File No. 70-8541
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.
POST-EFFECTIVE AMENDMENT NO. 2 TO
FORM U-1
APPLICATION OR DECLARATION
under
the
PUBLIC UTILITY HOLDING COMPANY ACT OF 1935
____________________________________________
National Fuel Gas Company National Fuel Gas
10 Lafayette Square Distribution Corporation
Buffalo, New York 14203 10 Lafayette Square
Buffalo, New York 14203
Seneca Resources Corporation National Fuel Gas Supply
10 Lafayette Square Corporation
Buffalo, New York 14203 10 Lafayette Square
Buffalo, New York 14203
National Fuel Resources, Inc. Utility Constructors, Inc.
10 Lafayette Square 10 Lafayette Square
Buffalo, New York 14203 Buffalo, New York 14203
(Names of companies filing this statement
and addresses of principal executive offices)
_____________________________________________
NATIONAL FUEL GAS COMPANY
(Name of top registered holding company)
_____________________________________________
Philip C. Ackerman Robert J. Reger, Jr., Esq.
Senior Vice President Reid & Priest LLP
National Fuel Gas Company 40 West 57th Street
10 Lafayette Square New York, New York 10019
Buffalo, New York 14203
(Names and addresses of agents for service)
<PAGE>
Item 1. Description of the Proposed Transaction.
Paragraphs 67 through 70 of Item 1 are revised in their
entirety to read as follows:
"Within thirty days following the trade date of any
Swap and Derivative Transaction or any swap completed pursuant to
the SEC order granted in connection with National's short-term
borrowings and system Money Pool arrangements (File No. 70-8297)
(a "Short-term Borrowing Swap"), National will submit a report to
the Commission disclosing the following information with respect
to such Swap and Derivative Transaction or Short-term Borrowing
Swap: the trade date; the type of Swap and Derivative
Transaction or Short-term Borrowing Swap traded; the notional
principal amount; a description of the index and margin in the
case of a swap or the underlying index and strike rate in the
case of a cap or a floor; the termination date; the name of the
counterparty; the material terms of the underlying instrument
(including the interest rate (or index and margin) and the
maturity or termination date of such instrument), and the name of
the subsidiary or subsidiaries to which the cash inflows and
outflows under the Swap and Derivative Transaction will be
allocated.
Within forty-five days following the close of each
fiscal quarter, National will submit a report to the Commission
disclosing additional information regarding its trading in Swap
and Derivative Transactions if the aggregate net cash outflow or
inflow for all swaps and/or the net cash outflow for all floors
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exceed $1 million during the quarter. Specifically, National
will disclose the net cash outflow or inflow for each swap, and
the net cash outflow for each floor, that has been open at any
time during such quarter. With respect to swaps, the net outflow
refers to the difference between the interest flow received by
National versus the interest flow paid by National during such
quarter for that swap. With respect to any floor, the cash
outflow refers to the sum of payments made by National during
such quarter under any floor sold by National.
National will additionally disclose, also within forty-
five days following the close of each fiscal quarter, the market
value for each Swap and Derivative Transaction and each Short-
term Borrowing Swap that is open at the close of such quarter, as
of that closing date, if the aggregate market value for all Swaps
and Derivative Transactions and Short-term Borrowing Swaps
increased or decreased by more than $1 million during the
quarter. National will also disclose any gains or losses
realized from the liquidation during such quarter of any position
in a Swap and Derivative Transaction or Short-term Borrowing Swap
if such gains or losses in the aggregate exceed $1 million. If a
report is required, it will include the proceeds and sale price
constituting such gain or loss, and its carrying value, if any.
Further, National will disclose, also within forty-five
days following the close of each fiscal quarter, certain
information if the aggregate notional principal amount of all
Swap and Derivative Transactions and all Short-term Borrowing
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<PAGE>
Swaps during that quarter exceeds by $1 million the outstanding
or notional principal amount of the underlying instrument.
Specifically, National will disclose the date and reason for such
condition as well as the identity of the Swap and Derivative
Transaction or Short-term Borrowing Swap causing such condition.
