Download SOAH DOCKET NO. 473-95-1563

SOAH DOCKET NO. 473-00-0498
PUC DOCKET NO. 21953
PUBLIC UTILITY COMMISSION OF TEXAS
COST UNBUNDLING AND SEPARATION
OF UTILITY BUSINESS ACTIVITIES, INCLUDING
SEPARATION OF COMPETITIVE ENERGY SERVICES
AND DISTRIBUTED GENERATION
REBUTTAL TESTIMONY OF
WENDY G. HARGUS
FOR
CENTRAL POWER AND LIGHT COMPANY
SOUTHWESTERN ELECTRIC POWER COMPANY
WEST TEXAS UTILITIES COMPANY
MARCH 2000
REBUTTAL TESTIMONY
1
WENDY G. HARGUS
TESTIMONY INDEX
SUBJECT
PAGE
I.
Introduction ................................................................................................................... 3
II.
Code Of Conduct - Credit Support ............................................................................... 5
III.
Cost Of Refinancing ..................................................................................................... 7
IV.
Requirement Of Refinancing To Transfer Assets ....................................................... 10
V.
Anticipated Costs Are Unduly Burdensome ............................................................... 14
REBUTTAL TESTIMONY
2
WENDY G. HARGUS
1
2
SOAH DOCKET NO. 473-00-0498
PUC DOCKET NO. 21953
3
PUBLIC UTILITY COMMISSION OF TEXAS
4
5
COST UNBUNDLING AND SEPARATION
6
OF UTILITY BUSINESS ACTIVITIES, INCLUDING
7
SEPARATION OF COMPETITIVE ENERGY SERVICES
8
AND DISTRIBUTED GENERATION
9
10
REBUTTAL TESTIMONY
11
OF
12
WENDY G. HARGUS
13
FOR
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CENTRAL POWER AND LIGHT COMPANY
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SOUTHWESTERN ELECTRIC POWER COMPANY
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WEST TEXAS UTILITIES COMPANY
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18
MARCH 2000
19
I. Introduction
20
My name is Wendy G. Hargus and I filed direct testimony in this case.
21
In this rebuttal testimony I will address factual and policy bases related to issues
22
raised in the position statements and briefs filed by PG&E Corporation (PG&E), the
23
Office of Regulatory Affairs (ORA) and South Texas Electric Cooperative (STEC), as
REBUTTAL TESTIMONY
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WENDY G. HARGUS
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well as the testimony of Carol A. Szerszen filed by the Office of Public Utility
2
Counsel (OPUC). These matters include;
3
(a)
Code of Conduct issues involving the question of whether the plan
4
filed by CPL, SWEPCO and WTU provides for unauthorized credit
5
support for competitive affiliates during the Stage 1 period;
6
(b)
the challenge to CSW’s calculation of the cost of retirement of debt
7
required to permit transfer of assets to separate legal entities on or
8
before January 1, 2002 and the differential in costs if the proposed
9
two-stage plan were to be implemented;
10
(c)
suggestions that the debt instruments of CPL, SWEPCO and WTU
11
may permit legal separation of the present operating company assets
12
prior to January 1, 2002, without retirement of first mortgage bonds
13
and other debt; and
14
(d)
suggestions that the additional anticipated costs of transfer of legal title
15
to operating company assets on or prior to January 1, 2002, are not
16
unduly burdensome.
17
Several of the intervenors have tried to picture the issue before the
18
Commission as a choice between the saving of refinancing costs for the CSW
19
companies versus lessened competition resulting from mere retention of asset
20
ownership during the Stage I period.
21
characterization. The choice before the Commission is only whether CSW will be
REBUTTAL TESTIMONY
4
This is an unfair and misleading
WENDY G. HARGUS
1
allowed to implement a two-stage plan in order to save unnecessary refinancing costs
2
without any negative impact on competition whatsoever.
3
4
II. Code Of Conduct - Credit Support
5
CSW disagrees with the contentions of some of the intervenors that the credit
6
support requirements of the Code of Conduct are not met. Under CSW’s proposal,
7
the Code of Conduct will be in full effect no later than January 1, 2002.
8
As discussed in my direct testimony, the sole purpose of retaining the existing
9
debt of the operating companies and their assets in the existing legal entities during
10
the Stage 1 period is to permit those companies to perform their contractual
11
commitments to their respective security holders without incurring the substantial and
12
unnecessary cost of early retirement and refinancing of a major portion of that debt.
13
The Code of Conduct requires that a utility shall not allow an affiliate to
14
obtain credit under any arrangement that would include a specific pledge of any assets
15
in the rate base of the utility or a pledge of cash reasonably necessary for utility
16
operations.
