New York, April 3, 2002 — Moody’s Investor’s Service downgraded the senior secured rating of Puget Sound Energy, Inc. (PSE) to Baa2 from Baa1, and its senior unsecured and issuer ratings to Baa3.
In addition, Moody’s downgraded the issuer rating of its PSE’s parent, Puget Energy, Inc., to Ba1 from Baa3. The outlook for all of the ratings is negative. The rating downgrades reflect PSE’s weaker credit profile, primarily resulting from the under recovery of power supply costs during the second half of 2001 and the first quarter of 2002.
The rating action also reflects the stabilizing effects of the settlement agreement recently approved by the Washington Utilities and Transportation Commission (WUTC) and other initiatives undertaken by PSE’s management. Importantly, the WUTC’s approval of the settlement agreement entered into back on March 20, 2002 by PSE and several significant parties to its regulatory proceedings resolved the company’s filing for interim rate relief and many of the key issues relating to its pending general rate case.
Moody’s believes the approved settlement signals an improved working relationship between PSE and the WUTC and its staff, which could help to restore PSE’s financial flexibility over time. The negative rating outlook reflects the pending WUTC staff review of PSE’s rate base and operating costs, which will influence the amount by which general electric and gas rates will ultimately be increased.
If, as expected, there are few, if any, adjustments, then the agency expects an adequate percentage increase for electric and gas base rates of about 6.5% and 9%, respectively. Under that scenario, Moody’s said it would likely change the rating outlooks to stable from negative. In the event of material disallowances resulting from the review of PSE’s rate base and operating costs, then additional pressure would come to bear on the ratings.
The ratings action concludes the review for possible downgrade of the aforementioned ratings, which commenced October 9, 2001. Puget Sound Energy, Inc. ratings downgraded include: senior secured debt to Baa2 from Baa1; senior unsecured debt, revolving credit facility, and issuer ratings to Baa3 from Baa2; preferred capital securities to Ba1 from Baa3; preferred stock to Ba2 from Ba1.
Puget Sound Energy’s short-term debt rating for commercial paper was not under review and remains at Prime-2. Puget Energy, Inc.’s issuer rating is downgraded to Ba1 from Baa3. Moody’s is taking a favorable view of the decisions by the board of PSE’s parent, Puget Energy, to reduce its common dividend by 46%, effective with the next payment.
Furthermore, the agency noted the company’s plan to add up to $125 million of additional common equity over the next 42 months through its dividend reinvestment plan and new market issuances.
The dividend reduction saves in the range of $70 million to $80 million per year for PSE, which is the principal source of funds for Puget Energy’s common dividend. Expected higher retained earnings for PSE and downstreaming of funds from common equity issuance by Puget Energy increase the likelihood that PSE can achieve key common equity milestones laid out in the settlement.
Achieving these milestones of 34%, 36%, and 39% by the end of 2003, 2004, and 2005, respectively, are essential to improving financial flexibility and avoid being penalized by a 2% reduction in rates. Other favorable aspects of the settlement include the prospects for general electric and gas rate increases of about 6.5% and 9%, respectively, which would become effective on July 1, 2002 and September 1, 2002, respectively.
These general rate increases, which will be based on a hypothetical 40% common equity ratio (compared to PSE’s 30% common equity ratio as of December 31, 2001) and an 11% allowed return on equity (compared to 10.5% currently), will become effective several months earlier than would have otherwise been the case if the settlement was not approved. In addition to the cash savings from the lower common dividend payout, the higher revenues from the prospective increase in general rates together with the $25 million of interim rate relief for the April 1, 2002 through June 30, 2002 period are expected to further improve PSE’s operating cash flow.
The near-term implementation of a power cost adjustment mechanism by July 1, 2002, subject to a collaborative process, will also reduce PSE’s business and financial risk profiles by helping to create a better match between future power supply costs and revenues.
Assuming PSE’s general electric and gas rates are increased by 6.5% and 9%, respectively, Moody’s expects PSE to be able to fully fund its capital expenditures with internally generated funds over the next few years, while restoring funds from operations coverage of interest to better than three times (3X) during the same time period. PSE’s liquidity position is also expected to improve as short-term debt balances are reduced, thereby freeing up available back-up liquidity under its $375 million bank credit facility.
Lastly, Moody’s notes that the downgrade of Puget Energy’s issuer rating to Ba1 from Baa3 takes into account the fact that PSE is Puget Energy’s predominant source of earnings and cash flow.
Puget Sound Energy, Inc. is a combination electric and gas utility subsidiary of Puget Energy, Inc. Both companies maintain headquarters in Bellevue, Washington.