(Release No. 35-27652; 70-10100)
Allegheny Energy, Inc., et al.
Supplemental Order Modifying Certain Conditions of Previous Order, Authorizing Payment of Dividends Out of Capital Surplus; and Reserving Jurisdiction
Allegheny Energy, Inc. ("Allegheny"), a registered public-utility holding company under the Public Utility Holding Company Act, as amended ("Act"), and its wholly owned subsidiary, Allegheny Energy Supply Company, L.L.C. ("AE Supply"), a registered public-utility holding company and a public-utility company within the meaning of the Act (together, "Applicants"), Hagerstown, Maryland, have filed an application-declaration, as amended ("Application"), under sections 6(a), 7, and 12 (c) of the Act and rules 46 and 54 under the Act. The Commission issued a notice of the Application on November 5, 2002 (Holding Co. Act Release No. 27596). The Commission received comments from UBS AG ("UBS"), a creditor of AE Supply, and a hearing request from Ms. Elizabeth Smith, an individual shareholder of Allegheny.
Allegheny has three state-regulated electric utility subsidiaries, West Penn Power Company ("West Penn"), Monongahela Power Company ("Monongahela Power") and The Potomac Edison Company ("Potomac Edison"), and one state-regulated gas utility subsidiary, Mountaineer Gas Company ("Mountaineer Gas"). Mountaineer Gas is a wholly owned subsidiary of Monongahela Power. The three electric utilities and the gas utility are collectively referred to below as the "Operating Companies."
AE Supply is the electric generating company for the Allegheny system. Between 1999 and 2001, in response to deregulation legislation in Maryland, West Virginia, Virginia and Pennsylvania, the electric Operating Companies transferred generating assets totaling approximately 6,900 megawatts ("MW") to AE Supply. AE Supply provides power to West Penn, Potomac Edison and Monongahela Power under contracts that represent a significant portion of the normal capacity of AE Supply's generating assets. Since its formation, AE Supply's core business has thus been the provision of power to the electric Operating Companies to serve their native load. Although AE Supply is a public-utility company for purposes of the Act, it is not a utility for purposes of state regulation, nor is it subject to regulation as a utility in any of the states in which it operates.
Allegheny entered the merchant power business with the purchase of a 276 MW generating unit located at the Fort Martin Power Station in West Virginia, which was subsequently transferred to AE Supply. Beginning in 2000, Allegheny significantly expanded its merchant power trading business. In May 2001, AE Supply acquired three natural gas-fired generating facilities with total capacity of 1,710 MW in Illinois, Indiana and Tennessee (Midwest), for a purchase price of approximately $1.1 billion. In addition, AE Supply has acquired, constructed or obtained contractual control over 569 MW of capacity.
Also, in 2001, AE Supply acquired Global Energy Markets, the energy commodity marketing and trading business of Merrill Lynch Capital Services, Inc. The acquisition of this business, discussed further below, provided AE Supply with expanded expertise in wholesale marketing, energy trading, fuel procurement, market analysis and risk management.
II. Current Financing Authorizations
By order dated December 31, 2001 (the "December 2001 Order"), the Commission authorized Allegheny, AE Supply and other subsidiaries of Allegheny to engage in various financing transactions through December 31, 2005 (the "Authorization Period"). Specifically, the December 2001 Order granted the following authorizations:
These transactions were subject to certain financing parameters, including the following, among others:
By order dated October 17, 2002 (Holding Co. Act Release No. 27579) (the "October 2002 Order"), the Commission released jurisdiction reserved in the December 2001 Order over the issuance of any secured debt by AE Supply and authorized AE Supply to issue and sell during the Authorization Period up to $2 billion of short-term and/or long-term secured debt at any one time outstanding. The debt would be secured by substantially all of the assets of AE Supply, including its utility assets and securities of public-utility companies and other companies held by it, and all or substantially all of the assets of its subsidiaries, in each case to the extent permitted by, and consistent with, contractual restrictions and applicable law.2 Any secured debt securities issued under the order would be included in, and subject to, the Financing Limit, and to the following parameters:
These parameters represented a modification of the corresponding financing parameters of the December 2001 Order applicable to unsecured debt of Allegheny and of AE Supply. Also, there was no requirement that the secured debt securities maintain an investment grade rating, as had been the case for unsecured debt in the December 2001 Order.
The October 2002 Order reserved jurisdiction, in addition to those matters over which jurisdiction was reserved in the December 2001 Order, over (1) the common stock equity to be maintained by Allegheny and AE Supply as a condition to the authorization for AE Supply to issue secured debt below the levels set forth in the October 2002 Order and (2) any interest rate higher than 12% plus the prime rate that would apply to any secured debt to be issued under the October 2002 Order.
III. Applicants' Current Financial Situation and Prospects
As discussed in the October 2002 Order, Applicants have experienced weaker financial performance and tightened liquidity during 2002, largely as a result of the deterioration of the merchant power and energy trading businesses.