17
reliable operations during the Stage 1 period before transfer of title to T&D assets and
18
generation assets, some financing most likely will be required. As I discussed at
19
pages 30-31 of my direct testimony, it is possible that in the course of securing
20
financing some level of credit support may be required from some creditworthy entity.
21
That support might be supplied by (a) CSW, CPL, SWEPCO, WTU or some other
22
CSW affiliate, (b) through credit insurance provided by third parties or (c) other
To accomplish the retirement of existing securities and to facilitate
REBUTTAL TESTIMONY
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WENDY G. HARGUS
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support from other creditworthy entities. CSW prefers to have each legal entity stand
2
alone in support of its debt and other obligations and will strive to minimize the need
3
for guarantees during and after the Stage 1 transition period. Until the details of a
4
particular financing are developed and then prevailing market conditions are known,
5
it cannot be determined if credit support will be required or who will provide it.
6
However, it can be said with certainty that none of those options would involve a
7
specific pledge of any of the assets in the rate base of the T&D entity or a pledge of
8
cash reasonably necessary for utility operations.
9
The contention by OPC witness Dr. Carol Szerszen on page 10 of her
10
testimony that “any interest payment default by the generation company would give
11
the bondholders reason to make claims on both generation and T&D assets” is wrong.
12
No financing by the PGC during Stage 1 or thereafter will involve any specific pledge
13
of T&D utility assets. My direct testimony discusses the possible use of guarantees
14
from CSW, the existing operating companies or another creditworthy entity, not a
15
pledge of rate base assets or cash. In fact, until retirement of all first mortgage bonds
16
issued by an existing operating company, its T&D assets, like its generation assets,
17
will remain subject to the lien of the first mortgage indenture which prohibits any
18
other lien or pledge. Continuation of ownership of T&D and generation assets by the
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existing operating companies and retention and servicing of their debt obligations
20
during the Stage 1 period for important and valid reasons does not violate the Code of
21
Conduct credit support provisions.
22
REBUTTAL TESTIMONY
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WENDY G. HARGUS
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III. Cost Of Refinancing
2
Dr. Szerszen’s testimony at pages 5-7 appears to say that because future
3
interest rates cannot be predicted with certainty, interest rate cost estimates for
4
refinancing of the present operating companies’ debt should simply be ignored and
5
excluded from the calculation of cost as though such cost did not exist. Any business
6
organization which failed to estimate and to take into consideration the future cost of
7
money in its financial planning would be derelict in the discharge of fundamental
8
duties to its investors and would be less able to compete for the business of
9
customers. This is an entirely legitimate matter to be considered in developing
10
CSW’s Plan. The estimates were prepared in a clear, responsible and traditional
11
manner.
12
uncertainty of future interest rates and provided some idea of the potential range of
13
interest costs that might be incurred.
In fact, CSW presented a range of estimates which incorporated the
14
Through utilization of low cost refinancing opportunities, retention of
15
investment grade credit ratings, selection of appropriate financing vehicles and
16
insistence on reasonable debt to equity and interest coverage ratios, CPL, SWEPCO
17
and WTU have maintained a relatively low embedded cost of debt. This cost is
18
considerably lower than currently prevailing costs of new debt. If a low interest rate
19
debt issue must be arbitrarily retired six years before it matures and it is replaced with
20
a higher interest rate debt issue, the difference in interest rate cost for that six year
21
period is a real cost of doing business - it is a perfectly legitimate business
22
consideration. In estimating the additional interest cost involved in refinancing the
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operating companies’ debt by either January 1, 2002, or January 1, 2008, the Base
2
Case shown on page 1 of EXHIBIT WGH-5 to my direct testimony uses then present
3
rates in a manner (consistent with normal financial practice) in order to calculate the
4
net present value of such additional costs as of January 1, 2002 and the net present
5
value of such additional costs as of January 1, 2008. Pages 2 and 3 of EXHIBIT
6
WGH-5 present alternative pessimistic and optimistic cases resulting from both
7
assumed higher and lower future interest rates. I agree with Dr. Szerszen that interest
8
rates are impossible to predict with 100% certainty; however, I believe that interest
9
costs are a real cost of refinancing that must be considered. Furthermore, I believe the
10
inclusion and presentation of estimated interest cost increases in my direct testimony
11
was appropriate, informative and presented in a traditional format. By hindsight, the
12
estimates of interest rate cost differentials may have been too small because interest
13
rates have increased significantly in the two month period since my direct testimony
14
was filed, thereby increasing the likely cost of forced refinancing of existing operating
15
company debt by January 1, 2002.
