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Docket No.

Witness: Bruce N. Williams





Direct Testimony of Bruce N. Williams

November 2010
1 Q. Please state your name, business address and present position with

2 PacifiCorp dba Rocky Mountain Power (the “Company”).

3 A. My name is Bruce N. Williams. My business address is 825 NE Multnomah, Suite

4 1900, Portland, Oregon 97232. My present position is Vice President and

5 Treasurer.

6 Qualifications

7 Q. Please describe your education and business experience.

8 A. I received a Bachelor of Science degree in Business Administration with a

9 concentration in Finance from Oregon State University in June 1980. I also

10 received the Chartered Financial Analyst designation upon passing the

11 examination in September 1986. I have been employed by the Company for 25

12 years. My business experience has included financing of the Company’s electric

13 operations and non-utility activities, responsibility for the investment

14 management of the Company’s qualified and non-qualified retirement plan assets,

15 and investor relations.

16 Q. Please describe your present duties.

17 A. I am responsible for the Company’s treasury, credit risk management, pension

18 and other investment management activities. I am also responsible for the

19 preparation of PacifiCorp’s embedded cost of debt and preferred equity and any

20 associated testimony related to capital structure for regulatory filings in all of

21 PacifiCorp’s state and federal jurisdictions.

22 Q. What is the purpose of your testimony?

23 A. I first present a financing overview of the Company. Next, I discuss the planned

Page 1 – Direct Testimony of Bruce N. Williams

1 amounts of common equity, debt, and preferred stock to be included in the

2 Company’s proposed capital structure. I then analyze the embedded cost of debt

3 and preferred stock supporting PacifiCorp’s electric operations in the state of

4 Wyoming for the test period. This analysis includes the use of forward interest

5 rates, the historical relationship of security trading patterns, and known and

6 measurable changes to the debt and preferred stock portfolios.

7 Q. What time period do your analyses cover?

8 A. The test period in this proceeding is the 12 months ending December 31, 2011.

9 To appropriately match the Company’s costs with customer prices during the

10 period, I determined the capital structure and costs of long-term debt and

11 preferred stock using an average of the five quarter ending balances spanning the

12 test period.

13 Q. What is the overall cost of capital that you are proposing in this proceeding?

14 A. Rocky Mountain Power is proposing an overall cost of capital of 8.36 percent.

15 This cost includes the Return on Equity recommendation from Dr. Samuel C.

16 Hadaway and the following capital structure and costs:

17 Overall Cost of Capital

Percent of % Weighted
Component Total Cost Average
Long Term Debt 46.6% 5.82% 2.71%
Preferred Stock 0.3% 5.43% .02%
Common Stock Equity 53.1% 10.60% 5.63%
Total 100.0% 8.36%
18 Financing Overview

19 Q. Please explain Rocky Mountain Power’s need for and sources of new capital.

20 A. As described in Mr. A. Richard Walje’s testimony, Rocky Mountain Power is in

Page 2 – Direct Testimony of Bruce N. Williams

1 the process of completing or adding significant new generation and transmission

2 facilities as well as local distribution facilities. The Company is expecting to add

3 over $2.6 billion in new plant investments between the June 30, 2010 historical

4 base year and December 31, 2011, the end of the test period. These and future

5 capital additions will require the Company to raise funds by issuing significant

6 amounts of new long-term debt in the capital markets, retaining earnings and

7 possibly obtaining new capital contributions from its parent company. The

8 retention of earnings will be available as a result of a continued freeze in payment

9 of any dividends or distributions by PacifiCorp to its parent company through the

10 end of the test period. Since the acquisition of PacifiCorp by MidAmerican

11 Energy Holdings Company (“MEHC”) in March 2006, PacifiCorp has made no

12 common stock dividends or distributions to MEHC. Meanwhile, PacifiCorp has

13 received $1.1 billion in additional cash equity contributions from MEHC and $2.0

14 billion of earnings have been retained in PacifiCorp. These figures are expected to

15 increase as all earnings of the Company are expected to be retained (i.e. no

16 dividends paid to MEHC) through the test period. These actions have been

17 critical to credit quality and for PacifiCorp to remain well-positioned to support

