FILE No. 70-8895
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
AMENDMENT NO. 3 TO
APPLICATION/DECLARATION
ON FORM U-1
Under
THE PUBLIC UTILITY HOLDING COMPANY ACT OF 1935
NORTHEAST UTILITIES HOLYOKE WATER POWER COMPANY
174 Brush Hill Avenue 1 Canal Street
West Springfield, MA 01090-0010 Holyoke, MA 01040
THE CONNECTICUT LIGHT AND PUBLIC SERVICE COMPANY
POWER COMPANY OF NEW HAMPSHIRE
107 Selden Street 1000 Elm Street
Berlin, CT 06037 Manchester, NH 03101
WESTERN MASSACHUSETTS NORTH ATLANTIC
ELECTRIC COMPANY ENERGY CORPORATION
174 Brush Hill Avenue 1000 Elm Street
West Springfield, MA 01090-0010 Manchester, NH 03101
(Names of companies filing this application and addresses
of principal offices)
NORTHEAST UTILITIES
(Name of top registered holding company)
Jeffrey C. Miller
Assistant General Counsel
Northeast Utilities Service Company
107 Selden Street
Berlin, CT 06037
(Name and address of agent for service)
The Commission is requested to mail signed copies of all orders, notices and
communications to:
Jane P. Seidl David R. McHale
Senior Counsel Assistant Treasurer
Northeast Utilities Service Northeast Utilities Service
Company Company
107 Selden Street 107 Selden Street
Berlin, CT 06037 Berlin, CT 06037
The Application/Declaration in this proceeding is hereby amended as
follows:
1. The following exhibits are filed herewith:
D.1 CL&P Application to DPUC
D.2 Order of DPUC
SIGNATURES
Pursuant to the requirements of the Public Utility Holding Company Act
of 1935, as amended, the undersigned have duly caused this Application to be
signed on behalf of each of them by the undersigned thereunto duly
authorized.
NORTHEAST UTILITIES
THE CONNECTICUT LIGHT AND POWER COMPANY
WESTERN MASSACHUSETTS ELECTRIC COMPANY
PUBLIC SERVICE COMPANY OF NEW HAMPSHIRE
HOLYOKE WATER POWER COMPANY
NORTH ATLANTIC ENERGY CORPORATION
By: /S/David R. McHale
Assistant Treasurer
Date: April 30, 1997
Exhibit D.1
December 16, 1996
Mr. Robert J. Murphy
Executive Secretary
Department of Public Utility Control
10 Franklin Square
New Britain, CT 06051
Re: The Connecticut Light and Power Company
Application With Respect to
Interest Rate Management Instruments
Dear Mr. Murphy:
The Connecticut Light and Power Company ("CL&P" or the "Company"), a
public service company within the meaning of Section 16-1 of the General
Statutes of Connecticut, Revision of 1958, hereby applies to the Department
for approval, pursuant to Section 16-43 of said General Statutes, to enter
into, perform, purchase and sell financial instruments intended to manage the
volatility of interest rates, including but not limited to interest rate
swaps, caps, floors, collars and forward rate agreements or any other similar
agreements ("Interest Rate Management Instruments") for the period ending
December 31, 2001, in a total notional principal amount not to exceed 25% of
the Company's total outstanding debt at any one time.
The Company is seeking authority to employ various types of Interest
Rate Management Instruments as a means of (i) prudently managing its
portfolio of outstanding long-term and short-term debt, such that it can
achieve some degree of control over the impact on earnings and customer rates
resulting from movements in interest rates, and (ii) prudently managing the
risk associated with the issuance of new long-term and short-term debt.
The Company adopts in support of this application the written testimony
and exhibits listed in Appendix I hereto. This application, the written
testimony, and exhibits listed in Appendix I hereto set forth all the
documents required to be filed by the Company and which the Company deems
necessary and desirable to support the granting of this application.
The following information is supplied as part of this application:
A. The exact legal name of the applicant and its principal place of
business:
The Connecticut Light and Power Company
107 Selden Street
Berlin, Connecticut 06037
B. The Company is a corporation specially chartered by the General
Assembly of the State of Connecticut.
C. The name, title, address and telephone number of the attorney or
other person to whom correspondence or communications in regard to
this application are to be addressed:
David R. McHale
Assistant Treasurer - Finance
The Connecticut Light and Power Company
c/o Northeast Utilities Service Company
P.O. Box 270
Hartford, Connecticut 06141-0270
(860) 665-5601
and
Jane P. Seidl, Esq.
Senior Counsel
The Connecticut Light and Power Company
c/o Northeast Utilities Service Company
P.O. Box 270
Hartford, Connecticut 06141-0270
(860) 665-5051
The Company respectfully requests the approval of the Department
pursuant to said Section 16-43 of the General Statues of Connecticut to enter
into, perform, purchase and sell the Interest Rate Management Instruments.
Enclosed herewith are one (1) original and twenty-two (22) copies of
this application, together with prepared testimony and exhibits.
Very truly yours,
THE CONNECTICUT LIGHT AND POWER COMPANY
BY:/s/David R. McHale
Assistant Treasurer - Finance
The Connecticut Light and Power Company
cc: Office of Consumer Counsel
THE CONNECTICUT LIGHT AND POWER COMPANY
APPENDIX I
Testimony and Exhibits
filed as part of Application With Respect to
Interest Rate Management Instruments
A. Testimony of David R. McHale, Assistant Treasurer - Finance of The
Connecticut Light and Power Company
B. Exhibits to Testimony
1. International Swap Dealers Association, Inc. Master Agreement.
2. Financial Risk Management Program Policies and Practices.
3. Application/Declaration on Form U-1 in File No. 70-8895 with
Respect to Interest Rate Management Instruments and amendments
thereto filed with the Securities and Exchange Commission (SEC),
and the SEC's comment letter dated September 5, 1996, concerning
the Company's application, and the SEC's approving order.
4. Form 10-K of Northeast Utilities and The Connecticut Light and
Power Company for the year ended December 31, 1995.
5. Forms 10-Q of The Connecticut Light and Power Company for the
quarters ended March 31, 1996, June 30, 1996 and September 30,1996.
6. Forms 8-K of The Connecticut Light and Power Company dated January
31, 1996, March 30, 1996, April 15, 1996, June 6, 1996, June 18,
1996, June 28, 1996, July 22, 1996 and August 19, 1996.
7. Proxy Statement of Northeast Utilities.
8. 1995 Annual Report to Shareholders of Northeast Utilities.
9. 1995 Annual Report to Shareholders of The Connecticut Light and
Power Company.
Exhibit A
TESTIMONY OF DAVID R. MCHALE
Q: Will you please state your position with The Connecticut Light and Power
Company ("CL&P" or the "Company")?
A: I am the Assistant Treasurer - Finance of the Company. I am also the
Assistant Treasurer of Northeast Utilities Service Company ("NUSCO") and
of Northeast Utilities ("NU").
Q: Will you please state the relationship of NUSCO to CL&P?