In addition, National will disclose the date (a) the related Swap
and Derivative Transaction or Short-term Borrowing Swap was
terminated or the notional principal amount of such instrument
was reduced or (b) a new instrument related to the open Swap and
Derivative Transaction or Short-term Borrowing Swap was entered
into, if applicable. If National enters into a new underlying
instrument for a Swap and Derivative Transaction or Short-term
Borrowing Swap, it will also disclose the terms of the new
underlying instrument."
The following paragraph is hereby added to Item 1:
"National requests that the Commission release its
reservation of jurisdiction over National's ability to enter into
Swaps and Derivative Transactions."
Item 6. Exhibits and Financial Statements.
The following exhibits are made a part of this
statement:
(A) Exhibits
D-2 Copy of Public Service Commission's
order, to Distribution's Petition
95-G-0090, issued and effective
May 5, 1995.
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<PAGE>
D-2(A) Copy of Public Service Commission's
order, to Distribution's Petition
95-G-0090, issued and effective
August 4, 1995.
SIGNATURES
Pursuant to the requirements of the Public Utility
Holding Company Act of 1935, the undersigned companies have duly
caused this post-effective amendment to be signed on their behalf
by the undersigned thereunto duly authorized.
NATIONAL FUEL GAS COMPANY
By /s/ Gerald T. Wehrlin
------------------------
Gerald T. Wehrlin
Controller
NATIONAL FUEL GAS
DISTRIBUTION CORPORATION
By /s/ Gerald T. Wehrlin
------------------------
Gerald T. Wehrlin
Senior Vice President,
Controller
SENECA RESOURCES CORPORATION
By /s/ Gerald T. Wehrlin
------------------------
Gerald T. Wehrlin
Controller
NATIONAL FUEL GAS SUPPLY
CORPORATION
By /s/ Joseph P. Pawlowski
------------------------
Joseph P. Pawlowski
Treasurer
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<PAGE>
NATIONAL FUEL RESOURCES, INC.
By /s/ Robert J. Kreppel
------------------------
Robert J. Kreppel
President
UTILITY CONSTRUCTORS, INC.
By /s/ Joseph P. Pawlowski
------------------------
Joseph P. Pawlowski
Treasurer
DATED: September 5, 1995
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<PAGE>
EXHIBIT INDEX
Exhibits
--------
D-2 Copy of Public Service Commission's order, to
Distribution's Petition 95-G-0090, issued and
effective May 5, 1995.
D-2(A) Copy of Public Service Commission's order, to
Distribution's Petition 95-G-0090, issued and
effective August 4, 1995.
EXHIBIT D-2
STATE OF NEW YORK
PUBLIC SERVICE COMMISSION
At a session of the Public Service
Commission held in the City of
Albany on April 19, 1995
COMMISSIONERS PRESENT:
Harold A. Jerry, Jr., Chairman
Lisa Rosenblum
William D. Cotter
Raymond J. O'Connor
John F. O'Mara
CASE 95-G-0090 - Petition of National Fuel Gas Distribution
Corporation for Authority to Issue and Sell not more than
$250,000,000 of Promissory Notes.
(Issued and Effective May 5, 1995)
By petition filed January 25, 1995, National Fuel Gas Distribution
Corporation (petitioner) has requested Commission authority to issue and sell
not to exceed $250 million of promissory notes. An issue of securities in the
amount authorized, subject to the conditions imposed in this Order, is
reasonably required for the purposes we specify and such purposes are not, in
whole or in part, reasonably chargeable to operating expenses or to income. For
the reasons detailed in the attached memorandum, approval of the petitioner's
request is necessary at this time for the general welfare in that the delay
resulting from the compliance with the prior notice requirement of Article 2 of
the State Administrative Procedure Act would in this instance be contrary to the
public interest. This Order, therefore, should be adopted as a permanent measure
pursuant to Section 202.6(c) of the State Administrative Procedure Act. The
Commission orders:
1. National Fuel Gas Distribution Corporation's request to issue
securities is approved as a permanent measure, pursuant to the emergency
provisions of the State Administrative Procedure Act, Section 202.6(c), because
the purpose of the emergency measure would be frustrated if subsequent notice
procedures were required.