18 the additional investments that have been and will continue to be made in the

19 Rocky Mountain Power service territory and the state of Wyoming in particular.

20 Q. How does the Company finance its electric utility operations?

21 A. The Company finances its regulated utility operations utilizing roughly a 50/50

22 percent mix of debt and common equity capital. Immediately prior to and during

23 periods of significant capital expenditures, the Company may allow the common

Page 3 – Direct Testimony of Bruce N. Williams

1 equity component of the capital structure to increase. This provides more

2 flexibility regarding the type and timing of debt financing, better access to the

3 capital markets, a more competitive cost of debt, and over the long-run, more

4 stable credit ratings; all of which assist in financing such expenditures. In

5 addition, all else being equal, the Company will need to have a greater common

6 equity component to offset various adjustments that rating agencies make to the

7 debt component of the Company’s published financial statements. I will discuss

8 these adjustments in greater detail later in this testimony.

9 Q. What type of debt and preferred equity securities does the Company employ

10 in meeting its financing requirements?

11 A. The Company relies on a mix of first mortgage bonds, other secured debt, tax-

12 exempt debt, and preferred stock to help meet its long-term financing

13 requirements. These securities employ various maturities in order to provide

14 flexibility and mitigate refinancing risks. The Company has completed the

15 majority of its long-term financing utilizing secured first mortgage bonds issued

16 under the Mortgage Indenture dated January 9, 1989. Exhibit RMP___(BNW-1)

17 shows that, over the 12 months ended December 31, 2011, the Company is

18 projected to have an average of approximately $5.9 billion of first mortgage

19 bonds outstanding, with an average cost of 6.25 percent. Presently, all

20 outstanding first mortgage bonds bear interest at fixed rates. Proceeds from the

21 issuance of the first mortgage bonds (and other financing instruments) are used to

22 finance the combined utility operation.

23 Another important source of financing has been the tax-exempt financing

Page 4 – Direct Testimony of Bruce N. Williams

1 associated with certain qualifying equipment at power generation plants. Under

2 arrangements with local counties and other tax-exempt entities, these entities

3 issue securities, the Company borrows the proceeds of these issuances from the

4 respective entities and pledges its credit quality to repay the debt in order to take

5 advantage of the tax-exempt status of the financings. The majority of these bonds

6 are in a variable rate mode and are re-marketed as often as weekly. In addition to

7 tax-exempt status, these securities take advantage of current very low short-term

8 interest rates. On the other hand, the variable rate structure of this type of

9 financing exposes the Company to re-marketing and interest rate risks. Hence,

10 the Company is careful as to the total amount of this variable rate financing that it

11 maintains in its capital structure.

12 During the 12 months ended December 31, 2011, PacifiCorp’s tax-exempt

13 portfolio is projected to be $738 million in principal amount with an average cost

14 of 2.34 percent (which includes the cost of issuance and credit enhancement).

15 Capital Structure

16 Q. How did the Company determine the capital structure proposed in this case?

17 A. The capital structure is based on the actual capital structure at June 30, 2010 and

18 forecasted capital activity, including known and measurable changes, through

19 December 31, 2011. The Company has averaged five quarter end capital

20 structures measured beginning at December 31, 2010 and concluding with

21 December 31, 2011. The budgeted capital activity includes known maturities of

22 certain debt issues that were outstanding at June 30, 2010, planned issuances of

23 long-term debt and the retention of all earnings available for common during the

Page 5 – Direct Testimony of Bruce N. Williams

1 test period. The known and measurable changes represent actual and forecasted

2 capital activity since June 30, 2010.

3 Q. Why is Rocky Mountain Power using an average of five quarter ends to

4 determine the proposed capital structure rather than simply an average of

5 the beginning and ending points as in previous cases?

6 A. As the Company has grown, its capital expenditure program has increased

7 significantly from historical levels which, in turn, have required new financings to

8 also be much larger. These larger financings are usually more efficient due to

9 lower transactional costs, and better received by investors who value the greater

10 liquidity that larger financings typically offer. However, the trade-off is greater

11 volatility in the Company’s capital structure ratios, particularly at quarter-end

12 following sizable financings. As such, the Company is proposing in this case to

13 use a capital structure that employs an average of the five quarter ending balances

14 over the test period to help smooth out this volatility. This is also the same

15 methodology the Company used in its most recent rate case. (Docket No. 20000-

16 352-ER-09)

17 Q. How does this capital structure compare to the capital structure that was

18 filed in the Company’s most recent rate cases.