A: NUSCO is a system service company that provides, among other things,
financial planning services to the affiliated companies of the NU
System. The applicant in this proceeding, CL&P, together with Public
Service Company of New Hampshire, Western Massachusetts Electric Company
and Holyoke Water Power Company, are the largest operating companies in
this System.
DESCRIPTION OF TRANSACTION
Q: Will you please describe the application that is the subject of this
hearing?
A: The Company is requesting the Department's approval to enter into,
perform, purchase and sell financial instruments intended to manage the
volatility of interest rates, including but not limited to interest rate
swaps, caps, floors, collars and forward rate agreements or any other
similar agreements ("Interest Rate Management Instruments") for the
period ending December 31, 2001, in a total notional principal amount
not to exceed 25% of the Company's total outstanding debt. The Company
will use these various types of Interest Rate Management Instruments as
a means of (i) prudently managing its portfolio of outstanding long-term
and short-term debt, such that it can achieve some degree of control
over the impact on earnings and customer rates resulting from movements
in interest rates, and (ii) prudently managing the risk associated with
the issuance of new long-term and short-term debt.
Q: Please describe the standard by which the Company will assess whether to
enter into Interest Rate Management Instruments?
A: The Company's objective is to optimize its variable-to-outstanding debt
ratio and mitigate the exposure of customer rates and earnings to
changes in interest rates. Accordingly, the Company will manage its
debt portfolio in accordance with prudent financial management practices
and make an assessment of the projected impact on the Company's rate
tariffs and earnings per share. Such management includes, but is not
limited to, an analysis of (i) current and projected levels of interest
rates, (ii) the current level of the Company's debt, (iii) future debt
maturities, and (iv) future financing requirements.
Q: Will you please describe how Interest Rate Management Instruments will
allow the Company to achieve such an objective?
A: Interest Rate Management Instruments are the tools by which the Company
can achieve such balance by, in effect, synthetically (i) converting
variable rate debt to fixed rate debt, (ii) converting fixed rate debt
to variable rate debt, (iii) limiting the impact of changes in interest
rates resulting from variable rate debt, and (iv) providing an option to
enter into Interest Rate Management Instrument transactions in future
periods for both existing exposures and planned issuances of debt
securities.
Q: What limits will the Company apply to its use of Interest Rate
Management Instruments?
A: The notional principal amount of Interest Rate Management Instruments
for the Company will not exceed 25% of its total outstanding debt at any
one time. "Total outstanding debt" is defined for this purpose as the
sum of the outstanding short-term and long-term debt rounded to the
nearest million dollars. At September 30, 1996, CL&P's total
outstanding debt was $2,057,035,000 and the related proposed limit of
notional principal amount would have been $514,259,000.
Furthermore, in no case will the notional principal amount of any
Interest Rate Management Instrument exceed that of the underlying debt
instrument and related interest rate exposure. In other words, the
Company will not engage in "leveraged" or "speculative" transactions. In
addition, the Company proposes to limit the tenor of Interest Rate
Management Instruments to the maximum maturity of the underlying Company
debt, or the maturity of anticipated specific future debt issuances,
proportionate to the amount of indebtedness at each maturity level.
Q: What interest rate indices are proposed for the Interest Rate Management
Instruments?
A: The underlying interest rate indices of such Interest Rate Management
Instruments will closely correspond to the underlying interest rate
indices of the Company's debt to which such Interest Rate Management
Instruments relate. Such indices currently include, but are not be
limited to, (i) floating rate indices such as the London Interbank
Offered Rate (LIBOR), prime rate, certificate of deposit rates,
commercial paper indices, the Federal funds rate, the J. J. Kenny high
grade tax-exempt rate, and the Public Securities Association Index
tax-exempt rate, and (ii) fixed rate indices such as United States
Treasury note and bond rates and long-term municipal bond rates.
Q: Please describe the terms and conditions of the proposed Interest Rate
Management Instrument transactions?
A: The terms and conditions of the proposed Interest Rate Management
Instrument transactions will be the same or substantially similar to
those of the International Swap Dealers Association, Inc. (ISDA) Master
Agreement (Master Agreement), the form of which is filed as Exhibit B.1.
The Company would enter into an individual Master Agreement with each
proposed counterparty. A confirmation pursuant to the Master Agreement
would identify the nature of each individual transaction, the applicable
notional principal amount, effective date, maturity, rates involved and
other pertinent terms and conditions.
The Company will enter into Interest Rate Management Instruments with
counterparties whose senior secured debt ratings, as published by
Standard & Poor's Corporation, are greater than or equal to "BBB+"", or
an equivalent rating from Moody's Investor Service, Inc., Fitch Investor
Service or Duff & Phelps. Additionally, at all times at least 75% of
the outstanding aggregate principal amount of Interest Rate Management
Instruments will be held by counterparties possessing Standard & Poor's
Corporation credit ratings of "A" rating or higher or equivalent rating.
In accordance with the ISDA Master Agreement, it is anticipated that
each party to a proposed Interest Rate Management Instrument transaction
will have the right to terminate such transactions by making early
termination payments. Attached hereto as Exhibit B.2 is a copy of the
Financial Risk Management Program Policies and Practices for the
Company, setting forth the guidelines and procedures for participating
in Interest Rate Management Instruments.
Q: Has the Department previously authorized the Company to enter into
Interest Rate Management Instruments?
A: Yes. In 1985, the Department authorized the Company to enter into an
interest rate swap covering various outstanding long-term debt of the
Company, in which the Company agreed to make payments to a counterparty
based on a fixed principal amount of up to $350 million and a fixed
interest rate, in return for the counterparty's agreement to make
payments to the Company based on the same principal amount at a floating
interest rate to be determined by the parties. (Docket No. 85-11-14).
This Application is based on the same principles, only with respect to
the entire portfolio of the Company's debt, in order to enhance
efficiency and flexibility. A similar arrangement for the Company was
approved by the Department in Docket No. 83-02-26.
Q: Could you please provide us with an example of how an interest rate swap
works?
A: A simplified interest rate swap could work as follows: The Company
holds a 3-year $20 million term note that has a variable interest rate
based on LIBOR. In order to minimize the Company's exposure to an
interest rate increase, the Company would agree to pay a counterparty a
fixed interest rate plus a credit spread on a notional amount of $20
million for a period of 3 years. In exchange the counterparty would
agree to pay the Company LIBOR on the same notional amount and term.
The actual swap payments for the Company would equal the difference
between LIBOR and the fixed rate plus the credit spread multiplied by
the notional amount for the particular interest period in question.
ADDITIONAL INFORMATION
Q: Will you please describe the projected costs for entering into Interest
Rate Management Instruments?
A: Interest Rate Management Instruments are subject to numerous variables
which will affect their cost, including (i) tenor, (ii) the strike rate,
or the rate at which it becomes effective, (iii) volatility of interest
rates, (iv) the current and projected level of interest rates, (v) the
notional principal amount of the Interest Rate Management Instrument,
and (vi) market variables such as the liquidity of the specific Interest
Rate Management Instrument. As such, it is difficult for the Company to
estimate the price it will pay for Interest Rate Management Instruments.