<PAGE>
C. 95-G-0090
2. National Fuel Gas Distribution Corporation is authorized to issue
and sell, not later than two years from the date of this Order, not to exceed
$250 million of promissory notes. The debt shall be issued under and pursuant to
the documents attached to the petition in this proceeding. No material
supplement to or modification of the said documents shall be executed without
the authority of this Commission. The debt shall be dated, bear a rate of
interest, mature and be redeemable in the manner specified in the above
documents.
3. Within ten days after the execution of the documents entered into
for the sale of the authorized securities, petitioner shall file with this
Commission verified copies thereof as executed.
4. The proceeds from the sale of the securities authorized by this
order shall be deposited in a special fund in a responsible banking institution
or institutions. The proceeds shall be applied solely and exclusively toward
reimbursement of petitioner's treasury for equivalent moneys expended for
capital purposes to December 31, 1994. The reimbursement funds shall be used
toward the payment of outstanding short-term debt, maturing senior securities
and/or sinking fund requirements on the dates of issuance of the said
securities. Any remaining funds are to be used toward expenditures on or after
January 1, 1995, for the purposes permitted under Public Service Law Section 69
which shall be over and above the expenditures made for such purposes through
funds originating from credits to the accumulated provisions for depreciation,
net salvage and accumulated deferred income taxes. Withdrawal of a portion or
all of the said reimbursement funds may be made from time to time for other
utility purposes during the period ending April 19, 1997, or may be invested in
short-term marketable securities on condition that such temporary withdrawal, to
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<PAGE>
C. 95-G-0090
the extent that the same are not offset by gross additions less funds
originating from credits to the accumulated provision for depreciation, net
salvage and accumulated deferred income taxes on or after January 1, 1995, are
restored to the special fund not later than April 19, 1997. The entire proceeds
from the issuance of the securities authorized by this Order shall be used for
the purposes specified above. In no instance shall any part of the special fund
be used to pay accrued interest or dividends on the discharged or refunded
obligations.
5. Petitioner shall file annually with the Director of the Office of
Accounting and Finance or his designee a verified report in the form prescribed
by 16 NYCRR Section 520.1, within 60 days after year end. The report shall also
include the date of withdrawal of any of the deposited funds as provided in
Clause 4 of this Order, the amount withdrawn, and the purposes for which such
withdrawal was made.
6. If, upon examination of the expenditures made from withdrawal from
the said special fund, it is determined that any expenditure is not a reasonable
and proper capital charge, or has not been duly authorized by the Commission, or
is in violation of any Order of the Commission or any provision of law, a sum
equal to such expenditure shall, upon Order of the Commission, promptly be
placed in the special fund and said sum shall be subject to all of the
conditions and restrictions of this Order.
7. The total costs and expenses of issuing the securities authorized by
this Order, paid or to be paid by petitioner and charged to Account 181 -
Unamortized Debt Expense, shall not exceed $1,500,000 unless any additional
amount expended is approved as a proper and reasonable cost of issuance by the
Director of Accounting and Finance or his designee, and petitioner shall submit
a verified report showing in detail all costs and expenses. Upon approval, the
petitioner shall make such adjustment of the charges to Account 181 -
Unamortized Debt Expense - as determined to be necessary and proper.
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C. 95-G-0090
8. The authority granted and the conditions imposed by this Order shall
not be construed as passing upon or otherwise approving the accuracy of the
books, records and accounts of petitioner.
9. The securities authorized by this Order shall not be issued unless
and until there has been filed with this Commission an unconditional acceptance
by petitioner agreeing to obey all terms, conditions and requirements of this
Order. If such acceptance is not so filed within a period of 30 days from the
effective date of this Order, this Order may be revoked by the Commission
without further notice.
