when Treasury rates are at all-time historical lows. Thies, Direct 31 Avista Corporation 1 Q.What is the status of the Company's lines of 2 credit secured by first mortgage bonds and its accounts 3 receivable program? 4 A.The Company has a $320 million line of credit 5 that expires in April 2011, and a $200 million line of 6 credit that expires November 24, 2009. The Company has the 7 option of increasing the $320 million line by $100 million 8 (up to $420 million) at any time during the term of the 9 agreement, subj ect to additional fees and obtaining bank 10 commitments. The agreement includes the option to release 11 the first mortgage bond security when the Company has an 12 investment grade credit rating. The Company also has the 13 option of renewing or upsizing the $200 million deal to 14 $250 million under certain circumstances.Addi tionally, 15 the Company has an $85 million accounts receivable funding 16 program that expires in March 2009. This agreement has 17 been renewed on a year-to-year basis, and we expect to 18 extend the agreement for another year. 19 The facilities have been sized to allow the Company to 20 maintain a liquidity cushion of at least $125 million at 21 all times to cover required working capital i counterparty 22 collateral requirements i and avoid issuing debt in 23 unfavorable market conditions if they persist through 2009. 24 Our liquidity is strong and we are confident that our 25 current agreements give us flexibility while facing both Thies, Direct 32 Avista Corporation 1 the volatile financial markets and volatile energy 2 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 Company should see an increase in the number of 11 counterparties willing to do business with us and the 12 collateral requirements are expected to decrease even 13 further, resul t ing in reduced borrowing cos ts .The lines 14 of credit and accounts receivable program are our primary 15 sources of immediate cash for borrowing to meet these needs 16 and for supporting the use of letters of credit. A line of 17 credit is required to manage daily cash flow since the 18 timing of cash receipts versus cash disbursements is never 19 totally balanced. 20 Q.What are Avista's plans regarding common equity 21 and why is this important? 22 A.Avista will continue to monitor the common equity 23 ratio of its capital structure, and assess the need to 24 issue additional common equity.Avista entered into a 25 sales agency agreement in December 2006 to issue up to two 26 million shares of our common stock from time to time. Thies, Direct 33 Avista Corporation 1 During the third quarter of 2008, we issued 750,000 shares 2 of common stock under this agreement. Our plan for 2009 is 3 to continue with the periodic offering of common stock as 4 needed to support the Company's common stock ratio. To the 5 extent that we are not able to access the equity market, 6 there will be increased pressure on our lines of credit, 7 and an increased need to issue long term debt, which is 8 likely to unfavorably impact our cost of debt and debt to 9 equity ratio.It is important to the rating agencies for 10 Avista to maintain a balanced debt/equity ratio in order to 11 minimize the risk of default on required debt interest 12 payments. 13 As Dr. Avera explains in his testimony, the 50.0 14 percent common equity ratio requested by Avista in this 15 case is consistent with the range of equity ratios 16 maintained by the firms in the Utility Proxy Group. 17 Dr. Avera notes that electric utili ties are facing, 18 among other things, rising cost structures, the need to 19 20 finance significant capital investment plans,and uncertainties over accommodating future environmental 21 mandates. A more conservative financial profile, in the 22 form of a higher common equity ratio, is consistent with 23 increasing uncertainties and the need to maintain the 24 continuous access to capital that is required to fund 25 operations and necessary system investment, even during 26 times of adverse capital market conditions. Thies, Direct 34 Avista Corporation 1 He also discusses Moody's warning to investors of the 2 risks associated with debt leverage and fixed obligations 3 and their advice to utili ties to not squander the 4 opportunity to strengthen the balance sheet as a buffer 5 against future uncertainties. Moody's noted that, absent a 6 thicker equity layer, utilities would be faced with lower 7 credit ratings in the face of rising business and operating 8 risks: 9 There are significant negative trends developing10 over the longer-term horizon. This developing11 negative concern primarily relates to our view12 that the sector's overall business and operating13 risks are rising - at an increasingly fast pace -14 but that the overall financial profile remains15 relatively steady. A rising risk profile16 accompanied by a relatively stable balance sheet17 profile would ultimately result in credit quality18 deterioration. 