However, the Company will undertake to limit the transaction costs of
Interest Rate Management Instruments. The cost of instruments requiring
upfront payments such as interest rate caps will be limited to 5% of the
principal amount of the transaction. In the case of a sale of an
Interest Rate Management Instrument such as one with an interest rate
floor, the Company could use such proceeds to lower the purchase price
of a corresponding Interest Rate Management Instrument, such as an
interest rate cap pertaining to the same debt obligation.
Additionally, the Company will not enter into (a) a floating-to-fixed
interest rate swap in which the swap fixed interest rate would exceed
the higher of (i) 200 basis points over the yield on U.S. Treasury
obligations of comparable maturities or (ii) the fixed interest rate
similar issuers pay in respect of comparable debt bearing comparable
maturities; and (b) a fixed-to-floating interest rate swap in which the
swap floating interest rate would be more than 200 basis points over the
applicable index rate used for the swap. Furthermore, the Company will
enter into a floating-to-fixed interest rate swap, as opposed to
reducing its floating rate debt and issuing a fixed-rate note of a
comparable maturity, only if the estimated costs associated with the
floating-to-fixed interest rate swap, including transactions costs, are
less than the costs of issuing the fixed rate debt and costs, if any, or
prudently reducing the floating rate debt.
Additional expenses based on NUSCO employee hours expended for Interest
Rate Management Instrument transactions entered into in the past,
including but not limited to the analysis, negotiation, documentation
and closing of such contracts, are estimated to not exceed $10,000 per
transaction. In general it is believed that the actual costs may be
less than $10,000, however, some margin is necessary for unanticipated
transaction costs and/or for additional time and resource requirements
needed to thoroughly understand newly fashioned and possibly more
sophisticated transactions.
Q: How does the Company's credit ratings affect the pricing of an Interest
Rate Management Instrument?
The Company's credit ratings would primarily affect the pricing of the
Company's underlying debt instrument. The Company's credit ratings are
not expected to affect the pricing of Interest Rate Management
Instruments, but they could affect other terms of an Interest Rate
Management Instrument, such as the notional amount, term or collateral
requirements requested by the Counterparty.
Q: How will the Company track service company costs and outside service
expenditures for each interest rate management instrument?
A: Only actual costs of services incurred in connection with a specific
Interest Rate Management Instrument transaction will be charged to the
relevant NU System Company. The core of NU's accounting system is
provided by a computer program known as the Management Information and
Budgeting System ("MIBS"). MIBS controls (i)the processing of actual
charges inputed from source systems such as payroll and purchasing, (ii)
the database reconciliations to assure that all transactions are
correct, (iii) the processing of allocations and NU System Company
billings and (iv) the performance of all internal and external financial
reporting.
Q: Are the proposed transactions subject to the jurisdiction of the
Securities and Exchange Commission ("SEC")?
A: Yes. The proposed transactions are subject to the jurisdiction of the
SEC under the Public Utility Holding Company Act of 1935 ("Act"), and an
application/declaration was filed under that Act on August 6, 1996.
Attached hereto as Exhibit B.3 is the SEC application and amendments
thereto, the SEC's letter to the Company dated September 5, 1996,
reflecting its detailed comments, and the SEC's approving order.
Q: How will the Company report the extent of its Interest Rate
Transactions?
A: The Company will fully disclose in its financial statements the extent
of its Interest Rate Management Instrument transactions in accordance
with current and future requirements of the SEC, generally accepted
accounting principles, and Financial Accounting Standards Board
practices. Current financial statements disclosures include (i) notional
principal amount and (ii) market value of outstanding Interest Rate
Management Instruments outstanding. The Company also undertakes to make
additional filings with the Department, which are consistent with the
requirements set forth in its application to the SEC. See, Exhibit B.3.
Q: Have you provided financial statements of the Company?
A: Yes. Copies of the Company's annual report to the SEC on Form 10-K for
the year ended December 31, 1995, its quarterly reports to the SEC on
Form 10-Q for the quarters ended March 31, 1996, June 30, 1996 and
September 30, 1996 and its current reports to the SEC on Form 8-K dated
January 31, 1996, March 30, 1996, April 15, 1996, June 6, 1996, June 18,
1996, June 28, 1996, July 22, 1996 and August 19, 1996 are filed
herewith as Exhibits B.4, B.5 and B.6, respectively. A copy of NU's
most recent proxy statement, NU's 1995 annual report to shareholders and
the Company's annual report to shareholders are filed herewith as
Exhibits B.7, B.8 and B.9.
Pro forma financial statements are not included in this filing because
the Company believes it is difficult to reflect the impact of what could
be numerous strategies designed to meet the Company's objectives
outlined above, namely management of the Company's existing and future
portfolio of long-term and short-term debt, such that the Company
achieves a balanced exposure to changes in interest rates as measured by
a ratio of total variable rate debt to total debt and the resulting
impact of the Company's earnings, and management of the risks associated
with the issuance of new short-term and long-term debt.
Q: Have the Interest Rate Management Instruments been approved by the
Company's Board of Directors?
A: The Company's Board of Directors will adopt approving resolutions of
specific transactions as are required by law or requested by
counterparties.
Q: Does that complete your testimony, Mr. McHale?
A: Yes. I have nothing further to offer at this time.
Exhibit D.2
STATE OF CONNECTICUT
DEPARTMENT OF PUBLIC UTILITY CONTROL
TEN FRANKLIN SQUARE
NEW BRITAIN, CT 06051
DOCKET NO. 96-12-16
APPLICATION OF THE CONNECTICUT LIGHT AND POWER COMPANY WITH RESPECT TO
INTEREST RATE MANAGEMENT INSTRUMENTS
March 5, 1997
By the following Commissioners:
Glenn Arthur
Reginald J. Smith
Janet Polinsky
DECISION
DECISION
I. INTRODUCTION
A. SUMMARY
This Decision allows the Connecticut Light and Power Company (CL&P or
Company) to use an Interest Rate Management Instrument (IRMI) program to
control interest rate risk and cost, while furnishing the Department of
Public Utility Control (Department) with reassurance that the IRMIs will be
sufficiently controlled and monitored. The Company may initiate IRMIs
without prior approval of the Department; except in certain instances where
pre-filing of information is required. (see pp. 8-11) The Company has
proposed several parameters which it believes will constrain the IRMI program
in order to assure that the financial condition of the Company is not
jeopardized nor result in windfall profits at the expense of additional
ratepayer risk. Response to Interrogatory EL-21(b). In the course of this
proceeding the Company acquiesced to several modifications to its parameters
in order to provide the Department with additional assurance and oversight of
the program. These modifications are further discussed below. Response to
EL-21 (a) to (h); Response to Late Filed Exhibit LFE-2. All parameters are
summarized in Appendix A to this Decision.
B. APPLICANT'S PROPOSAL AND EVIDENCE
By application filed December 17, 1996, and submitted pursuant to
Section 16-43 of the General Statutes of Connecticut. The Connecticut Light
and Power Company requests Department approval to enter into, perform,
purchase and sell financial instruments intended to manage the volatility of
interest rates, including but not limited to interest rate swaps, caps,
floors, collars and forward rate agreements or any other similar agreements
(Interest Rate Management Instruments or IRMIs) for the period ending
December 31, 2001, in total notional principal amount <F1> not to exceed 25%
of the Company's total outstanding debt at any one time. The Company seeks
authority to employ IRMIs as a means to prudently manage its outstanding
short-term and long-term debt in order to achieve some control over the
impact of interest rate movements on the Company's earnings and on customer's
rates and to prudently manage the risk associated with new short-term and
long-term debt issuances. Application, p. 1 <F2>.
