20110706Thies Di.pdf

DAVID J. MEYER
VICE PRESIDENT AND CHIEF COUNSEL FOR
REGULATORY & GOVERNMENTAL AFFAIRS
AVISTA CORPORATION
P . O. BOX 3727
1411 EAST MISSION AVENUE
SPOKANE, WASHINGTON 99220-3727
TELEPHONE: [phone]
FACSIMILE: [phone]
DAVID .MEYER~AVISTACORP. COM
2011 JUL -S Mill: 44
BEFORE THE IDAHO PUBLIC UTILITIES COMMISSION
IN THE MATTER OF THE APPLICATION
OF AVISTA CORPORATION FOR THE
AUTHORITY TO INCREASE ITS RATES
AND CHARGES FOR ELECTRIC AND
NATURAL GAS SERVICE TO ELECTRIC AND )
NATURAL GAS CUSTOMERS IN THE STATE
OF IDAHO
CASE NO. AVU-E-11-01
CASE NO. AVU-G-11-01
DIRECT TESTIMONY
OF
MARK 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 educa tion and
9 business experience?
10 A.I received a Bachelor of Arts degree with maj ors
11 in Accounting and Business Administration from Saint
12 Ambrose College in Davenport, Iowa, and became a Certified
13 Public Accountant in 1987. I have extensive experience in
14 finance, risk management, accounting and administration
15 wi thin the 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. Ij oined 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.
26 Q.What is the scope of your testimony in this
27 proceeding?Thies, Di 1
Avista Corporation
1 A.I will provide a financial overview of the
2 Company and will explain the overall rate of return
3 proposed by the Company in this filing for its electric and
4 natural gas operations.The proposed rate of return is
5 derived from Avista' s total cost of long-term debt and
6 common equity, weighted in proportion to the proposed
7 capi tal structure.
8 i will address the proposed capital structure, as well
9 as the proposed cost of total debt and equity in this
10 filing.Dr. Avera, on behalf of the Company, will provide
11 additional testimony related to the appropriate return on
12 equi ty for Avista, based on the specific circumstances of
13 the Company, together with the current state of the
14 financial markets.
15 In brief, I will provide information that shows:
16 . Avista' s plans call for significant capital17 expendi ture requirements for the utility over the
18 next two years to assure reliability in serving
19 our customers and meeting customer growth.
20 Capital expenditures of approximately $48221 million are planned for 2011-2012 for customer22 growth, investment in generation upgrades and23 transmission and distribution facilities, as well
24 as necessary maintenance and replacements of our25 natural gas utili ty systems. Capi tal26 expendi tures of approximately $1.2 billion27 (excluding forecasted wind expenditures), are28 planned for the five-year period ending December
29 31, 2015. Avista needs adequate cash flow from30 operations to fund these requirements, together31 wi th access to capital from external sources32 under reasonable terms.
33
34 . Avista's corporate credit rating from Standard &
35 Poor's (S&P) is currently BBB and Baa2 from36 Moody's Investors Service (Moody's). Avista must37 operate at a level that will support a solidThies, Di 2
Avista Corporation
1 investment grade corporate credit rating, of BBB
2 on a short-term basis and BBB+ as a long-term
3 goal, in order to access capital markets at
4 reasonable rates, which will decrease long-term
5 borrowing costs to customers. In March 2011, S&P
6 upgraded Avista's Corporate Credit Rating to BBB
7 from BBB- and Moody's upgraded Avista's Issuer
8 Rating to Baa2 from Baa3. A supportive regulatory
9 environment is an important consideration by the10 rating agencies when reviewing Avista.11 Maintaining solid credit metrics and credit12 ratings will also help support a stock price13 necessary to issue equity under reasonable terms14 to fund capital requirements.
15
16 . The Company is proposing an overall rate of17 return of 8.49%, including a 50.15% equity ratio18 and a 10.90% return on equity. Our proforma cost19 of debt is 6.05%.
2021 The Company's ini tiati ves to carefully manage its
22 operating costs and capital expenditures are an important
23 part of our performance, but are not sufficient without
24 revenues from the general rate request for our electric and
25 natural gas businesses in these cases.Sufficient cash
26 flows from operations can only be achieved with the support
27 of regulators in allowing the timely recovery of costs and
28 the ability to earn a reasonable return on investment.
29 A table of contents for my testimony is as follows:
30
31
32
33
34
35
36
37
38
Description Page
i.Introduction 1
II.Financial Overview 4
III.Credit Ratings 11
iv.Cash Flow 20
v.Capital Structure 26
VI.Cost of Debt 28
VII.Cost of Common Equity 29
Thies, Di 3
Avista Corporation
1 Q.Are you sponsoring any exhibits with your direet
2 testimony?
3 A.Yes. I am sponsoring Exhibit No.2, Schedule 1,
4 pages 1 through 4 and Confidential Schedule 2, which were
5 prepared under my direction.Avista's credit ratings by
6 S&P and Moody's are summarized on page 1, and Avista's
7 actual capital structure at December 31, 2010 and pro forma
8 capital structure at December 31, 2012 are included at page
9 2, with supporting information on pages 3 through 4.
10 Confidential Schedule 2 includes confidential information
11 related to the pro forma capital structure.
12
13
14
II. FINANCIAL OVERVIEW
Q.Please provide an overview of Avista' s financial
15 situation.
16 A.The Company has made solid progress in improving
17 its financial health in recent years, as demonstrated by
18 improved financial ratios and recent credit rating
19 upgrades. The Company has been able to improve and balance
20 its debt and equity ratios by paying down debt, issuing
21 addi tional common stock, and through additional retained
22 earnings.
23 Avista's goal is to operate at a level that will
24 support a solid corporate credit rating of BBB on a short
25 term basis and the Company's long term goal is to obtain a
26 Corporate Credit rating of BBB+.Operating at this rating
27 level will help reduce long-term costs to customers, reduceThies, Di 4
Avista Corporation
1 collateral requirements, and allow us to maintain access to
2 more counterparties for acquisition of natural gas and
3 electricity. We expect that a continued focus on the
4 regulated utility,conservati ve financing strategies
5 (including the issuance of common stock) and a supportive
6 regulatory environment will contribute to operating at this
7 rating level.
8 We are operating the business efficiently to keep