19 A. The capital structures are compared in the table below.

Rocky Mountain Power

Comparison of Capital Structures
Docket No. 20000-333- Docket No. 20000-352- 2010 General Rate
ER-08 ER-09 Case
Long-Term Debt 47.7% 46.9% 46.6%
Preferred Stock 0.4% 0.3% 0.3%
Common Equity 51.9% 52.8% 53.1%
Totals 100.0% 100.0% 100.0%

Page 6 – Direct Testimony of Bruce N. Williams

1 The proposed capital structure in this Docket has a slightly higher common equity

2 component. As the Company continues to invest in generating and transmission

3 facilities and local distribution network the slightly higher equity level is

4 necessary to produce financial ratios that meet rating agency targets to maintain

5 our current ratings.

6 Q. How does the proposed cost of capital compare to the cost of capital that was

7 determined in the Company’s most recent rate case?

8 A. The parties stipulated to an overall rate of return in the Company’s most recent

9 rate case of 8.33 percent. The Company’s proposed cost of capital in this case is

10 very similar at 8.36 percent.

11 Q. How does the Company determine the amount of common equity, debt and

12 preferred stock to be included in its capital structure?

13 A. As a regulated public utility, the Company has a duty and an obligation to provide

14 safe, adequate and reliable service to customers in its Wyoming service territory

15 while prudently balancing cost and risk. In order for Rocky Mountain Power to

16 fulfill its service obligation, the Company is making significant capital

17 expenditures for new plant investment, including new renewable resources and

18 environmental control investments on existing fossil-fired generation units. Each

19 of these capital investments also has associated operating and maintenance costs.

20 Through its planning process, the Company determined the amount of necessary

21 new financing needed to support these activities and to provide financial results

22 and credit ratings that balance the cost of capital with continued access to the

23 financial markets.

Page 7 – Direct Testimony of Bruce N. Williams

1 Q. Has the Company’s common equity balance increased following the

2 acquisition by MEHC?

3 A. Yes. Following the acquisition by MEHC the Company has received, through

4 September 30, 2010, a total of $1.1 billion of cash capital contributions from

5 MEHC via the Company’s direct parent company, PPW Holdings, LLC and has

6 retained an additional $2.0 billion of earnings as noted earlier in my testimony.

7 Q. Please explain the need for additional equity in the proposed capital

8 structure?

9 A. PacifiCorp’s need for extensive capital expenditures was discussed during the

10 MEHC acquisition. The Company is continuing to follow through on those capital

11 expenditure requirements. Given the Company’s business risks, the additional

12 equity contained in the capital structure is required to meet the credit rating

13 agencies’ credit metrics to hold an ‘A’ rating. The bottom line is that the

14 Company cannot finance these expenditures solely with new debt. Additional

15 equity is required along with improved business results and other considerations

16 to support the current senior secured ‘A’ credit rating from Standard & Poor’s

17 (“S&P”), ‘A2’ rating from Moody’s Investors Service (“Moody’s”), and ‘A-’from

18 Fitch Ratings.

19 Q. Please describe the changes to the amount of outstanding long-term debt.

20 A. During the period ending December 31, 2011, the balance of the outstanding

21 long-term debt will change through maturities and principal amortization totaling

22 $601.3 million.

23 In addition, the Company presently expects to issue new long-term debt in

Page 8 – Direct Testimony of Bruce N. Williams

1 the amount of $750 million with a coupon rate of 5.10 percent during 2011. This

2 expected issuance is included in the proposed capital structure and its expected

3 cost of 5.16 percent is included in the cost of debt calculation.

4 Q. Is the proposed capital structure consistent with the Company’s current

5 credit rating?