CL&P states that its IRMI objective is to optimize its variable-to-
outstanding debt ratio and mitigate the exposure of customer rates and
earnings to changes in interest rates. The Company believes that the use of
IRMIs will allow it to manage its debt portfolio by using synthetic financial
instruments to: (1) convert variable rate debt to fixed rate debt; (2)
convert fixed rate debt to variable rate debt; (3) limit the impact of
interest rate changes; and (4) provide an option to utilize IRMIs in future
transactions for both existing and planned debt issuances. Application,
Exhibit A, pp. 1-2.
The Company proposes to limit its ability to use IRMIs by establishing
certain parameters regarding their use. The first parameter would require
that the notional principal amount of IRMIs not exceed 25% of CL&P's total
outstanding debt <F3> at any one time. As of September 30, 1996, CL&P's
total outstanding debt stood at $2,098,810,680 and the corresponding 25%
limit on its notional principal would be $524,702,670. As of September 30,
1996, the Company has approximately $720 million dollars in variable rate
debt, $582 million net of cash. These debt figures translate to 34.3% and
27.75% variable debt to total outstanding debt, gross and net of cash,
respectively. In the course of this proceeding, the Company revised its
position and stated that it would not be opposed to a maximum limitation of
20% of total outstanding debt, as it believed 20% would still provide it with
the flexibility to manage its interest rate exposure. However, a limit lower
than 20% would significantly diminish the program's success by resulting in
additional transaction costs or time delays should CL&P need to apply to the
Department for additional authorizations. Response to Late Filed Exhibits
LFE-21 (g); LFE-21(h); Tr. 1/30/97, pp. 175-176; Tr. 2/5/97, pp. 162-163.
While the Company is comfortable with its present 30% variable rate debt
exposure, its current exposure gives it a greater tendency to use IRMIs to
reduce exposure to variable rate debt than to increase this exposure. As
such, the Company would not be opposed to having this parameter skewed
against variable rate debt, i.e., more restrictive with regard to using IRMIs
to increase variable debt exposure than with regard to using IRMIs to
decrease such exposure. Tr. 1/30/97, pp. 177-181.
The second parameter would limit the notional principal amount of the
IRMIs to that of the underlying debt instruments and related interest
exposure. By imposing this particular limitation the Company is precluded
from engaging in leveraged or speculative transactions. The final parameter
would limit the IRMI's tenor <F4> to the maximum maturity of the underlying
Company debt, or the maturity of anticipated specific future debt issuances
proportional to the amount of indebtedness at each maturity. Application,
Exhibit A, p. 2; Responses to Interrogatories EL-2, EL-6; Responses to LFE-2,
p. 5 and Exhibit A.
The Company also stated it would not enter into several types of IRMIs
where interest rates had the following characteristics:
A. Floating-to-fixed interest rate swap in which the swap fixed
interest rate would exceed the higher of (1) 200 basis points over the yield
in U.S. Treasury obligations of comparable maturities or (2) the fixed
interest rate similar issuers pay in respect of comparable debt bearing
comparable maturities; and
B. Fixed-to-floating interest rate swap in which the swap floating
interest rate would be more than 200 basis points over the applicable
interest rate used for the swap.
The Company stated it would only enter into a floating-to-fixed interest
rate swap in cases where the estimated total costs of issuing the swap are
less than the total costs of issuing fixed rate debt. Application, Exhibit
A, pp. 4-5.
In response to staff cross examination, the Company refined its 200
basis point limit on its swap spread for floating-to-fixed rates. The table
below summarizes the Company's proposed limits as refined.
Term (Years) Proposed Limit
Up to 5 Years 60 basis points
More than 5 Years to 10 Years 100 basis points
More than 10 Years to 34.5 Years 200 basis points
The Company stated that IRMI costs are commensurate with interest rate
volatility and tenor; thus longer term IRMIs which are associated with more
uncertainty have a greater cost. The above limits are established to provide
the Company with reasonable flexibility yet furnish the Department with
comfort and reassurance that IRMIs will be held to reasonable levels as
characterized by today's interest rate environment. Tr. 2/5/97, pp. 195-200;
Response to Late Filed Exhibit LFE-2 (Supplemental).
CL&P will also utilize other parameters in its selection and development
of IRMI's. The Company will utilize IRMI interest rate indices which closely
correspond to the underlying interest rate indices of the analogous Company
debt. These include the London Interbank Offered Rates (LIBOR), commercial
paper indices, and the Federal Funds rate. Additionally, the Company will
enter into IRMI contracts with counterparties whose senior debt is rated BBB+
or better by the Standard and Poor's Corporation (S&P) or an equivalent
rating from another reputable credit rating firm. Additionally, the Company
proposes to have at least 75% of the outstanding IRMI principal amount held
by counterparties with an S&P rating of A or better, or an equivalent rate
from other credit rating firms. Application, Exhibit A, pp. 2-3. The
Company believes there is still a very strong likelihood of repayment from
BBB+ rated banks. Including BBB+ rated counter parties enhances the universe
of banks the Company can do business with and provides CL&P the opportunity
to save on transaction costs by dealing with a lower rated, but potentially
more competitively priced, counterparty offer. The Company does not believe
that an intermediary figure would allow flexibility, meaning the choice would
either be 75% A or better or 100% A or better and not something in between.
Tr. 2/5/97, pp. 170-171; 173; 180.
The Company's Application also described the terms and conditions it
intends on using for its proposed IRMI's. The Company will use similar
transactions to those of the International Swap Dealers Association, Inc.
(ISDA) Master Agreement (Master Agreement). The Company proposes to enter
into an individual Master Agreement with each proposed counter party.
Exhibit B.1 of the Company's Application details the ISDA Master Agreement
and the typical terms and conditions include, but are not limited to,
notional principal amount, effective date, maturity, and rates. Exhibit B.2,
Northeast Utilities System's Financial Risk Management Program and Policies,
sets forth the Company's IRMI program procedures and guidelines.
Application, Exhibit A, p. 3; Exhibit B.2.
The Company's evidence also included estimates of the cost involved with
the proposed IRMI's. The Company states the individual IRMI's costs are
difficult to predict as each is subject to such variables as tenor, strike
rate, notional principal amount, market liquidity for the particular IRMI
type, interest rate volatility, and interest rate forecasts. For IRMI's
requiring up-front payments, the Company will limit IRMI transaction costs to
5% of the principal amount. The Company estimates the cost of NUSCO labor
time expended in the use of IRMIs to not exceed $10,000 per transaction.
Only the actual costs incurred in connection with specific IRMI transactions
will be charged to CL&P by NUSCO. The actual costs charged will be processed
through NU's computer based accounting system, Management Information and
Budgeting System (MIBS). Application, Exhibit A, p. 4-5.
