APSC FILED Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56
BEFORE THE ARKANSAS PUBLIC SERVICE COMMISSION
IN THE MATTER OF THE APPLICATION ) OF ENTERGY ARKANSAS, INC. FOR ) DOCKET NO. 15-015-U APPROVAL OF CHANGES IN RATES FOR ) RETAIL ELECTRIC SERVICE )
DIRECT TESTIMONY
OF
ELLEN LAPSON
PRINCIPAL, LAPSON ADVISORY
ON BEHALF OF
ENTERGY ARKANSAS, INC.
APRIL 24, 2015
1 Entergy Arkansas,APSC FILEDInc. Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56 Direct Testimony of Ellen Lapson Docket No. 15-015-U
1 I. INTRODUCTION AND BACKGROUND
2 Q. PLEASE STATE YOUR NAME, OCCUPATION, AND BUSINESS
3 ADDRESS.
4 A. My name is Ellen Lapson, and I am the founder and Principal with Lapson
5 Advisory. My business address is 370 Riverside Drive, New York, New
6 York 10025.
7
8 Q. ON WHOSE BEHALF ARE YOU TESTIFYING?
9 A. I am providing this direct testimony to the Arkansas Public Service
10 Commission (“APSC” or the “Commission”) on behalf of Entergy
11 Arkansas, Inc. (“EAI” or the “Company”).
12
13 Q. BRIEFLY DESCRIBE YOUR EDUCATIONAL AND PROFESSIONAL
14 BACKGROUND.
15 A. I graduated from Barnard College in 1969 earning a Bachelor of Arts
16 degree in English. I earned a Masters degree in Business Administration
17 with a concentration in Accounting from New York University’s Stern
18 School of Business in 1975. In 1978 I qualified as a Chartered Financial
19 Analyst (“CFA”), and I am a member of the CFA Institute. I began my
20 career in the financial markets as an equity analyst for five years at Argus
21 Research Corporation analyzing utility equity. For the next 20 years I held
22 several posts at Chemical Bank and Chemical Securities (now J.P.
23 Morgan Chase) as a corporate banker and an investment banker
2 Entergy Arkansas,APSC FILEDInc. Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56 Direct Testimony of Ellen Lapson Docket No. 15-015-U
1 structuring and executing financial transactions for utility and infrastructure
2 companies. Thereafter, I spent 17 years first as a senior director and then
3 as a managing director at Fitch Research. I managed analysts who rated
4 credits in the sectors of electricity and natural gas and project finance, and
5 on behalf of Fitch I communicated with bankers and investors in utility
6 securities. A little over three years ago I founded Lapson Advisory, and I
7 provide consulting services on matters that involve financing utilities and
8 infrastructure projects.
9
10 Q. HAVE YOU PREVIOUSLY TESTIFIED AS AN EXPERT WITNESS
11 BEFORE THIS COMMISSION OR ANY OTHER REGULATORY
12 COMMISSION?
13 A. Yes. I submitted written testimony before this Commission on behalf of
14 EAI in the rehearing of Docket No. 13-028-U. A list of the proceedings in
15 which I have testified or am currently a witness is included in
16 EAI Direct Exhibit EL-1, along with information about my professional
17 credentials and experience in the investment community.
18
19 Q. WHAT IS THE PURPOSE OF YOUR DIRECT TESTIMONY?
20 A. I address investment analysts’ view of the financial standing of EAI. As
21 discussed in the direct testimony of EAI President and Chief Executive
22 Officer Hugh T. McDonald, the Arkansas General Assembly recently
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1 enacted Act 725 of 2015 (“Act 725” or the “Act”), which prescribes certain
2 categories of evidence that may be presented by the Company and other
3 parties, and considered by the Commission, in support of a recommended
4 rate of return on common equity (“ROE”): 5 6 (1) The basis for the requested return on common equity, including 7 quantitative analysis based on widely accepted methodologies, 8 current market data, qualitative discussion, and analysis of 9 factors that influence the requested return on common equity; 10 11 (2) Evidence that the requested return on common equity is 12 comparable to values that have recently been approved for 13 public utilities that are delivering similar services with 14 corresponding risks within this state and in other similar 15 regulatory jurisdictions in the same general part of the country. 16 17 (3) Evidence of the financial, business, and other risks faced by the 18 utility, including regulatory oversight, numbers and types of 19 customers, rate mechanisms, cost allocation methods, rate 20 levels, rate design, reliability, and quality of service, as 21 compared to those faced by utilities delivering similar services 22 within this state and in other similar regulatory jurisdictions in 23 the same general part of the country; and 24 25 (4) Any other information, including without limitation: 26 (A) Macroeconomic data; 27 (B) Relevant commentary from ratings agencies and 28 investment analysts; 29 (C) Independent analysis of utility industry trends; 30 (D) Customer impact; and 31 (E) Any other relevant information. 1
32 Consistent with the Act, which recognizes that financial stability of the
33 utility is in the public interest, my testimony and analysis includes the
34 second, third and fourth categories of evidence set forth in Act 725. In his
1 Ark. Code Ann. § 23-4-410.
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1 direct testimony, Company witness Bruce H. Fairchild presents evidence
2 consistent with the first and second categories.
3 I first offer analysis and draw conclusions from several investment
4 analyst and rating agency reports that reacted unfavorably to the
5 combined effect of Order No. 21 in APSC Docket No. 13-028-U (“Order
6 No. 21”) on EAI’s financial strength, including the unusually low allowed
7 ROE as well as regulatory accounting methods, disallowances, and
8 adjustments that weakened EAI’s operating cash flow. In addition to the
9 reactions to the ROE granted in Order No. 21, I also discuss subsequent
10 reactions to Order No. 35 in APSC Docket No. 13-028-U issued
11 August 15, 2014 on rehearing (“Order No. 35”),2 and to the cumulative
12 effect of Order Nos. 21 and 35, which are adversely affecting EAI’s ability
13 to earn the APSC-determined ROE and to produce the cash flow needed
14 to maintain and improve EAI’s financial integrity during a period of high
15 capital expenditures on needed electric infrastructure.
16
17 Q. HOW IS YOUR TESTIMONY STRUCTURED?
18 A. After this introductory section, the remaining sections are as follows: 19 20 II. Summary of Key Points 21 III. Reaction of the Investment Community to APSC Order Nos. 21 and 35 22 IV. Economic and Capital Market Conditions 23 V. ROE Decisions in State Jurisdictions 24 VI. Conclusions
2 The APSC amended its Order No. 21 and raised EAI’s allowed ROE from 9.3 percent to 9.5 percent.
5 Entergy Arkansas,APSC FILEDInc. Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56 Direct Testimony of Ellen Lapson Docket No. 15-015-U
1
2 II. SUMMARY OF KEY POINTS
3 Q. PLEASE SUMMARIZE THE KEY POINTS OF YOUR TESTIMONY.
4 A. My testimony will demonstrate:
5 x The unusually low allowed ROE of 9.3 percent set in Order No.
6 21, even as modified to 9.5 percent by Order No. 35, together
7 with the pre-Act 725 methods of applying the Allowance for
8 Funds Used During Construction (“AFUDC”) and with other cost
9 disallowances, has undermined the confidence of investors and
10 credit rating agencies and has jeopardized EAI’s ability to attract
11 investment capital on reasonable terms relative to similar
12 utilities.
13 x Investors compare the ROEs authorized by the APSC versus
14 those authorized in other state jurisdictions, both nationally and
15 especially in comparison with neighboring regional utilities in
16 similar jurisdictions. Notwithstanding the increase in the ROE
17 after rehearing to 9.5 percent, EAI’s authorized ROE is at the
18 very low end relative to those of regional and national integrated
19 electric utilities.
20 x Order No. 21 affected the credit rating of EAI’s debt by Moody’s
21 Investors Service (“Moody’s”), lowering EAI’s ranking relative to
22 its peer utilities. Moody’s decision not to upgrade EAI at the
23 same time that it upgraded 143 other U.S. utilities, including four
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1 other Entergy Operating Companies,3 occurred promptly after
2 the APSC issued Order No. 21 in December 2013, and Moody’s
3 cited to less than favorable rate case outcomes in both
4 December 2013 and May 2010 and the Commission’s
5 “challenging regulatory environment.”4 Aside from the Moody’s
6 action, several investment analysts published critical reports
7 citing Order No. 21.
8 x To the investment public, Moody’s action was effectively a credit
9 rating downgrade for EAI relative to the aggregate of the U.S.
10 investor-owned utility sector.
11 x The subsequent modification of the ROE in Order No. 35 to 9.5
12 percent from 9.3 percent did not materially alter the views of
13 credit rating agencies or the investment community.
14 x The impact of Order No. 21, notwithstanding its modification by
15 Order No. 35, has deprived EAI of operating cash flow that is
16 needed to compensate investors for their full investment in vital
17 assets.
18 x Weak operating cash flow continues as a barrier that prevents
19 EAI from qualifying for an upgrade to its credit rating to match
20 the ratings of its affiliated Entergy operating companies and
3 The Entergy Operating Companies include EAI; Entergy Gulf States Louisiana, L.L.C. (“EGSL”); Entergy Louisiana, LLC (“ELL”); Entergy Mississippi, Inc. (“EMI”); Entergy New Orleans, Inc. (“ENOI”); and Entergy Texas, Inc. (“ETI”). 4 EAI Direct Exhibit EL-2 at 2.
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1 regional peer utilities. While EAI’s cash flow financial measures
2 seem to have stabilized, they are not as robust as those of
3 regional peer utilities. EAI’s relatively weaker cash flow and
4 financial performance will make it more costly for EAI to finance
5 its heavy capital expenditure program over the next several
6 years to the detriment of EAI’s customers, and could become
7 problematic in the future if or when the credit market becomes
8 constrained, as happens in the credit market cycle.
9 x Sound credit quality and open access to the financial market on
10 reasonable terms will provide important benefits to EAI’s
11 customers with respect to the significant capital investment EAI
12 faces.
13
14 III. REACTIONS OF THE INVESTMENT COMMUNITY TO ORDER NOS. 21
15 AND 35
16 Q. PLEASE SUMMARIZE THE MOODY’S REPORT DATED JANUARY 31,
17 2014 (“MOODY’S REPORT”).
18 A. The summary of the Moody’s Report, which is attached in its entirety as
19 EAI Direct Exhibit EL-2, stated that Moody’s evaluation of the U.S. public
20 utility regulatory environment and the opportunity for timely recovery of a
21 utility’s costs has evolved to an extent that would justify an upgrade by
22 one notch applied to most U.S. rate regulated utilities.
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1 Our revised view that the regulatory environment and timely 2 recovery of costs is in most cases more reliable than we 3 previously believed is expected to lead to a one notch 4 upgrade of most regulated utilities in the US, with some 5 exceptions.5
6 Moody’s would utilize a new set of “Low Business Risk” (“LBR”)
7 benchmarks that are meaningfully more leveraged and less stringent than
8 its Standard cash flow financial ratios.6 Under the new methodology,
9 utilities that Moody’s deemed to have Low Business Risk (i.e., relatively
10 stable operating cash flow) would be measured against a more permissive
11 yardstick.
12
13 Q. WHAT WAS THE OUTCOME OF MOODY’S DELIBERATIONS FOR
14 RATINGS OF THE UTILITY SECTOR AND FOR EAI?
15 A. On January 31, 2014, Moody’s upgraded by one notch the ratings of 143
16 out of 164 U.S. investor-owned utilities in the electric and gas sector that
17 were on review for upgrade, or 87 percent of the companies reviewed. Of
18 the Entergy Operating Companies under consideration, the ratings of four
19 were upgraded as predicted, but not the rating of EAI; it was affirmed at its
20 original rating, and its rating outlook was listed as ‘Stable.’
21 The impact on EAI of the Moody’s action was an effective credit
22 rating downgrade relative to its utility sector peers. While the rating of EAI
5 Id. 6 “Rating Methodology, Regulated Electricand Gas,”” Moody’sInvestors Serviceat 24-25 (December 23, 2013). https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_157160
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1 was not downgraded, its relative credit position within its sector was
2 lowered. Figure 1 and Tables 1 and 2 below summarize Moody’s
3 corporate credit ratings of 188 companies in the U.S. corporate utility
4 sector on January 28, 2014 (before Moody’s carried out the mass
5 upgrades) and on February 1, 2014 (immediately after the mass
6 upgrades). The source of data for the chart and figures is
7 EAI Direct Exhibit EL-3, attached to my direct testimony.
8
9 Figure 1 U.S. Utility Sector Issuer Ratings versus EAI’s Baa2 Issuer Rating
80%
70%
60%
50%
40%
30%
20%
10%
0% Jan. 28 2014 Feb 1 2014
Higher than Baa2 Baa2 or lower 10
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1 Table 1 Moody’s Issuer Ratings of 188 U.S. Utilities
Issuer Rating Jan. 28, 2014 Feb 1, 2014 Aa2 0 1 Aa3 1 1 A1 2 15 A2 15 28 A3 32 40 Baa1 43 54 Baa2 (EAI's rating) 61 32 Baa3 29 16 Below Baa3 5 1 Issuer Ratings 188 188
2
3 Table 2 Baa2 Rating of EAI Relative to Ratings of 188 U.S. Utilities
Jan. 28, 2014 Feb 1, 2014 Higher than Baa2 50% 75% Same as EAI (Baa2) 32% 17% Lower than Baa2 18% 9% 100% 100% Sources for Figure 1 and Tables 1 and 2: Moody’s Investors Service and EAI Direct Exhibit EL-3.
4
5 On January 28, 2014 the number of utilities with Moody’s corporate credit
6 ratings lower than EAI was 34 (18 percent); the number of utilities with the
7 same corporate credit rating as EAI was 61 (32 percent); and the number
8 of utilities with ratings higher than EAI was 93 (50 percent). On
9 February 1, 2014, after Moody’s rating actions, there were only 17 (9
10 percent) utilities rated lower than EAI, 32 (17 percent) utilities rated the
11 same as EAI, and 139 (75 percent) utilities rated higher than EAI.
11 Entergy Arkansas,APSC FILEDInc. Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56 Direct Testimony of Ellen Lapson Docket No. 15-015-U
1 It is quite clear that EAI’s credit ranking suffered erosion relative to
2 the Moody’s ratings of the entire set of its peer companies in the U.S.
3 electric and gas utility sector. By failing to receive an upgrade, EAI’s
4 credit position relative to peer companies moved from the bottom half of
5 the group to the bottom quarter. This is a meaningful difference in the
6 financial marketplace.
7
8 Q. WHAT EXPLANATION DID MOODY’S GIVE FOR ITS DECISION TO
9 LEAVE EAI’S RATING UNCHANGED WHEN IT UPGRADED 143 U.S.
10 UTILITY-SECTOR COMPANIES, INCLUDING FOUR OF EAI’S
11 AFFILIATES?
12 A. Moody’s noted the historically “relatively challenging regulatory
13 environment” and explained that its rating decision reflected the
14 “disappointing” outcome of EAI’s December 2013 rate order and
15 ratemaking procedures such as historic test periods and traditional rate
16 cases instead of riders or adjustment mechanisms, all of which give rise to
17 cash flow shortfalls that Moody’s characterizes as “regulatory lag.”
18 Moody's confirmed the ratings of Entergy Arkansas based on 19 the less than favorable rate case outcomes in May 2010 and 20 December 2013. Arkansas operates under traditional rate of 21 return regulation rather than the more credit supportive 22 formula rate plans in place in Louisiana and Mississippi, 23 where Entergy's other large subsidiaries operate. The rate 24 of return regulation contributes to regulatory lag at Entergy 25 Arkansas (EA)….7
7 EAI Direct Exhibit EL-2 at 2.
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1
2 Q. WHY IS A CASH FLOW SHORTFALL SUCH AN IMPORTANT FACTOR
3 IN MOODY’S RATING?
4 A. Moody’s emphasizes operating cash flow as the bedrock of a
5 corporation’s sustainability and financial strength. The financial
6 benchmarks that Moody’s uses to evaluate companies are largely
7 operating cash flow ratios, such as the ratio of operating cash flow to debt,
8 which is a way of measuring financial leverage. EAI incurs debt to build or
9 enhance its electric network and generating fleet. Companies need to
10 have adequate operating cash flow to pay interest and repay principal on
11 debt and to provide a financial cushion for contingencies. The Moody’s
12 Report is critical of any ratemaking methods, regulatory procedures or
13 disallowances that prevent EAI from receiving full or timely cash flow
14 recovery of its costs of doing business, including the cost of capital.