16
testimony, CSW’s proposed plan increases the likelihood of refinancing in a more
17
favorable interest rate environment rather than being forced to refinance within the
18
next year and one-half. Our inclusion of interest cost in the comparison between a
19
forced debt retirement by 2002 and retirement by 2008 is totally appropriate and is a
20
significant and valid justification for our two-stage plan.
As discussed on pages 24-25 of my direct
21
Dr. Szerszen’s contention on page six of her testimony that replacement debt
22
for the T&D utility will most likely have a lower interest rate than would be incurred
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WENDY G. HARGUS
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by the competitive generation subsidiary is entirely speculative. Interest rates to be
2
paid on future borrowings by the T&D utility and the PGC will be dependent on many
3
factors including the credit ratings ultimately assigned to the debt securities of our
4
EDC and PGC affiliates. There exists at present little experience in actual financing
5
methods, costs and credit rating determinations in refinancing debt by the component
6
businesses of a previously integrated utility. The important point is that the total of
7
increased refinancing costs resulting from requiring transfer of assets by January 1,
8
2002 will have an adverse effect on the ability to achieve lower restructuring costs.
9
Some intervenors have questioned the validity of the assumptions included in
10
the analysis of one-time transaction costs set forth in EXHIBIT WGH-5 to my direct
11
testimony. The estimated one-time transaction costs in the case of either 2002 debt
12
refinancing or 2008 debt refinancing are reasonable estimates of such costs based on
13
historical analyses of such costs, including tender offer success rates for the different
14
forms of securities involved, premiums required in tenders, fees of investment
15
bankers involved in the transactions, cost of U.S. Treasury securities required to be
16
deposited in escrow in order to defease first mortgage bonds and other relevant
17
factors. CSW prepared the study working with an investment bank that has broad
18
experience with these types of transactions. The complete study prepared by Morgan
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Stanley Dean Witter and further discussion of the assumptions has been provided in
20
response to requests for information in this case. As in the case of increased interest
21
costs, the two-stage plan is designed to permit avoidance of unnecessary costs which,
22
if incurred, would work against the goal of achieving lower restructuring costs.
REBUTTAL TESTIMONY
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WENDY G. HARGUS
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2
IV. Requirement Of Refinancing To Transfer Assets
3
Following adoption of SB-7, CSW engaged the services of outside counsel
4
familiar with our capital structures and the instruments and agreements governing the
5
debt of CPL, SWEPCO and WTU. With the assistance of counsel, as well as our
6
outside auditors and investment bankers, CSW Treasury personnel thoroughly
7
analyzed the collateral provisions, restrictive covenants and other relevant provisions
8
of these instruments and agreements in order to evaluate the alternatives available to
9
accomplish legal separation of the T&D assets from the generation assets of the
10
existing operating companies in a cost efficient manner. This is discussed in my
11
direct testimony at page 17. The analysis of alternatives, their respective costs of
12
refinancing and the litigation risks which would accompany the various alternatives
13
were all taken into consideration in developing our two-stage plan.
14
In its brief objecting to CSW’s plan, PG&E Corporation asserted at page 9
15
that “ . . . CSW appears to be substantially overstating the likelihood of the necessity
16
for refinancing its debt.” PG&E also states that “. . . Utilities have been able to divest
17
generation and other assets as part of the implementation of retail competition in their
18
states without having to refinance their existing debt.” The PG&E brief cites no
19
authority, precedent or analysis of CSW debt instruments to support an argument that
20
those sweeping contentions apply in any way to CSW’s debt or its two-stage plan.
21
22
With respect to this statement by PG&E, I would point out that each state
restructuring statute is different and unique.
REBUTTAL TESTIMONY
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Equally important, the choice of
WENDY G. HARGUS
1
financing vehicles, capital structures and governing instruments differ markedly
2
among utilities reflecting in part: historical negotiations among issuers, lenders and
3
investment bankers at the time of issuance; the relative credit standing of the debt
4
issuer at the time of a given financing; differing regulatory requirements in states
5
which have jurisdiction over the issuance of securities of utility companies subject to
6
their jurisdiction; and whether the issuer is subject to the jurisdiction of the Securities
7
and Exchange Commission under the Public Utility Holding Company Act of 1935.