By the Commission,
(Signed)
JOHN J. KELLIHER
Secretary
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EXHIBIT D-2(A)
STATE OF NEW YORK
PUBLIC SERVICE COMMISSION
CASE 95-G-0090 - Petition of National Fuel Gas Distribution
Corporation for Authority to Issue and Sell not more than
$250,000,000 of Promissory Notes. AMENDATORY PETITION OF
NATIONAL FUEL GAS DISTRIBUTION CORPORATION TO ASSUME THE COSTS
AND BENEFITS OF UP TO $350,000,000 NOTIONAL AMOUNT OF
DERIVATIVE INSTRUMENTS TO BE ENTERED INTO BY ITS PARENT
NATIONAL FUEL GAS COMPANY.
SAPA NO. 95-G-0090SA1
Effective date of rule:
[ ]Date of Filing with State Dept.
[X]Other: August 4, 1995
* * *
I, JOHN C. CRARY, Secretary of the New York State Public Service
Commission, hereby certify that:
1. The attached Commission action was duly adopted by a unanimous vote of
the Commissioners at a session held in the City of Albany on August 1,
1995, pursuant to authority vested in the Commission by the Public
Service Law, Section 69.
2. Prior notice of the proposed Commission action was published in the
State Register on May 10, 1995.
3. Additional prior notice is not required by the Public Service Law or
other statutes.
DATE:______August 4, 1995______ _ s/John C. Crary_______
SECRETARY
<PAGE>
Case 95-G-0090
_NATIONAL FUEL GAS DISTRIBUTION CORPORATION_____________
hereby admits service on this __________ day of ___________________________ of a
copy of an order of the Public Service Commission of the State of New York dated
August 1, 1995___________ adopted in a proceeding designed as Case 95-G-0090 -
Petition of National Fuel Gas Distribution Corporation for Authority to ISSUE
and SELL not more than $250,000,000 of Promissory Notes. AMENDATORY PETITION OF
NATIONAL FUEL GAS DISTRIBUTION CORPORATION TO ASSUME THE COSTS AND BENEFITS OF
UP TO $350,000,000 NOTIONAL AMOUNT OF DERIVATIVE INSTRUMENTS TO BE ENTERED INTO
BY ITS PARENT, NATIONAL FUEL GAS COMPANY.
And hereby accepts and agrees to obey all of the terms and conditions of the
said order of the Public Service Commission.
National Fuel Gas Distribution Corp.
(Name of Corporation)
By___________________________________
STATE OF NEW YORK )
) SS.:
COUNTY OF ________________ )
On this ________ day of _____________________________ before
me personally came ________________________________________ who being duly sworn
did depose and say that he is the ____________________________________ of the
the corporation described in and which executed the above instrument; that (s)he
knows the seal of said corporation; that the seal affixed to said instrument is
such corporate seal; that it was so affixed by order of the board of directors
of said corporation and that (s)he signed his/her name thereto by like order.
PLEASE SIGN THIS FORM OF ACCEPTANCE Notary Public
BEFORE A NOTARY PUBLIC AND RETURN TO:
PUBLIC SERVICE COMMISSION __________________ County
DEPARTMENT OF PUBLIC SERVICE
THREE EMPIRE STATE PLAZA
ALBANY, NEW YORK 12223
<PAGE>
STATE OF NEW YORK
PUBLIC SERVICE COMMISSION
At a session of the Public Service
Commission held in the City of
Albany on August 1, 1995
COMMISSIONERS PRESENT:
Harold A. Jerry, Jr., Chairman
Lisa Rosenblum
William D. Cotter
John F. O'Mara
CASE 95-G-0090 - Petition of National Fuel Gas Distribution Corporation for
Authority to Issue and Sell not more than $250,000,000 of Promissory Notes.
