LOS ANGELES - In a major revision of its ratings criteria, Fitch Investors Service said last week that investor-owned electric utilities are now at higher risk of being down-graded than government-owned systems.
From now on, Fitch will give more weight to competitive forces and less weight to financial performance when it assigns ratings to either investor-owned or public power electric utilities.
Despite the new approach, "sweeping changes" in the debt ratings of electric industry issuers "are unwarranted," a Fitch special report said.
Fitch rates more than 100 investor-owned companies and 40 public power and electric cooperative issuers.
As a group, investor-owned utilities cause more credit concerns for Fitch than public power utilities because of several factors that have increased in importance in recent months, the report said.
The investor-owned utilities have a higher concentration of expensive nuclear generation facilities, and are at greater risk of losing customers in a more deregulated environment, causing a "stranded plant investment," the report said.
In addition, corporate utilities rely on "traditional cost-of-service rate-regulated methodology," and they have a large exposure to industrial customers, the report said.
In contrast, "public power systems, which are designed to minimize profit, should do better" than investor-owned utilities in the short term because they are "aided by the use of less expensive, tax-exempt debt, greater rate flexibility, and system owners and ratepayers who are the same," the report said.
The Fitch rating criteria revisions involve adjustments in the importance of six major components.
The new risk components are: management, which is assigned a weighting of 20%; rate competitiveness, weighted 20%; financial/legal performance, 20%; quality of regulation, 15%; service-area demographics, 10%; and plant, 15%. "Plant" refers to the separation of generation from transmission and distribution services.
The new approach incorporates "a utility's management and planning, rate competitiveness, and cost of power production," the report said.
"The most significant difference between Fitch's new rating approach and past practice is the move from a heavy reliance on financial ratio analysis to a more balanced approach," the report said. "High coverage and equity ratios no longer are sufficient to measure a utility's health in an increasingly competitive environment.
"Financial performance remains an important indicator, but the singular focus placed by some on traditional ratio analysis when making credit decisions no longer seems appropriate," the report said.
The revised guidelines were developed by Fitch's global power group, formed last year by combining the Fitch taxable and tax-exempt utility groups into one unit.
Electric utilities are undergoing a structural change that has been described as analogous to the court-ordered breakup of AT&T in the early 1980s. One of the major developments is expected to be a widespread application of retail wheeling, a system in which customers are free to purchase power from any vendor. Retail wheeling may be fully implemented in California by 2002, and it is being tested in Michigan in a limited fashion, the Fitch report said.
"As recent regulatory events in California and Michigan demonstrate, the electric utility industry is embarking on unprecedented change to a competitive environment that is market driven and subject to shifting regulatory policy," the report said.
On April 20, the California Public Utilities Commission announced a retail wheeling plan that would allow California's three investor-owned utilities to choose their own power source by the year 2002. The proposal, designed to cut electric prices, would grant large customers and residential users access to competing generating sources. It also would require performance-based regulation to give the industry an incentive to perform well based on market standards.
The regulatory commission proposal is not expected "to prompt changes" in Fitch's ratings of California electric utilities, the report said, noting that the California plan would be phased in gradually.
There are more than 2,000 municipal utilities nationally and about 260 investor-owned utilities. The investor-owned utilities generate roughly 75% of the nation's electric energy; municipal systems provide about 10%. Rural electric cooperatives and federal power agencies provide the balance.
Investor-owned utilities are for-profit businesses owned by shareholders. Public power systems, or municipal utilities, are owned or operated by local governments or state agencies. Both investor-owned and municipal utilities issue tax-exempt debt.
Reflecting the new competitive environment, Fitch is developing a "competitive position index" that will measure a utility's position compared with its competition, Fitch managing director Alan Spen said last month at a Lehman Brothers conference on the changing public power industry.