9 costs as low as practicable for our customers, while at the
10 same time ensuring that our energy service is reliable, and
11 customers are satisfied.An efficient, well-run business
12 is not only important to our customers, but also to
13 investors.Addi tionally, the Company is working through
14 regulatory processes to recover our costs in a timely
15 manner so that earned returns are closer to those allowed
16 by regulators in each of the states we serve. This is one
17 of the key determinants from the rating agencies'
18 standpoint when they are reviewing our overall credit
19 ratings.
20 Q.Wha t additional steps has the Company taken to
21 improve its financial health?
22 A.We are working to assure there are adequate funds
23 for operations, capital expenditures and debt maturities.
24 In February 2011, Avista entered into a four-year committed
25 line of credit in the amount of $400 million. This
26 committed line of credit replaced the $320 million and $75
27 million committed line of credit agreements that had anThies, Di 5
Avista Corporation
1 expiration date of April 2011. In December 2010 Avista
2 elected to terminate the Receivables Purchase Agreement
3 prior to its March 2011 expiration based on the Company's
4 forecasted liquidity needs, the fact that S&P was not
5 recognizing the Accounts Receivable Program as a liquidity
6 source, as well as the increases in costs associated with
7 establishing a new multi-year program.
8 We obtain a portion of our capital requirements
9 through issuing common equity. In 2010, we issued over
10 $46.2 million of equity primarily through Avista' s Periodic
11 Offering Program (POP). In the first quarter of 2011, we
12 sold 255,000 shares for a total of $5.8 million through the
13 POP.
14 We have reduced our overall cost of debt to 5.99% as
15 of December 31, 2010, from approximately 6.92% in 2008, due
16 primarily to issuing the following debt:
17 September 2009:
18 0 $250 million of secured debt at a coupon of
19 5.125% due in 2022,
20 December 2010:
21
22
23
24
25
26
o $52 million of secured debt at a coupon of
3.89% due in 2020
o $35 million of secured debt at a coupon of
5.55% due in 2040
o $50 million of secured debt at a coupon of
1.68% due in 2013
Thies, Di 6
Avista Corporation
1 The total net proceeds from the sale of the $35
2 million and $52 million secured debt were used to redeem
3 $45 million of secured debt at a coupon of 6.125% due in
4 December 2013, and $30 million of secured debt at a coupon
5 of 7.25%, due in September 2013. Both were redeemed at par
6 plus a total make-whole redemption premium of $10.7
7 million. We did this in order to take advantage of
8 historically low interest rates and to reduce interest rate
9 risk for the future. The $50 million of secured debt was
10 issued to take advantage of historically low interest rates
11 and the expected increase in short-term borrowing costs
12 under the new line of credit agreement. The coupon rate on
13 the $50 million issuance was less than the estimated
14 borrowing rate on the new line of credit.
15 We are anticipating the cost of debt to rise to 6.05%
16 by December 31, 2012, from 5.99% as of December 31, 2010.
17 This increase is mainly due to the 2011 forecasted
18 remarketing of $83.7 million of Pollution Control Revenue
19 Bonds and the forecasted 2012 $75 million issuance of long-
20 term debt.
21 The Company entered into two. forward-starting interest
22 rate swaps for a total of $50 million as a hedge on a
23 portion of the interest payments on the long-term debt we
24 are planning to issue in 2012. The Company is continuing to
25 analyze the possibility of entering into additional
26 transactions in order to lock in the interest rate on
27 forecasted debt issuances at a time when Treasury ratesThies, Di 7
Avista Corporation
1 continue to be attractive. Additionally, the Company filed
2 a finance application with the Commission to support the
3 issuance of the $75 million debt securities forecasted to
4 be issued in 2012 and for debt securities beyond that. The
5 Company, depending on market conditions, could use part of
6 this requested authorization to supplement a debt
7 securi ties issuance in place of the already approved and
8 forecasted to be remarketed Pollution Control Bonds in
9 2011.
10 Q.In addition to having credit ratings that will
11 allow Avista to attract debt capital under reasonable
12 terms, is it also necessary to attract capital from equity
13 investors?
14 A.It is absolutely essential.Avista has two
15 primary sources of external capital: debt and equity
16
17
investors.As of December 31,2010,Avista had
approximately $2.3 billion of debt and equity.
18 Approximately half of that investment is funded by debt
19 holders, and the other half is funded by equity investors
20 and retained earnings. There tends to be a lot of emphasis
21 on maintaining credit metrics and credit ratings that will
22 provide access to debt capital under reasonable terms,
23 however, access to equity capital is equally important. In
24 fact, equity investors also focus on cash flows, capital
25 structure and liquidity, as do debt investors.
26 Addi tional equity capital generally comes in two
27 forms: retained earnings and new stock issuances. RetainedThies, Di 8
Avista Corporation
1 earnings represent the annual earnings (return on equity)
2 of the Company that is not paid out to investors in
3 dividends.The retained earnings are reinvested by the
4 Company in utility plant, and other capital requirements,
5 to serve customers, which avoids the need to issue new debt
6 or new stock. Occasionally, it's necessary to issue common
7 equi ty in order to maintain a balanced debt and equity
8 capi tal structure, which allows Avista access to both debt
9 and equity markets under reasonable terms, on a sustainable
10 basis.Because of the large capital requirements at
11 Avista, it is imperative that Avista have ready-access to
12 both the debt and equity markets at reasonable costs.It
13 is worth repeating that our capital requirements for the
14 next five years are sizable at approximately $1.2 billion,
15 as compared to our current rate base as of December 31,
16 2010 of $2.1 billion.
17 Q.Are the debt and equity capital markets a
18 competitive market?
19 A.Yes.Our ability to attract new capital,
20 especially equity capital, under reasonable terms is
