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01 Mar 2002
MOODY'S UPGRADES THE SECURITIES OF SOUTHERN CALIFORNIA EDISON COMPANY (SENIOR SECURED TO Ba2) FOLLOWING REPAYMENT OF PAST DUE PROCUREMENT RELATED CLAIMS
New York, March 01, 2002 -- Moody's Investors Service today upgraded the long-term debt securities
of Southern California Edison Company (SCE). The rating outlook
for the securities is stable.
Ratings upgraded and removed from review for further upgrade are SCE's
first mortgage bonds, upgraded to Ba2 from B3, its senior
unsecured rating, and issuer rating, upgraded to Ba3 from
Caa2, its junior subordinated debt, upgraded to B2 from Caa3,
its preferred stock, upgraded to B3 from Ca; and a shelf registration
for the issuance of first mortgage bonds, senior unsecured debt,
junior subordinated debt and preferred stock upgraded to (P)Ba2 from (P)B3,
to (P)Ba3 from (P)Caa2, to (P)B2 from (P)Caa3 and to (P)B3 from
(P)Ca, respectively. SCE's short-term ratings of Not
Prime and Speculative Grade are withdrawn.
The rating action reflects financial closure of $1.6 billion
in senior secured credit facilities, proceeds from which,
combined with cash on hand, have been used to repay creditors and
power suppliers past due amounts owed. Additionally, SCE
intends to remarket approximately $196 million of secured tax-exempt
debt on a fixed rate basis. These securities had been previously
repurchased by SCE. Use of funds, which aggregate $5,330
billion, will repay the following creditors and power suppliers:
· $400 million of long-term unsecured debt (1995
and 1996 series);
· $531 million of commercial paper;
· $1,650 million to bank creditors;
· $30 million of payments to QUID holders and preferred
equity holders; and
· $2,719 million to power suppliers.
The rating upgrade reflects the ability of SCE to repay all past due obligations
and to generate sufficient excess cash flow over the next two years to
repay the credit facilities, all procurement related debt,
and other SCE debt and preferred securities that mature in this timeframe.
SCE's prospects for achieving this level of free cash flow have been fortified
by the California Public Utilities Commission (CPUC) January 23rd approval
of the Procurement Related Obligations Account (PROACT) that codifies
the October 5, 2001 settlement of a federal filed rate doctrine
lawsuit between CPUC and SCE.
The settlement agreement enables SCE to recover from ratepayers previously
uncollected power procurement costs. Under the settlement agreement,
SCE retains all cash flow that it collects after satisfying its current
operating cash requirements, making required payments to the California
Department of Water Resources (CDWR) for supplying the "net-short"
energy requirements and making energy and capacity payments to the qualifying
facilities. This excess cash, which will vary each month,
will be used for debt retirement.
ANALYSIS OF PROACT
The settlement agreement states that SCE shall recover in retail electric
rates its procurement related obligations recorded in PROACT by no later
than December 31, 2005. SCE currently predicts that it should
fully collect sufficient cash flow to recover PROACT by the end of 2003.
The settlement agreement also states that the CPUC agrees to maintain
retail electric rates at no less than the current rates through the earlier
of PROACT recovery or December 31, 2003 and further states that
should procurement related obligations recorded in PROACT not be fully
recovered by December 31, 2003, the remaining balance shall
be recovered in rates over a two-year period that ends on December
The establishment of the PROACT account ($3.6 billion) also
helps to repair SCE's balance sheet. Previously, a CPUC order,
issued in March 2001, caused SCE to incur a $2.5 billion
after-tax write-off at year-end 2000, resulting
in SCE's total debt to total capitalization ratio to spike to 85%.
With the January 23rd CPUC approval of PROACT, much of this write-off
was reversed in the company's 2001 year-end statements and as such,
the company's total debt to total capitalization ratio at year-end
2001 was around 62%. Moreover, with SCE applying all
excess cash to the retirement of procurement related debt, SCE's
total debt to total capitalization is expected to decline rapidly during
2002 landing at 52% at year-end 2002 and declining to less
than 40% by year-end 2003.
ANALYSIS OF PROACT CASH FLOWS
While the collection of PROACT cash flows is subordinate to SCE satisfying
its own obligations as well as its obligations to CDWR and the qualifying
facilities, Moody's views the PROACT cash flows to be fairly predictable.
For one, most of the volatility that could reduce the amount of
PROACT cash flows has been either eliminated or reduced by actions taken
by SCE and others. For instance, SCE has entered into five
year contracts with the renewable qualifying facilities at an energy price
of 5.37 cents thereby eliminating the volatility in that component
of their cost structure. SCE has also hedged its exposure to increases
in natural gas prices for the next two years thereby reducing greatly
the volatility around payments to natural gas fired qualifying facilities.
Together, kilowatt-hour (Kwh) purchases from qualifying facilities
represent about one-third of the SCE's generation requirements.
Little volatility in fuel costs is likely to surface from SCE's owned
generation (represents 33% of SCE's total generating requirements),
which includes interests in hydro, nuclear, and coal assets.
The remaining third represents payments that SCE makes to CDWR.
These payments are based upon CDWR's revenue requirement, an amount
that was finalized at a CPUC hearing on February 21, 2002.
