SECURITIES AND EXCHANGE COMMISSION
(Release No. 35-27868; 70-10177)
Northeast Utilities, et al.
Order Authorizing Increased Investment in Exempt Wholesale Generators and Other Nonutility Businesses and Related Transactions; Reserving Jurisdiction
June 30, 2004
Northeast Utilities ("NU"), West Springfield, Massachusetts, a registered public-utility holding company under the Public Utility Holding Company Act of 1935, as amended ("Act"), NU's wholly owned nonutility holding company subsidiary, NU Enterprises, Inc. ("NUEI") and NUEI's wholly owned nonutility subsidiary, Select Energy, Inc. ("Select"), both located in Berlin, Connecticut (collectively, "Applicants"), have filed an application-declaration, as amended ("Application"), with the Securities and Exchange Commission ("Commission") under sections 6(a), 7, 9(a), 10, 12(b) and (c) and 32 of the Act and rules 43, 45, 46, 53 and 54. The Commission issued a notice of the filing of the Application on February 20, 2004 (Holding Co. Act Release No. 27803). The Commission did not receive any request for a hearing.
A. The NU Holding-Company System
NU, a Massachusetts business trust, NUEI and Select are part of the Northeast Utilities system of companies ("NU System"). NU is the parent holding company in the NU System and is not an operating company. The NU System provides franchised retail electric service in Connecticut, New Hampshire and western Massachusetts through three of NU's wholly owned public-utility subsidiaries: The Connecticut Light and Power Company ("CL&P"), Public Service Company of New Hampshire ("PSNH") and Western Massachusetts Electric Company ("WMECO"). Yankee Energy System, Inc. ("YES"), a holding company subsidiary of NU is exempt from registration under section 3(a)(1) of the Act. YES, through its wholly owned gas utility subsidiary, Yankee Gas Services Company ("Yankee Gas"), is primarily engaged in the retail distribution of natural gas in Connecticut. Yankee Gas, CL&P, PSNH and WMECO are referred to collectively below as the "NU Utility Companies."
The NU Utility Companies provide wholesale electric and gas service to various municipalities and other utilities throughout the northeast United States. Holyoke Water Power Company ("HWP"), an electric utility for purposes of the Act, owns a 147-megawatt coal-fired plant in Holyoke, Massachusetts and sells all of the output of its generation assets indirectly to Select under a wholesale contract.
NUEI is the holding company for NU's nonutility businesses. Currently, NUEI's many nonutility subsidiaries include, along with Select, Northeast Generation Company ("NGC") (at this time, NU's only exempt wholesale generator ("EWG"), as defined in section 32 of the Act); Mode 1 Communications, Inc. and Woods Network Services, Inc., (both exempt telecommunications companies, as defined in section 34 of the Act); Select Energy Services, Inc. ("Select Energy Services") (formerly, HEC Inc.)1, and certain energy-related companies, as defined in rule 58, including Northeast Generation Services Company and E.S. Boulos Company.
NU states that, like many utilities during the U.S. industry restructuring, it has divested most of its generating assets and increased its focus on the marketing and brokering of energy and related services. Energy marketing and brokering activities have become an integral part of its business and strategy for competing in the restructured energy industry, as shown by the increasing revenues of, and NU's investment in, Select.
Select began active operation under rule 58 in 1998. Applicants state that Select has contracts with major utilities to provide standard offer service for these utilities' customers. Select's revenues have grown from approximately $29 million in 1998 to approximately $2.5 billion in 2003.
In late 2001, Select acquired the securities of Niagara Mohawk Energy Marketing, Inc., another rule 58 energy marketing and brokering company in upstate New York, and renamed it Select Energy New York, Inc. ("SENY"). Since that time, Select has engaged in marketing and brokering of energy commodities, including electricity and natural gas, and sales of energy-related products and services as permitted under rule 58(b)(1)(iv) and (v). It engages in a wide variety of wholesale and retail transactions and is licensed to do business in approximately 11 states. Applicants state that it has become a major participant in energy marketing and brokering in the Northeast.
As of March 31, 2004, NU's investment in rule 58 companies in the aggregate was approximately $920.8 million (compared to a rule 58 limitation for NU in an aggregate amount of approximately $1.01 billion). A large portion of the investment, $309 million, is in the form of guarantees, discussed further below. As of March 31, 2004, NU's investment in Select and SENY, including guarantees, computed for purposes of rule 58, totalled approximately $840.7 million of NU's aggregate investment in rule 58 companies of $920.8 million. Of this amount, approximately $309 million consisted of guarantees issued for NU's nonutility subsidiaries.