5 19 This is especially the case for Avista, which faces 20 the dual challenge of financing significant capital 21 expansion plans in a turbulent market while at the same 22 time endeavoring to improve its credit standing. Avista is 23 committed to maintaining an appropriate level of equity to 24 support a strong credit rating. 25 Q.What are Avista' s plans regarding preferred 26 equity and other financing structures (for example, hybrid 27 instruents)? 28 A.Avista does not have any preferred equity or 29 other financing structures outstanding at December 31, 5 Moody'S Investors Service, ~U.S. Electric Utility Sector," Industry Outlook (Jan. 2008). Thies, Direct 35 Avista Corporation 1 2008.Currently, Avista does not plan to issue preferred 2 equity or other financing structures, but will continue to 3 evaluate the appropriateness of these financing vehicles. 4 5 6 V. CAPITAL STRUCTUR Q.Please explain the capital structure proposed by 7 Avista in this case. 8 A.Avista's current capital structure consists of a 9 blend of long-term debt and common equity necessary to 10 support the assets and operating capital of the Company. 11 The proportionate shares of Avista Corp.' s actual capital 12 structure on September 30, 2008, are shown on page 1 of 13 Exhibi t No.2, Schedule 2.A pro forma capital structure 14 is also shown on page 1, in the Schedule, which reflects 15 expected changes for the period ending June 30, 2009. 16 Supporting workpapers provide additional details related to 17 these adjustments on pages 3 through 4. 18 The rate of return to be applied to rate base in this 19 proceeding is equal to the weighted average cost of 20 capital, taking into account the pro forma adjusting items. 21 As shown on page 1 of Exhibit No.2, Schedule 2, Avista 22 Utilities is proposing an overall rate of return of 8.80%. 23 24 25 26 Thies, Direct 36 Avista Corporation 1 2 3 4 VI. COST OF DEBT Q.How have you determined the cost of debt? A.Cost of debt in the Company's proposed capital structure includes long-term debt.As shown on page 1 of 5 Schedule 2 of Exhibit No.2, the actual weighted average 6 cost of long-term debt outstanding on September 30, 2008 7 was 6.91%.The size and mix of debt changes over time 8 based upon the actual financing completed.We have made 9 certain pro forma adjustments to update the debt cost 10 through June 30, 2009 to 6.60%.Pro forma adjustments to 11 long-term debt reflect expected maturities of outstanding 12 debt and the issuance of new debt to fund those maturities. 13 The pro forma weighted cost of long-term debt was reduced 14 from 3.45% to 3.30%. 15 16 17 VII. COST OF COMMON EQUITY Q.What rate of return on common equity is the 18 Company proposing in this proceeding? 19 A.As further explained by Dr. Avera, the cost of 20 equity has increased since the conclusion of Avista' s last 21 general rate case.Difficult economic conditions and 22 increased volatility in the financial markets have caused a 23 flight to quality among investors, meaning that they have a 24 preference for investments with very low risk, such as U. S. 25 Treasury bonds, and they are demanding a higher premi ur 26 (return) for taking additional risk. As explained earlier Thies, Direct 37 Avista Corporation 1 in my testimony, the interest rate spreads between US 2 Treasuries and utility bonds increased dramatically in the 3 later part of 2008.Equi ty investments inherently contain 4 more risk, and our cost of equity has also increased since 5 our last rate case. 6 The Company is proposing an 11.0% return on common 7 equity (ROE), which falls below the lower end of Dr. 8 Avera's recommended range of required return on equity. 9 Dr. Avera testifies to analyses related to the cost of 10 common equity with an ROE range of 11.3% to 13.3%. In his 11 testimony Dr. Avera states that: 12 13 14 15 16 17 18 19 20 Considering investors' expectations forcapi tal markets and the need to support financial integrity and fund crucial capital investment even under adversecircumstances, I concluded that Avista' s requested ROE of 11.0% percent isreasonable. (P. 5, L. 40 - P. 6, L. 1) Q. Dr. Avera suggests an ROE range of 11.3% to 21 13.3%. Why is Avista requesting an ROE below the lower end 22 of the range? 