AMENDATORY PETITION OF NATIONAL FUEL GAS DISTRIBUTION CORPORATION TO ASSUME THE
COSTS AND BENEFITS OF UP TO $350,000,000 NOTIONAL AMOUNT OF DERIVATIVE
INSTRUMENTS TO BE ENTERED INTO BY ITS PARENT, NATIONAL FUEL GAS COMPANY. (SAPA
No. 95-G-0090 SA1)
(Issued and Effective August 4, 1995)
In a petition dated March 17, 1995, amending its initial petition of
January 25, 1995, National Fuel Gas Distribution Corporation (petitioner) has
requested authority to enter into up to $350 million of derivative transactions.
Entering into derivative transactions in the amount authorized, subject to the
conditions imposed in this Order, is reasonably required for the purposes we
specify and such purposes are not, in whole or in part, reasonably chargeable to
operating expenses or to income.
The Commission Orders:
1. National Fuel Gas Distribution Corporation is authorized to enter
into up to $350 million of derivative transactions not later two years from the
date of this Order. The transactions shall be entered into under and pursuant to
the documents attached to the petition in this proceeding. No material
supplement to or modification of the said documents shall be executed without
the approval of this Commission. Approval of these transactions is expressly
subject to the understanding that the transactions will be entered into pursuant
to the precautions described in the aforementioned documents.
<PAGE>
C. 95-G-0090
2. Petitioner shall not enter into any derivative transactions with a
counterparty unless said counterparty has a credit rating at least as high as
that of the petitioner, with a minimum rating of Baa by Moody's or the
equivalent. All derivative transactions authorized by this Order shall be
directly related to petitioner's outstanding long- or short-term debt. In
addition, the terms of the transaction shall require that the change in the
floating rate portion of the derivative transaction will be exactly equal to the
change in the underlying short-term debt index.
3. Within ten days after the execution of the documents entered into
for the derivative transactions, petitioner shall file with this Commission
verified copies thereof as executed.
4. Petitioner shall file annually with the Director of the Office of
Accounting and Finance or his designee a verified report within 60 days after
year end. Petitioner shall provide this Commission with the same information
that will be supplied to the Securities and Exchange Commission for any
transaction entered into under this Order. In addition, petitioner shall provide
information on what the cost and terms of traditional debt would have been had
it been issued. If derivative transactions are entered into in order to
refinance existing debt, petitioner shall demonstrate the savings achieved.
5. In rate proceedings, the loss and reward from entering into
derivative transactions shall go only to petitioner's shareholders. Recovery of
interest costs for debt related to a derivative transaction shall be calculated
using what the rate on traditional debt would have been had the derivative
transaction not occurred.
6. The total costs and expenses of entering into the derivative
transactions authorized by this Order, paid or to be paid by petitioner and
charged to a sub-account of Account 181 - Unamortized Debt Expense, shall not
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C. 95-G-0090
exceed $500,000 unless any additional amount expended is approved as a proper
and reasonable cost of issuance by the Director of Accounting and Finance or his
designee, and petitioner shall submit a verified report showing in detail all
costs and expenses. Upon approval, the petitioner shall make such adjustment of
the charges to the sub-account of Account 181 - Unamortized Debt Expense - as
determined to be necessary and proper. This sub-account of Account 181 -
Unamortized Debt Expense - shall contain only the costs and expenses related to
the derivative transactions entered into by the petitioner.
7. The authority granted and the conditions imposed by this Order shall
not be construed as passing upon or otherwise approving the accuracy of the
books, records and accounts of petitioner.
8. The transactions authorized by this Order shall not be entered into
unless and until there has been filed with this Commission an unconditional
acceptance by petitioner agreeing to obey all terms, conditions and requirements
of this Order. If such acceptance is not so filed within a period of 30 days
from the effective date of this Order, this Order may be revoked by the
Commission without further notice.