B. Current Financing Authorizations
NU is currently authorized to issue short-term debt in the amount of $400 million through June 30, 2006 and to issue up to $600 million in long-term debt through June 30, 2005.2 NU states that, as of May 31, 2004, $150 million of the $600 million of authorized long-term debt has been used and that it is not now requesting any further authority to issue and sell any common shares or to issue any additional long-term or short-term debt, nor is it requesting any other modification to any other terms or conditions of these orders.
In addition, the Commission has authorized NU and NUEI to issue guarantees for NU and NUEI's nonutility subsidiaries through June 30, 2004, in an aggregate amount not to exceed $500 million (together with the two financing orders discussed above, the "Financing Orders").3 Of this amount, as of March 31, 2004, guarantees issued for NU's nonutility subsidiaries made up approximately $309 million, with guarantees for Select and SENY accounting for $293 million.
II. The Proposals
A. Summary of Proposed Transactions
NU, NUEI and Select request authority through June 30, 2007 ("Authorization Period") for:
The proposed transactions are discussed further below.
B. Proposed Transactions
1. Investments in Energy-Related Companies
Applicants request authorization for NU to use the proceeds of authorized financings to invest, either directly or indirectly through NUEI, an aggregate amount of up to $500 million (including Guarantees, discussed in section 2, below) in excess of the amount permitted under rule 58 in existing and new energy-related companies, as defined in the rule and in Select Energy Services and other energy-related companies approved by order under sections 9(a)(1) and 10 of the Act (collectively, "energy-related companies"), during the Authorization Period. NU explains that its need to increase its investment in these companies is driven primarily by the expanded activity of Select.
Applicants seek authority for NU and NUEI to guarantee, indemnify and otherwise provide credit support, the Guarantees, of up to $750 million, the Guarantee Limit, for the debt or obligations of Nonutility Subsidiaries, during the Authorization Period. The requested authority is somewhat broader than the existing order described previously, because it would include nonutility affiliates, as well as nonutility subsidiaries, of NU and NUEI. NU states that the increased Guarantee authority, from $500 million to $750 million, together with the authorization to invest in energy-related companies, described above, will enable NU to grow its businesses, as appropriate and necessary, to continue to compete effectively with other energy marketing companies.
NU commits that it will, at all times during the Authorization Period, maintain common equity of at least 30% of its consolidated capitalization (common equity, preferred stock, long-term debt and short-term debt), including the Rate Reduction Bonds ("RRBs") as debt, as reflected in the most recent Form 10-K or Form 10-Q filed with the Commission, adjusted to reflect changes in capitalization since the balance sheet date of the filings.
NU further represents that no securitiess will be issued in reliance upon the requested authorization unless: (i) the security to be issued, if rated, is rated investment grade; (ii) all outstanding securities of the issuer that are rated are rated investment grade; and (iii) all outstanding securities of NU that are rated are rated investment grade ("Investment Grade Condition"). For purposes of this provision, a security will be deemed to be rated "investment grade" if it is rated investment grade by at least one nationally recognized statistical rating organization, as that term is used in paragraphs (c)(2)(vi)(E), (F) and (H) of rule 15c3-1 under the Securities Exchange Act of 1934. NU requests that the Commission reserve jurisdiction over the issuance of any securities that are not able to meet the Investment Grade Condition.
3. Expansion of Select's Business Outside the United States
Select seeks authority (a) to engage in a variety of activities related to its marketing and brokering business in energy commodities in Canada and Mexico and elsewhere outside of the United States and (b) to render energy management and consulting services anywhere in the world outside the United States.4 Select asks, with respect to subparagraph (a), that the Commission reserve jurisdiction over its authorization of energy marketing and brokering business activities outside the United States, Mexico and Canada, pending completion of the record.
4. Additional EWG Investments
NU seeks authority to use the proceeds of authorized financings to invest in additional EWGs in an aggregate amount of up to $1 billion, the EWG Investment Limit, through the Authorization Period.5 NU states that, in addition to the energy-related business activities, discussed above, the ownership of additional generation is important to support NUEI's energy marketing and brokering business.
