HOW RATING AGENCIES LOOK AT THE ENERGY INDUSTRY

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HOW RATING AGENCIES LOOK AT THE ENERGY INDUSTRY

• Dan Aschenbach,
• Senior Vice President,
• Infrastructure Team

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• ENERGY ASSOCIATION OF PENNSYLVANIA 2005
  FINANCIAL-ACCOUNTING CONFERENCE

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AGENDA

• ROLE OF RATINGS IN MARKETPLACE
• FUNDAMENTAL RATING FACTORS
• REGULATORY ENVIRONMENT
• NEXT MAJOR RESOURCE DECISION-KEY MANAGEMENT ISSUE

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RATING AGENCIES ROLE IN MARKETPLACE

• Objective observers of business and financial
  condition of issuers of financial instruments.

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CREDIT RATINGS

• Moodys credit ratings are opinions of the
  credit quality of individual obligations of an
  issuers general creditworthiness, without
  respect to individual debt obligations or other
  specific securities. The purpose of Moodys
  ratings is to provide investors with a simple
  system of gradation by which relative
  creditworthiness of securities may be noted.

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RATING SYMBOLS

• Gradations of creditworthiness are indicated
  by rating symbols
• Aaa Aa A
• Baa Ba B
• Caa Ca C
• Moodys appends numerical modifiers 1,2 and 3
  to each generic rating classification from Aa
  through Caa.

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RATINGS ARE OPINIONS

• Aaa-highest quality, minimal risk.
• Aa-high quality subject to very low credit risk.
• A- upper medium grade subject to low credit
  risk.
• Baa-medium grade subject to moderate credit risk
  may possess speculative characteristics.
• Ba-speculative subject to substantial credit
  risk.
• B- speculative high credit risk.

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LIMITATIONS ON USE

• Ratings should not be used alone as basis for
  investment decisions.
• Ratings are of no value projecting direction of
  stock prices.
• Ratings involve judgments about the future so not
  a direction reflection of statistical factors.

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OTHER CREDIT RATING TOOLS

• RATING OUTLOOK an opinion on the likely
  direction over the medium term of the rating.
• WATCH LIST an indication that a rating is under
  review for possible change in the short-term.

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FUNDAMENTAL CREDIT RATING FACTORS

• Business Fundamental and Competitive Position
• Financial Analysis
• Regulation and Rates
• Management Strategy
• Risks/Challenges
• Opportunities/Strengths

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Business Fundamentals and Competitive Position

• Characteristics of service area
• Corporate structure and governance
• Profitability
• Vulnerability to industry specific risks
• Major litigation
• Company estimates and forecasts

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Financial Analysis

• Earnings/Interest Coverage
• Cash Flow/Liquidity
• Capital Structure

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REGULATORY ENVIRONMENT REGULATION AND RATES KEY
FACTOR

• Cost Recovery/Certainty is Important Credit
  Factor
• California electricity deregulation /regulation
  failure is an example of what can go wrong
• Moodys evaluates
• Makeup of Commission
• Past record of rate treatment
• Rate procedures

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OPERATING ENVIRONMENT

• Industry restructuring
• FERC
• Energy Bill

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MANAGEMENT STRATEGY IS A KEY RATING FACTOR

• For Example NEXT RESOURCE DECISION
• Nuclear?
• Coal?
• Coal Gasification?

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FUNDAMENTAL FACTORS-SUMMARY

• CREDIT RISKS/CHALLENGES
• Punitive regulation?
• Environmental mandates requiring new costs
• Competitive pricing pressures
• Weal capital structure
• Potentially adverse litigation

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OPPORTUNITIES/STRENGTHS

• Competitive cost structure
• Low financing needs
• Sound regulation with predictable cost
  recovery in rates
• Supply-demand balance
• Financial flexibility

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AN EXAMPLEPGW

• RISK/CHALLENGES
• Highly leveraged with above average debt
  ratios
• Sizable low-income population is a factor
  in high collection delinquencies
• Weakened liquidity due to high level of
  receivables

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PGW

• STRENGTHS/OPPORTUNTIES
• Strong relationship with city and state
  regulator
• Bond ordinance includes strong covenants
  PUC must insure rates are set to meet covenant
• Sound management focused on improving
  financial stability

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Questions?