ML20030B599
| ML20030B599 | |
| Person / Time | |
|---|---|
| Site: | Allens Creek File:Houston Lighting and Power Company icon.png |
| Issue date: | 07/31/1981 |
| From: | Dean H HOUSTON LIGHTING & POWER CO. |
| To: | |
| Shared Package | |
| ML20030B571 | List: |
| References | |
| NUDOCS 8108180341 | |
| Download: ML20030B599 (16) | |
Text
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PAGE OF 1
2 3
4 5
6 7
8 9
10 11 DIRECT TESTIMONY OF 12 H.
R. DEAN 13 for 14 HOUSTON LIGHTING & POWER' COMPANY 15 July 1981 16 17 18 19 20 21 22 23 24 25 26 27 8108180341 010812' 28 PDR ADOCK 05000466 I
PDR HOUSTON LIGHTING & f0WER COMPANY
PAGE 1
OF 14 TESTIMONY OF HOLLIS R.
DEAN g
(
2 Q.
A SAE O
NAME, BUSINESS ADDRESS, MD POSITION 3
WITH HOUSTON LIGHTING & POWER COMPANY.
4 A.
My name is Hollis R.
Dean and my address is 611 Wal a r AV"""*'
Houston, Texas.
I am an Executive Vice 6
President and the chief financial officer of the 7
8 Company, and have ultimate responsibility for the Accounting, Computer Services, Corporate Development, 9
Internal and Operations Auditing, Rate and Corporate 10 Planning, and Treasury Departments.
I am also a director of the Company.
0 EEASE BRIE M DESCRIBE YOUR EDUCATIO N BACKGROUND 13 AND BUSINESS EXPERIENCE.
g A.
I received a Bachelor of Science Degree in Accounting from Bowling Green College of Commerce, Bowling Green, Kentucky, in 1946 and joined the Accounting Department g
of Houston Lighting & Power Company that same year.
I gg became Comptroller in 1966, Vice President in 1970, 9
Group Vice President in 1973 and Executive Vice 20 President in April, 1981.
In April, 1977, I was elected a director of the Company.
I am a Certified g
Public Accountant and a member of the American 3
Institute of Certified Public Accountants, the Texas g
Society of Certified Public Accountants, the Financial Executives Institute and the Finance Committee of the Edison Electric Institute.
28 HOUSTON LIGHTING & POWER COMPANY j
PAGE 2
op 14 3
Q.
MR. DEAN, PLEASE SUMMARIZE YOUR TESTIMONY IN THIS 2
PROCEEDING.
A.
My testimony outlines the need for rate relief at this 3
time to support the financing of HL&P's construction 4
5 Program.
I will also discuss the financial aspects of 6
the reassessment of that construction program and the 7
Company's financial objectives, g
Q.
WHAT IS THE BASIS FOR YOUR EVALUATION OF HL&P's 9
FINANCIAL REQUIREMENTS?
A.
I have long been involved in the planning and 10 imple.nentation of HL&P's outside financing, a function g;
that in recent years has been under my control and 12 13 supervision.
Over the years my responsibility for raising funds has led to an understanding of the 14 requ emen s r
nan a
n eg y ne essary to raise 15 adequate capital at reasonable cost.
Frequent meetings 16 with financial analysts, investment bankers and rating g
agen ies, together with regular review of reports and 18 materials relied on by authorities in the area of 39 rPorate financing, enables me to recommend and 20 imp ement objectives which will contribute to HL&P's l
21 finan ial integrity.
22 23 24 25 26 27 28 HOUSTON LIGHTING & POWER COMPANY
3 14 PAGE OF DESCRIPTION OF THE REQUEST g
2 Q.
WHY DOES HL&P NEED RATE RELIEF OF $248 MILLION OVER ADJUSTED TEST YEAR REVENUES?
4 A.
This increase is necessary to recover the cost of serving present customers which includes a return on 6
invested capital of 12.32%.
The increase will provide 7
HL&P with an opportunity to attain the financial 8
results required to support the construction program 9
necessary to meet the growing demand for electricity.
10 Q.
WHY IS THIS INCREASE NECESSARY AFTER THE RATE INCREASE 11 MADE EFFECTIVE IN OCTOBER, 1980?
12 The rates authorized in Docket 3320 have not and will A.
not enable HL&P to meet the requirements of the 14 financial community.
The current construction program 15 will require frequent trips to the capital markets to 16 offer new issues of debt and equity.
In order to 17 finance the program, the Company's financial integrity 18 must be improved by increasing interest coverages, the 19 amount of internally generated funds, and the return to 20 the Company's shareholders.
21 22 23 24 25 26 27 28 HOUSTON LIGHTING & POWER COMPANY
PAGE 4
OF 14 g
FINANCIAL ENVIRONMENT 2
Q.