As noted above, the Allegheny system significantly expanded its merchant power business, beginning in 2000. AE Supply acquired, constructed or obtained contractual control over a total of 2,250 MW of capacity. In addition, additional generating capacity totaling 810 MW will become available to AE Supply between 2003 and 2005. Applicants state that, at the time, the expansion of the merchant power business appeared to be a reasonable way to take advantage of Allegheny's experience with state deregulation and retail competition. Now, in difficult market conditions, the business is creating stress on the financial performance of AE Supply and Allegheny.
Applicants explain that the merchant power business has recently suffered a number of setbacks. Some markets, most notably California, have experienced interruptions of supply and price volatility. Merchant trading was negatively affected by the bankruptcy filing by Enron and liquidity problems experienced by several other major market participants. These events have caused state deregulation to be delayed, discontinued and/or reversed. As a result, the demand for merchant power has not developed as expected. Additional capacity, coupled with lower than expected loads and a relatively weak economy, have led to reduced wholesale prices in several regional markets in which AE Supply owns, operates or contractually controls generation assets.
The acquisition by AE Supply of Global Energy Markets in 2001 included a long-term contractual right to call up to 1,000 MW of generating capacity in southern California. Shortly after the acquisition, AE Supply entered into a power purchase agreement with the California Department of Water Resources (the "CDWR"). In 2002, in response to concern over the cost of natural gas and the prices for electricity in California, AE Supply entered into a series of forward purchases of electricity at prices above the contractual price of the CDWR contract. These purchases and related forward purchase hedges have negatively affected AE Supply's cash flows. In the first six months of 2002, AE Supply suffered trading losses of approximately $29 million.4
In 2002, AE Supply also suffered higher than normal unplanned outages at its generating facilities. These outages resulted in lower net revenues as a result of increased operation expenses, including the purchase of higher priced replacement power, and also reduced excess generation available for sale into the wholesale markets.
For the six months ended June 30, 2002, Allegheny had consolidated income before cumulative effect of accounting change of approximately $69 million. This result primarily reflects weak wholesale energy markets nationwide, reduced economic activity and unplanned generator outages, as discussed above. In addition, Allegheny recorded as of June 30, 2002, an after-tax charge for cancellation of generation projects ($23.3 million) and an impairment charge for unregulated investments ($5.5 million).
Also, for the six months ended June 30, 2002, Allegheny completed its assessment of goodwill in accordance with Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets," and determined that approximately $210 million of goodwill, primarily related to the acquisitions of Mountaineer Gas and West Virginia Power5 was impaired. Consequently, Allegheny recorded an after-tax charge of $130.5 million as the cumulative effect of an accounting change as of January 1, 2002.
The weakness in the wholesale energy markets is expected to continue into next year. As a result, Allegheny's financial forecasts continue to show a less profitable financial performance through 2003.
Applicants continue to believe that the underlying assets remain strong and will provide improved financial performance in the long term. In the short term, Applicants state that they have undertaken measures to reduce costs and raise cash and to refocus their business.
To reduce costs and bolster financial performance, AE Supply has cancelled a number of generation projects and has suspended construction of 540 MW of combustion turbine generation planned for St. Joseph, Indiana. This step will reduce capital expenditures by approximately $900 million over the next several years. Also, to increase liquidity, AE Supply has offered for sale certain of its assets, including certain generating facilities. During the third quarter of 2002, AE Supply announced a restructuring of its energy marketing and trading activities. AE Supply is significantly reducing its reliance on the wholesale energy trading business, primarily by restricting activities to an asset-backed strategy using its low-cost generation assets located in the Mid-Atlantic and Midwest regions. As a result, AE Supply's trading activities will focus on lowering risk, optimizing the value of its generation assets, and reducing the effect of mark-to-market earnings.6
Allegheny has also undertaken a number of cost-cutting initiatives in 2002, including reducing pre-tax operating expenses in 2002 by an estimated $45 million and reducing its workforce by approximately 10% through an early retirement option, normal attrition and selected staff reductions. This action is projected to reduce expenses in 2002 by $5 million and to result in annualized savings of $40 million to $50 million.7
Additionally, in order to increase liquidity, Allegheny did not pay a dividend to its shareholders in December 2002 and commits that the dividend to be paid in 2003 will be between 0% and 50% of the current dividend level. At its December 5, 2002 meeting, Allegheny's Board of Directors suspended the fourth quarter 2002 cash dividend on its common stock. Also, under the terms of the credit agreement to be entered into by Allegheny in connection with the proposed indebtedness to be incurred by Allegheny to repay existing indebtedness, Allegheny has agreed that it will not pay any dividends or other distributions in respect of its common stock. No determination has been made by the Board of Directors as to future dividend levels within this range.
Allegheny and AE Supply state that they need to be able to continue to engage in financing transactions, as previously authorized by the Commission and to the extent modified by this order, to address their liquidity needs at this time. AE Supply is currently in default in the payment of certain of its obligations and bank loans of Allegheny in the amount of $260 million matured on December 31, 2002. Consummation of the financing transactions will allow Applicants to raise funds to meet their respective financial obligations. This authority will also give Applicants the ability to restructure their capital structure, e.g., by refinancing short-term debt with long-term debt.