In response to staff cross examination, the Company refined its 5% (500
basis point) limit on its up-front payments as a percentage of principal
amount. The table below summarizes the Company's proposed limits.
Term (Years) Proposed Limit
Up to 5 Years 200 basis points
More than 5 Years to 10 Years 300 basis points
More than 10 Years to 34.5 Years 500 basis points
The Company stated that IRMI up-front payments are commensurate with tenor
since longer term IRMIs require greater payments than shorter term issues due
greater interest rate uncertainty. Tr. 2/5/97, pp. 183-186; Response to Late
Filed Exhibit LFE-2(Supplemental).
The Company's credit rating is not expected to affect the pricing of the
individual IRMI's, but could affect the terms, such as required collateral,
of the IRMIs. The Company did not include pro-forma financial statements as
it is difficult to determine the impact of IRMIs prospectively, but would
fully disclose the extent of IRMI transactions in accordance with Securities
and Exchange Commission's (SEC) requirements under the Public Utility Holding
Company Act of 1935 and other financial disclosure requirements as
established by Generally Accepted Accounting Principles (GAAP) and by
Financial Accounting Standards Board (FASB). Application, Exhibit A, pp. 5-
6.
D. CONDUCT OF THE PROCEEDING
By Notice of Hearing dated January 7, 1997, the Department opened the
proceeding and scheduled a public hearing, at its offices, 10 Franklin
Square, New Britain, Connecticut, for January 14, 1997, at which time the
hearing was opened and immediately continued to January 15, 1997. Following
the January 15, 1997 hearing and by Notice of Continued Hearing, the hearing
in this matter was continued to January 30, 1997. The hearing in this matter
was continued from the bench until February 5, 1997, at which time the
hearing was closed.
All parties were offered the opportunity to file Briefs and Reply Briefs
on February 11th and 13th respectively. The Department issued a draft
Decision in this docket on February 21, 1997. All parties were provided an
opportunity to file written exceptions to and present oral argument on the
draft Decision.
E. PARTIES TO THE PROCEEDING
The Department recognized The Connecticut Light and Power Company, P.O.
Box 270, Hartford, Connecticut 06141-0270 and the Office of Consumer Counsel
(OCC), 10 Franklin Square, New Britain, Connecticut 06051 as parties to the
proceeding.
F. JURISDICTION
The question of whether Department approval of this application is
required centers on General Statutes of Connecticut sec. 16-43 which, in
part, concerns the issuance and approval of securities and provides that:
(a) No public service company, without having first obtained the approval of
the department of public utility control, shall: ... (2) issue any notes,
bonds or other evidences of indebtedness or securities of any nature or lend
or borrow any moneys for a longer period than one year for any purpose other
than paying the expenses, including taxes, of conducting its business or for
the payment of dividends, or amend any provision of an indenture or similar
financial instrument if such amendment would affect the issuance or terms of
any such notes, bonds or other evidences of indebtedness or securities, ...
The department shall approve or disapprove each such issue or amendment
within thirty days after the filing of a written application for such
approval unless the applicant agrees to an extension of time.
It is quite likely that IRMI's were not contemplated at the time this
statute was drafted. The Company notes that the question of whether the
Department has jurisdiction over IRMI's is unclear and that the case law and
regulatory rulings on this issue are inconsistent. CL&P Brief, pp. 2-3. The
Company deemed it prudent to file this application for approval but would not
oppose an order disclaiming jurisdiction by the Department. CL&P Brief, p.
3.
The Department concludes that approval of an individual IRMI or an IRMI
program such as this requires Department approval since these instruments de
facto alter, by synthetically overlaying, the terms of previously authorized
securities. Regulations of Connecticut State Agencies section 16-1-61(a)(4)
require that companies seeking Department approval of a securities issuance
under Conn. Gen. Stat. Section 16-43 provide the terms of the issuance,
including rate of interest. IRMI's effectively constrain or alter existing
interest rate risk which was previously approved by the Department.
Therefore, where an IRMI in essence amends an underlying security, Conn. Gen.
Stat. Section 16-43 applies. In this analysis, the Department has not
considered whether an IRMI standing alone without an underlying security also
falls within the Department's jurisdiction and will leave that question for
another day. However, the Department notes that such an action would be of
questionable prudence for a public utility.
III. DEPARTMENT ANALYSIS
The Department's finds the Company's IRMI proposal, as originally
submitted, to be very broad in scope and initiatory. The proposal goes well
beyond any of the prior approvals the Department has authorized with respect
to IRMIs, such as swaps, to CL&P or any of the other companies the Department
regulates. To date the Department has approved the use of IRMIs in specific
cases, e.g., Decision dated April 15, 1986, in Docket No. 85-11-14,
Application of The Connecticut Light and Power Company for Approval of an
Interest Rate Swap and Fixed Rate Term Loan. The Decision in Docket No. 85-
11-14 approved CL&P's use of an interest rate swap in conjunction with the
issuance of a specific fixed rate term loan. In situations such as Docket
No. 85-11-14, the Department has authorized the use of a particular
derivative instrument in conjunction with the issuance of a specific
underlying debt instrument. In such situations the Department had
information which was known at the onset of each transaction, such as the
type of financial derivative instrument being proposed and its relationship
to a specific underlying debt instrument. Under the Company's current
proposal, the Department is requested to authorize the Company to utilize
IRMIs on all its current and future underlying debt as long as the Company
remains within its parameter to limit the total notional principal amount to
25% of the outstanding debt at the time. This implies that the notional
principal amount limit changes as the Company increases or decreases its
underlying debt.
If approved, this Application provides the Company with the ability to
vary its fixed to variable debt mix within a wide range. The table below
shows the range that the net of cash, fixed to variable debt mix can
fluctuate under the Company's 25% limit of total notional principal amount.
Debt Mix Current Rations(%) Potential Ratios(%)
Convert Convert
Variable to Fixed Fixed to Variable
Fixed 72.25% 97.25% 47.25%
Variable 27.75% 2.75% 52.75%
The use of IRMIs overlaid on to the Company's authorized capital can
result in the fixed to total debt mix ranging from a maximum of 97.25% to a
minimum of 47.25%. Conversely, the variable to total debt mix can range from
a maximum of 52.75% to a minimum of 2.75%, all without prior approval from
this Department.
The potential increase in variable rate debt, to a maximum of 52.75% of
total debt under the current capital structure, is of particular concern to
the Department since variable rate debt is by its nature more risky and
uncertain. The additional exposure to variable rate debt in the Company's
capital structure exposes the Company to increased interest rate volatility.
The trade-off is that variable rate debt tends to be cheaper than fixed rate
debt. Thus, while the conversion of fixed rate debt to variable rate debt
brings increased exposure to interest rate volatility, it generally results
in lower interest rate expense.
The Department is concerned with the broad latitude being requested by
the Company. Several of the proposed parameters result in only very broad
limits on the program. The Department's concern stems from several factors.