23 A.As I have testified, Avista has made solid 24 progress towards improving its financial health. If Avista 25 can earn an 11.0% ROE, I believe our financial condition 26 would continue to improve and would further strengthen the 27 credit ratings ratios. 28 Furthermore,as the Company has worked toward 29 improving its financial condition over the last several 30 years, it has done so with the customer in mind. Avista is Thies, Direct 38 Avista Corporation 1 attempting to balance the ability to continue to improve 2 our financial health and access capital markets under 3 reasonable terms with the impacts that increased retail 4 ra tes have on its cus tomers .In this case, al though we 5 believe an ROE greater than 11.0% is supported and is 6 warranted, we also believe the 11.0% provides a reasonable 7 balance of the competing objectives. 8 Q.Please sumrize the proposed capital structure 9 and the cost components for debt and commn equity. 10 A.As also shown on page 1 of Exhibit No.2, Schedule 11 2, the following illustration shows the capital structure 12 and cost components proposed by the Company. Thies i Direct 39 Avista Corporation 1 2 3 Illustration No.6: A VISTA CORPORATION Capital Structure and Overall Rate of Return 4 5 6 7 8 9 10 11 12 13 14 * Pro forma Common Equity of 50% is less than calculated Common Equity based on Pro Forma Capital Strcture at June 30, 2009 calculated above VIII. INCRESE IN PENSION EXPENSE Q.Has the Company included an adjustment in this 15 filing for increased pension expense? 16 A.Yes.The Company's pension expense has 17 increased, on a system basis, from $12.1 million for the 18 test year ended September 30, 2008 to $18.4 million6 for 19 2009. Company witness Ms. Andrews discusses the accounting 20 adjustment to results of operations to reflect this. 21 Q.What is the reason for the increase in pension 22 expense in 2009? 23 A.The increase in pension expense is due primarily 24 to the negative overall market performance in 2008. 6 Most recent analysis, just prior to ths fiing, indicates that the pension cost for 2009 may be higher at $22.2 millon. Thies, Direct 40 Avista Corporation 1 Although the pension plan assets are diversified among 2 investment classes, negative returns were associated with 3 virtually all assets except cash.The stock market had a 4 negative 38% return on the S&P 500 Index, and bond markets 5 and commodities also performed negatively in 2008. 6 The Company's 2008 pension plan return on assets is 7 estimated to be negative 21%.The negative returns and 8 resulting declining value of our pension plan assets 9 increased the pension expense for 2009. 10 The overall market decline impacted the pension plan 11 assets of other companies as well.Most companies with 12 defined benefit pension plans have experienced similar 13 asset value declines and increased funding levels as a 14 result of general market conditions and the Pension 15 Protection Act of 2006 (PPA). 16 Resul ts from an EEI survey conducted in early December 17 2008,indicated that all 24 electric utilities who 18 participated in the survey were estimating negative returns 19 for their pension plan assets in 2008.The 2008 average 20 expected pension returns of the 24 companies surveyed was a 21 negative 26.7%. The Company's pension returns, as described 22 above, were somewhat better than these reported returns. 23 Q.will you describe the prócess utilized by the 24 Company for administering investments in its defined 25 benefit plan (pension plan)? Thies, Direct 41 Avista Corporation 1 2 A.Yes. The Company has a very disciplined approach to the oversight and monitoring of the pension plan.The 3 Board of Directors of the Company, acting through the 4 Finance Committee of the Board, is responsible for setting, 5 monitoring and adjusting the Investment Policy Statement 6 (IPS) with respect to the investment of funds for the 7 pension plan.The IPS summarizes the Finance Committee's 8 investment policies for the management and oversight of the 9 pension plan.It sets forth' the objectives of the plan, 10 the strategies designed to achieve these objectives, 11 procedures for moni toring and control of plan assets and 12 the delegation of responsibilities for the oversight and 13 management of plan assets. Given the long-term time horizon 14 of the pension plan, the IPS is designed to endure multiple 15 market environments and to not be reactive to what might be 16 considered normal short-term events.The IPS includes a 17 policy portfolio that envisions a reasonably stable 18 allocation of assets among major asset classes. 