AE Supply currently proposes to obtain approximately $2.1 billion of debt to refinance outstanding indebtedness, including indebtedness relating to the Springdale facility in the approximate amount of $270 million, $380 million of notes related to the St. Joseph facility and approximately $10 million of indebtedness of Allegheny to be repaid by Allegheny from funds received as a dividend from AE Supply.8 This amount includes approximately $470 million of additional debt to meet AE Supply's liquidity requirements. Applicants estimate that of this additional liquidity, approximately $40 million will be applied to complete construction of the Springdale facility, approximately $65 million will be used to pay suspension or termination costs relating to the St. Joseph facility and the remainder will be applied to fund financing fees and transaction expenses, payments to trading counterparties, collateral requirements, capital expenditures, refinancing requirements, working capital requirements and be available for payment of unbudgeted contingency amounts. Applicants anticipate at this time that approximately $1.9 billion of this debt will initially be secured by assets of AE Supply and its subsidiaries. In addition, Allegheny may issue up to $330 million of unsecured indebtedness to repay existing indebtedness, to the extent that this debt is not repaid from funds received as a dividend from AE Supply. Applicants may also issue up to $2.55 billion aggregate principal amount (on a secured basis as and to the extent authorized in the October 2002 Order, or on an unsecured basis) to refinance, replace and substitute any indebtedness outstanding from time to time,9 provided in each case that the Revised Financing Conditions (as defined below) are met.
Applicants state that, as a result of business developments and steps taken to address the financial situation at AE Supply, the subsidiary may be required to record certain write-downs, impairment charges and other adjustments that would reduce its common equity level below 30% of total capitalization. In addition, AE Supply expects the aggregate amount of its debt outstanding to increase. First, the increase will reflect the additional debt that AE Supply will incur, as described above. Second, the increase in debt will reflect the inclusion on AE Supply's balance sheet of certain lease transactions, in accordance with generally accepted accounting principles.
On a consolidated basis, Allegheny's common equity ratio will also be negatively affected by these developments at AE Supply and the ratio is expected to drop below 30%. Accordingly, as discussed below, Applicants are seeking relief from the financing condition of the December 2001 Order concerning equity as a percentage of total capitalization.
Applicants state that they also need the ability to make intercompany loans and to issue Guarantees to support activities throughout the Allegheny system at any time the Revised Financing Conditions are met. Allegheny has provided intercompany loans, through the money pool, to the Operating Companies, and has also provided intercompany loans to AE Supply and other subsidiaries. AE Supply has issued guarantees to support the obligations of its subsidiaries. Also, certain other subsidiaries of Allegheny have issued guarantees to support the obligations of other system subsidiaries. Applicants state that the use of intercompany loans and guarantees is an integral part of the financial management of the Allegheny system. Any disruption in the ability to provide intercompany loans and Guarantees would be detrimental to the operations of the Operating Companies and the other system companies.
Applicants further state that companies in the Allegheny system need the ability to enter into, perform, purchase and sell financial instruments that are intended to manage the volatility of interest rates and currency exchange rates. Of immediate concern, Applicants may desire to manage the variability of the interest on the secured debt to be issued by AE Supply. Similarly, it may be prudent to manage the risk associated with any future issuances of securities by Allegheny system companies. Applicants thus request authorization to engage in hedging transactions under the December 2001 Order, provided that the Revised Financing Parameters, as defined in section IV, B, below, are satisfied.
Finally, Applicants further state that it is appropriate that the direct and indirect subsidiaries of Allegheny, other than the Operating Companies and AE Supply (collectively, the "Other Subsidiaries"), be able to pay dividends out of capital and unearned surplus. Applicants request authorization for the Other Subsidiaries to pay dividends out of capital at such times as the financing conditions set forth in the December 2001 Order are not met, provided that the Revised Financing Parameters of the requested order are met.
Applicants state that the inability to engage in financings in accordance with their financing authorizations, as modified in this Application, could result in the bankruptcy of Allegheny and/or AE Supply. These transactions, and the ability of AE Supply to pay dividends to Allegheny as requested, are critical to providing the funds necessary to meet the Applicants' respective financial obligations.
Both Applicants believe that they have more than sufficient assets to satisfy all of their respective creditors in a liquidation. Allegheny states, however, that the ability to engage in financings is preferable to reorganization through bankruptcy, which is an inefficient tool to fix what is primarily a problem arising out of a need to refinance maturing debt and to fund interim credit needs in circumstances where fundamental asset values are substantial. Allegheny notes that bankruptcy creates both known and unknown risks of increased costs, business disruptions, regulatory unease, departure of valuable employees and lost customers and other business opportunities. Bankrupt companies must pay significant expenses both for their own counsel and advisors and for legal and financial advisors to the creditors. Other costs are not readily identifiable or quantifiable; for example, trading counterparties can be expected to close out positions early. Out of the money positions (on a mark-to-market basis) that are currently unrealized would become fixed claims upon termination of underlying contracts in bankruptcy. Although the precise costs of these and many other expenses are not quantifiable, the expenses could, over the course of a bankruptcy proceeding, result in a substantial loss of economic value for current shareholders.