By the Commission,
(Signed)
JOHN C. CRARY
Secretary
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<PAGE>
STATE OF NEW YORK
DEPARTMENT OF PUBLIC SERVICE
July 17, 1995
TO: THE COMMISSION
FROM: OFFICE OF ACCOUNTING & FINANCE
SUBJECT: Case 95-G-0090 - Petition of National Fuel Gas Distribution
Corporation for Authority to Issue and Sell not more than $250,000,000
of Promissory Notes. AMENDATORY PETITION OF NATIONAL FUEL GAS
DISTRIBUTION CORPORATION TO ASSUME THE COSTS AND BENEFITS OF UP TO
$350,000,000 NOTIONAL AMOUNT OF DERIVATIVE INSTRUMENTS TO BE ENTERED
INTO BY ITS PARENT, NATIONAL FUEL GAS COMPANY. (SAPA No.
95-G-0090 SA1)
* * *
Summary Discussion
By Commission Order dated May 5, 1995, National Fuel Gas Distribution
Corporation (Distribution) was granted the authority to issue up to $250 million
of unsecured promissory notes to its parent, National Fuel Gas Corporation
(National). National raises all capital and passes the proceeds and the
associated costs of such capital along to its subsidiaries. In a March 17, 1995
supplement to Distribution's petition to issue the promissory notes,
Distribution requested authority to enter into up to $350 million of derivative
transactions. Derivative transactions are so named because their value is
derived from an underlying asset or index. These transactions would take place
during the 24-month period beginning on the date of this Order.
The derivative supplement to Case 95-G-0090 was not acted on at the
time of the debt approval in order to allow staff sufficient time to understand
the potential risks attendant with the proposed transactions and to determine
whether ratepayers should be insulated from such risks. The Office of Accounting
and Finance has examined Distribution's petition and conferred with
Distribution's management regarding the petition. We recommend that
Distribution's supplemental petition be approved subject to the modifications
and conditions of this Order.
<PAGE>
Case 95-G-0090
The provisions of the derivative transactions have several precautions
built into them to prevent them from causing extensive losses. For instance, the
transactions must be directly related to Distribution's debt and they may be
entered into only with banks that have a certain minimum credit rating. However,
despite these safeguards, such transactions carry greater risk than traditional
debt and these risks are not part of the everyday business of the utility.
Therefore, ratepayers should be shielded from such risk. The ratemaking clause
in the Order stipulates that while Distribution may enter into derivative
transactions, the loss or reward of such actions will go only to the company's
shareholders.
While this treatment for handling derivative transactions will produce
a slightly more complicated method of calculating debt cost, it is a progressive
step in the transition to a more competitive environment. Although the rate
treatment provides no direct benefit to ratepayers, approval of the company's
petition allows management to gain needed experience in derivative transactions
while simultaneously protecting ratepayers from any missteps of management.
Reasons for the Derivative Transactions
One type of derivative product commonly used in the financial world
today is interest rate swaps (See Appendix A for a description of interest rate
swaps and how they can mitigate risk). Distribution claims that having authority
to enter into these transactions will allow its management new tools for
reducing interest costs, as well as the ability to manage interest rate risk.
Such financial instruments allow management to take immediate advantage of
opportunities arising in the credit market, rather than having to await
regulatory approvals.
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<PAGE>
Case 95-G-0090
Moreover, these transactions provide an additional way to balance the
risks and costs associated with raising capital. For example, Distribution will
be able to manage its debt structure based on prevailing interest rates by using
the swap's ability to convert debt from fixed to variable rate or from variable
to fixed. Distribution may also have the opportunity to refund debt in a more
cost efficient manner, even effectively refunding debt before such debt is
callable. For instance, in 1994, Orange and Rockland Utilities, Inc. used an
interest rate swap in conjunction with variable-rate bonds to artificially
create fixed-rate debt. The proceeds of the variable-rate bonds were used to
refinance debt pursuant to Case 92-M-0862.
Precautions of the Derivative Transactions
While there are varied types of derivative transactions, the type of
contracts proposed in Distribution's supplemental petition and outlined more
fully in National's Form U-1 filing with the Securities and Exchange Commission
(SEC) (Schedule J in Distribution's petition) are straightforward and relatively
safe. Distribution has built precautions into its proposal which are meant to
avoid the possibility that there could be large-scale derivative losses similar
to those that have been publicized in recent months.