MR. DEAN, PLEASE DESCRIBE THE CURRENT FINANCIAL 3
ENVIRONMENT AND ITS EFFECTS ON HL&P.
4 A.
Our nation's high rate of inflation and aeneral 5
economic condition have seriously affected the 6
financial markets.
Interest rates are presently at levels that would have seemed impossible just a few l
8 years ago.
The prime rate, for example, stands as of this writing at 20.0%, which is below the 21.5% reached 10 in December 1980 but is still exceedingly high by II historical standards.
Interest rates on long-term debt 12 are also high.
In February, HL&P for the first time I
sold first mortgage bonds with a 10-year m6:urity and 14 raised $125 million at a cost to the Company of over 15 14%--its most expensive issue to date.
This compares 16 to HL&P's embedded cost of debt of d.71% for 30-year 17 bonds.
18 High interest rates are indicative of the 19 difficulty in obtaining funds in the current financial 20 environment.
The First Mortgage Bonds just described
'l were originally intended to be sold in December 1980 22 and were to mature in 30 years.
Because of the rate 23 differential between 30-year and 10-year bonds in 24 December, the maturity of the issue was shortened to 10 25 years.
The cost of 10-year bonds, however, was still 26 unacceptably high, and the sale was postponed until 27 28 HOUSTON LIGHTING & POWER COMPANY
5 PAGE OF 14 market conditions improved in February.
A proposed new 3
issue of preferred stock that was also to be sold in 2
December was cancelled because there was no market for 3
a split-rated, perpetual preferred stock.
4 j
Q.
H W HAS THE M ET FOR COMMM STOCK B M AFFECT W 3
A.
The prevailing high interest rates have had a 6
depressing effect on the prices of interest-rate 7
sensitive utility common stocks such as those of 8
Houstos. Industries Incorporated (HII), parent of HL&P, 9
and utility companies in general.
With expectations of 10 low dividend growth in utility common stocks, investors are looking primarily at current cash dividend yields, but yields of 11-12% on utility stocks cannot compete 13 with yiel.ls of 13-14% that are available on risk-free g
government securities.
Consequently, the Cost of common equity, like debt and preferred stock, has risen.
In March 1981, Houston Industries sold g
3,000,000 shares of common stock for net proceecs of
,g
$24.39 per share, which is the lowest price for a-39 Houston Industries common stock sale since February 20 1976.
The market-to-book ratio of the sale was 70%,
g our lowest ever.
This latest issue was the sixth se tive common stock sale below book value.
In 23 addition, the price received at each of these six stock g
sal s has been less than that received at the previous 25 sale.
27 28 HOUSTON LIGHTING & POWER COMPANY
PAGE 6
OF 14 g
It is clear that the financial integrity of the 2
Company has not been maintained as evidenced by the continued sale of substantial amounts of common stock 3
below book value.
This alarming trend must be reversed 4
if we are to be successful in raising the capital 5
required to support the required large construction 6
7 program.
8 Q.
WiiAT ARE THE IMPLICATIONS OF SELLING HOUSTON IIDUSTRIES' COMMON STOCK BELOW BOOK VALUE?
9 A.
The sale of common stock below book value dilutes the 10 ownership interests of existing shareholders.
To g;
illustrate, the March sale of 3,000,000 common shares 12 at a price to the public of $25.25 per share occurred 13 at a time when the book value per share was $34.97.
14 Immediately fo) lowing the sale, though, book value per 15 share dropped $0.70 to S34.27, siinply because the new 16 invest. ors paid less than book value for their shares.
37 Continued dilution has caused many institutional 18 investors to avoid purchases of newly-issued HII common 39 st ek.
In the March sale, an estimated 30% of the 20 shares offered were bought by institutions.
This 21 compares with 70% institutional purchases in one of our g
last sales above book value in February 1973.
The loss 23 f the institutional market has required HII to place 24 greater emphasis on retail customers for purchases of 25 its stock, which has led to the addition of a third 26 manager to the distribution group.
One drawback of the 27 28 HOUSTON LIGHTING & POWER COMPANY
7 OF 14 PAGE 3
retail market is that flotation costs are higher.
An 2
even greater concern is that if individual investors begin to avoid purchases of new stock issues like the 3
m re sophisticated institutional investors, the amount 4
f common equity financing and ultimately all financing 5
could be severely limited.
6 Q.
WHAT IS THE EFFECT OF THE MOODY'S DOWNGRADING ON HL&P?
7 A.
Effective November 21, 1980, Moody's Investors Service 8
9 lowered the rating on HL&P's first mortgage bonds from "Aa" to "A" and on HL&P's preferred stock from "aa" to 10 "a".
The rating report, which appears in Schedule H-9, 33 says "these actions reflect the increased vulnerability g
f II uston Lighting & Power Company in recognition of 13 their large continuous construction program and the 14 finan ing pressure placed on the company by that 15 Program."