6 A. This capital structure is intended to enable the Company to deliver its required

7 capital expenditures although the resulting credit ratios, while expected to be

8 stronger than historical ratios, may still be insufficient to maintain the current

9 credit rating. S&P was very clear on this point in their recent assessment of

10 PacifiCorp in stating “the…. utility’s credit metrics are more consistent on a

11 stand-alone basis with a ‘BBB’ category rating.”1 Clearly, PacifiCorp and its

12 customers have benefited from the higher ratings the Company would otherwise

13 likely have been awarded on a stand-alone basis were it not for the ownership by

14 MEHC and its parent, Berkshire Hathaway. Another important element

15 supporting the Company’s current ratings is the rating agencies’ expectations that

16 PacifiCorp will receive supportive regulatory treatment including reasonable

17 outcomes in rate proceedings. Absent ownership by MEHC and constructive

18 regulatory treatment that permits a fair opportunity for the Company to recover its

19 reasonable and prudent expenses, including a return on its investment comparable

20 to other similarly situated utilities, PacifiCorp’s senior secured and corporate

21 credit ratings would likely suffer at least a one rating level downgrade.

22 Maintaining the existing ratings is becoming more challenging due to the

23 additional adjustments that rating agencies are making to our published financial
Standard & Poor’s Rating Direct April 30, 2010.

Page 9 – Direct Testimony of Bruce N. Williams

1 results. I will discuss these adjustments in more detail later in this testimony.

2 Q. How does maintenance of the Company’s current credit rating benefit

3 customers?

4 A. The credit rating of a utility has a direct impact on the price that a utility pays to

5 attract the capital necessary to support its current and future operating needs. A

6 solid credit rating directly benefits customers by reducing immediate and future

7 borrowing costs related to the financing needed to support the Company’s

8 obligation to provide safe, adequate and reliable service to our customers.

9 Q. Are there other benefits related to maintaining current credit ratings?

10 A. Yes. During periods of capital market disruptions, higher-rated companies are

11 more likely to have ongoing, uninterrupted access to capital and access at lower

12 costs. This is not always the case with lower-rated companies, which find

13 themselves either unable to secure capital or able to secure capital only on

14 unfavorable terms and conditions during such periods.

15 In addition, higher-rated companies have greater access to the long-term

16 markets for power purchases and sales. Such access provides these companies

17 with more alternatives when attempting to meet the current and future load

18 requirements of their customers.

19 Finally, a company with strong ratings will often avoid having to meet

20 costly collateral requirements that are typically imposed on lower-rated

21 companies when securing power in these markets.

22 Q. Did S&P and Moody’s recently change the Company’s credit ratings?

23 A. Yes. S&P upgraded PacifiCorp’s senior secured debt to ‘A’ while it downgraded

Page 10 – Direct Testimony of Bruce N. Williams

1 PacifiCorp’s short-term debt ratings to ‘A-2’. Similarly, Moody’s recently

2 revised PacifiCorp’s senior secured debt to ‘A2’ from ‘A3’.

3 Q. Please explain these rating changes.

4 A. The action on the PacifiCorp’s senior secured debt merely reflects a change in

5 S&P’s methodology rather than a change in PacifiCorp’s credit quality or

6 financial metrics. S&P changed its approach to estimating the amount of collateral

7 that would be available to senior secured debt holders in the event of a default by

8 PacifiCorp on its first mortgage bonds.

9 S&P continues to be cautious about PacifiCorp credit metrics and, as

10 noted previously, views the Company’s credit metrics on a stand-alone basis as

11 more consistent with a ‘BBB’ rating. Indeed, in downgrading the Company’s

12 short-term debt ratings, S&P cited a need to take a firmer view on linking

13 PacifiCorp short-term ratings to stand-alone credit quality. S&P sustained their

14 current ‘A-‘ corporate credit rating based on their expectation “that management

15 will achieve cash flow metrics more consistent with an ‘A’ rating over the next

16 several years.”2

17 The upgrade of the Company’s senior secured debt by Moody’s was part

18 of an industry-wide action in which the majority of senior secured debt ratings of

19 investment-grade regulated utilities were upgraded by one level. The action was a

20 result of Moody’s analysis of the history of regulated utility defaults and was not

21 specific or unique to the Company.

Standard & Poor’s Rating Direct April 30, 2010.

Page 11 – Direct Testimony of Bruce N. Williams

1 Q. Does this rating action change the Company’s need to add equity to its capital

2 structure and improve its financial metrics?