With the CDWR revenue requirement established, subsequent changes
to the CDWR revenue requirement should not affect PROACT cash flows,
pursuant to the settlement agreement.
Other vulnerabilities to the timing of the PROACT cash flows include lower
demand for electricity, which would have the effect of reducing
the amount of Kwhs sold by SCE thereby reducing the amount of excess cash
flow. Mitigating this issue is the fact that SCE's electric sales
during 2001 have already declined by 4.5% due to higher
prices and attractive conservation incentives. These conservation
incentives offered by the state have terminated and the company has modeled
relatively flat electric sales for 2002 and 2003 in determining the 2003
timeframe for PROACT recovery. Additionally, the level of
PROACT cash flows could be impacted by a forced outage at one of SCE's
generating plants. Under this scenario, SCE's operating costs
would increase, and SCE would be relying more heavily on wholesale
purchases by CDWR to meet their customer load. While this scenario
is indeed plausible, all of SCE's plants have very strong operating
histories. Lastly, the state contemplates SCE being in the
position to assume power procurement from CDWR beginning in 2003.
While a number of regulatory issues need to be implemented for that to
occur, SCE's exposure to this potential issue is mitigated by the
fact the CDWR has contracted for significant portions of the net short.
Moreover, in all of these cases, SCE has the ability to continue
to collect the remaining amount of PROACT cash flows through 2005 should
the procurement related obligations recorded in PROACT not be fully collected
by year-end 2003.
REGULATORY & MARKET UNCERTAINTIES ARE REFLECTED IN THE RATING
Prospectively, SCE's financial metrics are quite strong for the
Ba2 senior secured rating. Strong predictable cash flows are expected
to materially reduce debt by more than $2.6 billion over
the next two years. Moody's expects SCE's operating cash flow to
cover both interest expense (including payments on subordinated notes)
and lease expense on average by 5.3x annually through 2006,
and expects annual operating cash flow to represent at least 35%
of SCE's total debt. While these metrics could arguably support
a higher rating, the Ba2 senior secured rating incorporates the
challenging and highly volatile regulatory environment and uncertain marketplace
that exists within California.
While the settlement between SCE and CPUC represent the first tangible
step towards helping to fix the energy markets in California, a
number of key market and regulatory issues remain unresolved, many
of which can indirectly affect SCE. For one, the CPUC still
remains an unpredictable regulatory body. Deregulation has effectively
halted in the state and no clear road map exists as to what the California
market place will become. The involvement of CDWR adds another
layer of uncertainty for SCE and other market participants. CDWR's
ability to complete the planned bond offering is an important step towards
continuing to repair the California marketplace but uncertainties still
persist around the timing and the completion of this transaction.
Related to the CDWR financing is the possibility that contracts entered
into by CDWR and generators may be renegotiated, all of which adds
more uncertainty to the outlook for the California marketplace.
Beyond that, Moody's believes that the utilities will be under pressure
to lower rates so that the impact of the CDWR contracts are more manageable
to ratepayers. Also, the CPUC and the utilities need to address
a number of regulatory matters including the establishment of power procurement
procedures, which among other things, insulates the utilities
from changing prices should the utilities return to the power procurement
business as outlined under AB1X. Finally, the outcome of
the Pacific Gas and Electric Company bankruptcy adds another unknown to
LEGAL CHALLENGE BY TURN
Moody's also notes that while SCE's settlement with the CPUC was unanimously
approved by the commission and received broad support from key legislators
including the governor, the attorney general, and the legislature,
one of the consumer groups, TURN, is opposed to the settlement
of this federal lawsuit. TURN has filed an appeal of the Federal
District Court judgment approving the settlement arguing, among
other things, that the CPUC did not have the authority to enter
into the settlement and that TURN's rights had been harmed since they
did not have ample time to respond to the settlement. TURN's efforts
to stay the settlement have not been successful as the appellate judge
denied their stay ruling that the settlement did not result in any irreparable
harm to them. SCE, CPUC, and TURN have each filed their
arguments and the hearing is scheduled for March 4th. The governor
and the legislature have each filed amicus briefs in support of the settlement.
A ruling from the appellate court will likely take months and any ruling
is likely to be appealed. The appellate court could remand the
case back to the District Court. As such, final resolution
of this issue could take years. While legal outcomes are difficult
to predict, Moody's believes that the settlement of the federal
lawsuit will likely stand in its current form given the consensual nature
of the agreement between SCE and the CPUC, the broad support that
it has within the state, and the fact that it represents a first
step towards repairing a broken market in the state.
As mentioned, SCE intends to remarket $196 million of tax-exempt
pollution control bonds previously repurchased by SCE. The bonds,
which have been assigned a Ba2 rating, will be remarketed as four
separate series: $81 million (Series A 1986), $25
million (Series B 1986), $40 million (Series C 1986),
and $50 million (Series D 1986). The bonds will be secured
by a first lien on SCE's plant through the company's first mortgage bond
indenture and will mature on February 28, 2008.
Headquartered in Rosemead, California, SCE is a vertically
integrated utility serving southern California and a wholly-owned
subsidiary of Edison International.
Vice President - Senior Analyst
Moody's Investors Service
Susan D. Abbott
Moody's Investors Service
No Related Data.
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