Gaining Access to Capital Markets

399 views

Published on

With potentially costly environmental upgrades on the horizon and the need to increase capacity over the long term, capital needs for cooperatives are growing rapidly. At the same time, traditional sources of funding are being constrained. As cooperatives increasingly turn to the markets, how can they ensure their members continue to benefit from low capital cost?

This ScottMadden insight is the second in a series on “Five Strategic Priorities for Generation and Transmission Cooperatives.” The report summary can be found here: http://www.scottmadden.com/insight/516/five-strategic-priorities-for-generation-and-transmission-cooperatives.html.

To learn more, please visit www.scottmadden.com.

0 Comments
0 Likes
Statistics
Notes
  • Be the first to comment

  • Be the first to like this

No Downloads
Views
Total views
399
On SlideShare
0
From Embeds
0
Number of Embeds
44
Actions
Shares
0
Downloads
7
Comments
0
Likes
0
Embeds 0
No embeds

No notes for slide

Gaining Access to Capital Markets

  1. 1. Copyright © 2012 by ScottMadden. All rights reserved. Gaining Access to Capital Markets A Generation and Transmission Cooperative Strategic Priority June 2012 Contact: Brad Kitchens (sbkitchens@scottmadden.com) Marc Miller (mdmiller@scottmadden.com)
  2. 2. Copyright © 2012 by ScottMadden. All rights reserved. Introduction This ScottMadden insight is the second in a series on “Five Strategic Priorities for Generation and Transmission Cooperatives.” Contents  Overview  The Increasing Dependence on the Capital Markets  The Role of Credit Ratings in Raising Capital  Maintaining Strong Credit Ratings  Thinking Strategically  Contact Us 1 Managing Generation Assets Ensuring Grid Security and Reliability Improving the Effectiveness of Stakeholder Management Fostering Economic Development Gaining Access to Capital Markets
  3. 3. Copyright © 2012 by ScottMadden. All rights reserved. 2 The 21 largest cooperatives** demonstrated the following financial characteristics in 2010: 0% 20% 40% 60% 80% 100% 120% Debt(%) Topcooperatives Debt/ Capitalization - 0.50 1.00 1.50 2.00 2.50 Ratio(X) Topcooperatives DebtService CoverageRatio  A median DSC ratio of 1.31x is within the range of a Fitch study in which ratios of public power firms rated AA or A ranged from 1.25x to 1.7x from 2005 to 2009*  The ability to consistently maintain relatively high debt levels (a median of 86% of total capitalization) reflects the low risk profile of most cooperatives *Sources: SNL Financial; RUS Form 12; ScottMadden analysis; U.S. Public Power Peer Study June 16, 2010 **Defined here as those with assets more than $1 billion or annual revenue more than $500 million  The impact of historically high levels of capital expenditures is evident in a view of the consolidated balance sheets of the 21 largest cooperatives** — Total Utility Plant (gross), at the 21 largest cooperatives has grown more than 77% since 2001, reaching $52 billion in 2010*  Compounding pressures are driving increased capital spending, yet financing from a primary source of cooperative funding, the Rural Utilities Service (RUS), is declining and becoming more restrictive (see next page) Regulatory & Legislative Environment  Strong rate-making ability or positive regulatory relationships  Consistent engagement with key stakeholders Business & Economic Environment  A diverse and growing service area  Community support for conservation and investments in efficiency Management & Operations  Experienced and effective leadership  Competitive operational performance  A diverse and low-cost resource mix Financial Performance  Strong historical financials, including balance sheet stability, appropriate debt service ratios, and sufficient liquidity Four Dimensions of Business Strength How Do Capital Markets Judge Cooperatives?What is Driving Cooperatives to Access Capital Markets? With potentially costly environmental upgrades on the horizon and the need to increase capacity over the long term, capital needs continue to intensify, and cooperatives will increasingly turn to the markets for funding. Gaining Access to Capital Markets Overview Median