First, Distribution has pledged that its derivative transactions will
not be "leveraged". This simply means that what the parties of the contract are
required to pay will not change any faster than the precise change in the
short-term debt index specified in the contract. This prevents a modest change
in interest rates from causing an unexpectedly large payment.
Second, Distribution has stated that all of the derivative transactions
will be "hedged". In other words, the transactions will be directly related to
Distribution's outstanding long- or short-term debt and will not be used as
speculative bets on the direction of interest rates.
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<PAGE>
Case 95-G-0090
In addition to the above precautions, National will not enter into any
swap transaction with a party unless that party meets minimum credit rating
requirements. This provides some assurance against the bank defaulting on the
contract.
Furthermore, staff will be monitoring all swap transactions. We
recommend that the Order require Distribution to supply the Public Service
Commission with the same information National must supply to the Securities and
Exchange Commission (SEC) for any transaction entered into under this Order.
Distribution will also provide information on what the cost of "traditional"
debt would have been if not for the derivative transaction. This hypothetical
debt rate will be used in the ratemaking process to determine what interest
costs will be recovered in rates (See Appendix B for a detailed explanation of
the ratemaking treatment).
Finally, if the derivative transactions are used to refinance existing
debt, Distribution will be required to demonstrate these savings, as our current
practice requires. While staff will be reviewing the savings of any refinancing
after the refinancing has taken place, this will allow Distribution to respond
rapidly to changes in the credit market. Staff will maintain its oversight of
such transactions, and if necessary address any concerns in a rate proceeding.
Conclusion and Recommendation
Distribution has sufficiently demonstrated the value of being allowed
to assume the costs and benefits of the derivative transactions outlined in its
petition. The petition strikes a balance between granting management flexibility
in controlling interest rate cost and risk, while taking precautions to ensure
that significant losses are not likely to occur.
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<PAGE>
Case 95-G-0090
Although these transactions carry with them risks that are beyond those of
traditional debt, ratepayers will be safeguarded by ascribing both the loss and
benefit of such transactions to Distribution's shareholders. We recommend,
therefore, that distribution be authorized to enter into these transactions,
subject to the conditions of the Order.
Respectfully submitted,
_s/ Jeffrey S. Hogan__________________
JEFFREY S. HOGAN
Senior Utility Financial Analyst
Approved:
_s/George E. Trahan__________
George E. Trahan
Chief, Accounting and Finance
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<PAGE>
Case 95-G-0090 Appendix A
Page 1 of 2
Description of Interest Rate Swaps
Interest rate swaps are relatively straightforward instruments. In
Distribution's case, they are a contract between National and a bank to exchange
interest payments for a set amount of time. One party pays a fixed amount while
the other pays a floating rate based on a short-term debt index. No additional
debt is created, and no principal is exchanged. Distribution would still have
"traditional" debt outstanding. In fact, the "swap" would be directly related to
a portion of Distribution's debt, but synthetically changing the terms of that
debt. The amount of the derivative transaction is equal to the amount of debt to
which it is directly related.
For instance, National might issue a note whose interest rate
fluctuates in accordance with some index, such as Treasury bills. This is called
floating-rate debt. National could then enter into a contract in which a bank
agrees to pay National an amount exactly equal to the sum National pays on the
variable debt. In exchange, National would pay the bank a fixed amount each
period. In this way, National has artificially created fixed-rate debt.
Depending on the length of the swap agreement, National could convert its
floating-rate debt into fixed-rate debt for all or part of the term of the
underlying variable-rate debt. Distribution has stated that it would assume the
responsibility of such a transaction from National if there is a sufficient
interest cost savings relative to a traditional fixed-rate debt issue.
National could also use interest rate swaps to convert fixed-rate debt
to floating rate debt by agreeing to receive a fixed payment from the bank equal
to its debt cost for a particular fixed-rate debt issue and paying the bank a
variable amount. While Distribution has historically relied on fixed-rate
medium- and long-term debt, such an interest rate swap would be considered by
Distribution's management.