15 In its January 31, 2014 report, Moody said the following about EAI’s
16 operating cash flow:
17 Entergy Arkansas' rating outlook is stable, reflecting Moody's 18 expectation that the utility's financial metrics will maintain 19 levels that are appropriate for its rating despite the 20 company's disappointing rate case outcomes. The outlook 21 also assumes that regulatory lag will remain manageable 22 and that the issues surrounding the company's exit from the 23 Entergy System Agreement will be resolved in a manner not 24 detrimental to credit quality. According to Moody's adjusted 25 projections, EA will likely be able to maintain appropriate
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1 metrics for the rating, including CFO pre-WC to debt,8 and 2 CFO pre-WC - Div to debt9 of around 16% and 14% 3 respectively.
4 To clarify what factors going forward could cause Moody’s to change EAI’s
5 ratings either upward or downward, Moody’s stated that EAI’s operating
6 cash flow ratios for 2012 and 2013 are unacceptably weak, and these
7 cash flow ratios constitute key indicators of a supportive or unsupportive
8 regulatory environment in Arkansas:
9 The ratings of Entergy Arkansas could be upgraded if there 10 were an improvement in the credit supportiveness of the 11 regulatory environment in Arkansas, along with a sustainable 12 increase in cash flow coverage metrics, including CFO pre- 13 WC to debt above 22%....
14 The ratings of Entergy Arkansas could be downgraded if 15 there were continuous adverse regulatory developments, if 16 there were a termination or any changes to the utility's rate 17 riders that would prevent full and timely recovery of prudently 18 incurred costs, or if there is not an improvement in cash flow 19 coverage metrics from unusually low 2012 and 2013 levels, 20 including CFO pre-WC to debt below 15% for an extended 21 period.
22
23 Q. SO FAR YOU HAVE FOCUSED ON RATINGS OF EAI BY MOODY’S
24 INVESTORS SERVICE. CAN YOU COMMENT ON EAI’S RATINGS
25 FROM STANDARD & POOR’S (S&P)?
26 A. S&P’s issuer ratings for EAI are BBB, equivalent to the Moody’s rating of
27 Baa2, and have been at that same rating level for a number of years. To
8 That is, the ratio of Operating Cash Flow before changes in Working Capital divided by total Debt. 9 That is, the ratio of Operating Cash Flow before changes in Working Capital less Dividends divided by total Debt.
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1 put that in perspective, the Edison Electric Institute reported that as of the
2 end of the third quarter of 2014, S&P rated 55 percent of Regulated and
3 Mostly Regulated U.S. utilities with issuer ratings higher than BBB, 35
4 percent were rated BBB, and 10 percent were rated lower than BBB.10 In
5 other words, more than half of the U.S. investor-owned utility sector is
6 more highly rated.
7 When considering multi-utility holding companies, such as Entergy
8 Corp. and its Operating Companies, investors generally place greater
9 weight upon the Moody’s ratings because the Moody’s ratings provide
10 more detail and depth about the individual business and financial
11 strengths or weaknesses of an operating subsidiary than do the S&P
12 ratings of subsidiary companies. This is an outgrowth of S&P’s use of a
13 credit method called the S&P Consolidated Rating Methodology that
14 determines a single consolidated rating for all the companies within a
15 group and applies that unified rating to all the companies in the group. By
16 contrast, Moody’s develops more individualized ratings of each operating
17 subsidiary, subject to some constraint if the parent is substantially more
18 highly leveraged or financially weaker than its operating subsidiary. In the
19 case of EAI and the other Operating Companies, the Moody’s ratings vary
20 depending upon a specific assessment of each company, whereas the
10 Back-Up Support on Credit Ratings, from Edison Electric Institute’s Third-quarter 2014 “Analysis of Credit Ratings” at: http://www.eei.org/resourcesandmedia/industrydataanalysis/industryfinancialanalysis/QtrlyFinanci alUpdates/Pages/default.aspx
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1 S&P ratings of the Entergy Operating Companies are converged at a
2 rating of BBB that represents the whole group. This can be seen in
3 EAI Direct Exhibit EL-11 attached to my testimony, which compares
4 Moody’s and S&P ratings for a regional group of companies that includes
5 most of the affiliated Entergy Operating Companies.
6
7 Q. WHAT ARE THE KEY ELEMENTS OF ORDER NO. 21 AS MODIFIED BY
8 ORDER NO. 35 THAT CREATED CONCERNS IN THE INVESTMENT
9 COMMUNITY OVER EAI’S FINANCIAL STRENGTH AND OPERATING
10 CASH FLOW?
11 A. The ROE determination and the below-cost approach to AFUDC, along
12 with other disallowances described in the Deutsche Bank report attached
13 and discussed below, are determinants of EAI’s operating cash flow,
14 which is an important element in the ratings process of Moody’s and other
15 agencies, and to the investment analysis of bondholders. Equity investors
16 noted the low authorized ROE relative to its peers and inadequate cost
17 recovery mechanisms.
18
19 Q. IS THERE EVIDENCE ASIDE FROM THE MOODY’S ACTION AND
20 COMMENTARY THAT INVESTMENT ANALYSTS VIEWED THE ORDER
21 UNFAVORABLY?
22 A. Yes. Several prominent securities analysts published reports that were
23 critical of Order No. 21. Excerpts of these reports follow, and the full 16 Entergy Arkansas,APSC FILEDInc. Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56 Direct Testimony of Ellen Lapson Docket No. 15-015-U
1 reports are attached as EAI Direct Exhibits EL-4, EL-5, EL-6, and EL-7.11
2 Deutsche Bank’s utility equity analytical team commented in its January 3,
3 2014 report:
4 We viewed the order negatively for ETR [Entergy Corp.], 5 particularly since the commission has recommended 6 additional cost disallowances versus Staff’s recommendation 7 and a lower ROE. In the order, the PSC has directed Staff 8 to file an updated revenue deficiency as compared to Staff’s 9 most recent $110M recommendation based on an ROE of 10 9.3% vs. the 9.6% ROE recommended by Staff and cost 11 disallowances totaling about $15M related to incentive 12 compensation.12
13 UBS reported on January 6, 2014 its unfavorable view of Order No. 21:
14 We read the decision negatively vs. our expectations. Vs. 15 the 9.8% normalized ROE posted in 2012, we see the 16 potential for a revenue reduction, or more importantly a 17 relatively flat net income profile.13
18 An analytical report published by International Strategy and Investment
19 Group, LLC on January 3, 2014 highlighted the fact that the ROE
20 determination was not only below EAI’s requested return but was even
21 below the APSC General Staff’s (“Staff”) recommended ROE, and also
22 pointed out that the ratio of equity to total capital allowed was below both
23 the EAI request and the Staff recommendation.14
11 All four reports are available on a subscription-only basis and, as such, are provided in their entirety as confidential documents pursuant to the conditions of Interim Protective Order No. 1 in this Docket. 12 EAI Direct Exhibit EL-4 at 7. 13 EAI Direct Exhibit EL-5 at 2. 14 EAI Direct Exhibit EL-6 at 1.
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1 Credit Suisse’s January 2, 2014 report pointed out that EAI, an
2 integrated electric utility subject to Arkansas regulation, bears greater risk
3 than a delivery-only utility in New York State, but was awarded the same
4 low ROE as Consolidated Edison Co. of NY:
5 We think the low allowed ROE in Arkansas (where there is 6 more risk than in NY at the same ROE) will sustain 7 questions about the supportiveness of ETR’s [Entergy 8 Corp.’s] states and the ability for ETR to execute on the 9 utility growth strategy.15
10
11 Q. DEUTSCHE BANK NOTED THAT IT VIEWED ORDER NO. 21
12 NEGATIVELY BECAUSE OF ADDITIONAL COST DISALLOWANCES
13 AND THE LOWER ROE.16 WHAT IS THE RELATIONSHIP BETWEEN
14 THE ADDITIONAL COST DISALLOWANCES AND ROE?
15 A. Deutsche Bank and other investors look at both allowed ROE and the
16 ability of a utility to earn the allowed ROE in the context of other regulatory
17 adjustments in a rate order such as cost disallowances. EAI calculated
18 that its earned ROE would be 8.09 percent instead of the 9.3 percent
19 allowed based on the decision in Order No. 21.17
20 Investors make their own calculations about the return that EAI will
21 actually earn, and given all the regulatory disallowances in Docket No.
22 13-028-U, investors likely lowered their expectations of the Company’s
15 EAI Direct Exhibit EL-7 at 1. 16 EAI Direct Exhibit EL-4 at 7. 17 Docket No. 13-028-U, EAI’s Petition for Rehearing and Clarification at 63 (January 29, 2014).
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1 future results even below the already disappointing allowed ROE.
2
3 Q. IN YOUR VIEW, WHAT WAS THE EFFECT OF THE POST-ORDER
4 NO. 21 ANALYTICAL REPORTS DISCUSSED ABOVE?
5 A. These reports are authored by several of the most highly regarded and
6 influential equity analysts in the financial community. Their publications
7 are widely read by institutional investors and are influential in the equity
8 investment community, as are Moody’s credit reports in the debt market.
9 These equity analysts’ reports would cause the reasonable investor to
10 place a higher discount rate on Entergy Corporation’s equity because of
11 the perception of greater regulatory risk relating to investment in EAI.
12
13 Q. WHAT WAS THE REACTION OF THE FINANCIAL COMMUNITY AFTER
14 THE APSC ISSUED ORDER NO. 35, MODIFYING ITS INITIAL ROE
15 DETERMINATION FROM 9.3 PERCENT TO 9.5 PERCENT?
16 A. Order No. 35 was commented upon in Moody’s updated credit analysis of
17 EAI on October 14, 2014. Moody’s reaffirmed its issuer credit rating of
18 Baa2, which it designates as “Stable’ and identified a “Restrictive
19 regulatory environment with equity returns below prevailing industry
20 averages, a credit negative,” as a leading “Rating Driver.”18 The Moody’s
18 The Moody’s Investors Service credit opinion is attached as EAI Direct Exhibit EL-8.
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1 report summarizes its underlying credit rationale and the APSC regulatory
2 environment as follows:
3 SUMMARY RATING RATIONALE 4 EA's Baa2 rating reflects a regulated utility operating under a 5 traditional rate of return regulation structure, which is more 6 restrictive than regional peers and has authorized equity 7 returns below industry averages. The utility exhibits cash 8 flow metrics that are steady in the high-teen's range, and has 9 a service territory with balanced exposure to industrial and 10 commercial sales. 11 12 Arkansas regulation is generally restrictive from an investor 13 perspective. EA operates under the traditional rate of return 14 regulation rather than the more credit supportive formula rate 15 plans in place at ETR's other regulated subsidiaries in 16 Louisiana and Mississippi, which contributes to regulatory 17 lag at EAI…
18 Regarding the 2014 ROE rehearing and the outcome of Order No. 35, the
19 report states:
20 EA requested a rehearing from the commission in February 21 2014, which was granted. The APSC issued an amended 22 order increasing the ROE from 9.3% to 9.5% in August 23 2014. Nevertheless, this process highlights the below 24 average regulatory environment for EA, resulting in a less 25 timely suite of recovery mechanisms and below average 26 returns.
27 Favorably, the report states that EAI’s cash flow ratios have been stable
28 and that the cash flow metrics are satisfactory to support the current level
29 of ratings. Finally, to clarify what could cause Moody’s to raise or lower
30 the credit rating from the current level, the report states:
20 Entergy Arkansas,APSC FILEDInc. Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56 Direct Testimony of Ellen Lapson Docket No. 15-015-U
1 What Could Change the Rating - Up 2 Unless there are significant improvements in the regulatory 3 framework and improvements in the utility's interaction in the 4 regulatory process, a rating upgrade is unlikely. However if 5 there is a material improvement in the Arkansas' regulatory 6 structure, along with a sustainable increase in cash flow 7 coverage metrics, including CFO pre-working capital to debt 8 above 22% and CFO pre WC less dividends to debt in the 9 high teens, an upgrade could be 10 considered.
11 What Could Change the Rating - Down 12 EA's rating could be downgraded if there were a series of 13 adverse regulatory developments which cause key financial 14 metrics to decline, including CFO pre WC to debt below the 15 mid-teens for a sustainable period of time.
16 In summary, Moody’s October 14, 2014 credit opinion identifies a
17 restrictive regulatory environment in Arkansas as a continuing factor that
18 restricts EAI’s ratings and causes Moody’s to rate EAI’s debt at a lower
19 rating than some other Entergy utility operating affiliates.
20
21 Q. DOES EAI CONTINUE TO BEAR WEAKER CREDIT RATINGS THAN
22 THE MAJORITY OF THE U.S. UTILITY SECTOR?
23 A. Yes. In Figure 2 below, I have added two bars to show Moody’s ratings of
24 the U.S. utility sector as of March 23, 2015. The unfavorable relationship
25 of EAI’s ratings relative to the rest of the investor-owned utility sector
26 persists. Currently 77 percent of 185 Moody’s issuer credit ratings of U.S
27 utilities are higher than EAI’s credit rating.
21 Entergy Arkansas,APSC FILEDInc. Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56 Direct Testimony of Ellen Lapson Docket No. 15-015-U
1 Figure 2 U.S. Utility Sector Ratings vs. EAI’s Rating, March 2015
Moody's Utility Long-Term Issuer Ratings 90%
80%
70%
60%
50%
40%
30%
20%
10%
0% Jan. 28 2014 Feb 1 2014 March 23, 2015
Higher than Baa2 Baa2 or lower
2 Source: Summary of EAI Direct Exhibit EL- 3.
3
4 Q. YOU DISCUSSED REGULATORY LAG AND CASH FLOW
5 SHORTFALLS AS CAUSES OF THE INVESTMENT COMMUNITY’S AND
6 RATING AGENCIES’ OPINION OF EAI. DO YOU FORESEE ANY
7 CHANGES AS A RESULT OF NEW REGULATORY MECHANISMS
8 PERMITTED UNDER ACT 725?
9 A. EAI is providing notice as part of this rate case that it elects to be
10 regulated under a Formula Rate Plan (“FRP”) pursuant to the Act. As
22 Entergy Arkansas,APSC FILEDInc. Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56 Direct Testimony of Ellen Lapson Docket No. 15-015-U
1 Company witness Jay A. Lewis explains, the Company’s proposed FRP
2 will allow for more stable rate adjustments both up and down as specified
3 cost factors change, without the delays and procedural burdens and
4 uncertainties of the traditional rate-making process. Implementation of an
5 FRP consistent with the Act and EAI’s proposal would improve the
6 likelihood that EAI can earn its authorized return, with fewer variations and
7 short-falls than in the past, and without exceeding the authorized return.
8
9 Q. WILL THE PROPOSED FRP MECHANISM ENHANCE EAI’S CREDIT
10 RATINGS AND THE VIEWS OF INVESTMENT ANALYSTS?
11 A. With an FRP mechanism that is functioning as planned to reduce
12 regulatory lag, EAI would actually earn ROEs closer to the authorized
13 ROE and it would have somewhat strong cash flow ratios (such as the
14 ratio of operating cash flow to debt). That in turn would materially improve
15 the assessment of EAI and of the Arkansas regulatory environment by the
16 investment community. In particular, it should be a strong influence on
17 credit ratings of EAI by Moody’s in its explanation of “What Could Change
18 the Rating – Up” in EAI Direct Exhibit EL-8 and quoted above.