19 Q.What are the investment policies for management 20 and oversight of the pension plan? 21 A.As stated in the IPS, the objectives of the 22 pension plan are designed to provide a total return that, 23 over the long term, provides sufficient assets to fund its 24 liabilities subj ect to an acceptable level of risk, 25 contributions and pension expense deemed appropriate by the 26 Board Finance Committee and to diversify investments within Thies, Direct 42 Avista Corporation 1 asset classes to reduce the impact of losses in single 2 investments. 3 Q. What resources does the Company utilize to perform 4 its duties under the investment Policy Statement related to 5 investment of Pension Assets? 6 A.The Company retains an external investment 7 management consultant to develop and recommend asset 8 allocation of the pension plan assets,evaluate and 9 recommend investment managers and monitor the performance 10 and business of the investment managers of the plan assets. 11 This consultant provides a quarterly performance and 12 compliance report of the plan assets. The performance 13 report is reviewed by the Company's internal Benefits Plan 14 Administration Committee quarterly. The performance report 15 is also reviewed by the Board Finance Committee on a 16 quarterly basis.In addition,a report detailing 17 compliance with the specific requirements 9f the IPS is 18 provided quarterly to the Board Finance Committee. 19 Q.What are 'the impacts of the Pension Protection 20 Act (PPA) on the Company's Pension plan? 21 A.The PPA was passed in 2006 and requires annual 22 increases to the pension funding level in order to 23 eventually achieve a fully funded plan.The PPA 24 established that in 2008 the funding level would be 92% of 25 26 the pension plan obligations.For 2009 this level increases to 94%.In 2008, Avista i s funding level was 92% Thies, Direct 43 Avista Corporation 1 and is projected to be 94% in 2009, based on increased 2 Company contributions to the plan. If the plan funding 3 level does not meet these established percentages, the 4 entire funding deficit must be added to the contribution 5 over the next seven years in order to be fully funded after 6 seven years.if the percentage falls below 80%, plan 7 restrictions would be imposed and the plan would be 8 considered Uat-risk." Should this occur, benefit accruals 9 would be frozen and plan participants would not be able to -\ 10 accrue additional pensibn benefits. Additionally, lump sum 11 distributions to participants would not be allowed. 12 To avoid these restrictions the Company is committed 13 to fully meeting these funding levels and complying with 14 the requirements of the PPA. 15 Q.Do the annual cash contributions to fhe pension 16 fund equal the annual pension expense recognized by the 17 Company? 18 A.No.In fact the cash contribution that Avista 19 will make to the pension fund in 2009 will be substantially 20 higher than the proforma expense of $18.4 million 21 identified earlier. The annual cash contribution is driven 22 by the need to comply with the funding requirements of the 23 PPA (e.g., 94% funded by the end of 2009).It will be 24 necessary to make a cash contribution to the pension fund 25 in 2009 of at least $42 million, and more recent analysis Thies, Direct 44 Avista Corporation 1 indicates that we may need to contribute $67 million of 2 cash in 2009. 3 The pension expense recognized by the Company is 4 determined using a formula as prescribed by Financial 5 Accounting Standard No. 87 (FAS 87). The objective of FAS 6 87 is to recognize the compensation cost of an employee i s 7 pension benefits (including prior service cost) over that 8 employee i s approximate service period. While the pension 9 cash contribution amount does affect the pension expense, 10 the FAS 87 assumptions and calculations are different from 11 those used to determine the funded status. 12 As can be seen by the differences in the 2009 cash 13 contribution of $67 million and the pension expense of 14 $18.4 million, the differing requirements of the PPA and 15 FAS 87 can result in a substantial difference between cash 16 contributions and recognition of expense.The current 17 level of pension expense reflected for ratemaking purposes 18 is $11.85 million. Therefore, until the conclusion of this 19 case, the current annualized difference between the cash 20 contribution and pension expense is over $55 million ($67 21 million - $11.85 million) . 