First, the Department believes that the limits as proposed by the Company may
be needlessly generous in most IRMI transaction situations. For example, the
proposed 200 basis point swap spread limit on swap transactions may be
appropriate for longer term underlying debt maturities, such as those with 34
year terms, but not appropriate for those with shorter terms, such as 3
months or 5 years.
Second, the Department is mindful of the Company's current financial
situation due in large part to difficulties with the Company's nuclear
operations. Consequently, the Department is careful to evaluate situations
where the Company may contemplate taking on additional risk for the future in
order to benefit today from a cash inflow, e.g., initiating a fixed-to-
floating interest rate swap, stand alone sale of an interest rate floor
and/or cap. Since the Company's financial condition may change over the
course of the IRMI program's tenure, a review of the program may be necessary
to evaluate program appropriateness in light of future unforeseen changes to
CL&P's financial condition.
Finally, the Department is aware that the financial derivative
instruments proposed for use in this Application are the subject of
continuous revision and change by the Wall Street practitioners who develop
them and of the plethora of nomenclature involved in the IRMI market. While
we do not want to restrict the Company from using an instrument simply
because Wall Street practitioners have re-named it, we are concerned with the
potential association of a very complex and exotic financial instrument with
a familiar term.
The Department does not want to unduly restrict CL&P at this juncture,
but must consider the additional risks ratepayers may face should the
Department authorize the Application as initially proposed by the Company.
The Department believes an IRMI program, in a modified form, can provide CL&P
with the ability to manage its interest rate risk while providing the
Department with control over the program's impact on ratepayer risk and
rates.
The Department's analysis focused on several of the parameter
modifications necessary for sufficient control of the program. Additionally,
the Department reviewed the entire IRMI program and its affect on the
Company's financial condition and capital structure.
A. NOTIONAL PRINCIPAL AMOUNT
The Department believes that the Company's request regarding the 25%
limit on notional principal amount is overly broad as it would allow variable
rate debt to effectively increase to a maximum of 52.75% without approval
from this Department. The Department is uncomfortable with the Company
having such broad latitude in varying the fixed to variable debt mix given
the risks associated with variable rate debt. The Department finds 20% of the
total outstanding debt a more appropriate limit and the Company has indicated
that such a limit is acceptable and workable. The Department authorizes CL&P
to utilize IRMIs in total notional principal amount not to exceed 20% of the
Company's total outstanding debt at any one time. Additionally, the
Department finds that should the Company need to synthetically convert its
variable rate to fixed rate debt in order to mitigate interest rate
volatility and its exposure to these risks; it should have the opportunity.
Therefore, the Department authorizes the Company to effectively manage its
variable interest rate exposure in the range of approximately 50% to 0%
variable rate debt to total outstanding debt, assuming its current 30%
variable rate debt exposure <F5>.
B. IRMI PROGRAM TERM
The Company requested approval for the period ending December 31, 2001.
The Department feels that given the initiatory nature of this proposal and
the complex issues and financial derivative instruments involved, this
program should be treated as a pilot program with a subsequent review of the
program's appropriateness after a sufficient period of time after the first
issuance of an IRMI instrument. Additionally, the Department feels it
necessary to review the program should the Company's current financial
condition change dramatically during the course of the IRMI program's term.
An example of what would constitute such a dramatic change would be a
downgrading to non-investment grade of the Company by the rating agencies
such as Standard & Poor's (S&P). The Department shall review the
appropriateness of the IRMI program as described in the Orders below.
C. IRMI INSTRUMENTS USE
1. Approved IRMIs for Program
In its Application, CL&P requests Department approval to enter into,
perform, purchase and sell financial instruments intended to manage the
volatility of interest rates, including but not limited to interest rate
swaps, caps, floors, collars and forward rate agreements or any other similar
agreements. These IRMI instruments can take on a variety of personas
utilizing very similar terminology. For instance, there can exist a variety
of interest rate caps using similar terminology but with radically different
risks and/or outcomes. One example is a momentum cap which caps the interest
rate at different levels over time. Although it may sound unusual, this type
of cap performs very similar to a basic cap, except that it changes the
degree of risk a company takes on over time. Another dramatically different
cap may be termed a Brazilian index cap. This instrument caps rates relative
to the Brazilian Coffee Index and is very different from the standard
definition of a cap since it takes on additional risks such a foreign
exchange rate and commodity risks that go well beyond the risk of U.S.
interest rate volatility <F6>.
The Department finds it is important to strictly define the types of
instruments the IRMI program will be comprised of and to restrict the Company
to IRMIs which closely match the underlying debt the Company plans on
hedging. During the course of the hearing, the Company revised its IRMI
definition to be inclusive of swaps, collars, caps, floors, futures,
swaptions and forward rate agreements. The Department will restrict the
Company to IRMIs consistent with this revised definition. Furthermore, the
Department prohibits CL&P from utilizing exotic financial derivatives and
requires that the Company only use IRMIs that are of the "Plain Vanilla" <F7>
IRMI type as defined above. Should the Company desire to utilize an IRMI
which is outside of this IRMI definition, the Company will be required to
file a separate application with the Department.
2. IRMI Pre-Filing
The Department is also concerned with the Company's request to sell or
write stand alone IRMIs, such as interest rate caps and floors, and its
request to swap fixed for variable interest rates. The Department's concern
regarding CL&P being authorized to write stand alone IRMIs is that in the
process of writing such IRMIs, CL&P will take upon itself the risk of having
to payout, to an IRMI purchasing party, at an the agreed upon strike rate
with out the underlying offsets that would accompany an IRMI transaction. In
an IRMI transaction, one counter party agrees to purchase and another agrees
to sell the IRMI with the purchasing party paying a transaction cost and
obtaining the guarantee that the seller (or writer) of the transaction will
be pay the purchaser the difference between the actual rate and strike rate.
<F8>. The selling party receives premium income and provides the obligation
to the purchaser that he will be paid the difference between actual and the
strike rate. Without the underlying offsets, CL&P will be taking on a role
that goes beyond its core responsibility of an electric company hedging
interest rate volatility to a company that acts more like a financial
intermediary. Writing stand alone options would require CL&P to establish a
loss reserve system and other like additional financial monitoring
mechanisms.
The Department is also concerned with the Company's proposal to engage
in fixed-to-floating interest rate swaps in which the swap spread would be
more than 200 basis points over the corresponding treasury bill or bond rate.
The option to engage in a fixed-to-floating swap provides CL&P with the
ability to take higher cost, higher rate fixed and substitute it for lower
cost variables to generate some short-term cash flow. In the course of
taking such action, the Company exposes itself to more risk and uncertainty,
i.e., interest rate volatility. Given the Company's current financial
situation the Department is cautious to not authorize financing avenues which
may at a later date unduly increase ratepayer's risks and rates.
However, the Department does not want to prevent the Company from
writing such IRMIs in situations where they are necessary to manage the
Company's interest rate risk. In the course of the proceedings, the Company
revised its application to state that it would not be opposed to an Order
requiring pre-authorization in cases where it plans on selling stand alone
IRMIs, but it would be opposed in cases where it would utilize a collar <F9>.
In Response to Late Filed Exhibits LFE-5 and LFE-5 (Revised), the Company put
forth its proposal for information to be filed in a pre-authorization form in
situations where it wants to sell stand alone IRMIs.