NU states that it is able to satisfy Commission requirements for the proposed additional EWG investments by meeting the applicable statutory requirements, as well as those stated in rule 53(c)6, as discussed below, and it, accordingly, requests the Commission to grant the requested authorization. In addition, NU asserts that the proposed EWG Investment Limit of $1 billion compares favorably with EWG investment limits authorized for other registered holding companies.7
a. NU's Internal Controls Applicable to Its EWG Investments
NU states that, through NUEI, it has a formal, stringent review and approval process for EWG investments by the NUEI companies, to align investment with the strategic objectives of NU and the NUEI companies, to demonstrate economic viability and to mitigate risks. In addition, NU states that it has other, additional, internal controls for the management of the investment once made. NU describes both its investment review process and ongoing management controls in its Application.8
b. Rule 53 Analysis of NU' s Proposed EWG Investments
To obtain Commission approval of EWG investments, a registered holding company must meet the requirements, among other things, of rule 53, promulgated under section 32 of the Act. Rule 53(c) provides that, in connection with a proposal to issue and sell securities to finance an investment in any EWG, or to guarantee the securities of any EWG, a registered holding company, that is unable to satisfy the requirements of rule 53(a), must "affirmatively demonstrate" that the proposal to issue securities to finance the acquisition of an EWG or the guarantee of a security of an EWG: "(1) will not have a substantial adverse impact upon the financial integrity of the registered holding company system; and (2) will not have an adverse impact on any utility subsidiary of the registered holding company, or its customers, or on the ability of State commissions to protect such subsidiary or customers."
b.1. Rule 53(c)(1) - The EWG Investments' Impact on the Financial Integrity of the Registered Holding Company System.
NU states that it can show, as discussed below, that there will be no "substantial adverse impact" on the NU System's financial integrity due to an increased EWG Investment Limit, of up to $1 billion, in several ways, including an analysis of historic trends in NU's other EWG investment, its consolidated capitalization ratios and retained earnings, and the market view of NU's securities.
(a) NU's Other EWG Investments. NU provides its experience with its only EWG investment, NGC, authorized in 2000, as support for its current proposal. NU states, among other things, that NGC has consistently contributed positively to earnings of NU on a consolidated basis. At the time, NU's investment in NGC, an EWG, was $469 million, or approximately 78% of NU's then-current average consolidated retained earnings. NU's investment in NGC has been reduced over time to approximately $448.2 million, or approximately 54.3% of its average consolidated retained earnings, as of March 31, 2004.9
(b) Size of NU's Proposed EWG Investment. NU asserts that its proposed investment is an acceptable commitment of its assets based on the Commission's current criteria. In recent Commission orders, the Commission has concluded that certain proposed "aggregate investment" levels well in excess of 100% of "consolidated retained earnings" have been reasonable commitments of capital, for a specific company's size, based on various pro forma financial ratios.10 These Commission ratios measure the proposed investment level as a percentage of consolidated capitalization, consolidated net utility plant, total consolidated capitalization and the total market value of an applicant's common stock.
NU's states that, as discussed below, its proposed $1.0 billion aggregate EWG investment would meet the relevant Commission criteria. Its proposed aggregate investment of up to $1.0 billion would, as of March 31, 2004, equal approximately 14.9% of NU's consolidated capitalization (including $1.7 billion of RRBs), 18.1% of NU's consolidated net utility plant, 8.7% of NU's total consolidated assets, and 42% of the market value of NU's outstanding common shares. In addition, NU shows that these NU ratios compare favorably to the ratios of other companies, because NU's ratios, for three of the four Commission criteria (consolidated capitalization, consolidated net utility and consolidated total assets), are better than the average in each of the other cases and, for the fourth Commission criterion (market value of stock), NU's ratio is within the Commission's previously approved range for market values of stock.11
(c) Consolidated Capitalization Ratios. NU states that its consolidated capitalization ratio, as of March 31, 2004, was 36.1% common and preferred equity and 63.9% debt (including approximately $1.7 billion in RRBs). When RRBs (non-recourse to the NU System) are not included as debt of NU (consolidated), the ratio becomes 48% common and preferred equity and 52% debt. NU states that these ratios, which exceed the Commission's 30% common equity ratio requirement, show the NU System's healthy financial balance.