Allegheny further notes that bankruptcy would create uncertainty about the status of AE Supply's agreements to sell power to the Operating Companies that they need to meet their obligations to customers. In a bankruptcy proceeding, creditors could be expected to scrutinize all major executory contracts and to object to any action or omission that is not in the best interest of AE Supply, regardless of the effect upon an Operating Company or its customers. Moreover, while debtors have a statutory right to reject uneconomic executory contracts, that right is of little or no financial benefit to companies such as Allegheny and AE Supply that maintain assets with a fair market value greater than their liabilities. The holder of the rejected contract will have an allowed unsecured damages claim equal to the full economic value of its loss (other than for any rejected real property leases, which are limited in amount under the Bankruptcy Code).
IV. Requested Authority
Applicants request authorization for AE Supply to pay dividends to Allegheny out of capital and unearned surplus in an amount not to exceed $500 million. Applicants also request authority to implement the Revised Financing Parameters (as defined below), which will apply to Allegheny and AE Supply, for a period from the date of the requested order to December 31, 2003 (the "Modified Authorization Period").
A. Payment by AE Supply to Allegheny of Dividends Out of Capital Surplus
Applicants anticipate that, to meet the liquidity needs of Allegheny, AE Supply will be required to pay dividends in excess of its current and retained earnings. Accordingly, Applicants seek authorization for AE Supply to pay dividends out of capital and unearned surplus up to $500 million, in order to provide Allegheny with the required liquidity.
Allegheny and AE Supply expect that AE supply will be required at closing of the new lending facilities to pay a dividend of approximately $10 million to Allegheny. In addition, Allegheny and AE Supply expect that their respective agreements with lenders will require that proceeds of debt and equity issuances and asset sales will be shared by AE Supply and Allegheny bank group lenders, pro rata based upon the loan principal amounts outstanding at the two companies. Accordingly, the dividend authority requested would permit AE Supply to make the dividend payments necessary to result in a full repayment of the approximately $330 million principal amount of bank borrowings expected to exist at the Allegheny level in the event of refinancing of AE Supply's debt, and partial payments as necessary upon asset sales or other issuances of indebtedness by AE Supply. As of June 30, 2002, AE Supply had retained earnings of approximately $220 million. To the extent that AE Supply is required under generally accepted accounting principles to record any writedowns, impairment charges or other adjustments, AE Supply's retained earnings would be further reduced. Thus, the declaration and payment of the proposed dividends would be charged in whole or in part to capital and/or unearned surplus. Allegheny and AE Supply represent that AE Supply will not declare or pay any dividend out of capital or unearned surplus in contravention of any law restricting the payment of dividends. In addition, AE Supply will comply with the terms of any credit agreements and indentures that restrict the amount and timing of distributions by AE Supply to its members. Furthermore, Allegheny has filed as a confidential exhibit to this Application a letter of a financial advisor to Allegheny confirming that the financial projections included as Exhibit H to the Application are reasonable.
Specifically, AE Supply will declare and pay dividends, in an aggregate amount of up to $350 million, to Allegheny only to the extent required by Allegheny to pay debt service on outstanding indebtedness which becomes payable beginning on December 31, 2002. Allegheny commits that any of these dividends received by Allegheny from AE Supply will be used solely to pay the principal of and interest on this indebtedness and none of the dividends will be used by Allegheny to pay dividends to its stockholders. To the extent that Allegheny does not require proceeds of dividends from AE Supply to pay the indebtedness of Allegheny, Applicants request that the Commission reserve jurisdiction over the declaration and payment of dividends by AE Supply out of capital and unearned surplus up to an aggregate amount of $500 million.
B. Modification of Financing Parameters
Applicants request that, during the Modified Authorization Period, their respective authorized financing transactions will be subject to certain parameters comparable to some of those parameters that were applicable to the issuance of unsecured debt by AE Supply in the October 2002 Order, as set forth above. Specifically, Applicants propose that the following parameters will apply:
Applicants request that, during the Modified Authorization Period, the financing parameters contained in the December 2001 Order remain effective even though those parameters are not satisfied, so long as the financing parameters requested in this Application (including these parameters as they may be amended from time to time in the future by the Commission) (collectively, the "Revised Financing Parameters") are satisfied.
Applicants request that the Commission reserve jurisdiction over any interest rate higher than the Modified Interest Rates. Applicants further request that their respective financing transactions not be subject during the Modified Authorization Period to the requirement to maintain either unsecured long-term debt or any commercial paper that may be issued at investment grade level. In addition, Applicants request authorization to issue short-term and/or long-term debt under those circumstances when the debt, upon issuance, is either unrated or is rated below investment grade.
Allegheny states that it is committed to a return of its ratio of common equity to
total capitalization to 30% or more at the earliest possible date. Allegheny expects to achieve this result, subject to market conditions, through the sale of assets and/or equity during 2003 or, if the 30% ratio is not achieved during 2003, in 2004. The Applicants commit to file an application with the Commission in a timely manner if, or to the extent that, Allegheny will seek relief from the requirement to maintain a 30% equity ratio after December 31, 2003, when the Modified Authorization Period expires.