21 dependent on our ability to offer a risk/reward opportunity
22
23
that is better than the equity investors'other
alternatives.We are competing with not only other
24 utili ties, but businesses in other sectors of the economy.
25 Demand for the stock supports the stock price, which
26 provides the opportunity to issue additional stock under
27 reasonable terms to fund capital investment requirements.Thies, Di 9
Avista Corporation
1 To the extent that the equity investor holds a
2 diversified portfolio of companies that includes utilities
3 and other energy companies, we would be competing with
4 those companies to attract those equity dollars.
5 Q.What is Avista doing to attract equity
6 investment?
7 A.Avista is carrying a capital structure that
8 provides the opportunity to have financial metrics that
9 offer a risk/reward proposition that is competitive and/or
10 attractive for equity holders.
11 We have steadily increased our dividend for common
12 shareholders over the past several years, to work toward a
13 dividend payout ratio that is comparable to other utilities
14 in the industry. This is an essential element in providing
15 a competi ti ve risk/ reward opportunity for equity investors.
16 We are employing tracking mechanisms such as the Power
17 Cost Adjustment (PCA) and Purchased Gas Adjustment (PGA),
18 approved by the Idaho Public Utili ties Commission (the
19 Commission), to balance the risk of owning and operating
20 the business in a manner that places us in a position to
21 offer a risk/reward opportunity that is competitive with
22 not only other utili ties, but with businesses in other
23 sectors of the economy.
24 Dr. Avera provides additional testimony related to the
25 appropriate return on equity for Avista that would allow
26 the Company access to equity capital under reasonable
27 terms, and on a sustainable basis.Thies, Di 10
Avista Corporation
1
2
3
4
III. CREDIT RATINGS
Q.How important are credit ratings for Avista?
A.Utili ties need ready access to capital markets in
all types of economic environments.The nature of our
5 business with long-term capital proj ects, our obligation to
6 serve, and the potential for high volatility in fuel and
7 purchased power markets, necessitates the need to have the
8 ability to go to the financial markets under reasonable
9 terms on a regular basis. In order to have this ability,
10 investors need to understand the risks related to any of
11 their investments. In order to help investors assess the
12
13
credi tworthiness of Avista,Nationally Recognized
Statistical Rating Organizations (rating agencies)
14 developed their own standardized ratings scale, otherwise
15 known as credit ratings. These credit ratings indicate the
16 financial strength of a company. These rating agencies
17 assign ratings to most of our bond issues so that investors
18 can determine the creditworthiness of an issue without
19 having to do the financial analysis on their own.
20 Q.Please explain the credit ratings for Avista's
21 debt securities.
22 A.Two of the most widely recognized rating agencies
23 are S&P and Moody's. These rating agencies assign a credit
24 rating to companies and their securities so investors can
25 more easily understand the risks associated with investing
Thies, Di 11
Avista Corporation
1 in their debt and preferred stockl.Credi t ratings have a
2 direct impact on the cost of debt to customers to finance
3 utility infrastructure, and can have a direct correlation
4 wi th the coupon rate the Company must pay in order to
5 attract investors. Avista's credit ratings are summarized
6 on page 1 of Exhibit No.2, Schedule 1.
7 As I mentioned before, Avista Corp.' s Corporate Credit
8 Rating was upgraded to BBB/Baa2 from BBB-/Baa3 in March
9 2011, by S&P and Moody's, respectively. As a direct result
10 of these upgrades:
11 . An additional $46 million in unsecured credit from
12 trading counterparties was immediately recognized.
13 . A letter of credit in the amount $4 million was
14
15
returned to the Company effective upon receiving the
upgrade, an approximate annual savings of $68,000.
16 . The applicable rates in the Company's line of credit
17
18
19
20
21
22
23
decreased as follows:
o The Facility Fees were reduced to 0.20% from
0.25%, an approximate savings of $200,000
annually.
o The Eurodollar Margin Spread was reduced to 1.30%
from 1.50%, an approximate savings of over
$100,000 for 2011.
lAs Dr. Avera notes in his testimony. " (W) hile the ratings agencies
were faulted during the financial crisis for failing to adequately
assess the risk associated with structured finance products, investors
continue to regard corporate credit ratings as a reliable guide to
investment risks." Avera Exhibit No.3, Schedule 2 P. 7Thies, Di 12
Avista Corporation
1 . An investment banker indicated that in the current
2
3
public market for 10-year debt the Company's coupon
rate could be 10 basis points lower depending on
4 market conditions.
5 The savings realized by these upgrades will directly
6 benefit customers by reducing the overall cost of debt and
7 other fees.
8 As shown in Illustration No.1, Avista's BBB corporate
9 credit rating from S&P places us among the average U. s.
10 Regulated Electric Utili ties.As I noted earlier, I
11 believe it's important that we operate with a Corporate
12 Credit Rating of BBB on a short-term basis and BBB+ on a
13 long-term basis. S&P and Moody's now have Avista on Stable
14
15
16
17
18
19
20
21
22
23
24
25
Outlook.
Illustration No.1:
S&P's Distribution of Credit Ratings
U.S. Regulated Electric Utilties
as of January 10, 2011
60
50 - --_.-
Investment Grade Non- investm ent Grade
Vli.Q)::40II::..300..
Q).Q 20E::Z 10
0 .. - -
AA- At A A- BBBt BBB BBB- BSt BB BB-
Thies, Di 13
Avista Corporation
1 Q.Please explain the implications of the credit
2 ratings in terms of the Company's ability to access
3 financial markets.
4 A.Credi t ratings impact investor demand and
5 expected return. More specifically, when the Company issues
6 debt, the credit rating is one factor that helps determine
7 the interest rate at which the debt will be issued. The
8 credit rating also determines the type of investor who will
9 be interested in purchasing the debt. For each type of
10 investment a potential investor could make, the investor
11 looks at the quality of that investment in terms of the
12 risk they are taking and the priority they would have for
