Trends and Rating Considerations in Utility Mergers and Acquisitions NARUC Staff Subcommittee on Accounting and Finance Portland, Maine September 2006 Glen Grabelsky Managing Director Fitch Ratings

Click to edit Master title style Agenda M&A Historical Perspective and Outlook Recent Trends in M&A Financial Players Take Center Stage M&A Credit Perspectives

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3 Fitch’s Outlook on M&A Activity >Consolidation is overdue and fewer impediments; >Opportunities to rationalize costs and enhance strategy: competitive genco, energy marketing, and risk management. Less burdensome capex impact; >Favorable capital markets environment: Interest rates remain near historic lows, and strong equity valuations—Hybrid securities offer new options; >PUHCA repeal not expected to accelerate activity, but rather change the partners; >Emergence of a new class of financial buyers: Macquarie, Brookfield, Babcock and Brown GE Financial, ArcLight; >Mega-deals still facing intense state scrutiny particularly given overall tariff pressure

Recent Trends In M&A—Who’s Selling M&A Activity has picked up in the last few years driven by several internal and external factors >Changing business strategy: Southern Union divestitures, Duke spin-offs; >Corporate Restructurings: Allegheny, Aquila, and Kinder Morgan >Turnarounds: Cascade Natural >Departing Foreign Owners: Scottish Power

Recent Trends in M&A—Who’s Buying The repeal of PUHCA has opened up the potential base of ownership or merger pairings >Funds---Macquarie, Brookfield, Babcock & Brown, ArcLight >Financial Institutions—Berkshire Hathaway, GE >Foreign: National Grid, Gaz Metro >Small In-market Consolidators: UGI, MDU, Empire District, >Geographic: Not yet

>Adoption of IDR/Recovery Rating methodology places greater emphasis on the regulated utility standalone financial profile (AES, Allegheny, CMS); >Ownership by financial sponsors does not necessarily imply more leverage at the regulated utility; >Initial rating considerations at the regulated utility will center on existing dividend practices, pro-forma servicing and distribution requirements, and regulatory or other ring-fencing mechanisms; >Parent company leverage tolerances may be higher for financial owners/sponsors with deep pockets and strong access to the capital markets; >Corporate and financial strategies for financial sponsors simpler and less vulnerable to strategic decisions: acquisitions, treasury share buybacks, etc.; >Leverage tolerance reflective of overall interest rate level/financing cost—higher interest rate environment and/or floating rate acquisition debt problematic General Rating Considerations

M&A Rating Implications Merger of Utilities >Generally credit neutral events; >Rating differential among partners has typically been modest, and Fitch has generally affirmed ratings on announcement; >Strategic benefits modest, and transaction financing is the dominant credit factor; >More often financed with stock as currency rather than leveraged, but back leveraging may occur; >Impediments to consummation may affect ratings: Tariff reductions, divestitures. Purchase by Financial Buyer >Considered on a case-by-case basis; >Generally no strategic benefits or synergies directly related to the transaction; >Transaction financing is the dominant credit factor; >Typically entail debt leverage at an intermediate holdco; >Fitch also considers regulatory ring- fencing provisions, which may provide greater credit separation from leveraged parent.

Fitch Credit Response to Pending Transactions >Exelon/PS Enterprise Group –Exelon affirmed (‘BBB+’) Outlook Stable –PEG affirmed (‘BBB’) Outlook revised to Positive >FPL/Constellation –FPL affirmed (‘A’) Outlook Stable –Constellation (‘A-) Outlook Stable >KeySpan/National Grid –KeySpan (‘A-’) Rating Watch Negative >NorthWestern/BBI –NorthWestern (‘BBB-’) Affirmed, Outlook Stable >Duquesne/Macquarie –Duquesne (‘BBB-’) Affirmed, Outlook Stable

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