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12 Apr 2001
MOODY'S REMOVES SOUTHERN CALIFORNIA EDISON AND AFFILIATES FROM REVIEW FOR POSSIBLE DOWNGRADE FOLLOWING SIGNING OF MOU; RATING OUTLOOK IS DEVELOPING
New York, April 12, 2001 -- Moody's Investors Service believes that the Memorandum of Understanding
(MOU) recently signed by Southern California Edison Company (SCE:
Senior Unsecured Debt - Caa2) and by the California Department
of Water Resources (CDWR), if approved and fully implemented,
should improve SCE's financial viability. As such, the ratings
are removed from review for possible downgrade.
However, Moody's remains concerned about the implementation risk,
including obtaining legislative approval to complete the transaction and
securing the numerous approvals from the California Public Utilities Commission
(CPUC) to implement the transaction in a way that maintains SCE's financial
strength over an extended period of time. For this reason,
the rating outlook is developing.
TERMS OF THE DEAL
Under the terms of the MOU, SCE will be able to recover up to $3.5
billion in net undercollections through the sale of SCE's transmission
assets to the CDWR for approximately $2.76 billion and through
the securitization of a dedicated rate component that will be part of
SCE's rate structure. The MOU contemplates the securitization occurring
in two parts. The first part will allow SCE to securitize approximately
$2.1 billion, an amount which represents the remaining
net undercollected amount should the transmission sale be consummated
under the terms described above. The second part, which is
expected to approximate the net gain on the transmission sale or about
$1.4 billion, should be viewed as contingency financing
should the transmission sale not be completed within two years.
Its principle purpose is to provide comfort to potential bridge financing
lenders that a reliable source of repayment exists for them should the
transmission sale not be completed in two years. Moody's believes
that the securitization financings, in whatever form they take,
could be completed before all of the necessary approvals, including
FERC, are obtained on the transmission sale.
In total and assuming that the transmission assets are sold, SCE
should collect about $4.7 billion in cash proceeds,
of which approximately $3.5 billion will be used to repay
past procurement related obligations, including any defaulted securities,
with the remaining $1.2 billion used to retire the debt
and equity on SCE's balance sheet that is associated with these transmission
assets. If the transmission assets are not sold within two years,
the MOU contemplates SCE receiving cash proceeds of approximately $3.5
billion to be used to repay past procurement related obligations.
In either case, the MOU provides a mechanism for the net receipt
of $3.5 billion for repayment of past procurement related
Also, as part of the deal, SCE will continue to own its generation
assets and will sell its output to California customers over a ten-year
period at a rate that incorporates a return on equity of 11.6%.
The MOU contemplates SCE having sufficient revenues to recover its costs
of owned generation (including the return on equity) and the costs associated
with making payments to qualifying facility (QF) generators. The
MOU contemplates SCE resuming procurement of the net short position after
2002 and calls for the CPUC to implement a cost recovery mechanism that
maintains SCE's financial integrity as it assumes this responsibility.
Other aspects of the deal include SCE and Edison International (EIX) agreeing
to make $3 billion of infrastructure investment for distribution
systems throughout SCE's service territory and SCE granting 21,000
acres of lands to the state for conservation. Also, CDWR
and an EIX affiliate agree to enter a ten-year purchase power agreement
under which CDWR purchases power from a power project currently under
construction at mutually agreed upon rates. Finally, and
after the MOU is implemented, SCE agrees to dismiss its federal
lawsuit with the CPUC seeking recovery of past undercollected costs under
the filed rate doctrine.
RISK ASSESSMENT OF THE MOU
Moody's generally views the terms of the MOU as being positive for SCE's
credit quality, particularly the ability to fully recover all past
net undercollections from the securization and from the transmission sale.
Moody's views the implementation risk as being large as it includes securing
legislative approval for the entire MOU and securing consistent and unambiguous
regulatory support from the CPUC for implementing the MOU. The
bankruptcy filing by Pacific Gas and Electric Company adds uncertainty
to whether legislative support will occur, particularly since the
governor and other supporters of a transmission purchase had sought to
purchase the entire transmission system from all three investor-owned
utilities. Although the state could still purchase Pacific Gas
and Electric Company's transmission system, its ability to complete
such a deal would require bankruptcy court approval. Alternatively,
the state could move forward with a purchase for a portion of the state's
transmission assets, but it remains unclear whether the legislature
would see as much value for the state to pursue a partial purchase.
Compounding the problem for legislators is the fact that the energy crisis
has already led to a number of unpopular developments including the depletion
of a large portion of the budget surplus and sizeable rate increases for
consumers, which together may temper their support for the MOU.
Ultimately, legislative support, in Moody's opinion,
will be heavily influenced by the governor's willingness to advance the
MOU and for the MOU to be viewed by the legislature as an essential part
of the solution to the energy crisis. Influencing that view will
be the legislature's collective assessment as to whether the failure to
support the MOU, which would likely lead to an SCE bankruptcy,
further complicates matters for the state.
Assuming legislative approval is obtained, the CPUC's implementation
of the MOU becomes the next critical element. Recent actions by
the CPUC, including the manner in which revenues are allocated between
the CDWR and SCE, are troublesome from an investor's standpoint
and have added to SCE's current financial woes. Resolution of this
issue is critical to fully understanding the cash flow available to SCE
and to enable the CDWR to issue the planned debt securities.
Also, a number of recent CPUC decisions must be altered to be consistent
with certain terms of the MOU. Among these changes include the
CPUC's adoption of the TURN proposal which directed the balance in SCE's
procurement cost account to be transferred on a monthly basis to SCE's
stranded cost account effective retroactively to January 1, 1998.