13 payment of principal and interest in the event that the
14 organization experiences severe financial stress.
15 Investment risks include the likelihood that a company will
16 not meet all of its debt obligations in terms of timeliness
17 and amounts owed for principal and interest. Secured debt
18 receives the highest ratings and priority for repayment
19 and, has the lowest relative risk.In challenging credit
20 markets, where investors are less likely to buy corporate
21 bonds (as opposed to U.S. Government bonds), a higher
22 credit rating will attract more investors, and a lower
23 credi t rating could reduce or eliminate the number of
24 potential investors. Thus, lower credit ratings may result
25 in a company having more difficulty accessing financial
26 markets and/or incur significantly higher financing costs.
Thies, Di 14
Avista Corporation
1 Q.What credit rating does Avista Corporation
2 believe is appropriate?
3 A.The move to investment grade in late 2007 and
4 2008 for Avista Corp was a significant step in improving
5 the Company's ability to access capital at a reasonable
6 cost. As Avista experienced, it took approximately six
7 years for the Company to regain its investment grade rating
8 from S&P after it was downgraded during the energy crisis.
9 The difference between investment grade and non-investment
10 grade is not only a matter of debt pricing, but also the
11 ability to access markets. To avoid adverse circumstances,
12 Avista should operate at a level that will support a solid
13 corporate investment grade credit rating, meaning operating
14 wi th a Corporate Credit Rating of BBB on a short-term basis
15 and BBB+ on a long-term basis using S&P'S rating scale. As
16 shown in Illustration 1 above, BBB and BBB+ are the average
17 ratings for U. S. regulated electric utili ties.The
18 Company's goal is to maintain a credit rating of at least
19 the utility average. A further upgrade to BBB+ would
20 further strengthen the Company by lowering debt pricing and
21 attracting additional investors.
22 A solid investment grade credit rating also allows the
23 Company to post less collateral with counterparties than
24 would otherwise be required with a lower credit rating,
25 which we experienced first-hand with the recent upgrade.
26 Financially heal thy utili ties have lower financing
27 costs which, in turn, benefit customers. In addition,Thies, Di 15
Avista Corporation
1 financially healthy utilities are better able to invest in
2 the needed infrastructure over time to serve their
3 customers, and to withstand the challenges and risks facing
4 the industry.
5 Q.What financial metrics are used by the rating
6 agencies to establish credit ratings?
7 A.S&P's financial ratio benchmarks used to rate
8 companies such as Avista are set forth in Illustration No.
9 2 below.
10 Illustration NO.2:
11
Standard & Poor's Financial Risk Indicative Ratios
FFO/Debt
(% )
FFO/Interest
(x)
Debt/Capital
(% )
Minimal
Modest
Intermediate
Significant
Aggressive
Highly
leveraged
Greater
than 60
45 - 60
30 - 45
20 - 30
12 - 20
Less than
12
(a)
(a)
(a)
(a)
( a)
Less than 25
35
45
60
60
than
(a)
25
35
45
50
Greater
60
12 Months Ended 12/31/10Ratios:
AvistaAdj usted (b) 17.9%4.11x 54.5%
(0) Not available, however, S&P has indicated that it is a
benchmark ratio used for the Utility industry.
(b) Calculated as of 12/31/10 based on last known S&P
methodology (the ratios include short-term debt) .
12
13
14
The ratios above are utilized to determine the
financial risk profile.Currently, Avista is in the
Thies, Di 16
Avista Corporation
1 Aggressive category.The financial risk category along
2 wi th the business risk profile (Avista is in the Excellent
3 category) is then utilized in Illustration No. 3 below to
4 determine a company's rating. S&P currently has Avista's
5 corporate credit rating as BBB, based upon an Aggressive
6 financial risk profile and Excellent business risk profile.
7 Illustration No.3:
8
Standard & Poor's Business and Financial Risk Profile Matrix
Financial Risk Profile
Business Highly
Risk Profile Minimal Modest Intermediate Significant Aggressive Leveraqed
Excellent AAA AA A A-BBB
Strong AAA A A-BBB BB BB-
Satisfactory A-BBBt BBB BB+BB-Bt
Fair BBB-BB+BB BB-B
Weak BB BB-B+B-
Vulnerable B+B ccc+
9
10 Moody's uses a similar methodology to analyze and
11 determine utility credit ratings.
12 Q.Please describe how S&P'S Financial Risk ratios
13 are calculated and what they mean?
14 A.The first ratio, Funds from operations/total debt
15 (%), calculates the amount of cash flow from operations as
16 a percent of total debt. The ratio indicates the company's
17
18
abili ty to fund debt obligations.The second ratio, Funds
from operations/ interest coverage (x) ,calcula tes the
19 amount of cash from operations that is available to cover
20 interest requirements.This ratio indicates how well a
Thies, Di 17
Avista Corporation
1 company's earnings can cover interest payments on its debt.
2 The third ratio, Total debt/total capital (%), is the
3 amount of debt in our total capital structure.The ratio
4 is an indication of the extent to which the company is
5 using debt to finance its operations.S&P looks at many
6 other financial ratios; however, these are the three most
7 important ratios they use when analyzing our financial
8 profile.
9 Q.Do rating agencies make adjustments to the
10 financial ratios that are calculated directly from the
11 financial statements of the Company?
12 A.Yes. Rating agencies make adjustments to debt to
13 factor in off-balance sheet commitments (e. g., purchased
14 power agreements and the unfunded status of pension and
15 other post-retirement benefits) that negatively impact the
16 ratios. For example, in 2010 S&P made adjustments to
17 Avista's debt totaling approximately $81 million primarily
18 related to purchased power contracts, post-retirement
19 benefi ts, and non-recourse debt.The adjusted financial
20 ratios for Avista are included in Illustration No. 2 above.
21 Q.What other risks are Avista and the utility
22 sector facing that may impact credit ratings?
23 A.Avista's credit ratings are impacted by risks
24 that could negatively affect the Company's cash flows.
25 These risks include, but are not limited to, the level and
26 volatility of wholesale electric market prices and natural
27 gas prices for fuel costs, liquidity in the wholesaleThies, Di 18