19 Standard & Poor’s recently raised its credit outlook for Entergy
20 Corporation and all the subsidiaries in the Entergy Corporation
21 consolidated group from Stable to Positive based on its assessment of the
22 FRP and other features of the Act that should enhance EAI’s opportunity
23 Entergy Arkansas,APSC FILEDInc. Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56 Direct Testimony of Ellen Lapson Docket No. 15-015-U
1 to earn its allowed return and improve its cash flow measures. They
2 described the rationale for their action as follows:
3 Rationale 4 We base the positive outlook on management's increased 5 focus on managing regulatory risk, which could strengthen 6 the company's business risk profile and may lead to a one- 7 notch upgrade over the next 24 months. The Arkansas Act 8 725, which will allow for formula rates, is indicative of the 9 company's increased focus on managing regulatory risk, 10 which should reduce regulatory lag, allowing the company to 11 earn its allowed return on equity.19
12 Further evidence that the authorization of EAI’s proposed FRP really
13 would improve EAI’s credit ratings in addition to investor sentiment is
14 provided by Moody’s announcement on April 7, 2015 that it upgraded the
15 issuer credit rating of Ameren Illinois to A3 from Baa1 based upon the
16 state’s extension to 2019 of a formula rate plan for infrastructure
17 investments. Moody’s explained its rating action as follows:
18 The upgrade of Ameren Illinois is primarily driven by the 19 improved regulatory environment in Illinois, which is now 20 more credit supportive of investor-owned T&D utilities. 21 Specifically, the extension of the sunset review of the Energy 22 Infrastructure Modernization Act (EIMA) until the end of 2019 23 will continue to provide Ameren Illinois a visible path for 24 infrastructure-related capital investments and cost recovery 25 over the next five years. "Not only does the current formula 26 ratemaking mechanism provide clarity for investment cost 27 recovery and improved transparency in cash flows for 28 Ameren Illinois," said Jairo Chung, Analyst, "but it also 29 significantly reduces contentiousness around rate cases." 20
19 Standard & Poor’s Ratings Services, RatingsDirect, “Entergy Corp. on Improved Regulatory Risk Management; Outlook Raised to Positive from Stable; Ratings Affirmed”, March 31, 2015. 20 Moody’s Investors Service, “Rating Action: Moody’s Upgrades Ameren Corp. and Ameren Illinois; Affirms Union Electric; Outlooks Stable”, April 7,2015.
24 Entergy Arkansas,APSC FILEDInc. Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56 Direct Testimony of Ellen Lapson Docket No. 15-015-U
1 I conclude that Arkansas’ recent enactment of Act 725 provides the APSC
2 the opportunity to move forward with the implementation of EAI’s
3 proposed FRP and thereby improve EAI’s financial standing.
4
5 Q. WHAT ARE THE BENEFITS FOR EAI’S RATEPAYERS OF IMPROVING
6 EAI’S OPERATING CASH FLOW AND IMPROVING CREDIT RATINGS
7 OR PREVENTING CREDIT RATING DOWNGRADES?
8 A. EAI’s customers and the economic development of the state of Arkansas
9 benefit when the utility has strong access to capital market funding to
10 finance its capital investment program for the benefit of customers. EAI
11 invested $535 million in 2014 for additions to utility plant and equipment,
12 40 percent above its average capital expenditure for the four years 2010-
13 2013.21 Also, as noted by Mr. McDonald, the 7-year projected capital
14 expenditure from 2013 – 2019 is expected to be $4.2 billion, a 63 percent
15 increase over the previous 7-year period.
16 EAI also needs financial strength and flexibility in order to be able
17 to fund the recovery of the electrical system in the event of storms or
18 natural disasters and during periods of adverse capital market conditions.
19
20 Q. IS EAI CURRRENTLY EXPERIENCING ADVERSE CAPITAL MARKET
21 CONDITIONS OR DIFFICULTY IN ACCESSING FUNDING?
21 Annual Report of Entergy Corporation to the SEC on Form 10-K for the year ended December 31, 2014.
25 Entergy Arkansas,APSC FILEDInc. Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56 Direct Testimony of Ellen Lapson Docket No. 15-015-U
1 A. Quite the contrary. As I will discuss further in the following section of my
2 testimony, the current capital market phase is one of open and easy
3 availability of financing. However, conditions in capital and credit markets
4 run in cycles, and there are times in the credit market cycle when credit is
5 less available than currently. When we enter an adverse phase in the
6 credit market cycle, companies with lower ratings or weaker credit metrics
7 have difficulty in renewing expiring credit facilities and issuing bonds at the
8 most favorable terms. Access to equity is typically constrained at those
9 times. In 2009 and the first half of 2010, utilities faced very challenging
10 conditions and those with ratings of BBB and below had difficulty in
11 renewing or increasing credit commitments and raising capital.
12 For utilities, funding capital expenditures is not discretionary; many
13 or most of EAI’s capital investments are required to maintain service
14 quality standards, to conform to environmental mandates, or to serve new
15 loads, regardless of whether the capital market environment is open and
16 easy or constrained and difficult. It is important that a utility remain
17 financially strong in order to be able to attract capital even at the least
18 accommodating part of the financial cycle.
19
26 Entergy Arkansas,APSC FILEDInc. Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56 Direct Testimony of Ellen Lapson Docket No. 15-015-U
1 IV. ECONOMIC AND CAPITAL MARKET CONDITIONS
2 Q. PLEASE DESCRIBE THE MONETARY CIRCUMSTANCES THAT
3 PREVAILED DURING THE MONTHS FOLLOWING APPROVAL OF NEW
4 RATES IN EAI’S PREVIOUS GENERAL RATE CASE?
5 A. The dominant factor in the monetary and capital market environment
6 during that period was a Federal Reserve (“Fed”) monetary policy
7 operation called Quantitative Easing 3 or “QE3” initiated in September,
8 2012.22 In general, a central bank implements a quantitative easing
9 operation, when more traditional forms of monetary policy have ceased to
10 be effective, by buying specified amounts of financial assets from
11 commercial banks and other private institutions, thus raising the prices of
12 those financial assets and lowering their yield, while simultaneously
13 increasing the monetary base.
14 Under QE3, the Fed made massive open market purchases of
15 long-term U.S. Treasury bonds and mortgage-backed securities. The Fed
16 bought $1.8 trillion of long-term bonds under QE3 from September 2012
17 until the end of October 2014. During the period of the Quantitative
18 Easing operations, the Fed suppressed short-term interest rates to near
19 zero by maintaining Federal Funds at a target rate of 0 to 0.25 percent.
20 The effect on financial markets was to depress long-term and short-term
21 rates to abnormally low levels, inflate the values of bonds and equities
22 QE3 followed two earlier rounds of Quantitative Easing, the first from November 2008 to mid- 2010 and the second from November 2010 through 2011.
27 Entergy Arkansas,APSC FILEDInc. Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56 Direct Testimony of Ellen Lapson Docket No. 15-015-U
1 (especially dividend-paying equities), and increase the monetary base
2 beyond the normal levels.
3
4 Q. HAVE NORMAL CAPITAL MARKET CONDITIONS BEEN ACHIEVED
5 SINCE THE FED BEGAN TO RAMP DOWN ITS QE BOND-BUYING
6 DURING 2014?
7 A. No, they have not. Interest rates and dividend yields remain artificially
8 suppressed because of the continuing Federal Reserve policy actions to
9 hold down short-term rates to near zero and the continuing balance of
10 $4.25 trillion of bonds that the Fed has removed from the capital market.
11 Figure 3 below shows that even after the QE3 purchases ceased at the
12 end of October 2014, massive holdings of U.S. Treasury bonds and
13 mortgage-backed securities remain on the books of the Federal Reserve
14 equal to $4.25 trillion at year-end 2014 (and currently). The Fed continues
15 to hold these securities in its portfolio of Securities Held Outright and to
16 reinvest any proceeds of bonds that mature in additional bond purchases
17 in order to keep the balance at $4.25 trillion, including approximately a
18 $3.5 trillion increment as a result of the Quantitative Easing operations.
28 Entergy Arkansas,APSC FILEDInc. Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56 Direct Testimony of Ellen Lapson Docket No. 15-015-U
1 Figure 3 The Federal Reserve Bond Portfolio
2 3 Data Source: Federal Reserve System, H.4.1
4 It isn’t easy to comprehend $4.25 trillion of bonds. To put that amount in
5 perspective, at the end of 2008 prior to these monetary policy operations,
6 the bonds held by the Fed amounted to $0.5 trillion (that is, $496 billion) or
7 3.4 percent of U.S. Gross Domestic Product (GDP). By year-end 2014,
8 after three rounds of QE bond purchases, the Fed’s holdings rose to 24.4
9 percent of GDP, and exceeded the GDP of Germany.23
23 Securities Held Outright from Federal Reserve System H.4.1; U.S. GDP in current U.S. dollars from the U.S. Bureau of Economic Analysis, “Current Dollar and Real GDP”, available at http://www.bea.gov/national/index.htm#gdp.
29 Entergy Arkansas,APSC FILEDInc. Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56 Direct Testimony of Ellen Lapson Docket No. 15-015-U
1 2 Q. HAS THERE BEEN ANY RECENT POLICY GUIDANCE FROM THE
3 FEDERAL RESERVE’S OPEN MARKET COMMITTEE (“FOMC”)
4 REGARDING PLANS TO NORMALIZE FINANCIAL MARKETS?
5 A. The Federal Reserve’s Open Market Committee published a policy memo
6 in mid-September 2014 that said explicitly that the Fed does not view the
7 current U.S. monetary situation as normal, and that the Fed intends to
8 “normalize” the capital markets in the future at a still-unspecified future
9 date. The Fed press release entitled “Policy Normalization Principles and
10 Plans” reveals that the Committee is planning future action to normalize
11 financial markets through a sequence of steps. The steps include first
12 raising the federal funds target rate (thus freeing short-term interest rates)
13 and subsequently reducing the balance of securities held by the Fed by
14 ceasing to reinvest repayments of principal in new bond purchases:
15 x The Committee intends to reduce the Federal Reserve's 16 securities holdings in a gradual and predictable manner 17 primarily by ceasing to reinvest repayments of principal 18 on securities held in the [System Open Market Account].
19 x The Committee expects to cease or commence phasing 20 out reinvestments after it begins increasing the target 21 range for the federal funds rate; the timing will depend on 22 how economic and financial conditions and the economic 23 outlook evolve.24
24 Federal Reserve Press Release, Sept. 17, 2014, Policy Normalization Principles and Plans, found at: http://www.federalreserve.gov/newsevents/press/monetary/20140917c.htm.
30 Entergy Arkansas,APSC FILEDInc. Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56 Direct Testimony of Ellen Lapson Docket No. 15-015-U
1 The official Federal Reserve release of September 17, 2014 speaks
2 repeatedly of the plans for future “normalization,” an acknowledgment that
3 the current situation is not normal, and also suggests that the massive
4 holdings of securities by the Fed have affected or distorted “the allocation
5 of credit across sectors of the economy.”
6
7 Q. WHAT ARE YOUR CONCLUSIONS ABOUT ESTIMATING THE COST
8 OF CAPITAL UNDER THE CURRENT CAPITAL MARKET
9 CONDITIONS?
10 A. Since 2009-2010, and particularly after the start of QE3 in October 2012,
11 the capital market environment was affected by unprecedented monetary
12 stimulus, the suppression of short-term interest rates, and the continuation
13 of massive holdings of long-term bonds by the Federal Reserve expressly
14 to force down long-term interest rates. This has resulted in abnormally
15 low interest yields and high security prices throughout the credit market,
16 the bond market, and the equity market. These extraordinary capital
17 market conditions require users of financial models (including the
18 Discounted Cash Flow (“DCF”) methodology as discussed below) to
19 exercise caution and to question the performance of their models in order
20 to avoid falling into error. There is “model risk” associated with the
21 excessive reliance or mechanical application of a model when the
22 variables that are inputs to the model are outside of the normal range.
23 “Model risk” is the risk that a theoretical model that is used to value real- 31 Entergy Arkansas,APSC FILEDInc. Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56 Direct Testimony of Ellen Lapson Docket No. 15-015-U
1 world transactions fails to predict or represent the real phenomenon that is
2 being modeled.25
3 When using the DCF model under the current extraordinary capital
4 market conditions, it is necessary to use multiple methodologies and
5 benchmarks of investment returns as a check, as Mr. Fairchild has done in
6 his testimony. In the case of the DCF model, the results of the model
7 have been suppressed by the presence of low input values, including
8 dividend yields of the proxy companies and distorted equity prices.
9 Investors and economists express a range of conflicting opinions
10 about how quickly or slowly the Federal Reserve will carry out its
11 normalization process, and at what point during that process the capital
12 market environment is likely to change. However, there is clear evidence
13 that investors do not view the current capital market environment as a
14 sustainable situation, as evidenced by the fact that the market is driven
15 sharply up and down by scraps of information, rumor, or opinion about
16 future Federal Reserve policy-driven operations.
17 Mr. Fairchild uses several widely accepted quantitative
18 methodologies and models in his testimony to reach his recommended
19 ROE for investors’ expectation based on the risk-return tradeoff principle,
20 i.e., required rates of return can be directly inferred from market data and
25 Although the concept of model risk was originally applied to derivative instruments and hedging transactions, it applies equally to models used to value companies, to manage investment portfolios, to assign credit ratings, or in this case, the use of the DCF methodology to determine the ROE that will provide a fair return and encourage investment in critical infrastructure.
32 Entergy Arkansas,APSC FILEDInc. Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56 Direct Testimony of Ellen Lapson Docket No. 15-015-U
1 generally accepted measures of risk exist. Such a process is necessary in
2 order to determine an ROE that will attract investment to EAI and keep
3 EAI’s financial condition sound, consistent with the mandates of the U.S.
4 Supreme Court cases of Bluefield Water Works & Improvement Co.
5 (1923) (“Bluefield”) and Hope Natural Gas (1944) (“Hope”).
6
7 V. ROE DECISIONS IN STATE JURISDICTIONS
8 Q. HOW DOES THE ROE DETERMINATION FOR EAI IN ORDER NO. 21
9 AND AS MODIFIED IN ORDER NO. 35 COMPARE WITH THE ROES
10 AUTHORIZED FOR OTHER U.S. UTILITIES OF COMPARABLE RISK?
11 A. The 9.3 percent ROE authorized in Order No. 21 and the subsequent 9.5
12 percent adjusted ROE in Order No. 35 cause EAI’s authorized return to
13 rank at the bottom of the group of integrated electric utilities, both
14 nationally and regionally. This would tend to put EAI at a competitive
15 disadvantage in raising capital to fund its large capital expenditure budget
16 relative to peer utilities of comparable risk.
17 EAI must compete in the financial market for long-term debt
18 financing and for equity capital from its parent, Entergy Corporation.
19 Since operating cash flow is not sufficient to fund its capital investment
20 commitments, external funding is required. Utilities compete in the capital
21 markets against every type of rival investment, including both other utilities
22 and non-utility businesses; nonetheless, the most appropriate peer
23 comparison for EAI is the U.S. integrated electric utility group. The current 33 Entergy Arkansas,APSC FILEDInc. Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56 Direct Testimony of Ellen Lapson Docket No. 15-015-U
1 ROE of 9.5 percent is one of the four lowest base ROE determinations
2 over the past eight quarters for integrated electric utilities in state
3 jurisdictions. Such a low base ROE determination places EAI’s external
4 funding needs at a competitive disadvantage in the capital market in
5 comparison with investments in utilities with higher authorized ROEs in
6 neighboring jurisdictions.
7
8 Q. WHEN MAKING INVESTMENT DECISIONS, ARE INVESTORS AWARE
9 OF RETURNS AUTHORIZED BY STATE COMMISSIONS?
10 A. Investors are aware of the returns authorized by state regulatory
11 commissions. They subscribe to service such as SNL Financial LP’s
12 Regulatory Research Associates (“RRA”) and AUS Monthly Utility Reports
13 to assist them to monitor and analyze such information. Since EAI
14 competes for capital in the marketplace against other types of utility
15 investments (as well as against the entire range of the capital markets),
16 the information provided by an analysis of ROEs authorized recently by a
17 national sample of state public service commissions. Investors are also
18 inclined to compare EAI’s return against the returns authorized to other
19 vertically integrated electric utilities in Southeastern and South Central
20 jurisdictions that are similar to the electric industry structure in Arkansas.
34 Entergy Arkansas,APSC FILEDInc. Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56 Direct Testimony of Ellen Lapson Docket No. 15-015-U
1
2 Q. HOW DID YOU PREPARE YOUR ANALYSIS OF THE STATE ROE
3 DETERMINATIONS?
4 A. I analyzed data on state ROE determinations published by RRA. The
5 Major Rate Case Decisions calendar year reports are prepared by RRA
6 each year to summarize the results of the year’s electric and gas rate case
7 decisions. The reports include several facts for each retail regulatory
8 decision, including overall rate of return on rate base, allowed return on
9 equity, common equity as a percent of the utility’s total capital structure,
10 test year, rate base valuation method, and dollar amount of approved rate
11 increase or decrease, as well as certain other details about the decision.26
12 Access to RRA reports and the RRA database is provided on a
13 subscription-only basis, and as such, the Major Rate Case Decisions –
14 Calendar 2013 and 2014 reports, which are attached as EAI Direct Exhibit
15 EL-9, are being provided pursuant to the conditions of Interim Protective
16 Order No. 1 in this docket.
17 To perform my analysis which appears as EAI Direct Exhibit EL-10,
18 I captured only cases in which RRA identified an ROE finding. Next, I
19 reviewed those orders to see if any incentives or penalties were identified
20 in the rate order. I then adjusted the total ROE by separating the reported
26 For example, the reports note whether the decision related to gas delivery, electric delivery, or vertically integrated electric service, and was an interim change in rates implemented. The reports also summarize the average historical quarterly and annual rates of return and allowed ROEs since 1990.
