S&P - Public Finance Criteria (2007). - The Global Clearinghouse

General Government UtilitiesService AreaAn analysis of a utility’s service area entails areview of its customer base and demographiccharacteristics.Standard & Poor’s examines each utility’s customerbase in terms of total number of customersand the number of customers by class. Revenues,kWh sales, margins and load factors are examinedfor each customer class and for the largest customers.The terms and time frames of any longtermcontracts negotiated with industrial andcommercial customers are also examined. Load factorsand unit costs charged to key industrial customersare particularly important because theydemonstrate the attractiveness of these customers toother suppliers or the opportunity for self-generation,and the potential for lost revenues. Large customers’supply options and cogenerationcapabilities are important to ascertain potential systemexposure. Also factored into the analysis of thecustomer base is an evaluation income levels todetermine the relative affordability of rates.The service areas of rural areas are sparsely populatedwith few customers per line mile, whichreduces the risk that a competing utility will cherrypick its most attractive customers. Yet, these serviceareas also limit the opportunities for revenuegrowth, and tend to increase capital investment andservice costs per unit of sales.Historically, Standard & Poor’s examined anelectric utility’s service area economy as a proxy forthe stability of the revenue stream pledged to repaythe utility’s debt. While economic analysis remainsa major focus, it can be tempered by the influenceof competitive factors.Favorable market characteristics include:■ Load factors for the system and leading customersthat do not make the system particularlyvulnerable to competitive factors;■ Stable or increasing population trends, in accordancewith other forecasts for the utility; and■ High wealth indicators relative to cost-of-livingindices and the level of electric rates.RegulationStandard & Poor’s assessment of regulationencompasses several regulatory factors. Theseinclude the impact of federal, state, or local regulatorswith regard to ratemaking, competition, transmission,and the environment. The impact of theregulatory framework will come into play amongseveral rating factors, particularly operational andfinancial factors.In terms of restructuring of electric markets,Standard & Poor’s believes that the movementtoward a more openly competitive environment ispossible over the long term, and would most likelyoccur on a state-by-state basis, as opposed to viafederal pre-emption. Standard & Poor’s recognizesthat many utilities will find that open markets willcreate opportunities, and also risks. Generally, however,public power utilities in regulatory environmentsthat do not require them to face directcompetitive threats from other power suppliers aresubject to less credit risk.FinancesA traditional analysis of a utility’s financial performanceincorporates a review of debt service coveragemargins and liquidity, but also examinesspecific utility results and decisions. For example,some utilities are emphasizing competitiveness overthe financial strength associated with excess coveragemargins and debt service reserves, in an attemptto ensure long-term system viability. Standard &Poor’s incorporates the effects of such policychanges and the potential diminution of financialcushions into its credit ratings. Standard & Poor’swill assess the costs of achieving competitivenessand the impact of competitiveness upon financialintegrity and system reliability. Reduced coverageand reserves may be appropriate for some utilitiesbut not for others, depending upon the degree towhich competitiveness can be enhanced and alsothe operational and competitive challenges thateach utility faces.Key financial ratios include debt service coverage,and fixed charge coverage; unrestricted cash as apercentage of total expenditures; and debt to equity,among others. While debt service coverage is a traditionalfinancial metric for municipal utilities, it iscommon for municipal electric systems to structuretheir operations using off-balance sheet debt forgeneration projects, and purchased power agreementsthat have debt-like characteristics. As such,fixed charge coverage, which imputes fixed paymentsassociated with power and transmission purchases,whether through debt service or capacitypayments tied to purchase contracts, is the morecritical coverage ratio in the financial analysis ofpublic power utilities. Transfers to other governments,while often expressly subordinate, are factoredinto the analysis as operating andmaintenance expenses that reduce available net revenues,since such transfers typically resemble propertytaxes, franchise fees, direct costreimbursements, dividend, or return-on-equity typepayments commonly paid by other enterprises suchas investor-owned utilities, and are assumed torecur annually.The balance sheet has become a key tool for controllingcosts and achieving competitiveness. Assetto-liabilitymanagement is particularly important124 Standard & Poor’s Public Finance Criteria 2007