Avista Corporation
1 market ( fewer counterparties and tighter credi t
2 restrictions), recoverability of natural gas and power
3 costs, streamflow and weather conditions, changes in
4 legislative and governmental regulations,rising
5 construction and raw material costs, customers' ability to
6 timely pay their bills, and access to capital markets at a
7 reasonable cost.
8 Credit ratings for the utility sector are also
9 adversely impacted by large capital expenditures for new
10 generation, transmission and distribution facilities, and
11 environmental compliance. The utility sector is in a cycle
12 of significant capital spending, which will likely be
13 funded by significant issuances of debt and equity.This
14 increases the competition for financial capital.
15 The increased capital spending needs and resulting
16 increased debt and equity issuances make regulation
17 supporting the full and timely recovery of prudently
18 incurred costs even more critical to the utility sector
19 than in previous years.
20 Q.How important is the regulatory environment in
21 which a Company operates?
22 A.The regulatory environment in which a company
23 operates is a major qualitative factor in determining a
24 company's creditworthiness.Moody's stated the following
25 regarding Avista's regulatory environment in March 2011' s
26 credit opinion:
Thies, Di 19
Avista corporation
1 Avista' s ratings could be negatively impacted if the
2 level of regulatory support wanes, if the contribution
3 of its unregulated business were to increase
4 disproportionately to those of its regulated
5 operations, or if CFO pre-WC to debt and CFO pre-WC
6 interest coverage were to fall below 15% and 3. 5x,
7 respectively, for a sustainable period. 2
8
9 S&P stated the following:
10 Regulation is the most critical aspect that11 underlies regulated integrated utili ties'12 credi tworthiness. Regulatory decisions can13 profoundly affect financial performance. Our14 assessment of the regulatory environments in15 which a utility operates is guided by certain16 principles, most prominently consistency and17 predictabili ty, as well as efficiency and18 timeliness. For a regulatory process to be19 considered supportive of credit quality, it must20 limi t uncertainty in the recovery of a utility's21 investment. They must also eliminate, or at22 least greatly reduce, the issue of rate-case lag,23 especially when a utility engages in a sizable24 capi tal expenditure program. 3
25
26
Due to the maj or capital expenditures planned by
Avista,a supportive regulatory environment will be
27 cri tical to Avista' s financial health.
28 iV. CASH FLOW
29 Q.What are the Company's sources to fund capital
30 requirements?
31 A.The Company utilizes cash flow from operations,
32 long-term debt and common stock issuances to fund its
33 capi tal expenditures.Addi tionally, on an interim basis,
34 the Company utilizes its credit facility to fund capital
2 Moody's Investor Service, Moody's Investor Servces, Rating Action: Moody's upgrades Avista's
ratings to Baa2, Stable, March 20113 Standard and Poor's, Key Credit Factors: Business and Financial Risks in the Investor-owned Utilties
Industr, March 2010.Thies, Di 20
Avista Corporation
1 needs until longer-term financing can be obtained.
2 Q.What are the Company's near-term capi tal
3 requiremen ts?
4 A.As a combination electric and natural gas
5 utility, over the next few years, capital will be required
6 for investment in generation upgrades, expansion and
7 replacement of transmission and distribution facilities,
8 customer growth as well as necessary upgrade and
9 replacements of our natural gas systems.
10 The amount of capital expenditures planned for 2011-
11 2012 is approximately $482 million and over a five year
12 period ending December 31, 2015 approximately $1.2 billion
13 (excl uding wind expenditures).For 2011, alone, these
14 costs equate to a total of approximately $249 million.
15 Total company rate base as of December 31, 2010, was $2.1
16 billion;therefore,these planned capital additions
17 represent substantial new investments given the relative
18 size of the Company.
19
20
Maj or capital expenditures are a normal part of
utili ty operations.Customers are added to the service
21 area, roads are relocated and require existing facilities
22 to be moved, and facilities continue to wear out and need
23 replacement. These and other requirements create the need
24 for significant capital expenditures each year.
25
Thies, Di 21
Avista Corporation
1 Q.What are the Company's long-term capi tal
2 requirements related to new energy resources?
3 A.Avista's Integrated Resource Plan has identified
4 the potential need for the Company to finance significant
5 expendi tures for electric generating facilities. The
6 preferred strategy outlined in our 2009 Integrated Resource
7 Plan included total expenditures of $1.25 billion by 2020,
8 including investment in wind resources and combined-cycle
9 combustion turbines (to meet customer load) as well as
10 upgrades at hydroelectric stations.
11 Q.What are the Company's near-term plans related to
12 its debt?
13 A.In 2011 the Company plans on remarketing $83.7
14 million of Pollution Control Revenue Bonds. The proceeds of
15 the planned remarketing of the $83.7 million Pollution
16 Control Revenue Bonds in 2011 will be used to repay funds
17 borrowed under our credit facility. In 2012 the Company is
18 forecasting the issuance of $75 million of long-term debt.
19 To support the issuance of $75 million of Debt Securities
20 in 2012,the Company filed a financing application
21 requesting the authority to issue up to $300 million in
22 debt securities on June 27, 2011. The Company, depending on
23 market conditions, could use part of this requested
24 authorization to supplement a debt securities issuance in
25 place of the already approved and forecasted to be
26 remarketed of the Pollution Control Bonds in 2011.
27 Illustration No. 4 below shows the amount of debtThies, Di 22
Avista Corporation
1 maturities for Avista each year including the maturity
2 dates of the forecasted long-term debt issuance and
3 remarketing of the Pollution Control Revenue Bonds (labeled
4 as (a), (b), and (c) on the chart) :
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
Illustration NO.4:
INII .¡'IlI 8)' I.
p,.f..~ ,U, 1'11
_,-___,t
"b
uiiH14UU17l:lH
2i~MiI U Yfrbl