22 Q.What impact does that timing difference have on 23 the Company? Thies, Direct 45 Avista Corporation 1 A.The result for Avista in 2009 is that the Company 2 would make a cash payment of $67 million, while recovering 3 $11.85 million of expense through its retail rates. Absent 4 some form of accounting treatment or, other relief from the 5 Commission, Avista would not recover the time value of 6 money on the difference between the cash payment and the 7 level of expense.Because of the magnitude of this 8 difference, the absence of a carrying cost would have a 9 significant impact on the earnings of the Company.The 10 difference of $55 million times the requested rate of 11 return of 8.80% is $4.8 million for 2009 alone. 12 Q.Have you seen these kinds of cash versus expense 13 differences in the past? 14 A.Nothing even close to this magnitude.A 15 comparison of cash payments versus pension expense for each 16 year from 1992 through 2008 is shown in Illustration No. 7 17 below.Not only are the annual differences much smaller, 18 but on a cumulative basis through 2007 , the difference is 19 only $1. 4 million.However, in 2008 the cash payment is 20 $16.0 million higher than the expense, and the difference 21 for 2009 will be even greater. Thies, Direct 46 Avista Corporation 1 Illustration NO.7: Year Cash Contribution Annual Expense Difference Cumulative Difference 1992 $0.0 -$1.1 $1.1 $1.1 1993 $0.0 -$0.5 $0.5 $1.6 1994 $0.0 $1.0 -$1.0 $0.6 1995 $0.0 $2.0 -$2.0 -$1.4 1996 $0.0 $2.4 -$2.4 -$3.8 1997 $3.3 $2.2 $1.1 -$2.7 1998 $0.0 $1.5 -$1.5 -$4.2 1999 $0.0 $2.4 -$2.4 -$6.6 2000 $3.3 $0.8 $2.5 -$4.1 2001 $0.0 $3.8 -$3.8 -$7.9 2002 $12.0 $9.3 $2.7 -$5.2 2003 $12.0 $14.9 -$2.9 -$8.1 2004 $15.0 $13.6 $1.4 -$6.7 2005 $15.0 $11.9 $3.1 -$3.5 2006 $15.0 $12.8 $2.2 -$1.3 2007 $15.0 $12.3 $2.7 $1.4 2008 $28.0 $12.0 $16.0 $17.3 2 3 Q.Do you expect these maj or cash versus expense 4 differences to continue for the indefinite future? 5 A.No.Although they may continue for some period 6 of time, as the financial markets recover, which we 7 anticipate they will at some point, the cash contribution 8 requirement for the pension plan will come down and 9 potentially go to zero at some point. At that point, there 10 would be opportunity for the cumulative difference between 11 cash and expense to again move toward zero. 12 In the meantime, however, we have a significant 13 difference between the cash contribution and pension 14 expense that needs to be addressed in some way. Thies, Direct 47 Avista Corporation 1 Q.What is the Company proposing with regard to this 2 difference between the cash contribution to fund the 3 pension plan and the annual level of pension expense? 4 A.Due to the substantial difference between the 5 2009 pension payment and the amount of authorized utility 6 pension cost, the Company is requesting approval to 7 establish a regulatory asset for the carrying costs on the 8 cumulative difference between payments and authorized 9 pension cost. It is important to emphasize that we are not 10 requesting accounting treatment to defer the actual dollar 11 differences between the cash payment and expense, but only 12 the carrying cost on those dollar differences. 13 In future periods if the pension cash payments are 14 less than the authorized cost, the cumulative difference 15 will decrease and the resulting carrying cost accrual will 16 decrease. 17 Q.When does the Company propose to start the 18 accrual of the carrying cost, and at what rate? 19 20 A.The Company is proposing to begin accruing the carrying charge effective February 1,2009,at its 21 authorized rate of return during the month the accrual 22 occurs, compounded annually. The current authorized rate of 23 return is 8.45%. 24 25 Q.How would the accrual calculations be made? A.A reduction to the cash payments would first be 26 made to remove the portion related to non-utility. The Thies, Direct 48 Avista Corporation 1 remaining utility portion would be allocated to utility 2 jurisdictions and services based on the labor dollars 3 included in this filing. 4 Assuming the Company will be making contributions to 5 the pension plan in 2009 of $67 million, after removing the 6 portion of pension costs related to non-utility companies 7 of 0.42%, or $0.28 million, the remaining portion of the 8 $67 million related to utility operations amounts to $66.72 9 million.In contrast, the amount of pension expense 10 related to utility operations on a system basis is $11.85 11 million from the last general rate case. 12 13 A carrying charge would be accrued each month, beginning February 1,2009, based on the cumulative 14 difference between the actual cash payments and the 15 authorized pension expense. 