8
For example, (a) restrictive covenants differ in their coverage and language;
9
(b) release of collateral provisions operate differently in the several forms of first
10
mortgage indentures used by utility companies; (c) pollution control bonds are issued
11
under instruments and agreements which differ markedly from state to state; and
12
(d) the nature of covenants and other relevant restrictions and provisions have evolved
13
over the years to meet the concerns of investors or to conform to prevailing financing
14
practice, making the respective dates when debt instruments were written a significant
15
factor.
16
As permitted by SB-7, CSW has elected to separate its present utility
17
operations into three separate but affiliated legal entities, the EDC, the PGC and the
18
REP. No divestiture of any asset is required by PURA. The statement that other
19
utilities have divested assets without refinancing their debt is meaningless without the
20
provision of specifics as to which state restructuring laws were involved, which
21
utilities were involved and what they elected to do and the pertinent provisions of
22
their governing instruments and agreements.
REBUTTAL TESTIMONY
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WENDY G. HARGUS
1
In similar vein is the suggestion on page 8 of the Position Statement of the
2
Office of Regulatory Affairs that the CSW companies’ estimate of an additional $35
3
million in refinancing costs is predominantly dependent upon “subjective”
4
interpretations of their bond covenants. ORA provides no specifics to support its
5
contention that any of CSW’s conclusions are “subjective” - in fact their use of the
6
term is meaningless. CSW’s analysis of the provisions governing the debt of CPL,
7
SWEPCO and WTU was objective, thorough, detailed and painstaking. It involved
8
hundreds of hours of work by professionals on my staff, outside counsel, our
9
independent auditors and investment bankers. This effort led us to develop the two-
10
stage plan which we filed on January 10, 2000 as the most cost-efficient way to
11
accomplish restructuring. Nevertheless, CSW will continue to look for additional
12
ways to further lessen the refinancing costs associated with restructuring.
13
In her testimony, Dr. Szerszen suggests at page 9 that (a) the first mortgage
14
indentures of CPL, SWEPCO and WTU can be amended by a vote of holders of two
15
thirds of the outstanding bonds to permit transfer of the generation assets and the
16
T&D assets to separate subsidiaries and (b) obtaining such amendments will “most
17
likely be less costly” than the tender offer/defeasence options which I outlined in my
18
direct testimony.
19
Dr. Szerszen is correct in that many provisions in the first mortgage indentures
20
can be amended by a vote of holders of two-thirds of the outstanding bonds issued
21
under the indenture. However, there are exceptions to this provision and she has
22
apparently overlooked the further provisions of the first mortgage indentures which
REBUTTAL TESTIMONY
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WENDY G. HARGUS
1
state that certain amendments shall not be made without the consent of the holder or
2
registered owner of each outstanding bond (i.e. 100% approval) which would be
3
affected thereby. CSW considered the possibility of asking bondholders to consent to
4
the necessary amendments; however, after consulting with counsel, CSW concluded
5
that the proposed amendment necessary to permit transfer of the generation assets and
6
the T&D assets to separate subsidiaries would so affect the lien of the indenture and
7
the security it provides so as to be prohibited by the indenture without 100%
8
bondholder approval. At best, any attempt to effect such an amendment could result
9
in bitter opposition from sophisticated bondholders and protracted and expensive
10
litigation.
11
Also with respect to (a) above, in proposing her amendment to the indenture,
12
Dr. Szerszen has overlooked the covenants of the first mortgage indentures which
13
govern the transfer of substantially all assets of the issuer of the bonds. There is no
14
doubt, in fact or in the relevant case law, that the transfer of all of the T&D assets of
15
one of the existing operating companies to one of its affiliated companies and the
16
transfer of all of the generation assets of that same company to another of its affiliated
17
companies, all pursuant to the same plan of reorganization, would constitute a transfer
18
of substantially all assets of the issuer of the bonds. In that event, the mortgage
19
indenture clearly requires a single transferee of substantially all the assets of the issuer
20
to become the obligor on the bonds and to assume all obligations of the issuer under
21
the bonds and the mortgage indenture. Therefore, transfer of such assets to two
22
separate independently operated entities would breach the covenants of the first
REBUTTAL TESTIMONY
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WENDY G. HARGUS
1
mortgage indenture. Any attempt to effect such transfers or to amend the indentures
2
to permit such transfers could also result in bitter opposition from sophisticated
3
bondholders and protracted and expensive litigation.
4
With respect to (b) above, Dr. Szerszen cites no authority or precedent for her
5
assertion that securing such amendment would “likely be less costly” than the tender
6
offer/defeasance options. It is my belief, based on discussions with our advisers, that
7
any bondholders who might agree to the weakened security which would result from
8
Dr. Szerszen’s proposal would demand a significant payment to secure their consent
9
to an indenture amendment that would allow it. Any such payment could be well in
10
excess of the transaction costs of retiring the bonds by tender offer and defeasance.