Q.What is the status of the Company's line of
21 credit agreements secured by first mortgage bonds and its
22 accounts receivable program?
23 A.In February 2011, Avista entered into a four-year
24 committed line of credit in the amount of $400 million with
25 an expiration date of February 2015. This committed line of
26 credit replaced the $320 million and $75 million committed
27 line of credit agreements that had an expiration date ofThies, Di 23
Avista Corporation
1 April 2011. The new committed line of credit is secured by
2 $400 million of non-transferable First Mortgage Bonds of
3 the Company.
4 The facility has been sized to allow the Company to
5 maintain adequate liquidity to cover daily cash needs,
6 manage counterparty collateral requirements, and avoid
7 issuing securities in unfavorable markets. We believe our
8 current agreement provides us adequate liquidity and
9 flexibility to face volatile financial markets and volatile
10 energy commodity prices.
11 This line of credit is our primary source of immediate
12 cash for borrowing to meet daily cash management needs and
13 supports the issuance of letters of credit and cash for
14 collateral needs. This credit facility is required to
15 manage daily cash flow since the timing of cash receipts
16 versus cash disbursements is never totally balanced.
17 In December 2010, the Company terminated the Accounts
18 Receivables program.We elected to terminate the
19 Receivables Purchase Agreement prior to its March 2011
20 expiration date based primarily on the Company's forecasted
21 liquidi ty needs, the fact that S&P was not recognizing the
22 Program as a liquidity source, as well as the increase in
23 costs associated with establishing a new multi-year
24 program.
25 Q.Is there pending legislation that may impact the
26 Company's collateral requirements?
Thies, Di 24
Avista Corporation
1 A.Yes.The Dodd-Frank Wall Street Reform and
2 Consumer Protection Act (Dodd-Frank Act) was signed into
3 law on July 21, 2010. The Dodd-Frank Act establishes
4 regulatory jurisdiction by the Commodity Futures Trading
5 Commission (CFTC)and the Securities and Exchange
6 Commission (SEC) for certain swaps (which include a variety
7 of derivative instruments) and the users of such swaps,
8 that otherwise would have been exempted under the Commodity
9 Exchange Dodd-Frank Act, federal securities laws and
10 federal banking laws.
11 A variety of rules must be adopted by federal agencies
12 (including the CFTC, SEC and the FERC) to implement the
13 Dodd-Frank Act. These rules, which will be developed and
14 implemented over timeframes as defined in the Dodd-Frank
15 Act, could have a significant impact on Avista Corp. that
16 was not clearly defined in the Act itself.
17 Under the Dodd-Frank Act, Swap Dealers and Major Swap
18 Participants will be required to post collateral to meet
19 minimum capital requirements as well as minimum initial and
20 variation margin requirements, the purpose of which is to
21 ensure the safety and soundness of the capital markets by
22 addressing concerns brought about by the global financial
23 crisis of 2007 and 2008. Swap Dealers and/or Major Swap
24 Participants are persons who serve as dealers in swaps or
25 who maintain a substantial position in swaps, for reasons
26 other than mitigating commercial risk.
Thies, Di 25
Avista Corporation
1 The Dodd-Frank Act also requires a broad category of
2 swaps to be cleared and traded on registered exchanges or
3 special derivatives exchanges. Such clearing requirements
4 would result in a significant change from our current
5 practice of bilateral transactions and negotiated credit
6 terms. An exemption to such clearing requirements is
7 outlined in the Dodd-Frank Act for end users that are not
8 Maj or Swap Participants or Swap Dealers and enter into
9 hedges to mitigate commercial risk. We expect to qualify
10 under the end user exemption; however, concern remains that
11 counterparties that are Swap Dealers or Maj or Swap
12 Participants will pass along the increased cost and margin
13 requirements through higher prices and reductions in
14 unsecured credit limits.
15 We continue to monitor developments and cannot predict
16 the impact the Dodd-Frank Act may ultimately have on our
17 operations.
18 V. CAPITAL STRUCTUR
19 Q.What are Avista's plans regarding common equity
20 and why is this important?
21 A.Avista continuously monitors the common equity
22 ratio of its capital structure, and assesses the need to
23
24
issue additional common equity.In 2010, we issued $46.2
million,including $43.2 million under the Periodic
25 Offering Program (POP). As of December 31,2010, we had 1.0
26 million shares available to be issued under the POP. We
27 expect to issue up to $25 million of common stock in 2011Thies, Di 26
Avista Corporation
1 and plans to continue to issue equity in 2012 in order to
2 maintain our capital structure at an appropriate level for
3 our business.In the first quarter of 2011, we sold
4 255,000 shares for a total of $5.8 million through the POP.
5 It is important to the rating agencies for Avista to
6 maintain a balanced debt/equity ratio in order to minimize
7 the risk of default on required debt interest payments.
8 Dr. Avera notes that electric utili ties are facing,
9 among other things, rising cost structures, the need to
10
11
finance significant capital investment plans,and
uncertainties over accommodating future environmental
12 mandates. A more conservative financial profile, in the
13 form of a higher common equity ratio, is consistent with
14 the increasing uncertainties and the need to maintain
15 continuous access to capital that is required to fund
16 operations and necessary system investment.
17 In his testimony Dr. Avera concludes that the 50.15
18 percent common equity ratio is reasonable based on the
19 following:
20 Avista' s requested capi talization is21 consistent with the Company's need to22 maintain its credit standing and financial23 flexibili ty as it seeks to raise24 addi tional capital to fund significant25 system investments and meet the26 requirements of its service terri tory;
2728 Avista's proposed common equity ratio is29 entirely consistent with the range of30 capi talizations maintained by the proxy31 group of utilities, and falls wi thin the32 49.3 percent and 51.5 percent average33 common equity ratios for the proxy
Thies, Di 27