Notwithstanding the proposed Revised Financing Parameters, Applicants commit that, at any time when Allegheny's ratio of common equity to total capitalization is not at least 30%, neither Allegheny nor any subsidiary will invest or commit to invest any funds in any new projects that qualify as EWGs or FUCOs; provided, however, that Allegheny may increase its investment in EWGs as a result of the qualification of existing projects as EWGs, and may make additional investments in an existing EWG to the extent necessary to complete any project or desirable to preserve or enhance the value of Allegheny's existing investment.12 Allegheny requests the Commission to reserve jurisdiction over any additional investment by Allegheny and its subsidiaries in EWGs during the period that Allegheny's common equity ratio is below 30%.
In addition, Applicants commit that at any time that Allegheny's ratio of common equity to total capitalization is not at least 30%, neither Allegheny nor any subsidiary will invest or commit to invest any funds in any new energy-related company within the meaning of rule 58 (a "Rule 58 Company"); provided, however, that Allegheny may increase its investment in an existing Rule 58 Company to the extent either necessary to complete any project or desirable to preserve or enhance the value of Allegheny's existing investment. In addition, notwithstanding the foregoing, Allegheny and/or AE Supply may invest in one or more new Rule 58 Companies that may be created in connection with the restructuring and/or reorganization of the existing energy trading business of AE Supply and its subsidiaries. Allegheny requests the Commission to reserve jurisdiction over any additional investment by Allegheny and its subsidiaries in Rule 58 Companies during the period that Allegheny's common equity ratio is below 30%.
As previously stated, Applicants may issue up to $2.55 billion aggregate principal amount (on a secured basis as and to the extent authorized in the October 2002 Order, or on an unsecured basis) to refinance, replace and substitute any indebtedness outstanding from time to time, provided in each case that the Revised Financing Conditions are met. Applicants request that the Commission reserve jurisdiction over the authorization of the issuance by the Applicants of any other debt securities authorized by the December 2001 Order at such time that the Financing Conditions set forth in the December 2001 Order are not satisfied.
V. Discussion and Request for Hearing
A. Applicable Statutory Standards
As discussed above, the Application seeks certain modifications to previous orders. Section 20(a) of the Act in pertinent part authorizes the Commission to amend orders "from time to time" "as it may deem necessary or appropriate to carry out the provisions of this title."
The Revised Financing Parameters sought by the Applicants would apply to financing transactions authorized under section 7 of the Act. Section 7(b) provides in relevant part that "[a] declaration filed under this section shall become effective within such reasonable time after the filing thereof as the Commission shall fix by rules and regulations or order."13 Section 7(d) provides that if the requirements of subsections (c) (concerning the type of security to be issued) and (g) (concerning any necessary state approval) are satisfied, the Commission shall permit a declaration regarding the issue or sale of security to become effective unless the Commission makes certain specified adverse findings. In particular, the declaration may not become effective if the Commission finds, among other things, that:
Thus, absent any adverse finding, the Commission approves a requested authorization. In this event, section 7(f) of the Act permits the Commission's order "to contain such terms and conditions as the Commission finds necessary to assure compliance with the conditions specified in this section."
The request by AE Supply for authorization to pay dividends out of capital surplus is subject to section 12(c) of the Act, which makes it unlawful for any registered holding company or subsidiary "to declare or pay any dividend on any security . . . in contravention of such rules and regulations or orders as the Commission deems necessary or appropriate to protect the financial integrity of companies in holding-company systems, to safeguard the working capital of public-utility companies, to prevent the payment of dividends out of capital or unearned surplus, or to prevent the circumvention of the provisions of this title or the rules, regulations, or orders thereunder."
B. Request for Hearing
Ms. Elizabeth Smith filed comments and a request for a hearing. Ms. Smith states that she owns shares of Allegheny. UBS AG ("UBS"), a creditor of AE Supply, also filed comments but did not request a hearing.
Ms. Smith identifies six issues that should be answered at a hearing.15 She suggests, first, that if Allegheny's request is granted, the Commission's "standards for financing, the 30% equity standard, the interest rate ceiling, and the securities rating floor" will no longer "carry any meaning." She comments in this regard that, "If a company is allowed to avoid the SEC's conditions during bad times, the conditions are almost meaningless because companies know they can get a waiver from these conditions." She adds that, "By letting Allegheny avoid the standards the SEC originally imposed to protect investors and consumers, the SEC appears to be taking the company's side rather than taking a hard line for the protection of investors and consumers." She concludes, rhetorically, that, "If the SEC's standards are waived when times are hard for a company and investors and consumers need protection the most, when do the SEC's conditions carry any meaning?"