11
And even if such an amendment were accomplished, the first mortgage bonds would
12
remain outstanding and the accompanying restrictive provisions of their indentures
13
would remain in force. To the cost of obtaining the consents of bondholders must be
14
added the likely significant litigation costs referred to above, the likelihood of lengthy
15
litigation and the inherent uncertainty of the outcome of any such litigation.
16
Moreover, as our financial advisers have told us, 100% consent to any amendment, at
17
any cost, is virtually impossible.
18
I believe Dr. Szerszen’s assertions about the ability to amend our first
19
mortgage indentures and the relative costs of so doing are both wrong and
20
impractical.
21
22
V. Anticipated Costs Are Unduly Burdensome
REBUTTAL TESTIMONY
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WENDY G. HARGUS
1
CSW and its electric operating subsidiaries have always been managed with a
2
view to operating in an efficient, low cost manner in order to maximize the return to
3
our investors and to provide our customers with low cost, high-quality electricity
4
services on which their prosperity and economic development are dependent. CSW’s
5
dedication to cost reduction will continue in the new competitive environment
6
resulting from implementation of SB-7.
7
The two-stage plan was prepared in order to minimize costs of refinancing of
8
significant amounts of debt and preferred securities of CPL, SWEPCO and WTU and
9
to preserve financing previously obtained, which is low-cost relative to current
10
markets, for the benefit of ratepayers and shareholders.
11
calculations between forced refinancing prior to January 1, 2002 and refinancing on
12
or before January 1, 2008 have been performed in a conservative, traditional and fair
13
manner. As I stated previously, they do not reflect the recent trend to higher interest
14
rates which may well increase the cost of forced refinancing by January 1, 2002. Nor
15
does the estimate take into consideration the market uncertainties involving the
16
refinancing of a very large amount of CPL, WTU and SWEPCO debt in the short time
17
frame between March 2000 and January 1, 2002, or the fact that such refinancing
18
would not relate to the traditional integrated utilities which issued the existing debt
19
but rather would be debt issued by companies which will own only T&D assets or
20
only generation assets. The estimate also does not take into account that forced
21
refinancing in the short time frame prior to January 1, 2002 lessens the ability to be
22
opportunistic in the timing of the refinancing in order to take advantage of lower
REBUTTAL TESTIMONY
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The cost differential
WENDY G. HARGUS
1
interest rates. All of this suggests that CSW’s best estimate of additional costs from
2
forced refinancing prior to January 1, 2002 is more than likely on the low side.
3
Nevertheless, whether the estimate is low, accurate or high, the additional
4
costs of refinancing by January 2002 are substantial and unduly burdensome.
5
Dr. Szerszen, using a $21.1 million additional cost figure, after inappropriately
6
carving out interest cost differentials, states that this amount is less than 6% of CPL’s
7
1998 net income and is 9.74% of SWEPCO’s and 6.63% of WTU’s 1998 net income.
8
Obviously CSW’s estimates, which it believes are more accurate and complete than
9
those of Dr. Szerszen, constitute a much higher percentage of our operating
10
companies’ net income.
Even at the lowest level of 6% of net income, CSW
11
considers costs of this magnitude to be very significant and unduly burdensome.
12
The cost savings inherent in the two stage plan have been characterized in the
13
position statement of certain intervenors and in Dr. Szerszen’s testimony as
14
acceptable trade offs for the enhanced competitive benefits to retail ratepayers which
15
would result from a mandated transfer of ownership of legal title to the T&D assets
16
and generation assets of CPL, SWEPCO and WTU to separate legal entities by
17
January 1, 2002. This characterization misrepresents the intent, purpose and effect of
18
CSW’s plan. The cost savings in our plan are not a trade off for a public detriment,
19
thereby inviting a value judgment by the Commission as to which is more worthy.
20
CSW has demonstrated that the two-stage plan produces only one result and that is
21
positive. It saves a very significant amount of unnecessary refinancing costs. It
22
produces no detriment to ratepayers; it does not jeopardize or delay the
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1
commencement of competitive retail electricity sales in the present service territories
2
of CPL, SWEPCO and WTU; it does not violate SB-7, the Code of Conduct or the
3
public policy of Texas nor the interests of retail electric customers in this state. It is
4
only and simply what it is - a means to save significant restructuring costs and to
5
prevent needless additions to the cost of operating the separate T&D and generation
6
businesses.
7
This concludes my rebuttal testimony.
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