16 Even though Standard & Poor's, Duff and Phelps, and 37 Fitch Investors Service maintained their "AA" or gg equivalent ratings on HL&P's first mortgage bonds and 39 Preferred stock, the Moody's downgrading signaled the 20 in reased risk of owning HL&P securities.
The 21 downgrading also contributed to our difficulty in 22 raising funds in late 1980 and early 1981, and will 23 continue to do so until Moody's "Aa" rating is 24 restored.
A higher cost of funds is inevitable with a Moody's 26 "A" rating.
The demand for funds is more intense since 27 28 HOUSTON LIGHTING & POWER COMPANY
c PAGE 8
op 14 more electric utilities have "A" - rated securities i
2 than "AA",
while the supply of funds is diminished since some institutional investors are limited to 3
purchases of high-grade bonds ("AAA" and "AA") while 4
many are limited to at least upper medium grade 5
bligations
("A").
Lvery downgrading thus eliminates a 6
portion of the market for our securities.
7 Any further deterioration in HL&P's credit standing 8
would jeopardize the Company's ability to finance its 9
nstruction program.
Thetc are, of course, no 10 assurances that the Moody's "Aa" rating can be 33 restored, but adequate rate relief and the reassessment g
f HL&P's construction program are major steps in that 13
- ff #D*
14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 HOUSTON LIGHTING & POWER COMPANY
9 OF 14 PAGE REASSESSMENT OF CONSTRUCTION PROGRAM g
2 U*
- "Y ""
"'^
U" *
- 0" O
^"
3 A.
The reassessment was largely a financial decision that 4
mpl ments HL&P's purchased power and 1ad management 5
6 Programs, and was prompted by the inabi.ity to obtain the massive amount of external funds that the prior 7
pr gram required.
This inability was based on a 8
judgment by the Company, with input from its investment 9
bankers, as to the maximum amount of new equity financing -- initially $200 million of common stock and 3,
$100 millica of treferred stock--that can reasonably be btained in a single year.
The revised program 13 recognizes these limits.
The financing plan will nevertheless entail considerable difficulty.
These limits exceed (by $27 million in the case of common equity and $50 million in the case of preferred stock) the largest amounts ever 18 raised in a single year by HL&P.
Thus, the continued 39 support of individual investors and the return of 20 institutional investors are important for the success g
of the financing plan.
g Without a foreseeable improvement in the 23 market-to-book value ratio of our common stock, 24 investors may refuse to purchase future stock issues.
25 If this occurs, the $200 million of common stock per 26 y ar w uld n t be achievable, thereby eliminating the 2'1 28 HOUSTON LIGHTING & POWER COMPANY i
10 OF 14 PAGE i
a g
one source of funds which is the catalyst to raising 2
alternate types of external funds (preferred stock and debt).
3 4
Despite the company's efforts to make financing its nstruction program attainable, major uncertainties 5
still exist.
For example, the dollar limits mentioned 6
above could easily change with financial market 7
conditions.
Also, the total effects from the Moody's 8
9 downgrading are unknown.
These and other uncertainties make adequate and timely rate relief all the more 10 important if we are to continUC to serve the customer 3,
in a reliable manner.
g 13 14 15 16 17 18 19 20 21 22 l
23 24 j
25 26 27 28 l
l HOUSTON LIGHTING & POWER COMPANY a
PAGE 11 OF 14 g
FINANCIAL OBJECTIVES 2
Q.
HAT ARE HL&P's FINANCI AL OBJECTWES?
3 A.
My valuation of the financial objectives necessary 4
f r satisfactory financial performance, based on S
6 in-depth discussions with the financial community, are as follows:
7 1)
Generate at least 40% of construction requirements 8
from internal aources.
9 2)
Sell common stock at or above book value.
10 3)
Achieve a pre-tax interest coverage excluding 33 AFUDC of not less than 3.5 times.
g 4)
Attain a targeted capital structure of 45% common 13 equity, debt less than 50% with preferred stock g
making up the difference.
33 5)
Limit the percentage of AFUDC to income available 16 to common to a level consistent with achieving the g
objectives listed above.
Maintenance of the quality of the company's fixed 39 in m
securities and improvement of common stock 20 Performance are contingent upon the actual realization 21 of these parameters.
The proposed level of revenues, which includes a 17% return on common equity with 7 6 23 CWIP and NFIP in rate base, should afford HL&P the 3
pp rtunity to satisfy the requirements of investors 25 and maintain financial integrity.
26 27 28 HOUSTON LIGHTING & POWER COMPANY
PAGE 12 op__ 14 Q.
HOW DID YOU DETERMINE THE OBJECTIVE FOR INTERNAL FUNDS 3
GENERATION?