Ms. Smith's comments do not raise any issue of law or fact. Ms. Smith states that approval of Allegheny's request would represent a "waiver" or, as she also says, an "avoidance" of the statutory standards. This derogation by the Commission would indicate that the conditions of the previous order were "almost meaningless." In short, Ms. Smith alleges that the Commission went through the motions of administering the Act in the previous order, but will abandon the effort now and "[take] the company's side," just when it should instead "tak[e] a hard line for the protection of investors and consumers." Presumably, the "hard line" would be a denial of the requested authorization. Ms. Smith does not explain how denying the application is necessary to protect investors and consumers.
Contrary to Ms. Smith's assertions, the requested authorization is not a "waiver" or "avoidance" of the statutory standards [of section 7]. We also do not agree that any of the terms or conditions of the December 2001 Order, i.e., "the 30% equity standard, the interest rate ceiling, and the securities rating floor," which Ms. Smith calls "standards," is a statutory standard. Applicants are requesting an amended order that would have terms and conditions different from the previous order. We review this request in light of the Applicants' current situation and in the context of all relevant statutory standards. Hence, the question for the Commission is whether the request, in toto, satisfies the statutory requirements.
We discussed the 30% equity test, in particular, in a recent order, Xcel Energy, Inc., where we noted that:
In recent years, the Commission has looked for an equity capitalization ratio of 30% at both the holding company level and at each of the holding company's utility subsidiaries, as a key proxy for the soundness of the holding company's capital structure. However, our administration of the Act demonstrates that the 30% common equity standard is a benchmark rather than an absolute requirement for the capital structures of holding-company systems. Historically, we have permitted capital structures with less than 30% common equity when mitigating circumstances are present, particularly when market conditions are concerned.16
Ms. Smith's second argument is that Allegheny's request to modify the interest rate ceiling of its debt to 12% plus prime does not meet the applicable statutory standards. Specifically, Ms. Smith contends that "Allegheny's proposal to issue debt with extremely high interest rates coupled with its proposal to sell revenue-generating assets violates [sections 7(d) (2) and (3)]" and so cannot be approved. Ms. Smith explains that:
[i]f Allegheny issues junk debt with high interest rates, this will place a lot of pressure on Allegheny to make these interest payments. This is something Allegheny doesn't need right now as it is already under pressure to make interest payments on its debt. And, if Allegheny sells some of its assets, these assets will impair Allegheny's ability to generate revenue. In other words, Allegheny's earning power will be reduced while its obligations will be increased.
In her view, "[i]ssuing junk status securities under these conditions clearly is not "reasonably adapted to the earning power of' Allegheny" and therefore an adverse finding is required under sections 7(d)(2) and (3).
We do not agree. Contrary to Ms. Smith's opinion, it is AE Supply rather than Allegheny that will issue the secured debt securities, as approved in the October 2002 Order. Now, as then, Applicants have submitted projected cash flows, balance sheets and income statements through the Modified Authorization Period that demonstrate that even with the higher interest cost that may be incurred, there will be sufficient cash and earnings of AE Supply to cover these obligations as well as satisfy its other obligations.17 These projections apply to a "leaner" AE Supply, following the restructuring and refocusing of its business described previously. Moreover, Allegheny itself, on a consolidated basis, is projected to have sufficient earnings to cover all of its obligations.18
Ms. Smith's third argument is that AE Supply's request to pay dividends out of capital surplus does not satisfy the standards of section 12(c) of the Act. Ms. Smith contends that this proposal "will bleed AE Supply of its working capital, to the detriment of its financial integrity." However, the record indicates that the issuance of secured debt by AE Supply will provide funds more than adequate to meet the cash needs of the subsidiary company during the Modified Authorization Period.
Ms. Smith's fourth argument is that AE Supply's request for authorization to sell utility assets does not satisfy the standards of section 12(c) of the Act. The Commission notes that Applicants have removed this request from the Application and plan to resubmit the request at a later time. Ms. Smith will be notified of any relevant filing and will have the opportunity to renew her objection at that time.
Ms. Smith asks, fifth, to what extent Allegheny's nonutility ventures have triggered the need for the current Application. She asserts that the Act "is supposed to prevent this from happening." However, the Act is not designed to prevent nonutility investments from losing money, although the Commission, in keeping with the policies of the Act, attempts to shelter the protected interests from any adverse consequences of nonutility diversification. The circumstances that have led to the filing of the current Application are explained in section III of this order. With respect to Allegheny's nonutility interests, as the Commission noted in a recent order, ". . . the Act contemplates that holding companies may invest in nonutility activities that satisfy the standards of the Act."19 Permissible nonutility activities of registered holding companies may be affected, as in this case, by adverse market conditions. Based on the Applicants' representations, the Commission believes that Applicants seek authorization for reasonable measures by which they can obtain the liquidity needed to satisfy their financial obligations and, possibly, to avoid bankruptcy. As was the case with respect to the October 2002 Order, the record in this matter contains evidence in support of the following:
Finally, Ms. Smith, assuming that problems with Allegheny's nonutility ventures have led to the need for the requests in the Application, asks if granting Allegheny's request would be a "subsidy from the public utility [sic]" to Allegheny's nonutility ventures. The answer to this question is no. The Operating Companies remain financially sound and have not been materially adversely affected by AE Supply's decline in financial performance. In addition, there is no evidence in the record, and Ms. Smith does not herself point to any specific evidence, that Allegheny is "milking" or otherwise abusing the Operating Companies to recover the losses that it is experiencing in its other businesses. As discussed previously, the requested authorizations offer a reasonable means by which AE Supply and Allegheny seek to avoid a bankruptcy filing that could adversely affect the Operating Companies.