35 Entergy Arkansas,APSC FILEDInc. Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56 Direct Testimony of Ellen Lapson Docket No. 15-015-U
1 ROE determination into a base ROE and incentive adders or penalties, if
2 applicable. I utilized only the base level ROE determinations in the state
3 decisions for purposes of this analysis.
4
5 Q. WHY DO YOU CHOOSE A 24-MONTH PERIOD FOR YOUR ANALYSIS?
6 A. In each quarter of a year, there are only a limited number of decisions in a
7 small number of state jurisdictions. For example, in 2014 RRA reported
8 nationwide between five and 13 decisions per quarter affecting electric
9 utilities in which there was a relevant finding as to ROE, and in each
10 quarter only a few state jurisdictions are represented. The sample group
11 from quarter to quarter is comprised of different companies in different
12 state jurisdictions. Some utilities are involved in frequent rate cases, while
13 other utilities have multiple year rate orders and are rarely reported in the
14 list of ROE decisions. Thus, the reported ROE determinations from
15 quarter to quarter, or even from one year versus another, do not represent
16 a constant population of states or companies in the sample. Extending
17 the data in the study to more quarters of data helps to make the sample
18 more representative. I have found that the minimum sample size to get a
19 good representation of national trends and a reasonably broad
20 representation of state commissions is at least two full years of data (eight
21 quarters). By choosing an eight-quarter span to correspond to each of the
36 Entergy Arkansas,APSC FILEDInc. Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56 Direct Testimony of Ellen Lapson Docket No. 15-015-U
1 review periods in this proceeding, my analysis captures a reasonably
2 broad set of ROE determinations in a diverse sampling of states.
3
4 Q. WHAT 24-MONTH PERIOD DID YOU USE FOR YOUR STUDY AND
5 WHAT WAS THE SIZE OF THE STUDY?
6 A. I studied the 24-month period from January 1, 2013 through December 31,
7 2014. The quarter ended December 31, 2014 is the most recent quarter
8 for which RRA has reported ROE determinations. During this period there
9 were 64 rate decisions for integrated electric utilities in which an ROE was
10 determined, in 30 different state jurisdictions. Looking at a regional group
11 of southeastern and south central states that investors would tend to
12 compare with Arkansas,27 there were 20 rate decisions for integrated
13 electric utilities in the relevant 24-month period.
14
15 Q. DO THE STATES INCLUDED IN YOUR SOUTHEASTERN/SOUTH
16 CENTRAL REGIONAL GROUP HAVE REGULATORY JURISDICTIONS
17 SIMILAR TO ARKANSAS?
18 A. For this study I selected state jurisdictions that investors are likely to
19 consider as regional peers because not only are these states in the same
20 quadrant of the map, but these states tend to compete among themselves
27 The states included in my regional group are: Alabama, Arkansas, Florida, Georgia, Kentucky Louisiana, Mississippi, Missouri, Oklahoma, North Carolina, South Carolina, Tennessee, and Texas,. However, RRA did not report any ROE decisions in Alabama, Kentucky, or Oklahoma during the period in question, so decisions in ten states are represented.
37 Entergy Arkansas,APSC FILEDInc. Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56 Direct Testimony of Ellen Lapson Docket No. 15-015-U
1 for economic development and employment growth. Furthermore, with
2 the exception of Texas, these are states that did not restructure the electric
3 industry, and their integrated electric utilities did not divest their power
4 generation facilities. Texas is a hybrid jurisdiction, in that some electric
5 utilities have remained as integrated electric utilities; in my review, only the
6 ROE determinations for those integrated electric utilities are included.
7
8 Q. WHY DO YOU CONSIDER THE INTEGRATED ELECTRIC UTILITIES AS
9 THE MOST APPROPRIATE GROUP FOR THE COMPARISON OF
10 STATE-AUTHORIZED ROES IN THIS PROCEEDING?
11 A. RRA reports ROE decisions for utilities engaged in distribution only,
12 integrated electric service (including regulated power generation as well
13 as transmission and distribution), and natural gas distribution. The gas
14 distribution and electric distribution utility groups are generally regarded by
15 investors as well as by state regulatory commissioners to have lower
16 business risk than integrated electric utilities that own and operate power
17 generation facilities. Since EAI is an integrated electric utility, the universe
18 of integrated electric utilities is the most appropriate sample group for this
19 analysis.
20
38 Entergy Arkansas,APSC FILEDInc. Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56 Direct Testimony of Ellen Lapson Docket No. 15-015-U
1 Q. PLEASE EXPLAIN THE ADJUSTMENT TO THE STATE ROE ANALYSIS
2 THAT YOU MADE ON PAGE 3 OF YOUR EAI DIRECT EXHIBIT EL-10.
3 A. During the period of the study, the Virginia Corporation Commission
4 (“VCC”) issued orders containing ROE determinations that relate to
5 individual power generation projects. The base ROE in some of those
6 decisions was 10.40 percent, while others used a base ROE of 10.00
7 percent. The VCC acted in separate proceedings for each generation
8 project receiving incentives, so there is a defensible position for including
9 all the VCC orders as distinct ROE decisions in my analysis. However,
10 doing so would tend to over-represent decisions by the VCC relative to
11 other state commissions. Therefore, in EAI Direct Exhibit EL-10, at page
12 3, I condensed the VCC return determinations for individual projects that
13 contained the same base ROE for the same company as another project-
14 specific order. For example, I replaced the ROE determinations for
15 several Virginia Power projects, all bearing a base ROE of 10.40 percent,
16 with a single ROE observation of 10.40 percent; similarly, I replaced the
17 ROE determinations for several Virginia Power projects all bearing base
18 ROEs of 10.0 percent with a single base ROE observation of 10.0 percent.
19 The consequence of this adjustment was to reduce the number of
20 observations by seven observations, leaving only three observations to
21 stand in for the other VCC decisions that have been removed. In this
22 adjusted analysis, the range and mid-point of the results is identical with
23 the unadjusted (that is, as reported) version, and the resulting median and 39 Entergy Arkansas,APSC FILEDInc. Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56 Direct Testimony of Ellen Lapson Docket No. 15-015-U
1 frequency distribution of state ROEs are very slightly lower than if I had
2 not made the adjustments.28 The results of the study are summarized
3 below in Table 3.
4
5 TABLE 3 Summary of ROE Decisions for Integrated Electric Utilities 24 Months, Jan. 1 2013 - Dec. 31, 2014 Integrated Electrics - National Regional Group Adjusted As reported (a) Adjusted (a) Central Tendency of ROEs % % % Median ROE 10.00 9.93 10.04 Midpoint ROE 10.23 10.23 10.22 Mean ROE 9.98 9.94 10.04 Frequency Distribution 10% 53% 46% 65% 9.75% 77% 73% 70%
Number of observations 64 56 20 Number of states 30 30 10
(a) Adjusted -Certain redundant ROE decisions are condensed. Sources: EAI Direct Exhibits EL-9 and EL-10.
6
7 Q. WHAT CONCLUSIONS DO YOU REACH ABOUT EAI’S CURRENT ROE
8 OF 9.5 PERCENT RELATIVE TO THE NATIONAL GROUP OF
9 INTEGRATED ELECTRIC UTILITIES?
10 A. EAI’s current authorized ROE of 9.5 percent is one of the four lowest ROE
11 decisions for integrated electric utilities in the period of the study in a
28 EAI Direct Exhibit EL-10 at 3 provides a list of the individual rate orders involved in the adjustments for each period.
40 Entergy Arkansas,APSC FILEDInc. Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56 Direct Testimony of Ellen Lapson Docket No. 15-015-U
1 group of 64 decisions (or 56 decisions, after the adjustment).29 In other
2 words, approximately 93 percent of the ROEs determined during the
3 period were higher than 9.5 percent. The median ROE authorized in the
4 24-month period covered by the study is 10 percent, and with the
5 adjustment to condense multiple decisions in Virginia, the median is only
6 modestly lower at 9.93 percent. The average (mean) ROE in the national
7 sample is 9.98 percent as reported and 9.94 percent after adjustment. So
8 the median and mean ROEs for the national peers are approximately 45
9 basis points higher than EAI’s authorized return.
10
11 Q. HAVE YOU FORMED ANY CONCLUSIONS ABOUT EAI’S CURRENTLY
12 AUTHORIZED ROE RELATIVE TO THE REGIONAL GROUP OF
13 UTILTIES?
14 A. EAI had the distinction of having the single lowest authorized ROE relative
15 to the regional peer group.30 Nineteen of the 20 decisions in the region
16 (after the compression of redundant ROEs) were higher. Overall, the
17 regional utility group exhibits a median and average value for ROE
18 determinations about 10 basis points higher than the national sample.
19 The median ROE as adjusted in the regional integrated electric utilities
20 was 10.04 percent, or 54 basis points higher than EAI’s current ROE of
21 9.5 percent.
29 EAI Direct Exhibit EL-10 at 1. 30 EAI Direct Exhibit EL-10 at 2.
41 Entergy Arkansas,APSC FILEDInc. Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56 Direct Testimony of Ellen Lapson Docket No. 15-015-U
1
2 Q. WHAT EVIDENCE IS PROVIDED BY THE CREDIT RATINGS OF
3 INTEGRATED ELECTRIC UTILITIES CORRESPONDING TO THE
4 STATE JURISDICTIONS IN THE REGIONAL GROUP?
5 A. The integrated electric utilities in the state jurisdictions in the regional
6 comparison group have higher Moody’s credit ratings than EAI, indicative
7 of better financial stability and strength. The median Issuer Credit Rating
8 of the regional comparison group is Baa1 (1 notch above EAI’s rating) and
9 the median rating of the group by S&P is BBB+, also 1 notch higher than
10 EAI.31
11
12 Q. WHAT IS EAI’S RECOMMENDED ROE IN THIS CASE AND IS IT
13 COMPARABLE TO THE ALLOWED RETURNS FOR THE NATIONAL
14 AND REGIONAL SAMPLE GROUPS?
15 A. EAI is requesting an ROE of 10.2 percent. As described by Mr. McDonald
16 and supported through the quantitative analyses provided by EAI witness
17 Bruce M. Fairchild, as well as the through the testimony of other Company
18 witnesses, EAI believes setting the ROE at 10.2 will ensure EAI is given
19 the opportunity to earn a fair and reasonable rate of return, commensurate
20 with the risk attendant to its business, and will position the Company to
31 EAI Direct Exhibit EL-11.
42 Entergy Arkansas,APSC FILEDInc. Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56 Direct Testimony of Ellen Lapson Docket No. 15-015-U
1 attract the capital necessary to fund the infrastructure necessary to
2 provide reliable service to its customers.
3 While EAI’s requested 10.2 percent ROE is slightly higher than the
4 average (mean) ROE in my national sample of 9.98 percent as reported
5 and 9.93 percent after adjustment, it reflects the need to select an ROE for
6 EAI above recently allowed ROEs to account for the fact that capital costs
7 will begin to increase as the Fed “normalizes” its monetary policies.
8
9 VI. CONCLUSIONS
10 Q. IN YOUR OPINION AS AN INVESTMENT ANALYST AND CREDIT
11 SPECIALIST, WHY IS IT ESSENTIAL IN THIS DOCKET THAT THE
12 COMMISSION IMPROVE EAI’S AUTHORIZED ROE AND REVERSE
13 THE TIDE OF NEGATIVE COMMENTARY FROM RATING AGENCIES
14 AND ANALYSTS?
15 A. Despite modifying EAI’s allowed ROE from 9.3 percent to 9.5 percent with
16 its Order No. 35 in Docket No. 13-028-U, the Commission’s revised ROE
17 determination remains significantly below the central tendency of other
18 state authorized ROEs (54 basis points below the median ROE of 10.04
19 percent authorized for integrated electric utilities in a ten state regional
20 group.32 The ROEs authorized for the broader national group are also
21 higher in nearly every case than EAI’s authorized ROE.33 EAI’s 9.5
32 EAI Direct Exhibit EL-10 at 2 and Table 3 above. 33 EAI Direct Exhibit EL-10 at 1 and Table 3 above.
43 Entergy Arkansas,APSC FILEDInc. Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56 Direct Testimony of Ellen Lapson Docket No. 15-015-U
1 percent return would lead a rational investor to invest elsewhere because
2 the investor has the potential to achieve a higher return by investing in
3 practically any other comparable utility.
4 EAI is not regarded by investment analysts and credit rating
5 agencies as operating in a low-risk jurisdiction with regulatory policies that
6 favor investors.34 The words used in the Moody’s report dated
7 January 31, 2014, “regulatory lag”, “cash flow shortfalls”, and “challenging”
8 are a common theme.35 Therefore, an ROE authorization that is materially
9 below the mean and median of other states for integrated electric utilities
10 conveys the message, whether intended or not, to the investment
11 community that the APSC does not give appropriate consideration to
12 invested capital, which in turn has raised the cost of capital for EAI.
13
14 Q. HOW DOES THE COMMISSION’S ROE DETERMINATION AND ANY
15 ORDERED DISALLOWANCES RELATE TO THE EVIDENCE
16 REGARDING POTENTIAL ADVERSE INVESTMENT MARKET
17 REACTION?
18 A. EAI’s requested 10.2 percent ROE would produce stronger operating cash
19 flow in the near term and recognize the higher capital costs that will prevail
34 With regard to investors’ concerns, RRA ranks the APSC’s regulatory jurisdiction as Average 3 (indicating the low end of Average); 34 jurisdictions ranked higher than Arkansas at March 28, 2015. In comparison with the southeast/ south central regional group of state jurisdictions, only the PUC Texas ranked lower than the APSC, and ten jurisdictions ranked higher. 35 EAI Direct Exhibit EL-2.
44 Entergy Arkansas,APSC FILEDInc. Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56 Direct Testimony of Ellen Lapson Docket No. 15-015-U
1 when it will be applicable. An ROE authorization for EAI materially below
2 its peer utilities would send the wrong message. Moreover, significant
3 cost disallowances would hinder EAI’s ability to earn its allowed return.
4 These issues have contributed to the concerns voiced by Moody’s
5 regarding improving EAI’s weak operating cash flow ratios and eliminating
6 the deficiency of cash flow that caused concern in the financial community
7 and among credit rating agencies.
8 Finally, with the passage of Act 725, the APSC has the opportunity
9 to approve changes, including EAI’s proposed FRP tariff, that would
10 enhance EAI’s financial and credit standing and benefit future economic
11 development. Failure to take advantage of that opportunity would
12 effectively send a distress signal concerning EAI to the investment
13 community, reinforcing or increasing negative expectations to EAI’s
14 financial detriment and ultimately the detriment of its customers.
15
16 Q. WHAT BENEFIT WOULD EAI’S CUSTOMERS OBTAIN AS A RESULT
17 OF APPROVING AN ROE COMPARABLE TO VALUES THAT HAVE
18 RECENTLY BEEN APPROVED FOR SIMILAR UTILITIES, AND
19 ALLOWING EAI TO RECOVER ALL OF ITS PRUDENTLY INCURED
20 COSTS?
21 A. Collectively, these revisions would improve EAI’s chances of a future
22 rating upgrade from Moody’s and S&P and avoid a ratings downgrade.
23 Improving EAI’s credit rating will enhance EAI’s access to debt and equity 45 Entergy Arkansas,APSC FILEDInc. Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56 Direct Testimony of Ellen Lapson Docket No. 15-015-U
1 capital. Improved capital market access aids the utility in funding
2 committed and discretionary capital expenditures for greater reliability,
3 environmental compliance, economic development, and efficiency at lower
4 capital costs. Also, it would assure that EAI would have the financial
5 resources and flexibility it needs to carry out service restoration after
6 emergencies, clearly a benefit to customers and to the public at large.