  4. 4. Copyright © 2012 by ScottMadden. All rights reserved. -7% 6% -10% 4% -13% -100% -80% -60% -40% -20% 0% 20% $0 $2,000 $4,000 $6,000 $8,000 2008 2009 2010 2011 2012 2013 RUS - Electric ProgramLoans $ MM Amounts adjusted for inflation to April 2012 CPI Gaining Access to Capital Markets The Increasing Dependence on the Capital Markets Just as capital needs are pushed higher, traditional sources of funding for cooperatives are being constrained. 3 *Sources: SNL Financial; RUS Form 12; ScottMadden analysis; Company reports; EEI Finance Department; USDA Rural Utilities Service, Electric Program; Fitch Special Report, No Relief in Capital Spending Plans, December, 2011; Fitch Ratings, 2012 Outlook: Utilities, Power, and Gas, December 2011 Growth in the cooperative asset base is accelerating  Cooperative capital spending, due to both stronger customer growth than other utilities and no relief from pressures to meet more stringent regulations, has driven growth in physical assets  The growth in total utility plant (gross) from 2001 to 2010 for the 21 largest cooperatives has been increasingly intense — YOY growth averaged 5.5% from 2002 to 2006 and 7.9% from 2007 to 2010 Traditional funding sources are more constrained  Cooperatives largely rely on RUS and two cooperative lending institutions, CoBank and National Rural Utilities Cooperative Finance Corporation (CFC), to finance capital needs  RUS financing is declining and becoming more restrictive, forcing borrowers to seek out alternatives, especially for base- load generation projects — The President’s Budget for Fiscal Year 2013 allocated a $6.1 billion loan level and would restrict lending on $4.0 billion of the total to renewable- related or carbon sequestration projects — Starting with the 2008 budget, lending for base load coal and nuclear plants was no longer available through RUS Cooperatives will increasingly rely on the capital markets to fill the gap between rising investment requirements and reduced funding from traditional sources
  5. 5. Copyright © 2012 by ScottMadden. All rights reserved. Gaining Access to Capital Markets The Role of Credit Ratings in Raising Capital Although raising funding from the capital markets depends on multiple factors, the most effective means of communicating a company’s relative strength is a strong credit rating. 4 Sources: SNL Financial and EEI Finance Department, S&P, U.S. Public Power Peer Study June 16, 2010; Moody’s Rating Methodology – US Electric G&T Cooperatives *Defined here as those with assets more than $1 billion or annual revenue more than $500 million The 21 largest cooperatives* compare favorably to IOUs Observations  Although rating agencies take multiple factors into consideration, there is a heavy weighting on key credit metrics such as debt service coverage (DSC), times interest earned ratio (TIER), days of cash on hand, and equity to capitalization  In 2010, the average credit rating of the 14 co-ops that make up Moody’s G&T cooperative sector peer group was A3, which is upper medium grade and second only to the average rating of the municipal sector peer group — This is due in part to the general flexibility cooperatives have to adjust rates and mitigate the risks of regulatory lag and cost disallowances  Decrease the relative amount of interest that must be paid to service debt  Simplify the credit review process  Reduce the restrictiveness of debt covenants  Facilitate the issuance of debt in both the public and private debt markets  Broaden the market of potential investors and lenders  Allow for greater financial flexibility Strong credit ratings yield numerous benefits  The 21 largest cooperatives demonstrated excellent credit ratings, with 86% receiving an A- rating or higher from S&P — Only 26% of North American IOUs achieved the same level, down from more than 60% in 2000  Maintaining strong credit ratings, while increasing borrowing, will be essential, which is why closely managing four dimensions of business strength is so important (see next page) 0% 20% 40% 60% 80% 100% Top 21 Coops US IOUs %ofthoserated S&P Credit Ratings AAA AA+, AA, AA- A+, A, A- BBB+, BBB BBB- BB+ and lower