UBS expresses concerns different than Ms. Smith. UBS states that, "the Commission should not permit AE Supply to pay dividends to Allegheny out of capital and unearned surplus unless, prior to or concurrently with the payment of such dividends, AE Supply satisfies all of its obligations that are then due and payable, including obligations to trading counterparties" such as UBS. Although payment of these dividends may slightly increase the risk that AE Supply will not be able to repay its creditors, Applicants respond that AE Supply would not anticipate paying any dividends to Allegheny if the payment would render AE Supply insolvent. As discussed in the Application, Allegheny states that the fair market value of the assets of AE Supply exceeds its liabilities. The underlying businesses of AE Supply are fundamentally sound, and Applicants project that AE Supply will have positive cash flow from operations in 2003. Applicants believe that the strength of the underlying assets of AE Supply will provide improved financial performance in the future. Furthermore, Applicants believe that upon the issuance of secured debt under the authorization granted in the October 2002 Order, and the application of the proceeds to refinance indebtedness outstanding as contemplated by the order, together with the actions being taken to refocus its business, AE Supply will have sufficient funds to meet its financial obligations. In contrast, as outlined above, a bankruptcy filing would impose numerous costs on Allegheny's investors and utility consumers. On balance, we therefore find that payment of the dividends for the purpose of repaying Allegheny's outstanding debt is appropriate and satisfies the statutory standards.
In conclusion, the Commission notes that neither the request for a hearing nor the comments of UBS provides any facts or information that would warrant a hearing. It is well settled that evidentiary hearings are required only where there exists a genuine issue of material fact.20 We find that it is not necessary to hold a hearing in this matter.
The Commission has carefully examined the Application under the applicable standards of the Act and has concluded that the proposed transactions are consistent with those standards.
Applicants state that the fees, commissions and expenses to be incurred in connection with the proposed transactions are estimated to be $20,000. These estimates do not include the underwriting fees, commissions or other similar remuneration paid in consummating the proposed financings. Applicants state that no state or federal commission, other than this Commission, has jurisdiction over the proposed transactions.
Due notice of the filing of the Application has been given in the manner prescribed by rule 23 under the Act, and no hearing has been ordered by the Commission. Based on the facts in the record, the Commission finds that the applicable standards of the Act and rules are satisfied and that no adverse findings are necessary.
IT IS ORDERED, under the applicable provisions of the Act and rules under the Act, that, except as to those matters over which jurisdiction has been reserved, the Application, as amended, be, and it hereby is, granted and permitted to become effective immediately, subject to the terms and conditions prescribed in rule 24 under the Act and the following condition:
Prior to the payment of any dividends by AE Supply to Allegheny, Allegheny will receive and file with the Commission, as an exhibit to its Application, an opinion letter from its financial advisor, Kroll, Zolfo, Cooper, confirming that the financial projections provided in Exhibit H to the Application, are reasonable.
IT IS FURTHER ORDERED, that Allegheny will file rule 24 certificates of notification quarterly, within 60 days after the end of each of the first three calendar quarters and 90 days after the end of the last calendar quarter, which will include the following information:
IT IS FURTHER ORDERED, that jurisdiction is reserved, pending completion of the record, (1) over the common stock equity ratio level to be maintained as a condition to the financing authorization for Allegheny and AE Supply below 28% in the case of Allegheny and 20% in the case of AE Supply, (2) over the issuance of debt securities at an interest rate in excess of the Modified Interest Rates, (3) to the extent that Allegheny does not require proceeds of dividends from AE Supply to repay obligations, over the declaration and payment of dividends by AE Supply out of capital surplus up to an aggregate amount of $500 million and (4) over the sale of the securities of public utility companies, other than the Operating Companies, held directly or indirectly by Applicants, and the sale of utility assets of Applicants and their subsidiaries, other than the Operating Companies.
IT IS FURTHER ORDERED, that the request for hearing be, and it hereby is, denied.
By the Commission.
1 By order dated April 17, 2002 (Holding Co. Act Release No. 27521), the Commission modified certain authorizations granted to Allegheny and AE Supply in the December 2001 Order. Specifically, the order authorized Allegheny to issue contracts to purchase common stock, in addition to other issuances of equity securities. In addition, Allegheny and AE Supply's respective authority to issue notes was modified to extend the maturity of the notes from 270 days to 364 days.
2 The debt would not be secured by any securities or utility assets of the Operating Companies.
3 In addition, the maturity of long-term debt will be not less than one year and will not exceed thirty years; and short-term debt will have a maturity of not less than one day and not more than 364 days.
4 Applicants state that, although the hedging strategy will result in short-term cash outflows through 2002, the total projected cash flows related to the CDWR contract remain significantly positive over the life of that contract. Beginning in 2003, AE Supply expects to realize gains related to the CDWR contract for the remainder of its term.