(d) Credit Ratings. NU has a corporate investment grade credit rating of Baa1 from Moody's and BBB+ from Standard and Poor's, with a "negative" outlook stemming from the planned expenditures for upgraded transmission lines by CL&P. It has received a senior unsecured debt rating of Baa1 and BBB from Moody's and Standard and Poor's, respectively, both with a "negative" outlook and BBB from Fitch with a "stable" outlook. NU states that these ratings reflect the investment community's view of the NU System and indicate the availability of cash for the NU companies from investors.
(e) Retained Earnings Growth. Over the past three years, the NU System's consolidated retained earnings have grown, as follows. For the year ended December 31, 2000, NU's consolidated retained earnings were $495.9 million. By the end of 2001, they had grown by 37% to $678.5 million. By December 31, 2002, the earnings had grown an additional 12.8% to $765.6 million. As of March 31, 2004, NU's consolidated retained earnings were $857.2 million. NU states that this continued and consistent increase, even through periods of industry deregulation, shows the strength and health of the NU System.
b.2. Rule 53(c)(2) - Impact on NU Utility Companies and Customers and on the Ability of State Commissions to Protect Them.
The second prong of rule 53(c) requires that an increase in NU's "aggregate investment" in EWGs not have an "adverse impact" on the NU Utility Companies or their customers, or on the ability of the relevant public service commissions (collectively, the "State Commissions") to protect the NU Utility Companies or their customers. In support of its contention that its proposal meets these requirements of rule 53(c)(2), NU notes (i) the insulation of the NU Utility Companies and their customers from the risk of potential direct adverse effects of investments in EWGs; (ii) the NU Utility Companies' financial integrity (including the ability of CL&P, PSNH and WMECO to issue senior securities); and (iii) the ability of the interested State Commissions to protect their ratepayers from any adverse impact12, all as discussed more fully below.
(a) Insulation from Certain Risks. NU states that all of its direct or indirect investments in EWGs are and will be segregated from the NU Utility Companies by being held in one or more separate corporate entities owned directly by NU or NUEI, NU's nonutility holding company subsidiary. The reason for creating one or more subsidiaries to hold EWG assets is to isolate the associated financial and operating risks from NU or any other affiliate.
NU commits that none of the NU Utility Companies will provide financing for, extend credit to, or sell or pledge its assets directly or indirectly to any EWG in which NU owns any interest; the indebtedness of any EWG project will not otherwise be recourse to any NU Utility Company; and there will be no contractual relationship between any EWG and any NU Utility Company other than through arms' length transactions entered into in full compliance with all relevant codes of conduct. NU further commits not to seek recovery in the retail rates of any NU Utility Company for any failed investment in, or inadequate returns from, an EWG investment. NU also acknowledges that rules 46(a) and 42 under the Act limit the NU Utility Companies' ability to make equity distributions from capital surplus without Commission approval.
NU also asserts that EWG investments will not have any negative impact on the ability of NU operating companies to fund operations and growth, stating that the NU Utility Companies currently have financial facilities in place that are adequate to fund operations. NU's expectation of continued strong credit ratings by the NU Utility Companies should allow them to continue to access the capital markets to finance their operations and growth.
Moreover, NU states that, to the extent that there may be indirect effects on the NU Utility Companies from EWG investments, through effects on NU's capital costs, the State Commissions have the authority and the means, through rate-making procedures, to prevent any adverse effects on the cost of capital due to investments in EWGs from being passed on to ratepayers.
NU states that it does not anticipate that increased levels of EWG investment will have any impact on utilization of the NU Utility Companies' employees. It states that the NU Utility Companies have not and will not increase staffing levels to support the operations of EWGs. NU does not expect there to be any significant need for the NU Utility Companies' personnel to support NU's investments in EWGs. NU states that it contemplates that project, management and home office support functions will be performed largely by NU, through its subsidiary companies and by outside consultants (e.g., engineers, investment advisors, accountants and attorneys), engaged by NU.13
(b) Credit Ratings. Each of the NU Utility Companies has investment grade long-term debt and/or corporate credit ratings from Moody's, Standard and Poor's and Fitch.14 Both Moody's and Standard and Poor's have a "negative" outlook on CL&P's securities stemming from CL&P's proposed expenditures for upgrading its transmission lines. Fitch has given CL&P a "stable" outlook. WMECO currently has a "negative" outlook from Standard and Poor's and a "stable" outlook from both Moody's and Fitch. PSNH currently has a "negative" outlook from Standard and Poor's and a "stable" outlook from both Moody's and Fitch. Yankee Gas currently has a "negative" outlook from Standard and Poor's and a "stable" outlook from Moody's.