16 Q.What accounts would be used to account for the 17 accrual of the carrying cost? 18 19 20 A.The accrual of the carrying cost would be recorded by debiting Account 182.3 Other Regula tory Assets and crediting Account 419 - Interest Income.The 21 carrying cost calculation and a breakdown of the regulatory 22 asset would be maintained by utility jurisdiction 23 (Washington and Idaho) and utility service (electric and 24 gas) .Should the accrual become negative, Account 431 - 25 Other Interest Expense would be debited and Account 182.3 26 would be credited until the balance in Account 182.3 Thies, Direct 49 Avista Corporation 1 reaches zero, and then, Account 254 - Other Regulatory 2 Liabilities would be credited.Deferred federal income 3 taxes would be recorded by debiting Account 410.2 4 Provision for Deferred Income Taxes, Other Income and 5 Deductions and crediting Account 283 - Accumulated Deferred 6 Income Taxes-Other. 7 Q.How would the deferred carrying costs be 8 recovered in rates? 9 A.The Company would continue to review the balance 10 of deferred carrying costs to determine if a rate adjustment to recover the costs was necessary.The11 12 13 regulatory asset/regulatory liability accounts will function like a balancing account.While a regulatory 14 asset will be created in 2009, a rebound in the investment 15 market could cause the regulatory asset to be offset by 16 regulatory liability entries over a period of time, and no 17 rate adjustment would be necessary.if a rate adjustment 18 were to become necessary, the Company would file a request 19 as part of a general rate case or other filing to recover 20 the deferral balance. 21 Q.Does that conclude your pre-filed direct 22 testimony? 23 A.Yes. Thies, Direct 50 Avista Corporation DAVID J. MEYER VICE PRESIDENT AND CHIEF COUNSEL OF 2009 JMl 23 PH 12: 38 REGULATORY & GOVERNENTAL AFFAIRS AVISTA CORPORATION P.O. BOX 3727 1411 EAST MISSION AVENUE SPOKAE, WASHINGTON 99220-3727 TELEPHONE: (509) 495-4316 FACSIMILE: (509) 495-8851 BEFORE THE IDAHO PUBLIC UTILITIES COMMISSION IN THE MATTER OF THE APPLICATION ) CASE NO. AVU-E-09-01 OF AVISTA CORPORATION FOR THE ) CASE NO. AVU-G-09-01 AUTHORITY TO INCREASE ITS RATES ) AND CHARGES FOR ELECTRIC AND ) NATURAL GAS SERVICE TO ELECTRIC ) EXHIBIT NO. 2 AN NATURAL GAS CUSTOMERS IN THE )STATE OF IDAHO ) MARK T. THIES ) FOR AVISTA CORPORATION (ELECTRIC AND NATURA GAS) A V I S T A C O R P O R A T I O N Lo n g - t e n n S e c u r i t i e s C r e d i t R a t i n g s St a n d a r d & P o o r ' s Mo o d y ' s Fi t c h La s t R e v i e w e d Fe b r u 2 0 0 8 De c e m b e r 2 0 0 7 Au g u s t 20 0 7 Cr e d i t O u t l o o k St a b l e St a b l e Po s i t i v e A+ Al A+ A A2 A A- A3 A- BB B + F i r s t M o r t g a g e B o n d s Ba a l Se c u r M e d i u m - T e r m N o t e s BB B Ba a 2 Fi r s t M o r t g a g e B o n d s Se c u r e d M e d i u m - T e r m N o t e s BB B - Av i s t a C o r p . l C o r p o r a t e r a t i n g Ba a 3 Av i s t a C o r p . / l s u e r r a t i n g Se n i o r C o r p r a t e N o t e s 9 . 7 5 % Se n i o r C o r p o r a t e N o t e s 9 . 7 5 % IN V S T M E N T G R A E BB + Ba l Tr u s t - O r i g i n a t e d P r e f e r e d S e c u r i t i e s BB B + BB B F i r s t M o r t g a g e B o n d s Se c u r e M e d i u m - T e r N o t e s BB B - S e n i o r C o r p o r a t e N o t e s 9 . 7 5 % BB + A v i s t a C o r p . l l s s u e r r a t i n g Tr u t - O r i g i n a t e d P r e f e r r e d S e c u r t i e s BB Tr u t - O r g i n a t e d P r e f e r e d S e c u r i t i e s Ba 2 BB BB - Ba 3 BB - Ex h i b i t N O . 2 Ca s e N o . A V U - E - 0 9 - 0 1 A V U - G - 0 9 - 0 1 M. T h i e s , A v i s t a Sc h e d u l e 1 , p . 1 o f 1 AVISTA CORPORATIO~ Capital Structure and Overall Rate of Return * Pro forma Common Equity of50% is less than calculated Common Equity based on Pro Forma Capital Strctue at June 30, 2009 calculated above Assumptions LStarted with 9-30-2008 actual 2. Proforma through 6-30-2009 3. The forecasted equity and debt numbers come from foreca~t SEP 18 model run 4. Equity is adjusted for Other Comprehensive Income and capital stock expense of$25,853,741 5. Forecasted issuance of $14.75 milion of additional equity through different company programs Exhibit NO.2 Case No. AVU-E-09-01 AVU-G-09-01 M. Thies, Avista Schedule 2, p. 1 of 3 AV I S T A C O R P O R A T I O N Co s t o f L o n g - T e r m D e b t D e t a i l Ju n e 3 0 , 2 0 0 9 Pr i n c i p a l Li n e Co u p o n Ma t u r i Se t t l e m e n t Pr i n c i p a l Is s u a n c e Re d e m p t i o n Ne t Yi e l d to Ou t t a n d i n g Ef f e c t v e Li n e No . De s c r i p t i o n Ra t e Da t e Da t e Am o u n t Co s t s Co s t s Pr o c e e d s Ma t u r i t y 06 . 