CPUC's adoption of this proposal delays the end to the rate freeze and
requires SCE to record an after-tax charge of $2.5
billion. Moody's believes that SCE will likely take this charge
but recognizes that should the MOU be approved and implemented,
a regulatory asset could be created which would restore the equity write-off.
Assuming the plan is legislatively approved, Moody's believes there
is a reasonable probability that the CPUC would follow through on the
terms of the MOU. In Moody's opinion, the CPUC, although
an independent body of the state, has been greatly influenced by
the governor throughout this crisis and should, in Moody's opinion,
follow the directives outlined in a plan supported by the governor.
For this reason, Moody's believes that securing legislative approval
of the MOU significantly enhances SCE's chance for financial recovery
outside of bankruptcy.
MOU'S EXPECTED IMPACT ON SCE'S RATINGS
Moody's believes the fully implemented MOU could greatly improve the ratings
of SCE. For one, securitization proceeds, transmission
asset sales proceeds, and cash on hand should be sufficient to repay
all outstanding past obligations, including the payment of all defaulted
debt securities, obligations to generators and amounts due to other
unpaid creditors. Repayment of these obligations will greatly improve
SCE's underlying credit quality.
However, SCE's prospective cash flow and debt service capabilities
still remain unknown due in large part to the many regulatory uncertainties
still unresolved. In addition, although the MOU is a comprehensive
document, new implementation issues may develop as the CDWR and
SCE advances aspects of the MOU into final agreements and as the CPUC
implements the rules surrounding CDWR's role as a power procurer.
Moreover, outstanding issues remain with certain of the QF's that
need to be rectified, which could also impact SCE's future cash
flow. While Moody's believes that implementing the terms of the
MOU will greatly improve SCE's current ratings, these uncertainties,
all of which impact SCE's future cash flow, make it difficult to
predict, at this time, whether an implemented MOU will result
in SCE being upgraded to an investment grade rating.
BANKRUPTCY POSSIBILITY STILL EXISTS
Although the execution of the MOU is the first tangible step toward financial
recovery, the possibility of an SCE bankruptcy still remains.
In addition to the legislative and regulatory hurdles that exist,
numerous creditors remain unpaid. Although the plan, if approved
and implemented, provides full repayment to creditors, timing
issues around repayment remain difficult to predict. SCE believes
that full repayment to unpaid creditors could occur as early as fall 2001,
but the timing of that repayment could, for instance, be impacted
by a voter initiative. Additionally, the QF's, while
expecting to receive payments for future deliveries beginning on April
16, 2001, are owed material sums of money for past deliveries
and are filing lawsuits against SCE, which collectively could push
SCE closer to bankruptcy. SCE has publicly stated that it believes
that an out-of-court solution to the problem is better than
bankruptcy. SCE's ability to hold off unpaid creditors while the
legislative and regulatory process continues ultimately rests with creditors
believing that favorable progress is being made. The signing of
this MOU clearly advances the process down the road, but the road
still has hurdles to overcome, some of which are outside of SCE's
RATINGS REMAIN UNCHANGED & REMOVED FROM REVIEW FOR POSSIBLE DOWNGRADE.
Given the numerous legislative, regulatory and implementation issues
that need to be addressed, SCE's ratings remain unchanged.
However, investors should note that legislative approval of the
MOU could result in a positive rating action as it brings SCE closer to
fully repaying its past obligations to various creditors. Should
legislation pass, subsequent positive rating actions could follow
depending upon both the manner in which the CPUC implements the legislation
and the extent to which Moody's gains a better understanding of SCE's
prospective cash flows. In light of these potential positive developments,
the ratings are removed from possible downgrade.
Ratings confirmed and removed from review for possible downgrade include
the first mortgage bonds and the secured pollution control bonds of SCE
at B3; the issuer rating, the senior unsecured notes,
the unsecured debentures, and the unsecured pollution control bonds
of SCE, at Caa2; the guaranteed notes of SCE Capital at Caa2;
the junior subordinated debt of Southern California Edison Company,
at Caa3; the preferred stock of SCE at "caa"; and a shelf registration
for SCE's issuance of senior secured debt, senior unsecured debt,
and preferred stock, at (P)B3, (P)Caa2 and (P)"caa",
respectively. SCE's short-term ratings of Not Prime and
Speculative Grade are confirmed.
Also confirmed and removed from review for possible downgrade include
the senior unsecured debt of EIX at Caa3; the junior subordinate
debt of EIX at Ca, the preferred stock of EIX Trust I and II at
"ca", the shelf registration for EIX's issuance of senior debt and
junior subordinate debt at (P)Caa2 and P(Ca) and a shelf registration
for EIX and EIX Trust III's issuance of preferred stock to (P)"ca".
EIX's short-term rating of Not Prime is confirmed. Also
confirmed and removed from review for possible downgrade include the senior
unsecured debt of Edison Funding Company (EFC) at B2. EFC's commercial
paper is confirmed at Not Prime.
Headquartered in Rosemead, California, SCE is a vertically
integrated utility and a wholly-owned subsidiary of EIX.
Susan D. Abbott
Moody's Investors Service
JOURNALISTS: (212) 553-0376
SUBSCRIBERS: (212) 553-1653
VP - Sr. Credit Officer
Moody's Investors Service
JOURNALISTS: (212) 553-0376
SUBSCRIBERS: (212) 553-1653
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