The Company also put forth in Late Filed Exhibits LFE-5 and LFE-5
(Revised) a proposal to address the Department's concern regarding fixed-to-
floating interest rate swaps. The proposal would be used for Department pre-
authorization to engage in the above mentioned transactions and would require
an expedited response time, no more than 3 days, in order to accommodate the
dynamic nature of the IRMI market.
The Department finds that pre-authorization requiring such expedited
treatment is not suitable for conducting a through review. Therefore, the
Department finds that the above mentioned pre-authorization information for
stand alone sale of IRMIs and fixed-to-floating swaps be filed as a pre-
filing requirement. The Department would take up to 3 days to inform the
Company that it should not proceed with the transaction. Should the
Department not prohibit the transaction within the 3 day window, the
Department may conduct an immediate post-review within 30 days limited to
prudence and cost issues or restrictions related to subsequent IRMIs
transactions. Should the Department take no action, it has reserved the
right to review the transaction during the Company's next general rate
review. The Company should not misinterpret pre-filing requirements, as
opposed to pre-authorization of the transaction, to be approval of the costs
to be incurred. The Company is instructed to submit the pre-filing
information as described in Late Filed Exhibits LFE-5 and LFE-5 (Revised) in
the above described situations. Additionally, the Company will not engage in
fixed-to-floating interest rate swaps in which the swap spread would be more
than 200 basis points over the corresponding treasury rate or otherwise
outside the general parameters described in Late Filed Exhibit LFE-2
(supplemental).
3. Swap Spread and Transaction Cost Limits
The Department is also concerned regarding the broad limits the Company
placed both on its swap spread (up to 200 basis points) and on its 5% maximum
transaction cost for IRMIs requiring up-front payments. The Department finds
that in both cases the Company has associated the need for the relatively
high limits with the need to have the ability to hedge its longer term
maturing debt. The Department finds that IRMI transaction costs are
commensurate with tenor since longer term IRMIs are more costly to enter than
shorter term issues due interest rate uncertainty. Consequently, the
Department believes that a 200 basis point limit on a swaps spread is more
appropriate for swapping longer term maturities than for shorter term
maturities. Likewise, a 500 basis point limit on up-front payments is more
appropriate for long term tenors than for shorter term ones. The Department
finds that the limits developed by the Company in Late Filed Exhibit LFE-
2(supplemental) and presented previously, for up-front transaction premiums
and swap spreads, are more appropriate since each relates tenor with an
associated basis point limit. The Department is aware that the limits which
characterize today's interest rates and may not necessarily characterize
future pricing levels. However, the Department finds that any issuance of an
IRMI outside of these general parameters, in the absence of a dramatic change
in the capital markets, signals that the Department should take a closer
prudence review during the next general rate proceeding and during the review
of this IRMI program as described in the Orders below.
IV. FINDINGS OF FACT
1. IRMIs manage the impact of interest rate volatility on outstanding
short-term and long-term debt.
2. CL&P requests approval to issue IRMIs in total notional principle amount
not to exceed 25% of its outstanding debt, but stated that it would not be
opposed to a maximum limitation in total notional principle amount of 20%.
3. A total notional principle amount limit lower than 20% would
significantly diminish the program's success by resulting in additional
transaction costs or time delays.
4. The term of the IRMI program is for the period ending December 31, 2001.
5. At least 75% of the outstanding IRMI principal amount held by
counterparties will have an S&P rating of A or better, or an equivalent rate
from other credit rating firms.
6. The IRMI program will utilize similar transactions to those of the
International Swap Dealers Association, Inc. (ISDA) Master Agreement (Master
Agreement).
7. The IRMI program procedures and guidelines are set forth in Exhibit B.2:
Northeast Utilities System's Financial Risk Management Program and Policies.
8. Individual IRMI's cost are difficult to predict as each is subject to
such variables as tenor, strike rate, notional principal amount, market
liquidity, etc.
9. IRMI costs are commensurate with interest rate volatility and tenor.
10. Longer term IRMIs are associated with more uncertainty and consequently
have a greater cost.
11. CL&P proposes a 200 basis point over comparable U.S. treasury obligation
as its swap spread limit.
12. IRMI up-front payments are commensurate with tenor.
13. Longer term IRMIs require greater up-front payments than shorter term
IRMI due greater interest rate uncertainty.
14. CL&P will limit transaction costs to 5% of the principal amount on
IRMI's requiring up-front payments.
15. The Company's credit rating is not expected to affect the pricing of the
individual IRMI's,
16. The Company's credit rating could affect the IRMI's terms, such as
required collateral.
17. CL&P will fully disclose the extent of IRMI transactions in accordance
with requirement's of the SEC, GAAP and by FASB.
18. The Company's financial condition may change over the course of the IRMI
program's tenure.
19. IRMI's are the subject of continuous revision and change by the Wall
Street practitioners who develop them.
20. The parameters of the IRMI program as approved by the Department are
summarized in Appendix A.
V. CONCLUSION AND ORDERS
A. CONCLUSION
1. The Company can use IRMIs in total notional principal amount not to
exceed 20% of the Company's total outstanding debt at any one time. -. The
Department believes that the Company's proposed IRMI program with the above
discussed Departmental modifications should provide CL&P with the flexibility
to adjust its exposure to interest rate volatility while providing the
Department with the governance and oversight it needs to ensure this program
is beneficial to ratepayers in the long run and in the public interest. The
Department's analysis has focused on the issues of contention with respect to
CL&P's IRMI program proposal. The issues and/or Company parameters which the
Department found appropriate are summarized and included in Appendix A below
and are incorporated into this Decision.
B. ORDERS
For the following Orders, please submit to the Executive Secretary an
original and six (6) copies of the requested material, identified by Docket
Number, Title (specify re-opening) and Order Number.
1. The terms and conditions under which the IRMI program operates shall be
as specified by the Company in Exhibit B.2., Financial Risk Management
Program Policies and Practices in its Application and no further material
written or oral supplements to or material modifications shall be executed
without prior written approval of the Department.
2. The Company shall submit, within 30 days following the completion of a
swap transaction, an exhibit which 1) details the terms and conditions of the
swap, such as Exhibit B.1, the ISDA's master agreement; 2) depicts the
transaction costs; 3) depicts the new relationship between outstanding debt
to IRMIs; 4) the estimated interest rate expense savings; 5) the affect to
the capital structure and 6) the swap rate and swap spread.
3. The Company shall submit, within 30 days following the completion of a
non-swap IRMI transaction an exhibit which: 1) details the terms and
conditions of the IRMI; 2) depicts the transaction costs; 3) depicts the new
relationship between outstanding debt to IRMIs; 4) the estimated interest
rate expense savings and 5) the affect to the capital structure.
4. The Company will submit, within 180 days of the issuance of the first
IRMI transaction, an exhibit showing the purpose, the terms, the current
position of the transaction and any other information necessary to facilitate
the Department's review of the program's continuation.
5. The Company will submit, within 360 days of its initial issuance of the
first IRMI transaction, an exhibit showing the purpose, the terms, the
current position of all the transactions entered in and any other information
necessary to facilitate the Department's review of the program's
continuation.