2 A.
HL&P's financial objective of at least 40% internally 3
generated funds reflects a realistic appraisal of the 4
nstraints to external financing.
As the high level 5
f construction -cpenditures places pressure on the 6
Company's cash position, investors recognize thati 7
additional external financing is necessary.
Based on 8
the size of our current construction program and the 9
am unt of external financing that we can reasonably 10 expect to accomplish during a year, a minimum of 40%
internally generated funds is required if we are to g
successfully complete our financing program.
13 Q.
WHY IS A PRE-TAX INTEREST COVERAGE OF NOT LESS THAN g
M QUIR W IS A.
The financial risk associated with a company's debt 16 securities is whether earnings are sufficient for 17 timely payment of interest.
18 In rder to quantify this risk, bond rating 19 agencies utilize Coverage ratios in assigning Credit ratings.
If a "AA" rating is to be maintained, an g
electric utility should consistently achieve interest Coverages in the 3.5x to 4.0x range.
HL&P's rate application wi11 provide earnings which 3
Will result in Coverage ratios within this range and all w f r finan ing flexibility by keeping pre forma 26 coverages from dropping below acceptable levels when g
new bonds are sold.
28 HOUSTON LIGHTING & POWER COMPANY j
13 op 14 PAGE g
Q.
HOW DID YOU DETERMINE HL&P's TARGETED CAPITAL STRUCTURE?
2 A.
The capital structure should change over time to 3
reflect changing conditions, such as the costs and 4
risks associated with various sources of capital.
5 Required return on equity, interest coverages, and 6
embedded and current costs of debt all influence the 7
development of an appropriate capital structure.
8 HL&P's cul; rent capital structure objective represents 9
an increase in the equity portion of permanent 10 capital.
This is in response to the increased risk associated with electric utility operating environments g
in gen ral, high interest rates, volatile financial 13 markets, economic uncertainty, and HL&P's construction g
requirements.
Q.
M ASE SUMMAR N HL&P'S CAM TAL STRUCTURE AT THE END 16 OF THE TEST YEAR.
g A.
As shown in Schedule H, HL&P's capitalization at 8
March 31, 1981 consisted of:
,9
^* ""
70 (000 Omitted)
Percent 21 Long Term Debt
$1,704,142 49.05%
22 Preferred Stock 243,518 7.01 23 Common Equity 1,526,588 43.94 24 This capital structure reflects a movement toward the
'S ranges established in our statement of financial 26 objectives and in prior rate cases before this 27 28 HOUSTON LIGHTING & POWER COMPANY L
PAGE 14 op,__14 g
Commission.
I":. is therefore an appropriate basis for 2
the determination of IIL&P's overall cost of capital.
3 Q.
MR. DEAN, HOW DOES THE " QUALITY OF EARNINGS" RELATE TO THE CONSTRUCTION BUDGET AND THE LEVEL OF AFUDC?
4 5
Construction expenditures can only be met with cash.
A.
Thus, earnings that result from AFUDC, which is simply 6
a n n-cash book entry, are not available to finance 7
8 IIL&P's construction program since no internal cash is 9
generated.
Earnings, which include AFUDC, must be at a level sufficient to meet investor requirements.
10 However, the AFUDC component must be limited to a level
- 3 which will still allow the Company to generate at least g
13 40% of its capital requirements internally.
This can be accomplished by allowing sufficient construction 14 w rk in progress in rate base.
15 Q.
AN HA EN IF INVESTORS PERCEWE THAT HL&P MM 16 NOT MEET SOME OR ALL OF THE FINANCIAL OBJECTIVBS YOU 37 HAVE DISCUSSED?
gg A.
Expectations of inadequate cash generation, increased 39 external finan ing, and prospective limits to dividend 20 gr wth may preclude sales of common stock at or above 21 book value and adversely affect the risk posture of the 22 Company's debt securities.
It j a investor expectations 23 that will ultimately determine the Company's actual 24 Cost of Capital and market accessibility.
Q.
DO S TH ONCMDE YOUR TESTIMONY?
26 A.
Yes, it does.
28 HOUSTON LIGHTING & POWER COMPANY
)
'IHE STATE OF TEXAS 8
COUNTY OF HARRIS S
Before me, the urdersigned authority, on this day personally ap-peared Hollis R. Dean, haviry been duly sw rn, upon oath says:
"My name is ibilis R. Dean, I am of legal age and a resident of the State of Texas. 'Ihe forejoirg testimony, and exhibits, offered by me on behalf of Ibuston Lightirg & Power (bmpany, are true and correct, and the opinions stated therein are, in my judjment and based upon my professional experience, true and correct."
h,DM Hollis R. Dean Subscribed and swrn to before me by the said Ibilis R. Dean this 15TH day of JL/NE._,1981.
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