Avista Corporation
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
utilities, based on year-end 2010 data and
near-term expectations , respectively; and,
The requested capitalization reflects the
importance of an adequate equity layer to
accommodate Avista's operating risks andthe pressures of funding significant
capital investments. This is reinforced
by the need to consider the impact of
uncertain capital market conditions, as
well as off-balance sheet commitments such
as purchased power agreements, which carry
with them some level of imputed debt.
(Avera Testimony, P. 7, ll. 7-28).
Q.Please explain the capital structure proposed by
17 Avista in this case.
18 A.Avista's current capital structure consists of a
19 blend of long-term debt and common equity necessary to
20 support the assets and operating capital of the Company.
21 The proportionate shares of Avista Corp. ' s pro forma
22 capi tal structure are 50.15% common equity, and 49.85%
23 long-term debt as shown in Schedule 1, page 2. Additional
24 details related to these adjustments are located on pages 3
25 through 4 of Schedule 1, and in Confidential Schedule 2.
26 VI. COST OF DEBT
27
28
Q.How have you determned the cost of debt?
Cost of total long-term debt in the Company'sA.
29 proposed capital structure includes forecasted and actual
30 weighted average long-term debt.As shown in Schedule 1,
31 page 2, the actual weighted average cost of long-term debt
32 outstanding on December 31, 2010 was 5.99%.The size and
33 mix of debt changes over time based upon the actual
34 financing completed.We have made certain pro formaThies, Di 28
Avista Corporation
1 adjustments to update the debt cost through December 31,
2 2012. Pro forma adjustments to total long-term debt reflect
3 the issuance of new debt for the pro forma period.
4 We are anticipating the cost of debt to rise to 6.0&%
5 in 2012, from 5.99% in 2010. This increase is mainly due to
6 the remarketing of the Pollution Control Revenue Bonds in
7 2011, which are currently owned by the Company and the
8 forecasted issuance in 2012 of the $75 million in long-term
9 debt.
10 VII. COST OF COMMON EQUITY
11 Q.What rate of return on common equity is the
12 Company proposing in this proceeding?
13 A.The Company is proposing a 10.90% return on
14 common equity (ROE), which falls essentially at the
15 midpoint of Dr. Avera's recommended range of required
16 return on equity. Dr. Avera testifies to analyses related
17 to the cost of common equity with an ROE range of 10.3% to
18 11.3% and 10.45% to 11.45% (after accounting for the impact
19 of common equity flotation costs).In his testimony Dr.
20 Avera states that:
21 My conclusion that a 10.90 percent ROE for22 Avista is a reasonable estimate of23 investors' required return is also24 reinforced by the greater uncertainties25 associated with Avista's relatively small26 size and the fact that current cost of27 capital estimates are likely to understate28 investors' requirements at the time the29 outcome of this proceeding becomes30 effective and beyond. (Avera Testimony, at31 P.6, lL. 13-21)
32
Thies, Di 29
Avista Corporation
1 As I have testified, Avista has made solid progress
2 towards improving its financial health. If Avista can earn
3 a 10.9% ROE, I believe our financial condition would
4 continue to improve and would further strengthen the credit
5 ratings ratios. Stronger credit ratings ratios could lead
6 to the Company's long-term goal of obtaining an upgrade to
7 our corporate credit rating to BBB+ from BBB. An upgrade
8 could reduce the cost of debt, which is a direct savings to
9 customers.
10 Q.Please sumrize the proposed capital structure
11 and the cost components for debt and common equity.
12 A.Illustration No. 5 below shows the capital
13 structure and cost components proposed by the Company.
14 Illustration NO.5:
AVISTA CORPORATION
Forecasted Cost of Capital
December 31,2012
Percent of
Total
Amount Capital Cost Component
Total Debt $1,290,800,000 49.85%6.05%3.02%
Common Equity 1,298,799,363 50.15%10.90%5.47%
Total $ 2,589,599,363 100.00%8.49%
15 Q.Does that conclude your pre-filed direct
16 testimony?
17 A.Yes.
Thies, Di 30
Avista Corporation
Last Upgraded
Credit Outlook
AVISTA CORPORA nON
Long-term Securities Credit Ratings
Standard & Poor's Moody's
March 201 1 March 2011
Stable Stable
A+Al
A A2
A.A3 First Mortgage Bonds
Secured Medium-Term Notes
BBB+ First Mortgage Bonds
Secured Medium-Term Notes
Baal
BBB A vista Corp.lCorporate rating Baa2 A vista Corp.llssuer rating
BBB-Baa3
INVESTMENT GRADE
BB+ Trust-Originated Preferred Securities Bal Trust-Originated Preferred Securities
BB Ba2
BB-Ba3
Exhibit NO.2
Case No. AVU-E-11-01 and AVU-G-11-01
M. Thies. Avista
Schedule 1. p. 1 of 4
AVISTA CORPORATION
Forecasted Cost of Capital
December 31.2012
Percent of
Amount Total Capital Cost Component
Total Debt $1,290.800,000 49.85%6.05%3.02%
Common Equity 1,298,799,363 50.15%10.90%(1)5.47%
Total $2,589,599,363 100.00%8.49%
AVISTA CORPORATION
Embedded Cost of Capital
December 31. 2010
Percent of
Amount Total Capital Cost Component
Total Debt $1,139,100,000 49.89%5.99%2.99%
Common Equity 1,143,970,128 50.11%10.50%(2)5.26%
TOTAL $2,283,070,128 100.00%8.25%
(1) Proposed Return on Common Equity - See Avera testimony
(2) The rate adjustment implemented on October 1,2010, did not have a specific authorized retu on
equity. The prior rate case settlement implemented in August 2009 had an authorized retu on equity of
10.5 percent.
Assumptions:
A Stared with 12-31-2010 actuals
B Forecasted through 12-31-2012
C The forecasted equity and debt numbers come from forecast APR8 model
o Equity is adjusted for Other Comprehensive Income and Capital Stock Expense ($20.0 milion as of
December 31, 2012 and $18.2 milion as of December 31, 2010)
E Confidential - See Exhibit 2 Schedule 2C
Exhibit NO.2
Case No. AVU-E-11-01 and AVU-G-11-01
M. Thies, Avista
Schedule 1, p. 2 of 4
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30 31 32 33 34 35 36 37 38 39 40
Ex
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2
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Av
g
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f
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)
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3
Tr
u
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P
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4 5
Nu
m
b
e
r