7
8 Q. DOES THIS CONCLUDE YOUR DIRECT TESTIMONY?
9 A. Yes.
46 APSC FILED Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56
CERTIFICATE OF SERVICE
I, Laura R. Landreaux, do hereby certify that a copy of the foregoing has been served upon all parties of record by forwarding the same by electronic mail and/or first class mail, postage prepaid, this 24th day of April, 2015.
/s/ Laura R. Landreaux Laura R. Landreaux
47 APSC FILED Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56
BEFORE THE ARKANSAS PUBLIC SERVICE COMMISSION
IN THE MATTER OF THE APPLICATION ) OF ENTERGY ARKANSAS, INC. FOR ) DOCKET NO. 15-015-U APPROVAL OF CHANGES IN RATES FOR ) RETAIL ELECTRIC SERVICE )
EAI DIRECT EXHIBIT EL-1
EXPERIENCE AND QUALIFICATIONS, ELLEN LAPSON, CFA
48 EAI Direct Exhibit EL-1 Docket No. 15-015-U Page 1 of 6 APSC FILED Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56
EXPERIENCE AND QUALIFICATIONS ELLEN LAPSON, CFA
LAPSON ADVISORY 370 Riverside Dr., 9D Financial Consulting, New York, NY 10025 Expert Testimony, +1-212-866-1040 Financial Training www.lapsonadvisory.com
SUMMARY OF QUALIFICATIONS Industry expert on financing utilities and similar types of infrastructure. Over 40 years of professional experience in commercial and investment banking, securities analysis, and credit ratings. Focus on utilities, power generation and alternative energy sources, natural gas and fuels, corporate and project finance. Provide executive training in utility financial analysis and credit analysis. Consult and provide expert witness testimony in matters involving capital access for infrastructure, energy and utilities. MBA in accounting and finance; Chartered Financial Analyst (CFA).
EMPLOYMENT
Lapson Advisory Financial consulting services to utilities and Principal developers of infrastructure projects. Financial Dec. 2011 - present strategy and credit advisory for power, energy, infrastructure companies, and utilities. Legislative and regulatory communications and expert witness testimony. Financial and credit training.
Fitch Ratings Chair of Fitch’s global Corporate Finance Criteria Utilities, Power & Gas Committee overseeing criteria for rating Managing Director corporations, financial institutions, insurers, REITs, 1999-2011 and project finance transactions (2010-2011). Senior Director Manager or primary analyst on credit ratings of over 1994-1999 200 utility, pipeline, power generation companies. Utility tariff monetization. Senior member of rating committees for utilities and energy and power- related projects. Liaison with utility sector fixed income investors, focusing on 50 largest institutional investors holding utility and power bonds, buy-side and sell-side analysts, and utility bankers.
49 EAI Direct Exhibit EL-1 Docket No. 15-015-U Page 2 of 6 APSC FILED Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56
JP Morgan Chase Managed financial advisory transactions, structured debt (formerly Chemical NY private placements, syndicated credit facilities for Corp.) utilities, mining and metals, project finance. Structured Vice President financing for utility regulatory assets (first of its kind 1975-94 “stranded cost” securitization transaction) for Puget Asst. Vice President Energy, 1992-94. 1974-1975 Led financing for bankrupt utility as debtor-in- possession; prepared financing plans for distressed utilities; structured exit financing for reorganization of two utilities emerging from Chapter 11. Divisional Controller - 1981-1986 Argus Research Corp. Equity analysis of U.S. electric and gas utilities, natural Equity Security Analyst – gas pipelines, and telecommunications companies. Utilities Modeling and projecting corporate financial statements. 1969-1974 Research coverage and reports.
EDUCATION & LICENSING Stern School of Business, New York University, MBA, 1975 Major concentration: Accounting Master’s Thesis: Cash Flow vs. Accrual Accounting Data in Utility Equity Valuation Chartered Financial Analyst (CFA©) since 1978 Barnard College, Columbia University, BA, 1969
PROFESSIONAL ASSOCIATIONS Institute of Chartered Financial Analysts, 1978 - present Wall Street Utility Group, 1996 - present
ADVISORY COUNCILS AND BOARD SERVICE Panelist representing U.S. investment community in roundtable on International Accounting Standard Board proposals for financial reporting for rate-regulated activities, sponsored by Edison Electric Institute and American Gas Assn, Dec. 2014
National Academy of Sciences/ National Research Council, Resilient America Forum, July 2014.
MIT Energy Institute, External Advisory Council, The Future of Solar Energy, 2012-2014.
Electric Power Research Institute, Advisory Council, 2004-2011; Chair, 2009 and 2010.
50 EAI Direct Exhibit EL-1 Docket No. 15-015-U Page 3 of 6 APSC FILED Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56
EXPERT WITNESS TESTIMONY
Jurisdiction Proceeding Topic U.S. Federal Energy Docket No. EL14-12, ABATE, et al. vs Capital market effects on Regulatory MISO, Inc. et al., on behalf of the MISO cost of equity capital; Commission Transmission Owners (2015) capital spending and risk U.S. Federal Energy Dockets No. EL12-59 and 13-78, Golden Capital market effects on Regulatory Spread Electric Coop., on behalf of South- cost of equity capital; Commission western Public Service Co., Respondent. capital spending and risk U.S. Federal Energy Dockets No. EL13-33 and EL14-86, ENE Capital market Regulatory et al. vs. Bangor Hydro-Electric Co. et al., environment affecting the Commission on behalf of New England Transmission cost of equity capital Owners. (2015) U.S. Federal Energy Dockets No. ER13-1508 et alia, Entergy Capital market Regulatory Arkansas, Inc. and other Entergy utility environment affecting the Commission subsidiaries, on behalf of Entergy Services cost of equity capital Inc. (2014) Delaware Public DE Case 14-193, Merger of Exelon Corp. Ring-fencing for utility Service Commission and Pepco Holdings, Inc. on behalf of the merger; avoidance of Joint Applicants (2015) financial harm Maryland Public Case No. 9361, Merger of Exelon Corp. Ring-fencing for utility Service Commission and Pepco Holdings, Inc. on behalf of the merger; avoidance of Joint Applicants (2015) financial harm New Jersey Board of BPU Docket No. EM 14060581, Merger of Ring-fencing for utility Public Utilities Exelon Corp. and Pepco Holdings, Inc., on merger; avoidance of behalf of the Joint Applicants (2015) financial harm U.S. Federal Energy Docket ER15-572 Application of New Incentive compensation Regulatory York Transco, LLC, on behalf of NY for electric transmission; Commission Transco, LLC. (2015) capital market and financial strength U.S. Federal Energy Docket EL 14-90-000 Seminole Electric Capital market Regulatory Cooperative, Inc. and Florida Municipal environment affecting the Commission Power Agency vs. Duke Energy FL on determination of the cost behalf of Duke Energy (2014) of equity capital DC Public Service Formal Case No. 1119 Merger of Exelon Ring-fencing for utility Commission Corp. and Pepco Holdings Inc., on behalf merger; avoidance of of the Joint Applicants (2014-2015) financial harm U.S. Federal Energy Docket EL14-86-000 Attorney General of Return on Equity; capital Regulatory Massachusetts et. al. vs. Bangor Hydro- market environment Commission Electric Company, et. al on behalf of New England Transmission Owners (2014) Arkansas Public Docket No. 13-028-U. Rehearing direct Investor and rating Service Commission testimony on behalf of Entergy Arkansas. agency reactions to ROE (2014) set by Order.
51 EAI Direct Exhibit EL-1 Docket No. 15-015-U Page 4 of 6 APSC FILED Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56
Jurisdiction Proceeding Topic Illinois Commerce Docket No. 12-0560 Rock Island Clean Access to capital for a Commission Line LLC, on behalf of Commonwealth merchant electric Edison Company, an intervenor (2013) transmission line; financial capability
U.S. Federal Energy Docket EL13-48-000 Delaware Division Return on Equity; capital Regulatory of the Public Advocate, et. al. vs. Baltimore market view of Commission Gas and Electric Company and PEPCO transmission investment Holdings et al., on behalf of (i)Baltimore Gas and Electric and (ii) PEPCO and subsidiaries (2013) U.S. Federal Energy Docket EL11-66-000 Martha Coakley et. Return on Equity; capital Regulatory al. vs. Bangor Hydro-Electric Company, et. market view of Commission al on behalf of a group of New England transmission investment Transmission Owners (2012-13) New York Public Cases 13-E-0030; 13-G-0031; and 13-S- Cash flow and financial Service Commission 0032 on behalf of Consolidated Edison strength; regulatory Company of New York. (2013) mechanisms Public Service Case. 9214 “In The Matter Of Whether Effect of certain power Commission of New Generating Facilities Are Needed To contracts on the credit and Maryland Meet Long-Term Demand For Standard financial strength of MD Offer Service”, on behalf of Baltimore Gas utility counterparties and Electric Co., Potomac Electric Power Co., and Delmarva Power & Light (2012)
The following are some cases in which Lapson testified as a representative of Fitch Ratings from 2001-2005. Fitch Ratings ceased this activity in 2006.
Jurisdiction Proceeding Topic Michigan Public Capacity Needs Forum, open public Mechanisms for funding Service Commission session, April 21, 2005 new power capacity in a competitive market
U.S. Federal Energy RTO & ISO Performance Standards, Performance measures of Regulatory private session with Comm. Brownell and the financial viability of Commission Staff, Feb. 23, 2004 RTOs
U.S. Bankruptcy Court Bankruptcy reorganization of Pacific Gas Likely credit ratings on & Electric, report submitted by intervenor emergence with an California Public Utilities Commission alternate plan of Staff, Dec. 2002 reorganization
52 EAI Direct Exhibit EL-1 Docket No. 15-015-U Page 5 of 6 APSC FILED Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56
CONSULTING & ADVISORY ASSIGNMENTS Utility (Undisclosed) Evaluated debt equivalence of power purchase obligations. 2014 Objective: Clarify credit impact of various contract obligations.
Bank (Undisclosed) Research and recommendations on Loss Given Default and 2013-14 historical experience of default and recovery in the regulated utility sector. Objective: Efficient capital allocation for loan portfolio.
GenOn Energy Inc. White Paper on appropriate industry peers for a competitive 2012 power generation and energy company. Objective: Improve peer comparisons in shareholder communications and for compensation studies.
Toll Highway Advised on adding debt while minimizing risk of downgrade. (Undisclosed) Recommend strategy for added leverage and rating agency 2011 communications. Objectives: Increase leverage and free up equity for alternate growth investments, while preserving credit ratings.
Transmission Recommended the appropriate capital structure and debt leverage Utility during a period of high capital spending. (Undisclosed) Objective: Reduce need for added equity during multi-year capex 2012 project; preserve existing credit ratings.
District Thermal Cooling Recommended a project loan structure to deal with seasonal cash Company flow. Optimized payment schedule, form and timing of financial (Undisclosed) covenants. Objectives: Reduce default risk; efficient borrowing structure.
PROFESSIONAL AND EXECUTIVE TRAINING CoBank, Denver CO “Midstream Gas and MLPs Advanced Credit Training”, 2014
Empire District Electric In-house executive training session on Utility Sector Financial Evaluation, Co., Joppa MO 2014
PPL Energy Corp, In-house Financial Training, 2014 Allentown PA
SNL Knowledge Center “Credit Analysis for the Power & Gas Sector”; Courses “Analyst Training in the Power & Gas Sectors: Financial Statement Analysis”, 2012-2013
EEI Transmission and “Financing and Access to Capital”, 2012
53 EAI Direct Exhibit EL-1 Docket No. 15-015-U Page 6 of 6 APSC FILED Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56
Wholesale Markets School
National Rural Utilities “Credit Analysis for the Power Sector”, 2012 Cooperative Finance Corporation
Judicial Institute of “Utility Regulation and the Courts: Impact of Court Decisions on Maryland (Private Financial Markets and Credit”, Annapolis MD, 2007 seminar for MD judges)
Edison Electric Institute “New Analyst Training Institute: Fixed Income Analysis and Credit Ratings”, 2008 and 2004
PUBLICATIONS BOOK CHAPTERS Electric & Natural Gas Business: Understanding It, 2003 and Beyond, Robert E. Willett ed., Financial Communications Company, Houston, TX, 2003. Chapter 1: “Standard Market Design: Credit of Some Sectors Will Be Affected by SMD”, Ellen Lapson, pp. 3-14.
Energy Modeling and the Management of Uncertainty, Robert Jameson ed., Risk Publications, London, 1999. “Managing Risks Through Contract Technology: Know Your Counterparty”, Ellen Lapson, pp 154-155.
The US Power Market: Restructuring and Risk Management, Robert Jameson ed., Risk Publications, London, 1997. “Managing Credit Risk in the Electricity Market”, Ellen Lapson (pp 281-291).
Deregulation of the Electric Utility Industry – Proceedings of the AIMR Seminar; ed. AIMR (CFA Institute), Charlottesville, VA, 1997. Speaker 3: E. Lapson.
ARTICLES “First Person With Ellen Lapson: The Economy, Technology, and R&D”, Interview with Ellen Lapson, EPRI Journal, Spring, 2009.
“Rising Unit Costs & Credit Quality: Warning Signals”, Ellen Lapson. Public Utility Fortnightly, Feb. 2006.
“The Future of Fuel Diversity”, Ellen Lapson and Richard Hunter, Public Utility Fortnightly, Oct. 2004.