3 0 - 2 0 0 9 Co s t No . (a ) (b ) ( c ) (d ) (e ) (I ) (g ) (h ) (i ) (j ) (k ) 1 SM T N S e r i e s A Se r i e s C o s t s A 08 - 3 1 - 2 0 1 0 05 - 0 1 . 1 9 9 3 37 3 , 6 9 3 21 , 6 6 3 1 2 SM T N S e r i e s A 6. 6 7 % 07 - 1 2 - 2 0 1 0 07 - 1 2 - 1 9 9 3 5, 0 0 0 , 0 0 0 35 , 0 8 1 69 0 , 4 6 4 4, 2 7 4 , 4 5 5 8.2 7 5 % 5, 0 0 0 , 0 0 0 41 3 , 7 6 5 2 3 SM T N S e r i e s A 7. 1 8 % 08 - 1 1 - 2 0 2 3 08 . 1 2 . 1 9 9 3 7, 0 0 0 , 0 0 0 54 , 3 6 4 6,9 4 5 , 6 3 6 7.2 4 4 % 7,0 0 0 , 0 0 0 50 7 , 0 6 4 3 4 SM T N S e r i e s A 7. 3 7 % 05 - 1 0 - 2 0 1 2 05 - 1 0 . 1 9 9 3 7, 0 0 0 , 0 0 0 49 , 1 1 4 1, 2 2 7 , 8 8 3 5,7 2 3 , 0 0 3 9.4 5 5 % 7, 0 0 0 , 0 0 0 66 1 , 8 7 7 4 5 SM T N S e r i e s A 7. 3 9 % 05 - 1 1 - 2 0 1 8 05 . 1 1 . 1 9 9 3 7, 0 0 0 , 0 0 0 54 , 3 6 4 1, 2 2 7 , 8 8 3 5,7 1 7 , 7 5 3 9.2 8 7 % 7, 0 0 0 , 0 0 65 0 , 1 1 4 5 6 SM T N S e r i e s A 7. 4 5 % 06 - 1 1 . 2 0 1 8 08 - 9 - 1 9 9 3 15 , 5 0 0 , 0 0 0 17 0 , 5 9 7 2, 1 4 0 , 4 4 0 13 , 1 8 8 , 9 6 3 8.9 5 3 % 15 , 5 0 0 , 0 0 0 1, 3 8 7 , 7 1 5 6 7 SM T N S e r i e s A 7. 5 3 % 05 - 0 5 . 2 0 2 3 05 - 0 6 - 1 9 9 3 5, 5 0 0 , 0 0 0 42 , 7 1 2 96 3 , 0 1 1 4,4 9 4 , 2 7 7 9.3 5 9 % 5, 5 0 0 , 0 0 0 51 4 , 7 4 4 7 8 SM T N S e r i e s A 7. 5 4 % 05 - 0 5 - 2 0 2 3 05 - 0 7 . 1 9 9 3 1,0 0 0 , 0 0 0 7, 7 6 6 17 5 , 4 1 2 81 6 , 8 2 2 9.3 7 5 % 1,0 0 0 , 0 0 0 93 , 7 4 7 8 9 SM T N S e r i e s S 6. 9 0 % 07 . 0 1 . 2 0 1 0 06 - 0 9 - 1 9 9 5 5, 0 0 0 , 0 0 0 37 , 9 4 4 4,9 6 2 , 0 5 6 6.9 8 2 % 5, 0 0 0 , 0 0 0 34 9 , 0 7 7 9 10 5. 7 0 % F M S ' s 5. 7 0 % 07 - 0 1 - 2 0 3 7 12 - 1 5 - 2 0 0 6 15 0 , 0 0 0 , 0 0 0 8, 6 6 2 , 3 0 4 14 1 , 3 3 7 , 6 9 6 6.1 2 0 % 15 0 , 0 0 0 , 0 0 0 9, 1 7 9 , 6 7 4 10 11 6. 1 2 5 % F M S ' s 6. 1 3 % 09 - 0 1 - 2 0 1 3 09 - 0 8 - 2 0 0 3 45 , 0 0 , 0 0 0 1,0 5 5 , 1 4 0 81 5 , 8 2 4 43 , 1 2 9 , 0 3 6 6.7 0 3 % 45 , 0 0 0 , 0 0 0 3, 0 1 6 , 2 4 8 11 12 5. 4 5 % F M S ' s 5. 4 5 % 12 - 0 1 - 2 0 1 9 11 - 1 8 - 2 0 0 4 90 , 0 0 0 , 0 0 0 1,4 3 2 , 0 8 1 88 , 5 6 7 , 9 1 9 5.6 0 8 % 90 , 0 0 0 , 0 0 0 5,0 4 7 , 0 0 1 12 13 6. 2 5 % F M S ' s 6. 2 5 % 12 - 0 1 - 2 0 3 5 11 - 1 7 - 2 0 0 5 15 0 , 0 0 0 , 0 0 0 .2 , 1 9 2 , 9 1 8 15 2 , 1 9 2 , 9 1 8 6.1 4 3 % 15 0 , 0 0 0 , 0 0 0 9, 2 1 3 , 7 9 8 13 14 5. 9 5 % F M S ' s 5. 9 5 % 06 - 0 1 . 2 0 1 8 04 - 0 2 - 2 0 0 8 25 0 , 0 0 0 , 0 0 0 19 , 4 7 5 , 0 0 0 23 0 , 5 2 5 , 0 0 0 7. 0 3 4 % 25 0 , 0 0 0 , 0 0 0 17 , 5 8 5 , 1 4 4 14 15 7.2 5 % F M S ' s 7. 2 5 % 12 - 1 6 - 2 0 1 3 12 - 1 6 - 2 0 0 8 30 , 0 0 0 , 0 0 0 40 0 , 0 0 0 29 , 6 0 0 , 0 0 0 7.5 7 5 % 30 , 0 0 0 , 0 0 0 2, 2 7 2 , 5 9 3 15 16 PC S ' s K e t t e F a l l s 6. 0 0 % 12 - 0 1 . 2 0 2 3 07 . 2 9 . 1 9 9 3 4, 1 0 0 , 0 0 0 6.5 2 3 % 4, 1 0 0 , 0 0 0 16 17 4 10 - 0 1 ' 2 0 3 2 66 , 7 0 0 , 0 0 66 . 7 0 0 , 0 0 0 17 18 06 . 1 5 - 2 0 1 3 18 19 MT N ' s S e r i e s C 6. 3 7 % 06 - 1 9 - 2 0 2 8 06 . 1 9 . 1 9 9 8 25 , 0 0 0 , 0 0 0 15 8 , 3 0 4 18 8 , 6 4 9 24 , 6 5 3 , 0 4 7 6. 4 7 5 % 25 , 0 0 0 , 0 0 0 1, 6 1 8 , 8 6 3 19 20 MT N ' s S e r e s C 8. 0 2 % 10 - 2 6 - 2 0 1 0 10 - 2 6 - 1 9 9 9 25 , 0 0 0 , 0 0 0 16 1 , 2 8 7 70 7 , 5 2 7 24 , 1 3 1 , 1 8 6 8. 5 1 3 % 25 , 0 0 0 , 0 0 0 2, 1 2 8 , 2 0 7 20 21 84 1 , 9 7 7 , 3 8 5 6. 7 8 6 % 88 8 , 8 0 0 , 0 0 0 60 , 3 1 1 , 0 3 7 21 22 22 23 Re p u r c h a s e 1 7.7 4 % 12 . 3 1 . 2 0 1 7 06 - 3 0 - 2 0 0 6 6,8 7 5 , 0 0 0 48 3 , 5 8 2 6, 3 9 1 , 4 1 8 8. 7 2 1 % 2 66 , 5 8 6 23 24 Re p u r c h a s e 1 8. 1 7 % 06 - 3 0 2 0 1 5 06 . 3 0 . 2 0 0 5 26 , 0 0 0 , 0 0 0 1, 7 3 5 , 7 9 6 24 , 2 6 4 , 2 0 4 9. 2 0 6 % 2 25 7 , 5 5 9 24 25 Re p u r c h a s e 1 8. 4 1 % 06 . 3 0 - 2 0 1 4 06 - 3 0 - 2 0 0 4 36 , 5 9 0 , 0 0 0 7, 3 5 8 , 6 8 0 29 , 2 3 1 , 3 2 0 11 . 9 0 3 % 2 1,2 9 7 , 2 0 5 25 26 Re p u r c h a s e 1 8.6 8 % 09 - 3 0 - 2 0 1 2 06 - 3 0 - 2 0 0 3 52 , 4 8 5 , 0 0 0 2, 8 1 9 , 8 6 0 49 , 6 6 5 , 1 4 0 9. 5 6 4 % 2 48 1 , 1 7 9 26 27 Re p u r c h a s e 1 8.7 6 % 09 - 3 0 - 2 0 1 0 06 - 3 0 . 2 0 0 2 20 3 , 5 9 0 , 0 0 0 9, 9 5 8 , 7 8 2 19 3 , 6 3 1 , 2 1 8 9. 