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Utility Upgrades/Downgrades Even for First Time Since 1999

For the first time since 1999, electric, gas and water utilities received as many credit rating upgrades as downgrades from Standard & Poor's Ratings Services (S&P) in 2006. S&P recorded 21 upgrades and 21 downgrades last year, "a stark contrast with recent years, when downside rating actions dominated."

In the fourth quarter, there were no ratings upgrades and only eight downgrades, with seven of those related to Ameren Corp., which is facing regulatory uncertainty in Illinois (see Daily GPI, Oct. 10, 2006).

"The drivers of upside rating activity in 2006 were improving financial conditions (including enhanced liquidity, increased free cash flow and deleveraging), refocused business strategies that led to stronger business profiles, constructive rate orders and successful recapitalization plans," S&P said Tuesday in a research note. "Negative rating actions were mainly the result of subpar financial parameters, accelerating capital spending, extremely challenging regulatory environments, greater operating risk associated with higher risk assets and political opposition to higher rates."

In Illinois, it wasn't just Ameren that suffered from downgrades due to regulatory uncertainty around rates; Commonwealth Edison, a subsidiary of Exelon, also was downgraded by S&P. "Although state lawmakers failed to pass during the November 2006 and January 2007 sessions legislation to extend for another three years a long-lived electric rate freeze for the Illinois utilities, Standard & Poor's remains concerned that such legislation could, in the coming months, resurface and that state senate opposition to such legislation could erode once customers begin to feel in earnest the impact of new and higher rates," the ratings agency said.

Other news of note last year on the ratings front were the failures of mergers between Exelon Corp. and Public Service Enterprise Group Inc. (see Daily GPI, Sept. 15, 2006) and FPL Group Inc. and Constellation Energy Inc. (see Daily GPI, Oct. 30, 2006; Oct. 26, 2006).

Despite the merger flame-outs, utility industry ratings still hover around 'BBB.' About 54% of companies carry ratings in the 'BBB' category; the percentage of utilities rated 'A-' and above is 31%. Nearly 15% of all utility ratings fall into speculative grade, 'BB+' and below. Only 12% of ratings in the sector have positive outlooks. While the number of negative outlooks has climbed considerably, to 20% from 14% one year ago, the number of companies with negative "CreditWatch" listings has not noticeably changed and stands at 31 or 12%.

Financing activity in the domestic power industry has declined somewhat over the last 12 months, S&P said. About $46.6 billion of medium- to long-term debt, preferred stock and hybrid securities were issued in 2006, compared with about $51.8 billion in 2005. S&P said it expects debt financing to gradually increase as companies begin construction of new generating capacity, expand and improve transmission and distribution facilities, satisfy increasingly stringent environmental requirements for coal-fired plants and fund mergers and acquisitions.

"Notwithstanding the challenges that lie ahead, Standard & Poor's expects the industry's near-term credit quality to be relatively steady," the agency said. "What could cause this assessment to change is event risk, principally in the form of accelerated M&A activity that could ultimately be a principal but uncertain driver of rating movement despite the recent collapse of two high-profile combinations."

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