3 A. No. Due to the extensive capital expenditure program, without continued

4 improvement in financial metrics along with supportive state regulatory outcomes

5 in our rate cases, the ratings direction is likely to be lower rather than higher for

6 PacifiCorp.

7 Q. Does S&P’s recent credit reports on PacifiCorp underline S&P’s expectation

8 that PacifiCorp improve its financial metrics in order to maintain its current

9 credit rating?

10 A. Yes. S&P made several references to the need for PacifiCorp to improve its

11 stand-alone financial metrics, noting that PacifiCorp’s financial risk profile

12 reflects a large capital program and the need to shore up cash flow metrics. S&P

13 also stated that “Given the recent turmoil in both the liquidity and capital markets,

14 we have taken a firmer view on the need to link the PacifiCorp short-term ratings

15 to its stand-alone quality, which supports an ‘A-2’ short-term rating.” S&P also

16 reiterated its credit view that “supportive rate case outcomes remain key to

17 maintaining and improving upon the company’s financial performance.” Exhibits

18 RMP___(BNW-2) and RMP___(BNW-3) are the October 7, 2010 and April 30,

19 2010 S&P Ratings Direct publications.

20 Purchase Power Agreements

21 Q. Is the Company subject to rating agency debt imputation associated with

22 Purchase Power Agreements?

23 A. Yes. Rating agencies and financial analysts consider Purchase Power Agreements

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1 (“PPAs”) to be debt-like and will impute debt and related interest when

2 calculating financial ratios. For example, S&P will adjust the Company’s

3 published financial results and impute debt balances and interest expense resulting

4 from PPAs when assessing creditworthiness. They do so in order to obtain a more

5 accurate assessment of a company’s financial commitments and fixed payments.

6 Exhibit RMP___(BNW-4) is the May 7, 2007, publication by S&P detailing its

7 view of the debt aspects of PPAs.

8 Q. How does this impact the Company?

9 A. During a recent ratings review, S&P evaluated the Company’s PPAs and other

10 related long-term commitments. Approximately $396 million of additional debt

11 and related interest expense of $26 million was added to the Company’s debt and

12 coverage tests solely as a result of PPAs. There were also other adjustments made

13 by S&P that resulted in a total of approximately $1 billion of debt and $78 million

14 of interest being imputed into PacifiCorp’s credit ratios.3

15 Q. How would the inclusion of this PPA related debt and these other

16 adjustments affect the Company’s capital structure as S&P reviews your

17 credit metrics?

18 A. Negatively. By including the imputed debt resulting from PPAs and these other

19 adjustments, the Company’s capital structure has a lower equity component as a

20 corollary to the higher debt component, lower coverage ratios and reduced

21 financial flexibility than what might otherwise appear to be the case from a

22 review of the book value capital structure. For example, if one were to add the

23 total $1 billion amount of debt adjustments that Standard & Poor’s makes to the
Standard & Poor’s Rating Direct October 7, 2010.

Page 13 – Direct Testimony of Bruce N. Williams

1 Company’s capital structure in this case, the resulting common equity percentage

2 would decline from 53.1 percent to 49.6 percent. The 49.6 percent equity ratio

3 falls below S&P’s published expectations for PacifiCorp.

Illustration of Rating Agency Adjustments to

PacifiCorp’s Capital Structure
($ in millions)
Book Values/Ratios Rating Agency Adjusted Book
Adjustments Values/Ratios
Long-Term Debt $6,675/46.6% $1,000 $ 7,675/50.1%
Preferred Stock $41 / 0.3 % 0 $41 /0.3 %
Common Equity $7,160 / 53.1% 0 $ 7160/ 49.6%
Totals $14,326/ 100.0% $ 15,326/ 100.0%

4 Financing Cost Calculations

5 Q. How did you calculate the Company’s embedded costs of long-term debt and

6 preferred stock?

7 A. I calculated the embedded costs of debt and preferred stock using the

8 methodology relied upon in the Company’s previous rate cases in Wyoming and

9 other jurisdictions.