o
f

D
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s

i
n

M
o
n
t
h
31
29
31
30
31
30
31
31
30
31
30
31
36
6
6
Ra
t
e

T
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u
s
t

P
r
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f
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r
2.0
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0
7
5
%
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2
5
%
2.3
2
5
%
2.3
2
5
%
2.7
0
0
%
2.7
0
0
%
2.7
0
0
%
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7
5
%
3.0
7
5
%
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0
7
5
%
7
Tr
u
s
t

P
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e
f
r
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I
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E
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2
8
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e
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g
e

b
o
o
w
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g

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e

u
s
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d

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n

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c
a
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n

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f

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e
f
f
e
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c
o
s
t
s

b
e
l
o
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5
9
%
9 10
Co
u
p
o
Ma
t
u
r
i
t
y
Se
t
t
l
e
m
e
n
t
Pr
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n
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p
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l
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to

OU
t
s
n
d
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g
Ef
f
e
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t
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v
e
11
De
s
c
r
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n
Ra
t
e
Da
t
e
Da
Am
u
n
t
Co
t
s
Ex
p
n
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e
s
Pr
o
c
e
d
s
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t
r
i
t
y
12
1
1
/
2
0
1
2
Co
s
t
12
(a
)
(b
)
(
e
)
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)
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)
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)
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)
(h
)
(i
)
OJ
(k
)
13
Tr
u
s
t

P
r
e
f
e
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r
2.
5
9
%
61
1
/
2
0
3
7
61
/
1
9
9
7
40
.
0
0
.
0
0
1.
2
9
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0
8
6
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,
7
6
9
.
1
2
5
40
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4
7
3
.
0
3
9
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4
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%
40
.
0
0
0
.
0
0
0
1.
0
1
6
.
3
1
4
Ex
h
i
b
i
t

No
.

2
ca
s
e

N
o
.

A
V
U
-
E
-
1
1
-
0
1

a
n
d

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h
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s
.

A
v
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a
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d
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1
,

p
.

4

o
f

4
CONFIDENTIAL
Forecasted Cost of Capital
Pages 1 through 1
THESE PAGES ALLEGEDLY CONTAIN TRAE SECRETS OR
CONFIDENTIAL MATERIALS AN AR SEPARTELY FILED.
Exhibi t No. 2
Case No. AVU-E-II-0l
M. Thies, Avista
Schedule 2, p. 1 of 1