6. The Company will submit, within 30 days of dramatic change in its
current financial condition, such as credit rating downgrade, an exhibit
showing how the change affects the success of the IRMI program including the
affect on terms such as required collateral.
7. The Company shall file a separate application should it desire to
utilize an IRMI which is outside the IRMI definition as described in this
analysis.
8. The Company shall submit the pre-filing information as described in Late
Filed Exhibits LFE-5 and LFE-5(Revised) should the Company wish to engage in
the stand alone sale of an IRMI and/or in a interest rate swap fixed to
floating rates.
9. The Company will not engage in fixed-to-floating interest rate swaps in
which the swap spread would be more than 200 basis points over the applicable
interest rate used for the swap or outside the general parameters described.
10. The term of the IRMI program shall extend through December 31, 2001 with
subsequent intermediary Department review as described in the Orders above.
11. At least 3 days prior to the issuance of IRMIs with pre-filing
requirements, the Company shall submit the pre-filing information as
described in Late Filed Exhibits LFE-5 and LFE-5 (Revised). After the
initial 3 day pre-filing window, the Department may conduct an immediate
post-review within 30 days limited to prudence and cost issues or
restrictions related to subsequent IRMIs transactions.
DOCKET NO. 96-12-16
APPLICATION OF THE CONNECTICUT LIGHT AND POWER COMPANY WITH RESPECT TO
INTEREST RATE INSTRUMENTS
This Decision is adopted by the following Commissioners:
Glenn Arthur
Reginald J. Smith
Janet Polinsky
CERTIFICATE OF SERVICE
The foregoing is a true and correct copy of the Decision issued by the
Department of Public Utility Control, State of Connecticut, and was forwarded
by Certified Mail to all parties of record in this proceeding on the date
indicated.
/s/Robert J. Murphy Date 3/11/97
Executive Secretary
Department of Public Utility Control
Appendix A
APPENDIX A
Company Proposal
Quality Parameters:
1. Notional Principal amount of outstanding Interest Rate Management
Instruments (IRMIs) not to exceed 25% of the total outstanding variable rate
debt at any one time.
Department Authorized
Notional Principal amount of outstanding Interest Rate Management Instruments
(IRMIs) not to exceed 20% of the total outstanding variable rate debt at any
one time.
Company Proposal
Effective Period Parameter
2. Proposed effective date of the order is through December 31, 2001.
Department Authorized
The Department will review IRMI program within 180 days of the issuance of
the first IRMI transaction.
The Department will review the program's continuation within 360 days of its
initial review of the issuance of the first IRMI transaction.
Company Proposal
Hedged Application Parameters:
3. Notional principal amount of any IRMI will not exceed that of the
underlying debt instrument and related interest rate exposure, i.e., the
Company will not engage in "leveraged" or "speculative" transactions.
Department Authorized
As Proposed
Company Proposal
Hedged Application Parameters:
4. IRMIs tenor will be limited to the maximum maturity of the underlying
Company debt, or the maturity of anticipated specific future debt issuances
proportionate to the amount to indebtedness at each maturity level.
Department Authorized
As Proposed
Company Proposal
Hedged Application Parameters:
5. Underlying interest rate indices of such IRMIs will closely correspond to
the underlying interest rate indices of the Company's debt to which such
IRMIs relate.
Department Authorized
As Proposed
Company Proposal
Counterparties Parameters:
6. The Company will enter into individual Master Agreements with each
proposed counterparty. The terms and conditions will be the same or
substantially similar to those of the International Swap Dealers Association,
Inc. (ISDA) Master Agreement.
Department Authorized
As Proposed
Company Proposal
Counterparties Parameters:
7. The Company will enter into IRMIs with counterparties whose senior
secured debt ratings, as published by Standard & Poor's Corporation, are
greater than or equal to "BBB+", or an equivalent rating from Moody's
Investor Service, Inc., Fitch Investor Service Or Duff & Phelps.
Department Authorized
As Proposed
Company Proposal
Counterparties Parameters:
8. At any one time no more than 25% of the outstanding aggregate principal
amount of IRMIs will be held by counterparties possessing credit ratings
below Standard & Poor's Corporation "A" rating, and in no case lower than
BBB+, or equivalent rating.
Department Authorized
As Proposed
Company Proposal
Costs Parameters
9. The premium paid for those IRMIs requiring upfront payments, such as
interest rate caps, will be limited to five percent (5%) of the notional
amount of the transaction.
Department Authorized
As Proposed
Company Proposal
Costs Parameters
10. The Company will limit transaction costs as measured by a "swap spread"
to 200 basis points.
Department Authorized
The Company will not engage in fixed-to-floating interest rate swaps in which
the swap spread would be more than 200 basis points over the equivalent
treasury security's interest rate.
Additionally, the Company shall submit the pre-filing information as
described in Late Filed Exhibits LFE-5 and LFE-5(Revised) should the Company
wish to engage in the stand alone sale of an IRMI and/or in a interest rate
swap fixed to floating rates.
Company Proposal
Disclosure Parameters
11. The Company will submit an annual informational report to the Commission
in a format specifying the parties to each Interest Rate Management
Instrument, the specific portfolio security subject to the hedge, the
instrument type, the notional amount, the instrument features, cost, timing
and any other relevant features.
Department Authorized
As Proposed
Company Proposal
Disclosure Parameters
12. The Company will fully disclose in its financial statements the extent
of its Interest Rate Management Instrument transactions in accordance with
current and future Commission requirements, generally accepted accounting
principles, and Financial Accounting Standards Board ("FASB") practices.
Department Authorized
As Proposed
<F1> Notional principal amount is the principal amount or quantity
corresponding to the underlying debt whose interest rate is affected through
the use of IRMIs. Response to Late Filed Exhibit 1.
<F2> CL&P revised its IRMI definition to be defined inclusive of swaps,
collars, caps, floors, futures, swaptions and forward rate agreements.
Response to EL-21(e); Tr. 2/5/97, pp. 163-164.
<F3> Total outstanding debt is the sum of outstanding short-term and long-
term debt rounded to the nearest million dollars. Application, Exhibit A, p.
2;
<F4> Tenor is the total period in which the IRMI is operative. Response
to Late Filed Exhibit 1.
<F5> For example, if the actual variable interest rate exposure were 20% then
the Company could effectively manage its exposure between 40% and 0% variable
rate debt to total outstanding debt.
<F6> Such instruments are termed "exotics."
<F7> Plain Vanilla is a term used to describe the most basic form of a
single-currency constant-notional principal interest rate instrument. The
Department includes an IRMI where the notional amount could be amortized over
a period of time when the underlying debt instrument is subject to a similar
amortization. Tr. 1/30/97, p. 170.
<F8> Strike rate is the interest rate at which the IRMI can be bought or
sold. Responses to Late Filed Exhibit LFE-1.
<F9> Collar is the combination of a purchased cap and a written floor. The
premium earned from writing the floor can be used to offset the cost of
purchasing the cap. Response to Interrogatory EL-21(d); Tr. 2/5/97, p. 207.