54 APSC FILED Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56
BEFORE THE ARKANSAS PUBLIC SERVICE COMMISSION
IN THE MATTER OF THE APPLICATION ) OF ENTERGY ARKANSAS, INC. FOR ) DOCKET NO. 15-015-U APPROVAL OF CHANGES IN RATES FOR ) RETAIL ELECTRIC SERVICE )
EAI DIRECT EXHIBIT EL-2
MOODY’S INVESTORS SERVICE
“RATING ACTION: MOODY’S UPGRADES CERTAIN ENTERGY SUBSIDIARIES, OUTLOOKS STABLE”
JANUARY 31, 2014
55 EAI Direct Exhibit EL-2 Docket No. 15-015-U Page 1 of 7 APSC FILED Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56
Rating Action: Moody's upgrades certain Entergy subsidiaries, outlooks stable
Global Credit Research - 31 Jan 2014 Approximately $11 Billion of Debt Securities Upgraded
New York, January 31, 2014 -- Moody's Investors Service upgraded the long-term ratings of Entergy Gulf States Louisiana, LLC (Issuer Rating to Baa1 from Baa2, Senior Secured to A2 from A3, Preferred Stock to Baa3 from Ba1); Entergy Louisiana, LLC (Issuer Rating and Senior Unsecured to Baa1 from Baa2, Senior Secured to A2 from A3, Preferred Stock to Baa3 from Ba1); Entergy Mississippi, Inc. (Issuer Rating to Baa2 from Baa3, Senior Secured to A3 from Baa1, Preferred Stock to Ba1 from Ba2); and Entergy Texas, Inc. (Issuer Rating to Baa3 from Ba1, Senior Secured to Baa1 from Baa2, and Senior Secured Shelf to (P)Baa1 from (P)Baa2). Moody's also confirmed the rating of Entergy Arkansas, Inc. This rating action concludes the review of these companies' ratings Moody's initiated on November 8, 2013. The rating outlooks of Entergy Corporation and all of its subsidiaries are stable. RATINGS RATIONALE Moody's had placed the ratings on review for upgrade in response to Moody's more favorable view of the relative credit supportiveness of the US regulatory environment, as detailed in the September 2013 Request for Comment titled "Proposed Refinements to the Regulated Utilities Rating Methodology and our Evolving View of US Utility Regulation." Among the critical factors supporting this view include better cost recovery provisions, reduced regulatory lag, and generally fair and open relationships between utilities and regulators. The US utility sector's low number of defaults, high recovery rates, and generally strong financial metrics from a global perspective provide additional corroboration for these upgrades. Entergy Gulf States Louisiana (EGSL) is regulated by the Louisiana Public Service Commission (LPSC), which has provided a relatively stable and credit supportive regulatory environment. Like other major utilities in the state, EGSL operates with earnings-sharing mechanisms and Formula Rate Plan (FRP). Moody's generally views FRPs as a credit positive, since they reduce regulatory lag and provide transparency on cost recoveries. EGSL has been operating under an FRP established in 2009 with an ROE mid-point of 10.65% and a +/- 75 basis point bandwidth. Earnings outside the bandwidth are allocated 60% to customers and 40% to the company. The company has recently over-earned under the FRP. LTM third-quarter 2013 metrics further justify the rationale, with Cash Flow Interest Coverage of 6.9x and CFO pre-WC to debt of 29%. Entergy Louisiana (EL) is also regulated by the LPSC and benefits from a similar earnings-sharing mechanism and FRP structure. EL's FRP through 2012 incorporated a ROE mid-point of 10.25% and a +/- 80 basis point bandwidth, which included a recovery mechanism for LPSC-approved capacity additions. Similar to EGSL's FRP, earnings outside EL's bandwidth are allocated 60% to customers and 40% to the company. In December 2013, the LPSC and EL filed a settlement for its pending rate case, under which EL's base rates were to remain unchanged and the company was allowed to operate under a FRP through the 2016 test-year. The updated FRP incorporated a ROE of 9.95% and +/- 80 basis point bandwidth. In addition, the settlement included several riders outside of the FRP formula, including a capacity rider and the ability to recover costs associated with EL's MISO integration. EL is also permitted to implement a $10 million base rate increase in December 2014. Certain other costs, including MISO related costs, capacity and purchase costs, environmental-related costs, efficiency-related costs, storm costs, and certain depreciation and decommissioning costs would be recover outside of the FRP mechanism. LTM third-quarter 2013 metrics further justify the rationale, with Cash Flow Interest Coverage of 5.5x and CFO pre-WC to debt of 20%. Mississippi has traditionally fostered a fairly supportive regulatory environment for investor owned utilities. Entergy Mississippi (EM) has benefited from an ability to recover fuel costs in rates on a timely basis by filing for small but relatively frequent adjustments in rates. The company operates under a FRP that was modified in March 2010 to align it more with FRPs of other utilities in Mississippi. The modification replaced the old revenue change limit (2% with a $14.5 million cap) with a 4% limit (no dollar cap), with any adjustment over 2% requiring a hearing. These changes were slightly positive from a credit standpoint. In August 2013, the MPSC approved $22.3 rate increase, which would reset EM's ROE to 10.59%, which compares to an 8.96% earned ROE for 2012, with the increase
56 EAI Direct Exhibit EL-2 Docket No. 15-015-U Page 2 of 7 APSC FILED Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56 effective as of September 2013. LTM third-quarter 2013 metrics further justify the rationale, with Cash Flow Interest Coverage of 4.6x and CFO pre-WC to debt of 19%. Moody's generally views the regulatory climate in Texas as credit positive for transmission and distribution utilities operating within ERCOT but somehow challenging for vertically integrated utilities operating outside of ERCOT. The PUC generally has not permitted the utilities to include construction work in progress (CWIP) in rate base, with the exception of certain environmental compliance costs. However, the companies are permitted to adjust rates through surcharge mechanisms to reflect certain types of new transmission and distribution investment, fuel and purchased power costs are recovered through a separate fuel factor, the level of which is established in base rate cases. On September 2013, ET filed a rate case with the PUCT requesting a $38.6 million base rate increase, reflecting a 10.4% ROE based on a test year ending March 31, 2013. ET also sought to implement several riders, including a rough production cost equalization adjustment rider (Rider RPCEA), a rate case expense rider (Rider RCE), deferred tax accounting rider (Rider DTA), and a transmission cost recovery rider (Rider TCRF). On January 17, the PUCT's staff filed testimony regarding the pending case recommending that the PUCT approve a $3.4 million base rate increase based on 9.2% ROE, the settlement decision is expected by March 5, after rebuttal testimony, hearing, and briefs. The resolution of this case will be an important indicator of the trend in long-term credit supportiveness of Texas's regulatory environment. Despite being on a quarterly basis, LTM third-quarter 2013 metrics were stronger than initially projected, with Cash Flow Interest Coverage of 5.4x and CFO pre-WC to debt of 25%. Fiscal year end 2012 metrics were 4.5x Cash Flow Interest Coverage and 20% CFO pre-WC to debt. Moody's confirmed the ratings of Entergy Arkansas based on the less than favorable rate case outcomes in May 2010 and December 2013. Arkansas operates under traditional rate of return regulation rather than the more credit supportive formula rate plans in place in Louisiana and Mississippi, where Entergy's other large subsidiaries operate. The rate of return regulation contributes to regulatory lag at Entergy Arkansas (EA). Under Arkansas regulation, the test year is either fully historical or 6 months historical and 6 months projected. However, there are fuel and certain other riders that help offset some aspects of the lag. Historically, EA has experienced a relatively challenging regulatory environment. In March 2013, EA filed for a rate increase with the Arkansas Public Service Commission (APSC) that included MISO and capacity costs riders, receiving a decision in December 2013. The outcome was disappointing as EA received a base rate increase of $81 million (without specifying the amounts to be recovered through MISO and Capacity Costs riders) based on a 9.3% ROE, significantly below its requested base rate increase of $145 million based on 10.4% ROE. Resolution of EA's May 2010 rate case also yielded an increase below that expected of $63.7 million (10.3% ROE) against the expected $168 million (10.6% ROE). LTM third-quarter 2013 metrics are consistent with that of fiscal year end 2012, with Cash Flow Interest Coverage of 4.5x and CFO pre-WC to debt of 13%. According to Moody's adjusted projections, EA will be able to maintain appropriate metrics for the rating, including CFO pre-WC to debt, and CFO pre-WC -- Div to debt of around 16% and 14% respectively. Rating Outlook Entergy Gulf States Louisiana, Entergy Louisiana, and Entergy Mississippi outlooks are stable, reflecting that Moody's expects the companies will continue to exhibit financial metrics that are appropriate for their current ratings, that in Louisiana formula rate plan will continue to provide regulatory transparency and certainty, and that Mississippi's regulation will remain reasonably long-term credit supportive and allow the recovery of prudently incurred costs. Entergy Texas' rating outlook is stable, reflecting Moody's view that the company will continue to generate adequate metrics for its rating. Although the regulatory lag for vertically integrated utilities will remain less credit supportive over the medium term in Texas, Moody's does not expect the regulatory environment to deteriorate. According to Moody's adjusted projections, ET will likely be able to maintain appropriate metrics for the rating, including CFO pre-WC to debt, and CFO pre-WC -- Div to debt of around 15% and 12% respectively. Entergy Arkansas' rating outlook is stable, reflecting Moody's expectation that the utility's financial metrics will maintain levels that are appropriate for its rating despite the company's disappointing rate case outcomes. The outlook also assumes that regulatory lag will remain manageable and that the issues surrounding the company's exit from the Entergy System Agreement will be resolved in a manner not detrimental to credit quality. According to Moody's adjusted projections, EA will likely be able to maintain appropriate metrics for the rating, including CFO pre-WC to debt, and CFO pre-WC -- Div to debt of around 16% and 14% respectively. What Could Change the Rating - Up
57 EAI Direct Exhibit EL-2 Docket No. 15-015-U Page 3 of 7 APSC FILED Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56
Entergy Gulf States Louisiana and Entergy Louisiana ratings could be upgraded if material long-term credit improvements were to happen in Louisiana regulation that set the state far above other jurisdictions in the US, if economic conditions in its service territory continued to improve, and if recently improved financial metrics were sustained in the absence of bonus depreciation, including consistent CFO pre-WC plus interest to interest above 5.5x and CFO pre-WC to debt nearing the mid-20% range. The ratings for Entergy Mississippi could be further upgraded if there were an improvement in the regulatory and political environment in the state, or if there were a sustained increase in EM's cash flow coverage metrics, including CFO pre- WC to debt above 19%. The rating of Entergy Texas is unlikely to be upgraded in the near term; however an upgrade could come under consideration if there is a material and sustained improvement in the regulatory environment in Texas for vertically integrated utilities --outside ERCOT- including the implementation of long-term credit-supportive rate design and cost recovery mechanisms, and continued strong financial metrics, including CFO pre-WC to Debt above 16% on a sustained basis. The ratings of Entergy Arkansas could be upgraded if there were an improvement in the credit supportiveness of the regulatory environment in Arkansas, along with a sustainable increase in cash flow coverage metrics, including CFO pre-WC to debt above 22%. What Could Change the Rating - Down The ratings for Entergy Gulf States Louisiana, Entergy Louisiana, and Entergy Mississippi could be downgraded if there were a deterioration in the regulatory environment for utilities in Louisiana, and Mississippi, if there were significant additional storm costs that were not recovered on a timely basis through the regulatory process, or if financial metrics excluding bonus depreciation exhibited a sustained decline. The ratings of Entergy Texas could be downgraded if the business and regulatory environment in which it operates were to deteriorate, if pending or future rate case outcomes are detrimental to its credit profile, or if there were a significant decline in financial metrics, including CFO pre-WC to debt below 13% on a sustained basis. The ratings of Entergy Arkansas could be downgraded if there were continuous adverse regulatory developments, if there were a termination or any changes to the utility's rate riders that would prevent full and timely recovery of prudently incurred costs, or if there is not an improvement in cash flow coverage metrics from unusually low 2012 and 2013 levels, including CFO pre-WC to debt below 15% for an extended period. The principal methodology used in these ratings was Regulated Electric and Gas Utilities published in December 2013. Please see the Credit Policy page on www.moodys.com for a copy of this methodology. The following ratings of Entergy Gulf States Louisiana are upgraded: Issuer Rating to Baa1 from Baa2 Preference Stock to Baa3 from Ba1 Pref. Shelf to (P)Baa3 from (P)Ba1 First Mortgage Bonds to A2 from A3 The outlook of Entergy Gulf States Louisiana is stable from RUR-UP The following ratings of Entergy Louisiana are upgraded: Issuer Rating to Baa1 from Baa2 Senior Unsecured to Baa1 from Baa2 Pref. Stock to Baa3 from Ba1 Backed First Mortgage Bonds to A2 from A3 Underlying First Mortgage Bonds to A2 from A3 First Mortgage Bonds to A2 from A3
58 EAI Direct Exhibit EL-2 Docket No. 15-015-U Page 4 of 7 APSC FILED Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56
The outlook of Entergy Louisiana is stable from RUR-UP The following rating of W3A Funding Corporation has been upgraded: BACKED Senior Secured Shelf to (P)Baa1 from (P)Baa2 The outlook of W3A Funding Corporation is stable from RUR-UP The following ratings of Entergy Mississippi are upgraded: Issuer Rating to Baa2 from Baa3 Senior Secured Shelf to (P)A3 from (P)Baa1 Pref. Stock to Ba1 from Ba2 Underlying First Mortgage Bonds to A3 from Baa1 First Mortgage Bonds to A3 from Baa1 Backed First Mortgage Bonds to A3 from Baa1 The outlook of Entergy Mississippi is stable from RUR-UP The following ratings of Entergy Texas are upgraded: Issuer Rating to Baa3 from Ba1 Senior Secured Shelf to (P)Baa1 from (P)Baa2 First Mortgage Bonds to Baa1 from Baa2 The outlook of Entergy Texas is stable from RUR-UP The following ratings of Entergy Arkansas, Inc. are confirmed: Issuer Rating, Confirmed at Baa2 Pref. Stock Preferred Stock, Confirmed at Ba1 Pref. Stock Shelf, Confirmed at (P)Ba1 Senior Secured First Mortgage Bonds, Confirmed at A3 The outlook of Entergy Arkansas, Inc. is stable from RUR-UP REGULATORY DISCLOSURES For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the rating action on the support provider and in relation to each particular rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com. For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this rating action, and whose ratings may change as a result of this rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.