6 2 8 % 2 1,8 4 1 , 4 8 0 27 28 3, 9 4 4 , 0 0 9 28 29 29 30 30 31 4 31 32 32 33 TO T A L P R O F O R M C O S T O F D E B T 6 1 3 0 / 2 0 0 9 89 7 , 5 0 8 , 6 6 7 6.5 9 7 % 94 5 , 8 0 0 , 0 0 0 62 , 3 9 0 , 2 3 5 33 1 T h e c o u p o n r a t e u s e d i s t h e c o s t o f d e b t a t t h e t i m e o f t h e r e p u r c h a s e s 2 T h e a m o u n t a r e c a l c u l a t e d u s i n g t h I R R f u n c t i o n 3 I n f o r m a t i o n p u l l s f r o m t h e . V a r . R a t e L o n g . T e r m t a b 4 F o r e c a s t e d i s s u a n c e s Ex h i b i t N O . 2 Ca s e N o . A V U - E - 0 9 - o 1 A V U - G - 0 9 - 0 1 M. T h i e s , A v i s t a Sc h e d u l e 2 , p . 2 o f 3 AV I S T A C O R P O R A T I O N Pr o f o r m a C o s t o f L o n g - T e r m V a r i a b l e R a t e Ju n e 3 0 . 2 0 0 9 1 2 3 4 5 6 7 8 g 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 (a ) Tr u s t P r e f e r r e d PB C ' s To t a l S h o r t T e r m D e b t Nu m b e r o f D a y s i n M o n t h Ac u a l R a t e s T r u s t P r e f e r r e d Tr u s t P r e f e r r e d I n t e r e s t E x p e n s e To t a l In t e r e s t E x p e n s e Fo r e c a s t e d M o n t h l y B o r r o w n g R a t e Nu m b e r o f D a y s i n M o n t h Ac t u a l R a t e s P C B ' s PB C ' s T o t a l l n t e r e s t E x p e n s e Fo r e c a s t e d M o n t h l y B o r r o w i n g R a t e De s c r i p t i o n (a l Tr u s t P r e f e r r e d PC B ' s Ju n - 0 8 (b ) $4 0 , 0 0 0 , 0 0 0 $1 7 , 0 0 0 , 0 0 0 $5 7 , 0 0 0 , 0 0 0 Ju l - Q 8 ( c ) $4 0 , 0 0 0 , 0 0 0 $1 7 , 0 0 0 , 0 0 0 $5 7 , 0 0 0 , 0 0 0 Au g - 0 8 (d ) $4 0 , 0 0 0 , 0 0 0 $1 7 , 0 0 0 , 0 0 0 $5 7 , 0 0 0 , 0 0 0 Se p - 0 8 (e ) $4 0 , 0 0 , 0 0 0 $1 7 , 0 0 0 , 0 0 0 $5 7 , 0 0 0 , 0 0 0 Oc t - Q 8 (I ) $4 0 , 0 0 0 , 0 0 0 $1 7 , 0 0 0 , 0 0 0 $5 7 , 0 0 0 , 0 0 0 No v - 0 8 (g ) $4 0 , 0 0 0 , 0 0 0 $1 7 , 0 0 0 , 0 0 0 $5 7 , 0 0 0 , 0 0 0 De c . o 8 (h ) $4 0 , 0 0 0 , 0 0 0 $1 7 , 0 0 0 , 0 0 0 $5 7 , 0 0 0 , 0 0 0 Ja n . o 9 (i) $4 0 , 0 0 0 , 0 0 0 $1 7 , 0 0 0 , 0 0 0 $5 7 , 0 0 0 , 0 0 0 Fe b - O g ü) $4 0 , 0 0 0 , 0 0 0 $1 7 , 0 0 0 , 0 0 0 $5 7 , 0 0 0 , 0 0 0 Ma r - Q 9 (k ) $4 0 , 0 0 0 , 0 0 0 $1 7 , 0 0 0 , 0 0 0 $5 7 , 0 0 0 , 0 0 0 Ap r - Q 9 (i ) $4 0 , 0 0 0 , 0 0 0 $1 7 , 0 0 0 , 0 0 0 $5 7 , 0 0 0 , 0 0 0 Ma y - Q g (m ) $4 0 , 0 0 0 , 0 0 0 $1 7 , 0 0 0 , 0 0 0 $5 7 , 0 0 0 , 0 0 0 Ju n - O g (n ) $4 0 , 0 0 0 , 0 0 0 $1 7 , 0 0 0 , 0 0 0 $5 7 , 0 0 0 , 0 0 0 Av g o f (0 ) 40 , 0 0 0 , 0 0 0 17 , 0 0 , 0 0 0 $5 7 , 0 0 0 , 0 0 0 Co u p o n Ra t e (b ) 3. 3 1 % 3. 6 9 % 31 3. 5 6 % 12 2 , 5 1 9 12 2 , 5 1 9=3.5 6 % 31 5.1 3 % 75 , 0 2 4 75 , 0 2 4=5. 1 3 % Ma t u r i t y Da t e ( c ) 06 - 0 1 - 2 0 3 7 03 . 0 1 - 2 0 3 4 31 3. 5 6 % 12 2 , 5 1 9 12 2 , 5 1 9 3. 5 6 % 31 5.1 3 % 75 , 0 2 4 75 , 0 2 4 5.1 3 % Se t t l e m e n t Da t e (d ) 06 - 0 3 - 1 9 9 7 12 - 3 1 - 2 0 0 8 30 3. 6 9 % 12 2 , 8 3 3 12 2 , 8 3 3 3. 6 9 % 30 5. 1 3 % 72 , 6 0 4 72 , 6 0 4 5. 1 3 % Pr i n c i p a l Am o u n t (e ) 40 , 0 0 0 , 0 0 0 17 , 0 0 0 , 0 0 0 31 3.6 9 % 12 6 , 9 2 8 12 6 , 9 2 8 3.6 9 % 31 5.1 3 % 75 , 0 2 4 75 , 0 2 4 5. 1 3 % Is s u a n c e Co s t s (I ) 1,2 9 6 , 0 8 6 34 0 , 0 0 0 30 3. 6 9 % 12 2 , 8 3 3 12 2 , 8 3 3 =3. 6 9 % 30 5.1 3 % 72 , 6 0 4 72 , 6 0 4=5.1 3 % lo s s l R e a c q Ex ~ s e s (g ) .2 , 5 0 0 , 0 0 0 2, 3 3 2 , 6 3 2 31 3.0 6 % 10 5 , 2 7 3 10 5 , 2 7 3 =3. 0 6 % 31 5. 1 3 %~75 , 0 2 4=5. 1 3 % Ne t Pr o c e d s (h ) 41 , 2 0 3 , 9 1 4 14 , 3 2 7 , 3 6 8 31 3. 0 6 % 10 5 , 2 7 3 10 5 , 2 7 3 28 3. 0 6 % 95 , 0 8 5 95 , 0 8 5 31 3. 1 3 % 10 7 , 8 1 1 10 7 , 8 1 1 30 2. 8 8 % 96 , 0 0 0 96 , 0 0 0 31 2. 8 8 % 99 , 2 0 0 99 , 2 0 0 30 2.8 8 % 96 , 0 0 0 96 , 0 0 0 3. 0 6 % 3 . 0 6 % 3 . 1 3 % 2 . 8 8 % 2 . 8 8 % 2 . 8 8 % Av e r a g e b o r r o w i n g r a t e u s e d i n t h e c a l u c l a t i o n o f t h e e f f e c t v e c o s t s b e l o w 31 2.2 5 % 32 , 9 3 8 32 , 9 3 8 28 2. 2 5 % 29 , 7 5 0 29 , 7 5 0 31 2. 2 5 % 32 , 9 3 8 32 , 9 3 8 30 2.0 0 %~28 , 3 3 3 31 2. 0 0 % 29 , 2 7 8 29 , 2 7 8 30 2.0 0 % 28 , 3 3 3 28 , 3 3 3 2. 2 5 % 2 . 2 5 % 2 . 2 5 % 2 . 0 0 % 2 . 0 0 % 2 . 0 0 % Av e r a g e b o r r o w i n g r a t e u s e d i n t h e c a l u c l a t i o n o f t h e e f f e c v e c o t s b e l o w Yie l d t o Ma t u r i t y (i l 3. 1 7 2 % 4. 7 6 6 % Pri n c i p a l Ou t s t a n d i n g 12 - 3 1 - 2 0 0 8 ü) 40 , 0 0 0 , 0 0 0 17 , 0 0 0 , 0 0 0 Ef f e c i v e Co s t (k ) 1,2 6 8 , 9 3 0 81 0 , 2 6 8 36 5 1, 3 2 2 , 2 7 3 1,3 2 2 , 2 7 3 3.3 1 % 36 5 62 6 , 8 7 5 62 6 , 8 7 5 3.6 9 % Ex h i b i t N O . 2 Ga s e N o . A V U - E - Q 9 - Q 1 A V U . G - Q 9 - Q 1 M. T h i e , A v i s t a Sc h e d u l e 2 , p . 3 o f 3