  6. 6. Copyright © 2012 by ScottMadden. All rights reserved.  “No single financial ratio stands apart from the rest. On the contrary, the ratios are examined together, providing a context for a utility’s financial position that informs a complete analysis.” – Fitch  “Like public power utilities, G&T cooperatives' highly leveraged capital structures reflect an inability to access capital markets to fund a perpetual equity cushion. Low, but sound debt service coverage ratios reflect the use of amortizing debt and an absence of profit-related revenues.” – S&P A strong credit rating must be maintained over time by focusing on the factors that are critical to understanding and enhancing four dimensions of business strength. Gaining Access to Capital Markets Maintaining Strong Credit Ratings 5  “Managing through an extended period of high capital investment is [a] principal risk to bondholders, should adequate and timely returns on investment not be authorized.” – Fitch  “The extent to which a G&T coop can ensure timely and full recovery of its costs and investments will have an integral effect on its overall financial performance and thus its credit worthiness.” – Moody’s  “Cooperative utilities with rate-setting authority have shown they are willing to raise rates as needed to maintain their financial metrics.” – S&P  “The pace of environmental regulatory compliance, direction of fuel prices and economic trends are a source of continuing uncertainty, which then places a greater weight on utility management to skillfully navigate the operating environment.” – Moody’s  “As the highly coal dependent cooperative sector’s power plants reach the end of their useful lives, the regulations’ operational and cost consequences will rise to the fore and color utilities’ resource decisions.” – S&P  “[Cooperatives] willingness to [proactively raise rates to meet increasing costs] may come under growing pressure in 2012, as recent rate increases, coupled with persistent declines in median household income levels, have eroded affordability metrics over the past three years.” – Fitch  “Low natural gas prices have helped many utilities reduce operating costs and emissions, but those cooperatives with long generation positions, and that rely on selling surplus power to nonmember customers, have found themselves in a tight position as shrinking wholesale electricity prices have reduced sales' margins.” – S&P Regulatory & Legislative Environment Business & Economic Environment Management & Operations Financial Performance Four Dimensions of Business Strength *Sources: Moody’s Rating Methodology – U.S. Electric G&T Cooperatives, December 2009; S&P Rate Changes crucial for cooperatives to withstand EPA regulations, weak economy; Fitch Public Power Methodology, March 2011; Fitch U.S. Public Power Rating Criteria, January 2012; S&P Criteria for rating public power companies, February 2011
  7. 7. Copyright © 2012 by ScottMadden. All rights reserved. In today’s dynamic and challenging environment, it is more important than ever to ask the right questions and truly understand the implications of the answers.  How can we increase the likelihood that our regulators make decisions that are credit supportive?  How should we prepare to react to pending and potential legislation?  Are we positioned for strong performance in the economy we are forecasting? Are our members?  How are we recognizing and mitigating the adverse risks in today’s rapidly changing business environment?  Have we planned our resource portfolios effectively? Are we getting the most out of the assets we have?  Do we have the right management team to pursue our strategy?  Is our balance sheet strong enough to facilitate necessary investment and protect our members against adverse impacts?  Meet formal targets for financial metrics (e.g., DSC, equity/capitalization, and days of cash on-hand)  Improve our credit rating and take advantage of low interest rates to minimize financing costs  Implement an integrated planning process and align the organization on pursuit of key performance measures  Develop a comprehensive asset management strategy and appropriately diversify our portfolio of generation assets  Recognize and engage consistently with our key stakeholders and improve important relationships  Commit to economic development and pursue focused and measurable objectives Gaining Access to Capital Markets Thinking Strategically 6 Possible Goals for the Organization Practical Questions for Management
  8. 8. Copyright © 2012 by ScottMadden. All rights reserved. Contact Us ScottMadden has undertaken numerous consulting projects for cooperatives across the country. If you are interested in learning more about gaining access to capital markets, please contact us. Brad Kitchens President and CEO ScottMadden, Inc. 3495 Piedmont Rd, Bldg 10 Suite 805 Atlanta, GA 30305 Phone: 404-814-0020 sbkitchens@scottmadden.com Marc Miller Director ScottMadden, Inc. 3495 Piedmont Rd, Bldg 10 Suite 805 Atlanta, GA 30305 Phone: 404-814-0020 mdmiller@scottmadden.com 7

×