59 EAI Direct Exhibit EL-2 Docket No. 15-015-U Page 5 of 7 APSC FILED Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56
Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review. Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating. Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating. Susana Vivares Vice President - Senior Analyst Corporate Finance Group Moody's Investors Service, Inc. 250 Greenwich Street New York, NY 10007 U.S.A. JOURNALISTS: 212-553-0376 SUBSCRIBERS: 212-553-1653 William L. Hess MD - Utilities Corporate Finance Group JOURNALISTS: 212-553-0376 SUBSCRIBERS: 212-553-1653 Releasing Office: Moody's Investors Service, Inc. 250 Greenwich Street New York, NY 10007 U.S.A. JOURNALISTS: 212-553-0376 SUBSCRIBERS: 212-553-1653
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60 EAI Direct Exhibit EL-2 Docket No. 15-015-U Page 6 of 7 APSC FILED Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56
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61 EAI Direct Exhibit EL-2 Docket No. 15-015-U Page 7 of 7 APSC FILED Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56
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62 APSC FILED Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56
BEFORE THE ARKANSAS PUBLIC SERVICE COMMISSION
IN THE MATTER OF THE APPLICATION ) OF ENTERGY ARKANSAS, INC. FOR ) DOCKET NO. 15-015-U APPROVAL OF CHANGES IN RATES FOR ) RETAIL ELECTRIC SERVICE )
EAI DIRECT EXHIBIT EL-3
MOODY’S ISSUER CREDIT RATINGS - U.S. ELECTRIC AND GAS
63 EAI Direct Exhibit EL-3 Docket No. 15-015-U Page 1 of 4 APSC FILED Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56
Moody's Issuer Credit Ratings - U.S. Electric and Gas Utility Sector Sorted by Rating March 23, 2015
Corporate LT Corporate LT Corporate LT Rating Rating Rating Moody's- Moody's- Feb Moody's- Jan Company Name March 23 2015 1 2014 28 2014 1 New Jersey Natural Gas Co. Aa2 Aa2 Aa3 2 DTE Gas Co. Aa3 Aa3 A1 3 Alabama Power Co. A1 A1 A2 4 Consumers Energy Co. A1 A3 Baa1 5 Duke Energy Carolinas LLC A1 A1 A2 6 Duke Energy Progress Inc. A1 A1 A2 7 Elm Road Generating Station Supercriticap A1 A1 A2 8 Florida Power & Light Co. A1 A1 A2 9 ITC Great Plains LLC A1 Baa1 Baa1 10 Madison Gas and Electric Co. A1 A1 A1 11 MidAmerican Energy Co. A1 A1 A2 12 Oklahoma Gas and Electric Co. A1 A1 A2 13 San Diego Gas & Electric Co. A1 A1 A2 14 Southern California Gas Co. A1 A1 A2 15 Washington Gas Light Co. A1 A1 A2 16 Wisconsin Electric Power Co. A1 A1 A2 17 Wisconsin Gas LLC A1 A1 A2 18 Wisconsin Power and Light Co A1 A1 A2 19 Wisconsin Public Service Corp. A1 A1 A2 20 Atmos Energy Corp. A2 A2 A3 21 Central Hudson Gas & Electric A2 A2 A3 22 Consolidated Edison Co. of NY A2 A2 A3 23 DTE Electric Co. A2 A2 A3 24 Duke Energy Indiana Inc. A2 A2 A3 25 Gulf Power Co. A2 A2 A3 26 Indiana Gas Co. A2 A2 A3 27 North Shore Gas Co. A2 A2 A3 28 Northern Illinois Gas Co. A2 A2 A3 29 Northern States Power Co - WI A2 A2 A3 30 Northern States Power Co. - MN A2 A2 A3 31 NSTAR Electric Co. A2 A2 A2 32 PECO Energy Co. A2 A2 A3 33 Peoples Gas Light & Coke Co. A2 A2 A3 34 Piedmont Natural Gas Co. A2 A2 A3 35 Public Service Electric Gas A2 A2 A3 36 Questar Corp. A2 A2 A3 37 Questar Gas Co. A2 A2 A3 38 South Jersey Gas Co. A2 A2 A3 39 Southern California Edison Co. A2 A2 A3 40 Southern Indiana Gas & Elec Co A2 A2 A3 41 Tampa Electric Co. A2 A2 A3 42 UGI Utilities Inc. A2 A2 A3 43 Vectren Utility Holdings Inc. A2 A2 A3 44 Virginia Electric & Power Co. A2 A2 A3 45 Wisconsin Energy Corp. A2 A2 A3 46 AGL Capital Corp A3 A3 Baa1 47 ALLETE Inc. A3 A3 Baa1 48 Alliant Energy A3 A3 Baa1 64 EAI Direct Exhibit EL-3 Docket No. 15-015-U Page 2 of 4 APSC FILED Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56
Corporate LT Corporate LT Corporate LT Rating Rating Rating Moody's- Moody's- Feb Moody's- Jan Company Name March 23 2015 1 2014 28 2014 49 Arizona Public Service Co. A3 A3 Baa1 50 Baltimore Gas and Electric Co. A3 A3 Baa1 51 Black Hills Power Inc. A3 A3 Baa1 52 CenterPoint Energy Houston A3 A3 Baa1 53 Central Maine Power Co. A3 A3 Baa1 54 Cleco Power LLC A3 Baa1 Baa2 55 Consolidated Edison Inc. A3 A3 Baa1 56 CT Natural Gas Corp. A3 A3 Baa1 57 DTE Energy Co. A3 A3 Baa1 58 Duke Energy Corp A3 A3 Baa1 59 Duke Energy Florida Inc. A3 A3 Baa1 60 Duquesne Light Co. A3 A3 Baa1 61 Edison International A3 A3 Baa1 62 Georgia Power Co. A3 A3 A3 63 Idaho Power Co. A3 A3 Baa1 64 Integrys Energy Group Inc. A3 Baa1 Baa1 65 International Transmission Company A3 A3 A3 66 ITC Midwest LLC A3 A3 A3 67 Kentucky Utilities Co. A3 A3 Baa1 68 Laclede Gas Co. A3 A3 Baa1 69 Louisville Gas & Electric Co. A3 A3 Baa1 70 Michigan Electric Transmission Company, LLC A3 A3 A3 71 MidAmerican Energy Holdings Co A3 A3 Baa1 72 NorthWestern Corp. A3 A3 Baa1 73 NY State Electric & Gas Corp. A3 A3 Baa1 74 OGE Energy Corp. A3 A3 Baa1 75 Orange & Rockland Utlts Inc. A3 A3 Baa1 76 Otter Tail Power Company A3 A3 A3 77 Pacific Gas and Electric Co. A3 A3 Baa1 78 PacifiCorp A3 A3 Baa1 79 Portland General Electric Co. A3 A3 Baa1 80 Public Service Co. of CO A3 A3 Baa1 81 Public Service Co. of OK A3 A3 Baa1 82 Southwest Gas Corp. A3 A3 Baa1 83 Superior Water, Light and Power Company A3 A3 Baa1 84 Trans Allegheny interstate Line A3 Baa1 Baa1 85 Tucson Electric Power Co. A3 Baa1 Baa2 86 UNS Electric Inc. A3 Baa1 Baa2 87 UNS Gas, Inc. A3 Baa1 Baa2 88 Western Massachusetts Electric A3 A3 Baa1 89 Xcel Energy Inc. A3 A3 Baa1 90 Monongahela Power Co A3 Baa1 Baa1 91 WGL Holdings Inc. A3 P-2 P-2 92 AEP Texas Central Co. Baa1 Baa1 Baa2 93 AEP Texas North Co. Baa1 Baa1 Baa2 94 Ameren Illinois Baa1 Baa1 Baa2 95 American Electric Power Co. Baa1 Baa1 Baa1 96 Appalachian Power Co. Baa1 Baa1 Baa2 97 Avista Corp. Baa1 Baa1 Baa2 98 Berkshire Gas Co. Baa1 Baa1 Baa2 65 99 Black Hills Corp Baa1 Baa1 baa2 EAI Direct Exhibit EL-3 Docket No. 15-015-U Page 3 of 4 APSC FILED Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56
Corporate LT Corporate LT Corporate LT Rating Rating Rating Moody's- Moody's- Feb Moody's- Jan Company Name March 23 2015 1 2014 28 2014 100 CenterPoint Energy Inc. Baa1 Baa1 baa2 101 Cleco Corp. Baa1 Baa2 Baa3 102 Commonwealth Edison Co. Baa1 Baa1 Baa2 103 Connecticut Light & Power Co. Baa1 Baa1 Baa2 104 Delmarva Power & Light Co. Baa1 Baa1 Baa2 105 Duke Energy Kentucky Inc. Baa1 Baa1 Baa1 106 El Paso Electric Co. Baa1 Baa1 Baa2 107 Empire District Electric Co. Baa1 Baa1 Baa2 108 Entergy Gulf States LA LLC Baa1 Baa1 Baa2 109 Entergy Louisiana LLC Baa1 Baa1 Baa2 110 Hawaiian Electric Co. Baa1 Baa1 Baa1 111 IDACORP Inc. Baa1 Baa1 Baa2 112 Indiana Michigan Power Co. Baa1 Baa1 Baa2 113 Indianapolis Power & Light Co. Baa1 Baa1 Baa2 114 Kansas City Power & Light Company Baa1 Baa1 Baa2 115 Metropolitan Edison Baa1 Baa2 Baa2 116 Mississippi Power Co. Baa1 Baa1 Baa1 117 Nevada Power Co. Baa1 Baa1 Baa2 118 NextEra Energy, Inc. Baa1 Baa1 Baa1 119 Northeast Utilities Baa1 Baa1 Baa2 120 Northern IN Public Svc Co. Baa1 Baa1 Baa2 121 Ohio Edison Baa1 Baa2 Baa2 122 Pinnacle West Capital Corp. Baa1 Baa1 Baa2 123 Potomac Electric Power Co. Baa1 Baa1 Baa2 124 PPL Electric Utilities Corporation Baa1 Baa1 Baa2 125 Progress Energy Inc. Baa1 Baa1 Baa2 126 Public Service Co. of NH Baa1 Baa1 Baa2 127 Puget Sound Energy Inc. Baa1 Baa1 Baa2 128 Rochester Gas & Electric Corp. Baa1 Baa1 Baa2 129 SEMCO Energy Inc. Baa1 Baa1 Baa2 130 Sierra Pacific Power Co. Baa1 Baa1 Baa2 131 Southern Connecticut Gas Co. Baa1 Baa1 Baa2 132 Southern Power Co. Baa1 Baa1 Baa1 133 Southwestern Public Service Co Baa1 Baa1 Baa2 134 TECO Energy Inc. Baa1 Baa1 Baa2 135 Texas-New Mexico Power Co. Baa1 Baa1 Baa2 136 The Southern Company Baa1 Baa1 Baa1 137 Union Electric Co. Baa1 Baa1 Baa2 138 United Illuminating Co. Baa1 Baa1 Baa2 139 UNS Energy Corp. Baa1 Baa2 Baa3 140 West Penn Power Co. Baa1 Baa2 Baa2 141 Westar Energy Inc. Baa1 Baa1 Baa2 142 Yankee Gas Services Company Baa1 Baa1 Baa2 143 Ameren Corp. Baa2 Baa2 Baa3 144 American Transmission System Baa2 Baa2 Baa2 145 Atlantic City Electric Co. Baa2 Baa2 Baa2 146 CMS Energy Corp. Baa2 Baa2 Baa3 147 Dominion Resources Inc. Baa2 Baa2 Baa2 148 Entergy Arkansas Inc. Baa2 Baa2 Baa2 149 Entergy Mississippi Inc. Baa2 Baa2 Baa3 66 150 Exelon Corporation Baa2 Baa2 Baa2 EAI Direct Exhibit EL-3 Docket No. 15-015-U Page 4 of 4 APSC FILED Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56
Corporate LT Corporate LT Corporate LT Rating Rating Rating Moody's- Moody's- Feb Moody's- Jan Company Name March 23 2015 1 2014 28 2014 151 Great Plains Energy Inc. Baa2 Baa2 Baa3 152 ITC Holdings Corp. Baa2 Baa2 Baa2 153 Jersey Central Power & Light Baa2 Baa2 Baa2 154 Kansas City Power & Light Greater MO Operating Baa2 Baa2 Baa3 155 Kentucky Power Co. Baa2 Baa2 Baa2 156 Laclede Group Inc. Baa2 Baa1 Baa2 157 LG&E and KU Energy LLC Baa2 Baa2 Baa2 158 NISource Capital Markets, Inc, Baa2 Baa2 Baa3 159 NISource Finance Corp. Baa2 Baa2 Baa3 160 NV Energy Baa2 Baa2 Baa3 161 Otter Tail Corp. Baa2 Baa2 Baa3 162 Pennsylvania Electric Baa2 Baa2 Baa2 163 PNG Companies LLC Baa2 Baa2 Baa3 164 Potomac Edison Co. Baa2 Baa3 Baa3 165 Public Service Enterprise Group Baa2 Baa2 Baa2 166 SourceGas LLC Baa2 Baa2 Baa3 167 South Carolina Elec and Gas Baa2 Baa2 Baa2 168 Southwestern Electric Power Co Baa2 Baa2 Baa3 169 UIL Holdings Corp. Baa2 Baa2 Baa3 170 Monongahela Power Co Baa2 [Baa3] [Baa3] 171 Cleveland Electric Illuminating Baa3 Baa3 Baa3 172 Dayton Power and Light Baa3 Baa3 Baa3 173 Duquesne Light Holdings Inc. Baa3 Baa3 Baa3 174 Entergy Corporation Baa3 Baa3 Baa3 175 Entergy Texas Inc. Baa3 Baa3 Ba1 176 FirstEnergy Corp. Baa3 Baa3 Baa3 177 FirstEnergy Solutions Baa3 Baa3 Baa3 178 IPALCO Enterprises Inc. Baa3 Baa3 Ba1 179 Pepco Holdings Inc. Baa3 Baa3 Baa3 180 PNM Resources Inc. Baa3 Baa3 Ba1 181 PPL Corp. Baa3 Baa3 Baa3 182 Puget Energy Inc. Baa3 Baa3 Ba1 183 SCANA Baa3 Baa3 Baa3 184 Toledo Edison Baa3 Baa3 Baa3 185 Entergy New Orleans Ba2 Ba2 Ba2 186 Hawaiian Electric Industries NO LT Rating Baa2 Baa2 187 NiSource Inc. no debt rating Baa2 Baa3 188 AGL Resources Withdawn A3 Baa1 189 Atlanta Gas Light Co. Withdrawn A2 A3 190 Pivotal Utility Holdings Withdrawn A2 A3
Source: Moody's Investors Service
67 APSC FILED Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56
BEFORE THE ARKANSAS PUBLIC SERVICE COMMISSION
IN THE MATTER OF THE APPLICATION ) OF ENTERGY ARKANSAS, INC. FOR ) DOCKET NO. 15-015-U APPROVAL OF CHANGES IN RATES FOR ) RETAIL ELECTRIC SERVICE )
EAI DIRECT EXHIBIT EL-4
DEUTSCHE BANK MARKETS RESEARCH
DB UTILITY SPOTLIGHT (#144)
JANUARY 3, 2014
THIS EXHIBIT CONTAINS CONFIDENTIAL PROTECTED INFORMATION PROVIDED PURSUANT TO THE COMMISSION’S INTERIM PROTECTIVE ORDER NO. 1 ISSUED ON MARCH 17, 2015 IN THIS DOCKET
68 EAI Direct Exhibit EL-4 Docket No. 15-015-U Deutsche Bank Page 1 of 31 Markets Research
North America Industry Date United States APSC FILED Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:583 JanuaryPM: Docket 2014 15-015-U-Doc. 56 Industrials DB Utility Spotlight Utilities and Power (#144) Industry Update
Utilities hoping for a better 2014
Deutsche Bank Securities Inc. Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors69 should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MICA(P) 054/04/2013.
EAI Direct Exhibit EL-4 Docket No. 15-015-U Page 2 of 31
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70 EAI Direct Exhibit EL-4 Docket No. 15-015-U 3 January 2014 Page 3 of 31 Utilities and Power DB Utility Spotlight (#144)
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Entergy Corp. (ETR) – Final order in AR rate case
We viewed the order negatively for ETR, particularly since the commission has recommended additional cost disallowances versus Staff’s recommendation and a lower ROE. In the order, the PSC has directed Staff to file an updated revenue deficiency as compared to Staff’s most recent $110M recommendation based on an ROE of 9.3% vs. the 9.6% ROE recommended by Staff and cost disallowances totaling about $15M related to incentive compensation.
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BEFORE THE ARKANSAS PUBLIC SERVICE COMMISSION
IN THE MATTER OF THE APPLICATION ) OF ENTERGY ARKANSAS, INC. FOR ) DOCKET NO. 15-015-U APPROVAL OF CHANGES IN RATES FOR ) RETAIL ELECTRIC SERVICE )
EAI DIRECT EXHIBIT EL-5
UBS
US IPP WEEKLY POWER POINTS
JANUARY 6, 2014
THIS EXHIBIT CONTAINS CONFIDENTIAL PROTECTED INFORMATION PROVIDED PURSUANT TO THE COMMISSION’S INTERIM PROTECTIVE ORDER NO. 1 ISSUED ON MARCH 17, 2015 IN THIS DOCKET
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Entergy’s awarded 9.3% ROE by AR PSC
We read the decision negatively vs. our expectations. Vs. the 9.8% normalized ROE posted in 2012, we see the potential for a revenue reduction, or more importantly a relatively flat net income profile.
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BEFORE THE ARKANSAS PUBLIC SERVICE COMMISSION
IN THE MATTER OF THE APPLICATION ) OF ENTERGY ARKANSAS, INC. FOR ) DOCKET NO. 15-015-U APPROVAL OF CHANGES IN RATES FOR ) RETAIL ELECTRIC SERVICE )
EAI DIRECT EXHIBIT EL-6
INTERNATIONAL STRATEGY & INVESTMENT GROUP LLC POWER & UTILITIES RESEARCH DIVERSIFIED UTILITIES
ENTERGY CORP (ETR)
JANUARY 3, 2014
THIS EXHIBIT CONTAINS CONFIDENTIAL PROTECTED INFORMATION PROVIDED PURSUANT TO THE COMMISSION’S INTERIM PROTECTIVE ORDER NO. 1 ISSUED ON MARCH 17, 2015 IN THIS DOCKET
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BEFORE THE ARKANSAS PUBLIC SERVICE COMMISSION
IN THE MATTER OF THE APPLICATION ) OF ENTERGY ARKANSAS, INC. FOR ) DOCKET NO. 15-015-U APPROVAL OF CHANGES IN RATES FOR ) RETAIL ELECTRIC SERVICE )
EAI DIRECT EXHIBIT EL-7
CREDIT SUISSE
UTILITY ROE TRENDS IN 2013
JANUARY 2, 2014
THIS EXHIBIT CONTAINS CONFIDENTIAL PROTECTED INFORMATION PROVIDED PURSUANT TO THE COMMISSION’S INTERIM PROTECTIVE ORDER NO. 1 ISSUED ON MARCH 17, 2015 IN THIS DOCKET
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Source: Company data, Credit Suisse estimates 117
EAI Direct Exhibit EL-7 Docket No. 15-015-U Exhibit 2: 2012 Rate Case Outcomes Page 3 of 7 APSC FILED Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56
118 Source: Company data, Credit Suisse estimates
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122 APSC FILED Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56
BEFORE THE ARKANSAS PUBLIC SERVICE COMMISSION
IN THE MATTER OF THE APPLICATION ) OF ENTERGY ARKANSAS, INC. FOR ) DOCKET NO. 15-015-U APPROVAL OF CHANGES IN RATES FOR ) RETAIL ELECTRIC SERVICE )
EAI DIRECT EXHIBIT EL-8
MOODY’S INVESTORS SERVICE OCTOBER 14, 2014 ENTERGY ARKANSAS INC.
123 EAI Direct Exhibit EL-8 Docket No. 15-015-U Page 1 of 7 APSC FILED Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56
Credit Opinion: Entergy Arkansas, Inc.
Global Credit Research - 14 Oct 2014 Little Rock, Arkansas, United States
Ratings
Category Moody's Rating Outlook Stable Issuer Rating Baa2 First Mortgage Bonds A3 Senior Secured Shelf (P)A3 Pref. Stock Ba1 Parent: Entergy Corporation Outlook Stable Issuer Rating Baa3 Senior Unsecured Baa3 Commercial Paper P-3
Contacts
Analyst Phone Susana Vivares/New York City 212.553.4694 William L. Hess/New York City 212.553.3837
Key Indicators
[1]Entergy Arkansas, Inc. 6/30/2014 (LTM) 12/31/2013 12/31/2012 12/31/2011 12/31/2010 CFO pre-WC + Interest / Interest 6.5x 5.7x 4.8x 6.1x 6.2x CFO pre-WC / Debt 20.1% 18.4% 14.4% 22.0% 24.8% CFO pre-WC - Dividends / Debt 19.8% 17.6% 13.8% 17.4% 17.7% Debt / Capitalization 42.5% 42.8% 43.8% 44.5% 44.4%
[1] All ratios are based on 'Adjusted' financial data and incorporate Moody's Global Standard Adjustments for Non- Financial Corporations. Source: Moody's Financial Metrics
Note: For definitions of Moody's most common ratio terms please see the accompanying User's Guide.