(c) Debt/Equity Ratios. In connection with its short-term debt authorization, NU and the NU Utility Companies have committed that, except in the case of CL&P and PSNH, NU and the NU Utility Companies, would, at all times, during the relevant authorization period, maintain common equity of at least 30% of its consolidated capitalization (common equity, preferred stock, long-term debt and short-term debt) as reflected in the most recent Form 10-K or Form 10-Q filed with the Commission, adjusted to reflect changes in capitalization since the balance sheet date. WMECO's ratio exceeds the Commission's 30% common equity requirement.15 NU states that, when the impact of RRBs is not included, each of the NU Utility Companies is well above the 30% threshold.
NU has committed that it will, and it will cause the NU Utility Companies to, adhere to the Commission's 30% common equity ratio requirement, if the EWG Investment Limit is modified as requested.16 NU notes that it has made a similar commitment in connection with its Guarantee proposal, discussed in section 2., above.
(d) Ability to Fund Operations. NU also states its view that investments in EWGs will not have any negative impact on the ability of the NU Utility Companies to fund operations and growth. NU explains that the NU Utility Companies have financial facilities in place that are adequate to support their operations. NU states further that the expectation of continued strong credit ratings by the NU Utility Companies should allow them to continue to access the capital markets to finance their operations and growth.
(e) State Utility Oversight. NU believes that the State Commissions that regulate the NU Utility Companies are able to protect utility customers within their respective states. The Commission solicited the views of each of the State Commissions regarding their ability to protect the ratepayers of their states from the proposed transactions and none of the State Commissions opposed the proposal.
In addition, NU will provide the information required by Form U5S to permit the Commission to monitor the effect of NU's EWG investments on NU's financial condition. Finally, none of the three conditions described in rule 53(b) exist. Specifically, (1) there has been no bankruptcy of any NU Subsidiaries; (2) NU's average consolidated retained earnings for the previous four quarters has not decreased by 10% from the average for the four quarters preceding that period; and (3) in the past fiscal year, NU has not reported operating losses attributable to its direct or indirect investments in EWGs which exceeded 5% of its consolidated retained earnings. NU commits to file a post-effective amendment to this Application should any of these events occur during the Authorization Period.
As required under rule 53(c), the Commission finds that NU has demonstrated that the proposed transactions will not have a substantial adverse impact on the financial integrity of the holding company system and will not have an adverse impact on the NU Utility Companies or on the ability of the State Commissions to protect the customers of these companies.
5. Internal Corporate Reorganizations of Nonutility Subsidiaries
Finally, NU and NUEI seek authority to engage in internal corporate reorganizations to better organize the Nonutility Subsidiaries and investments.17 NU states that it intends to consolidate or otherwise reorganize all or any part of its direct and indirect ownership interests in Nonutility Subsidiaries and the activities and functions related to these investments.18 NU states that the internal transactions would be undertaken to eliminate corporate complexities, to combine related business segments for staffing and management purposes, to eliminate administrative costs, to achieve tax savings, or for other ordinary and necessary business purposes. NU requests authority to engage in these transactions through the Authorization Period.
Fees, commissions and expenses of the Applicants expected to be paid or incurred, directly or indirectly, in connection with the transactions described above (other than costs of additional investments in EWGs) are estimated to be not in excess of $25,000. It is stated that, other than as noted above, the proposed transactions are not subject to the jurisdiction of any state or federal commission other than this Commission.
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 requested of or ordered by the Commission. Based on the facts in the record, the Commission finds that, except as to those matters over which jurisdiction has been reserved, the applicable standards of the Act are satisfied and no adverse findings are necessary.
IT IS ORDERED, under the applicable provisions of the Act and rules that, except as to matters as to which jurisdiction has been reserved, the Application is granted and permitted to become effective immediately, subject to the terms and conditions prescribed in rule 24 under the Act, provided that NU will file certificates under rule 24 within 60 days after the end of each calendar quarter, beginning with the quarter ending June 30, 2004, containing the following information:
IT IS FURTHER ORDERED that jurisdiction is reserved over (1) the issuance by NU of any securities for which the Investment Grade Condition cannot be met and (2) the authorization of energy marketing and brokering business activities outside the United States, Mexico and Canada, pending completion of the record.
For the Commission, by the Division of Investment Management, under delegated authority.
Margaret H. McFarland
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