<PAGE>
Case 95-G-0090 Appendix A
Page 2 of 2
Distribution has also requested approval to enter into derivative
transactions called "caps" and "floors". These common transactions allow
management to guard against the risks associated with variable rate debt by
creating maximum and minimum possible interest rates.
<PAGE>
Case 95-G-0090 Appendix B
Page 1 of 3
Risks and Rate Treatment of the Transactions
While the derivative transactions are structured to avoid excessively
large losses, there are risks attendant with these transactions which are beyond
those associated with traditional debt. However, these risks are an unavoidable
trade-off for the opportunity to garner lower interest costs. For instance,
under some possible derivative transactions, a change in National's credit
rating could result in higher fixed interest costs for outstanding debt issues.
In addition, unexpected interest rate changes may lead Distribution to terminate
its derivative contract. The costs of such a move could be substantial.
Staff has conducted an analysis of what the possible costs and benefits
of these transactions might be. While it is difficult to quantify the possible
costs of interest rate swaps because of the fact that they are dependent on such
things as future interest rate movements, some conclusions can be drawn.
In situations where Distribution is paying the fixed-rate portion of a
swap, the benefit of such a transaction is the difference between what
Distribution's overall fixed cost is compared to what the fixed cost of a
traditional debt issue would have been. This will typically be anywhere from a
few basis points to perhaps 20 basis points. One cost of such a transaction
would be the amount Distribution would have to pay to terminate the swap
contract. It is not expected that such costs would be substantially higher than
the cost of call premiums on traditional debt, perhaps equal to as much as 10
percent of the outstanding principal of the underlying debt issue.
As for interest rate swaps where Distribution is paying the
floating-rate, the costs to terminate the swap could be extensive. The amount
would depend on how high the floating rate is, the outlook for interest rates,
and the term remaining on the swap contract. While the "worst case" scenario
would be Distribution having a substantial amount of long-term, floating-rate
debt when interest rates spike upwards unexpectedly, this scenario is very
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Case 95-G-0090 Appendix B
Page 2 of 3
unlikely. In addition, such a capital structure would be imprudent for a
utility. Distribution's management has stated that it would most likely use this
strategy with a maximum term of a few years and when the yield curve is
conducive to such a strategy. In addition, Distribution could use the "caps" and
"floors" mentioned earlier to limit interest rate risk. In such scenarios, it
can be expected that termination costs will not greatly exceed standard call
premiums.
Though these risks are acceptable for Distribution to take if
management feels they are outweighed by the interest cost savings, such risks
should not fall on ratepayers. Therefore, the Order requires the additional risk
to be filtered out during the ratemaking process by having National's
shareholders assume both the benefits and the costs of these transactions.
This protection of ratepayers will be achieved in future rate
proceedings by applying a debt cost rate which is equal to what the
"traditional" debt cost would have been (as reported by Distribution at the
commencement of the transactions and reviewed by staff). Currently, the
Commission approves the authority of Distribution to issue debt. The terms of
this debt are then reviewed by staff after it has been issued. Any concerns with
such terms can be raised in the next rate proceeding. In rate proceedings, staff
uses the actual debt costs for fixed-rate debt and forecasted rates for
variable-rate debt to calculate what level of interest costs will be recovered
in rates. With derivative transactions, staff will continue to monitor what debt
is issued and will review the swaps which are entered into. However, in rate
cases, staff will impute what the rate on traditional debt would have been had
Distribution not used derivatives rather than the overall interest cost which is
actually paid through the derivative transaction.
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Case 95-G-0090 Appendix B
Page 3 of 3
In addition to applying what the interest rate would have been with
traditional debt in a rate proceeding, staff will also assume that reasonable
call provisions would have been built into traditional debt. If, at a later
date, such debt would have been reasonably refinanced, staff will impute such a
refinancing in a rate proceeding. In this way, ratepayers are insulated from the
affect of Distribution's use of derivatives.