Opinion
Rating Drivers Restrictive regulatory environment with equity returns below prevailing industry averages, a credit negative Service territory still in recovery stage, so growth prospects are lagging compared to regional peers Cash flow coverage metrics are steady in the high-teen's range Joining MISO should help manage load and assure reliability
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Corporate Profile Entergy Arkansas, Inc. (EA, Baa2 stable) is a vertically integrated utility regulated by the Arkansas Public Service Commission (APSC), a wholly owned subsidiary of Entergy Corporation (ETR, Baa3 stable), serving approximately 700,000 retail electric customers. Its last filed rate base was approximately $4.8 billion, as of year- end 2012, and it earned a book return on equity (ROE) of about 9.5% as of August 2014. EA produced 52% of its generation from nuclear reactors, 33% from coal, 14% from gas, and 1% from hydro. EA has a balanced customer base, 38% of total kilowatt hours sold in 2013, with remaining sales broken down into 32% industrial, 28% commercial, and 2% governmental. EA began operating in the Midcontinent Independent System Operator (MISO) regional transmission organization (RTO) in December 2013. SUMMARY RATING RATIONALE EA's Baa2 rating reflects a regulated utility operating under a traditional rate of return regulation structure, which is more restrictive than regional peers and has authorized equity returns below industry averages. The utility exhibits cash flow metrics that are steady in the high-teen's range, and has a service territory with balanced exposure to industrial and commercial sales. DETAILED RATING CONSIDERATIONS RESTRICTIVE REGULATORY ENVIRONMENT WITH EQUITY RETURNS BELOW PREVAILING INDUSTRY AVERAGES, A CREDIT NEGATIVE Arkansas regulation is generally restrictive from an investor perspective. EA operates under the traditional rate of return regulation rather than the more credit supportive formula rate plans in place at ETR's other regulated subsidiaries in Louisiana and Mississippi, which contributes to regulatory lag at EA. The APSC generally relies on a year-end original cost rate base for a historical test year in rate proceedings, with riders in place that allow the utilities to recover costs such as fuel and purchased power, gas commodity, energy efficiency, and MISO capacity costs. In February 2014, the APSC approved EA's request to exclude from its revised energy cost rate calculation $66 million of deferred fuel and purchased energy costs incurred in 2013 from a stator incident at Arkansas Nuclear One. EA was authorized to retain the amount in its deferred fuel balance with recovery, until more detail regarding the incident is available. In March 2013, EA filed with the APSC, requesting a rate increase of $174 million, which included $49 million of revenue being transferred from collection in riders to base rates, and proposing a ROE of 10.4%. Later in December 2013, the APSC issued an order for an $81 million revenue deficiency, including increases in storm reserve accrual and depreciation expenses, with a 9.3% ROE. EA requested a rehearing from the commission in February 2014, which was granted. The APSC issued an amended order increasing the ROE from 9.3% to 9.5% in August 2014. Nevertheless, this process highlights the below average regulatory environment for EA, resulting in a less timely suite of recovery mechanisms and below average returns. SERVICE TERRITORY STILL IN RECOVERY STAGE EA is the largest utility within the ETR family, with a service territory consisting of 63 counties covering the majority of the state of Arkansas. According to Moody's Economy, Arkansas' recovery has been stuck in neutral over the past several months and is lagging those of its peers in the western South Central region. Private services growth has leveled off over the last several months, and manufacturing has only recently started to gain ground after an extended period of decline. The unemployment rate declined to 6.2% in July, but this was driven entirely by a decrease in the labor force rather than an increase in hiring. Little Rock has a stable employment base, consisting of an educated and skilled workforce, lower business costs, and higher per capita income compared to the rest of Arkansas. A strong public sector bolsters demand, picking up the slack from private sector. Arkansas will remain in recovery in 2014, driven by gains in housing, private services, and to a lesser extent manufacturing. Over the long term, Arkansas is expected to have employment and income growth in line with the national average. CASH FLOW COVERAGE METRICS IN THAT ARE ADEQUATE FOR ITS RATING EA's financial and cash flow metrics map in the low-A to high-Baa range, well positioned for its current rating. In 2012, the utility recorded a three-year average interest coverage ratio of 5.7x, cash flow from operations before
125 EAI Direct Exhibit EL-8 Docket No. 15-015-U Page 3 of 7 APSC FILED Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56 working-capital changes (CFO pre-WC) to debt of 20%, and total debt to capitalization of 44%; for 2013 key financial metrics were 5.6x, 18% and 44%, respectively; and for LTM Q2 2014 key financial metrics were 6.0x, 19%, and 45%, respectively. In 2015 and 2016, CFO pre-WC to debt is expected to remain in the high-teens to low-twenties range, with debt to capitalization in the low forties. CFO pre-WC was $515 million and $571 million for 2013 and LTM Q2 2014, respectively. Total debt remained constant at approximately $2.8 billion over the same time period. Capital expenditures (capex) including nuclear fuel are expected to be around $600 to $650 million per year in 2014 and 2015, barring any major generating asset purchases. Capex in the first two quarters of 2014 were in line with projections, at a sum of $365 million. EA's capital plan for 2014-2016 reflects a focus on environmental compliance, spending for storms, new generation resource requirements, and transmission investments to support economic development. This makes a return to the historical level of capex of below $500 million per year rather unlikely. The lack of a formula rate plan and recovery of construction work in progress has the potential to exacerbate regulatory lag and hamper the utility's ability to earn its allowed return, a potential credit negative. JOINING MISO HELPS TO MANAGE LOAD AND ASSURE RELIABILITY In April 2013, APSC approved the proposed transfer of functional control of its electric transmission system to the MISO. EA, like its affiliates, joined the MISO RTO in December 2013, a move that helps EA manage generation resources to meet load and assure reliability. Being a member of MISO facilitates EA's access to lower cost resources across the RTO; however, MISO could have resource planning requirements that could cause EA to increase its reserve margin over time with longer term contracts or owned resources. We expect that any necessary generation or transmission investments required in conjunction with the transition into MISO will be recoverable in rates. Liquidity Profile EA's liquidity is adequate. The company relies on its participation in the Entergy System money pool for most of its liquidity and short-term funding needs, but also has the ability to draw upon its own credit facilities and the parent company's committed credit facility for emergency situations. EA's FERC authorized borrowing limit for short-term borrowings is $250 million. EA also has credit facilities in the amount of $20 million, maturing in April 2015 (and expected to be refinanced shortly) and $150 million scheduled to expire in March 2019. The stand-alone facilities require EA to meet a 65% debt to capitalization covenant, with which the company was in compliance as of 2Q 2014. In addition, EA has a nuclear fuel trust with an $85 million facility that expires in June 2016 that backstops the trust's commercial paper. As of Q2 2014, EA had cash and short-term investments of $32 million, $11 million borrowed from the money pool, $40 million of commercial paper outstanding under the fuel trust, and no utilization under the stand-alone facilities. For LTM 2Q 2014, EA had CFO of $511 million, Capex of $663 million (including nuclear fuel) and paid out dividends of $9 million, yielding $161 million of negative free cash flow. The negative free cash flow has been funded with money pool borrowings and dividend reductions in the past, and will likely require debt issuances in the future. For 2014 and 2015, we estimate that CFO will be in the $500 to $550 million range, with capex at approximately the same level. This is likely to result in another year of negative free cash flow, the magnitude of which will depend on the level of dividends. The company's dividend payout ratio was 9% in 2013 and 7% in 2012. EA's next long-term debt maturity is $55 million of VIE notes payable due in July 2016. Liquidity is important to the Entergy system, due to the size of the company's unregulated wholesale power business, the company's reliance on natural gas fired generation, which can experience price volatility leading to increased working capital requirements, and the experience of Entergy's Gulf Coast subsidiaries in dealing with severe storm events. Rating Outlook EA's rating outlook is stable, reflecting our expectation that the utility's financial metrics, including a ratio of cash flow to debt, will remain in the high-teen's range. In addition, the stable outlook incorporates a view that Arkansas' restrictive regulatory environment, which results in a less timely suite of recovery mechanisms and below average return, will not worsen or become more contentious. What Could Change the Rating - Up Unless there are significant improvements in the regulatory framework and improvements in the utility's interaction
126 EAI Direct Exhibit EL-8 Docket No. 15-015-U Page 4 of 7 APSC FILED Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56 in the regulatory process, a rating upgrade is unlikely. However if there is a material improvement in the Arkansas' regulatory structure, along with a sustainable increase in cash flow coverage metrics, including CFO pre-working capital to debt above 22% and CFO pre WC less dividends to debt in the high teens, an upgrade could be considered. What Could Change the Rating - Down EA's rating could be downgraded if there were a series of adverse regulatory developments which cause key financial metrics to decline, including CFO pre WC to debt below the mid-teens for a sustainable period of time.
Rating Factors
Entergy Arkansas, Inc.
Regulated Electric and Gas Utilities Industry Current LTM [3]Moody's 12-18 Month Grid [1][2] 06/30/2014 Forward ViewAs of October 2014 Factor 1 : Regulatory Framework (25%) Measure Score Measure Score a) Legislative and Judicial Underpinnings of A A A A the Regulatory Framework b) Consistency and Predictability of Baa Baa Baa Baa Regulation Factor 2 : Ability to Recover Costs and Earn Returns (25%) a) Timeliness of Recovery of Operating and Baa Baa Baa Baa Capital Costs b) Sufficiency of Rates and Returns Baa Baa Baa Baa Factor 3 : Diversification (10%) a) Market Position Baa Baa Baa Baa b) Generation and Fuel Diversity Ba Ba Ba Ba Factor 4 : Financial Strength (40%) a) CFO pre-WC + Interest / Interest (3 Year 6.0x A 5.5x - 6.0x A Avg) b) CFO pre-WC / Debt (3 Year Avg) 18.7% Baa 18% - 22% Baa c) CFO pre-WC - Dividends / Debt (3 Year 17.2% A 17% - 21% A Avg) d) Debt / Capitalization (3 Year Avg) 44.5% A 40% - 45% A Rating: Grid-Indicated Rating Before Notching Baa1 Baa1 Adjustment HoldCo Structural Subordination Notching n/a n/a a) Indicated Rating from Grid Baa1 Baa1 b) Actual Rating Assigned Baa2 Baa2
[1] All ratios are based on 'Adjusted' financial data and incorporate Moody's Global Standard Adjustments for Non- Financial Corporations. [2] As of 06/30/2014(L); Source: Moody's Financial Metrics [3] This represents Moody's forward view; not the view of the issuer; and unless noted in the text, does not incorporate significant acquisitions and divestitures.
This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on http://www.moodys.com for the most updated credit rating action information and rating history.
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129 EAI Direct Exhibit EL-8 Docket No. 15-015-U Page 7 of 7 APSC FILED Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56 section 761G of the Corporations Act 2001. MOODY'S credit rating is an opinion as to the creditworthiness of a debt obligation of the issuer, not on the equity securities of the issuer or any form of security that is available to retail clients. It would be dangerous for "retail clients" to make any investment decision based on MOODY'S credit rating. If in doubt you should contact your financial or other professional adviser.
130 APSC FILED Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56
BEFORE THE ARKANSAS PUBLIC SERVICE COMMISSION
IN THE MATTER OF THE APPLICATION ) OF ENTERGY ARKANSAS, INC. FOR ) DOCKET NO. 15-015-U APPROVAL OF CHANGES IN RATES FOR ) RETAIL ELECTRIC SERVICE )
EAI DIRECT EXHIBIT EL-9
REGULATORY RESEARCH ASSOCIATES MAJOR RATE CASE DECISIONS CALENDAR YEARS 2013 AND 2014
THIS EXHIBIT CONTAINS CONFIDENTIAL PROTECTED INFORMATION PROVIDED PURSUANT TO THE COMMISSION’S INTERIM PROTECTIVE ORDER NO. 1 ISSUED ON MARCH 17, 2015 IN THIS DOCKET
131 APSC FILED Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56
BEFORE THE ARKANSAS PUBLIC SERVICE COMMISSION
IN THE MATTER OF THE APPLICATION ) OF ENTERGY ARKANSAS, INC. FOR ) DOCKET NO. 15-015-U APPROVAL OF CHANGES IN RATES FOR ) RETAIL ELECTRIC SERVICE )
EAI DIRECT EXHIBIT EL-10
ROE DECISIONS IN STATE JURISDICTIONS JANUARY 1, 2013 – DECEMBER 31, 2014
THIS EXHIBIT CONTAINS CONFIDENTIAL PROTECTED INFORMATION PROVIDED PURSUANT TO THE COMMISSION’S INTERIM PROTECTIVE ORDER NO. 1 ISSUED ON MARCH 17, 2015 IN THIS DOCKET
132 APSC FILED Time: 4/24/2015 1:59:53 PM: Recvd 4/24/2015 1:58:58 PM: Docket 15-015-U-Doc. 56
BEFORE THE ARKANSAS PUBLIC SERVICE COMMISSION
IN THE MATTER OF THE APPLICATION ) OF ENTERGY ARKANSAS, INC. FOR ) DOCKET NO. 15-015-U APPROVAL OF CHANGES IN RATES FOR ) RETAIL ELECTRIC SERVICE )
EAI DIRECT EXHIBIT EL-11
CREDIT RATINGS OF UTILITIES IN REGIONAL COMPARISON GROUP
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Integrated Electric Utility Ratings: Southeastern/ South Central Region Standard & Poors Moody's Ratings Ratings Senior Senior LT Issuer Unsec. LT Issuer Unsec. Rating Rating Rating Rating Company Name Moody's Moody's Company Name S&P S&P 1 Alabama Power Co. A1 A1 1 Alabama Power Co. AA 2 Duke Energy Carolinas LLC A1 A1 2 Georgia Power Co. AA 3 Florida Power & Light Co. A1 - 3 Gulf Power Co. AA 4 Oklahoma Gas and Electric Co. A1 A1 4 Mississippi Power Co. AA 5 Gulf Power Co. A2 A2 5 Florida Power & Light Co. A- - 6 Tampa Electric Co. A2 A2 6 Interstate Power & Light Co. A- A- 7 Virginia Electric & Power Co. A2 A2 7 Oklahoma Gas and Electric Co. A- A- 8 Cleco Power LLC A3 A3 8 Virginia Electric & Power Co. A- A- 9 Duke Energy Florida Inc. A3 A3 9 Cleco Power LLC BBB+ BBB+ 10 Georgia Power Co. A3 A3 10 Duke Energy Carolinas LLC BBB+ BBB+ 11 Interstate Power & Light Co. A3 A3 11 Duke Energy Florida Inc. BBB+ BBB+ 12 Kentucky Utilities Co. A3 A3 12 Duke Energy Kentucky Inc. BBB+ BBB+ 13 Louisville Gas & Electric Co. A3 A3 13 South Carolina Electric & Gas BBB+ - 14 Public Service Co. of OK A3 A3 14 Tampa Electric Co. BBB+ BBB+ 15 AEP Texas North Co. Baa1 - 15 Entergy Arkansas Inc. BBB - 16 Duke Energy Kentucky Inc. - Baa1 16 El Paso Electric Co. BBB BBB 17 El Paso Electric Co. Baa1 Baa1 17 Entergy Gulf States LA LLC BBB - 18 Entergy Gulf States LA LLC Baa1 - 18 Entergy Louisiana LLC BBB BBB 19 Entergy Louisiana LLC Baa1 Baa1 19 Entergy Mississippi Inc. BBB - 20 Mississippi Power Co. Baa1 Baa1 20 Entergy Texas Inc. BBB - 21 Entergy Arkansas Inc. Baa2 - 21 Kentucky Power Co. BBB BBB 22 Entergy Mississippi Inc. Baa2 - 22 Kentucky Utilities Co. BBB - 23 Kentucky Power Co. Baa2 Baa2 23 Louisville Gas & Electric Co. BBB - 24 South Carolina Electric & Gas Baa2 - 24 Public Service Co. of OK BBB BBB 25 Southwestern Electric Power Co Baa2 Baa2 25 Southwestern Electric Power Co BBB BBB 26 Entergy Texas Inc. Baa3 - 26 AEP Texas North Co. BBB -
Median Rating Baa1 Median Rating BBB+ Higher rated than EAI 76% Higher rated than EAI 59% Same as EAI 21% Same as EAI 41% Lower rated than EAI 3% Lower rated than EAI 0%
Unsec. = Unsecured Debt. Source: SNL Financial, LLC. Ratings as of March 28, 2015
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