AE Supply is currently litigating certain challenges to the CDWR contract before the Federal Energy Regulatory Commission. AE Supply continues to pursue settlement discussions with the State of California. AE Supply is also evaluating options to monetize the value of the CDWR contract and related positions.
5 This company was acquired in 1999 by Monongahela Power and subsequently dissolved, leaving Monongahela Power with an additional 24,000 natural gas customers.
6 In conjunction with its decision to restructure its energy trading activities, AE Supply performed a comprehensive assessment of the valuation techniques and assumptions used to value its existing portfolio of energy commodity contracts. AE Supply determined that the valuation methodologies for certain contracts with option features needed to be revised to reflect current market conditions. As a result, AE Supply may be required to reduce the value of its portfolio of energy commodity contracts.
7 In September 2002, Allegheny incurred a current period cost associated with the work force reduction.
8 Allegheny currently has outstanding approximately $335 million borrowed under its bank facilities, $260 million of which came due on December 31, 2002, and $300 million of its 7.75% Notes due 2005. Applicants estimate that the bank facilities will be refinanced by Allegheny or repaid with proceeds of AE Supply's secured debt which will be paid as a dividend from AE Supply to Allegheny.
9 After giving effect to the proposed issuance of approximately $2.1 billion of debt by AE Supply and approximately $330 million of debt by Allegheny, and the application of the proceeds of those issuances, Applicants will have approximately $2.55 billion outstanding under the authorization granted by the Commission in the December 2001 Order.
10 Because AE Supply is a limited liability company, "common stock equity" means, for this purpose, the membership interests of AE Supply.
11 Applicants note, however, that the interest rate applicable after the occurrence of a default may be increased by an additional increment, typically 200 basis points.
12 The Application identifies eight existing EWGs in which Allegheny and its subsidiaries currently have investments.
13 Section 7(b) adds the proviso, "unless the Commission, prior to the expiration of such period, shall have issued an order to the declarant to show cause why such declaration should become effective."
14 The declaration also may not become effective if the Commission finds that: the fees, commissions or other remuneration paid directly or indirectly in connection with the financing are not reasonable [section 7(d)(4)]; or, in the case of a security that is a guarantee, the circumstances are such as to constitute the making of the guarantee an improper risk for the declarant [section 7(d)(5)].
15 On December 20, 2002, Ms. Smith filed a supplement to her hearing request to which Allegheny responded on January 9, 2003. Ms. Smith identified three other additional potential issues. First, she argues that the notice that the Commission provided with respect to a prior order granted to Allegheny was inadequate. Second, she argues that the Commission should investigate the reasons why the Chairman of Allegheny, Alan J. Noia, received a bonus of $562,000 in 2002. Finally, noting that Allegheny recently restated its financial statements for 2002, she suggests that the SEC should investigate whether Allegheny's "old financial statements" are "false and misleading." Ms. Smith's additional comments were filed after the close of the comment period in this matter. In addition, none of the issues Ms. Smith raises warrant either a hearing or denial of the application. Ms. Smith's first issue is related to a prior Commission order. Because that issue arises in the context of a separate proceeding, it has no relevance to this proceeding. Second, notwithstanding the receipt of a bonus by Mr. Noia and the restatement of financials by Allegheny, we believe that Allegheny's application meets the standards set forth in sections 6, 7 and 12(c) of the Act, and that the facts alleged in Ms. Smith's additional comments would not warrant any negative findings under any of these sections. Ms. Smith's additional comments therefore do not raise a material issue of fact or law that would warrant a hearing in this matter.
16 Xcel Energy, Inc., Holding Co. Act Release No. 27533 (May 30, 2002) (citations omitted).
17 This order requires Allegheny to receive and file with the Commission, as an exhibit to the Application, an opinion letter from its financial advisor, Kroll, Zolfo, Cooper, confirming that the financial projections provided in Exhibit H to the Application, are reasonable.
18 The Commission notes also that the proposed interest rate would create a ceiling that was absent from the December 2001 Order, which required that "the effective cost of money on long-term debt borrowings will not exceed the greater of 400 basis points over comparable term U.S. Treasury securities or the gross spread over U.S. Treasuries that is consistent with similar securities of comparable credit quality and maturities issued by other companies."
19 Xcel Energy, Inc., supra note 15.
20 See City of New Orleans v. SEC, 969 F.2d 1163 at 1167 n.6 (D.C. Cir. 1992), quoting Wisconsin's Environmental Decade, Inc. v. SEC, 882 F.2d 523, 526 (D.C. Cir. 1989). As the Court of Appeals went on to note, "[T]he proponent of such a hearing `must make a minimal showing that material facts are in dispute' and may not rely on mere `bald or conclusory allegations that such a dispute exists.' " Id. (quoting Connecticut Bankers' Ass'n. v. Board of Governors of the Federal Reserve System, 627 F.2d 245, 251 (D.C. Cir. 1980).
21 The financial projections referred to in Item 4 will be filed on a confidential basis.