10 Q. Please explain the cost of long-term debt calculation.

11 A. I calculated the cost of debt by issue, based on each debt series’ interest rate and

12 net proceeds at the issuance date, to produce a bond yield to maturity for each

13 series of debt. It should be noted that in the event a bond was issued to refinance a

14 higher cost bond, the pre-tax premium and unamortized costs, if any, associated

15 with the refinancing were subtracted from the net proceeds of the bonds that were

16 issued. Each bond yield was then multiplied by the principal amount outstanding

17 of each debt issue, resulting in an annualized cost of each debt issue. Aggregating

18 the annual cost of each debt issue produces the total annualized cost of debt.
Page 14 – Direct Testimony of Bruce N. Williams
1 Dividing the total annualized cost of debt by the total principal amount of debt

2 outstanding produces the weighted average cost for all debt issues. This is the

3 Company’s embedded cost of long-term debt.

4 Q. How did you calculate the embedded cost of preferred stock?

5 A. The embedded cost of preferred stock was calculated by first determining the cost

6 of money for each issue. I begin by dividing the annual dividend per share by the

7 per share net proceeds for each series of preferred stock. The resulting cost rate

8 associated with each series was then multiplied by the total par or stated value

9 outstanding for each issue to yield the annualized cost for each issue. The sum of

10 annualized costs for each issue produces the total annual cost for the entire

11 preferred stock portfolio. I then divided the total annual cost by the total amount

12 of preferred stock outstanding to produce the weighted average cost for all issues.

13 This is the Company’s embedded cost of preferred stock.

14 Q. A portion of the securities in the Company’s debt portfolio bears variable

15 rates. What is the basis for the projected interest rates used by the

16 Company?

17 A. The Company’s variable rate long-term debt in this case is in the form of tax-

18 exempt debt. Exhibit RMP___(BNW-5) shows that, on average, these securities

19 had been trading at approximately 93 percent of the 30-day London Inter Bank

20 Offer Rate (“LIBOR”) for the period January 2000 through June, 2010. Therefore,

21 the Company has applied a factor of 93 percent to the forward 30-day LIBOR

22 rates at each quarter-end spanning the test period and then added the respective

23 credit enhancement and remarketing fees for each floating rate tax-exempt bond.

Page 15 – Direct Testimony of Bruce N. Williams

1 Credit enhancement and remarketing fees are included in the interest component

2 because these are costs which contribute directly to the interest rate on the

3 securities and are charged to interest expense. This method is consistent with the

4 Company’s past practices when determining the cost of debt in previous

5 Wyoming general rate cases as well as the other states that regulate PacifiCorp.

6 Q. Regarding the new long-term debt issuances mentioned above, how did you

7 determine the interest rate for this new long-term debt?

8 A. I projected that this new long-term debt would be issued at the Company’s

9 estimated recent credit spread over the projected long-term Treasury rates as of

10 May, 2011. Further, I added in the effect of issuance costs to the debt offering.

11 This reflects our best estimate of the costs of new debt, assuming the Company’s

12 senior secured long-term debt ratings remain unchanged.

13 Q. What is the resulting estimated interest rate for this new long-term debt?

14 A. The Company’s current estimated credit spread for thirty-year debt is 1.10

15 percent. The recent forward long-term Treasury rate for May, 2011 is

16 approximately 4.00 percent. Issuance costs for this type of debt add

17 approximately 6 basis points (i.e. 0.06 percent) to the all-in cost. Therefore the

18 projected cost of the new long-term debt is as follows:

Forward Treasury Rate 4.00 percent

Credit Spread 1.10 percent

Issuance Costs 0.06 percent

All-in Cost 5.16 percent

Page 16 – Direct Testimony of Bruce N. Williams

1 Embedded Cost of Long-Term Debt

2 Q. What is the Company’s embedded cost of long-term debt?

3 A. The cost of long-term debt is 5.82 percent for the period ending December 31,

4 2011, as shown in Exhibit RMP___(BNW-1).

5 Embedded Cost of Preferred Stock

6 Q. What is the Company’s embedded cost of preferred stock?

7 A. Exhibit RMP___(BNW-6) shows the embedded cost of preferred stock for the

8 period ending December 31, 2011, to be 5.43 percent.

9 Q. Does this conclude your direct testimony?

10 A. Yes.

Page 17 – Direct Testimony of Bruce N. Williams