Fitch Downgrades Chugach Elec Assoc Bonds to 'A-'; Stable Outlook.

Energy Editors/Business Editors/Environment Writers

NEW YORK--(BUSINESS WIRE)--Dec. 12, 2003

Fitch Ratings has downgraded Chugach Electric Association, Inc.'s (Chugach) $330 million in outstanding senior unsecured bonds to 'A-' from 'A', and has removed the Negative Rating Watch. Fitch has assigned a Stable Rating Outlook. The rating represents an underlying rating as the bonds are insured by MBIA Assurance Corp., whose financial strength is rated 'AAA' by Fitch. The downgrade reflects a negative stance taken by the Regulatory Commission of Alaska (RCA) toward Chugach in 2003 and tighter projected financial protection measures as a result. The rating downgrade and removal from Negative Rating Watch follows a recent meeting with management updating Chugach's financial projections and management's prospective business and rate strategy.

Historically, Chugach has benefited from consistently solid financial performance, competitive electric retail rates, diversified customer base, and a supportive regulatory framework. In addition, long-term, firm natural gas supply contracts have helped support solid operating generation assets and, along with two hydroelectric power purchase contracts, have met the needs of a moderately growing service territory. Financial performance had been very stable through 2001, with debt service coverage ranging from 1.50-1.85 times (x), and times interest earned ratio (TIER) at 1.35x or higher. Chugach's balance sheet was similarly solid, with equity-to-total capitalization in the 25%-29% range since 1996. Chugach's key concern had been the ongoing discontent among its wholesale customers, but their attempts to change Chugach's operations and/or acquire the utility have not been successful.

Beginning in early 2003, a series of RCA rate orders ensued which were uncharacteristically negative for Chugach, and eventually led to the credit rating downgrade. On July 10, 2001, Chugach filed a general rate case with the RCA seeking a 6.5% rate increase, or net margins of $11.9 million. The additional revenues were needed to help fund capital expenditures, meet rising operating expenses, and build equity to 30%. Chugach was also requesting an interim rate increase of 4%. After rendering two rate decisions, the RCA eventually approved an interim rate increase of 3.97% (effective Nov. 1, 2001), but the RCA's decisions quickly deteriorated for Chugach thereafter.

Following an updated rate case filing by Chugach on April 15, 2002, to reflect lower interests costs for refinancing, whereby Chugach requested a lower base rate increase (5.7%) than originally filed, the RCA rendered its initial decision (Rate Order No. 26). RCA Order No. 26 resolved certain issues in Chugach's favor, but the financial adjustments were by and large more heavily weighted against Chugach including: (1) reduction in overall TIER from 1.35x to 1.30x (a loss in margins of about $1.3 million), (2) requiring that capitalized interest be offset against interest expense includable in the revenue requirement, (3) lowering recoverable interest expense on variable rate securities, and (4) shifting a larger portion of margin burden on retail users by reducing the allowable TIER for wholesale customers to 1.10x from 1.15x. In addition, Chugach would have to refund the interim rate increase collected since implementation (approximately $1.8 million for 2001 and 2002).

Pursuant to Order No. 26, Chugach's financial performance fell below the 1.10x TIER requirement and resulted in a net loss of $2 million for 2002. If the Order remained as is, Chugach would not meet the 2003 TIER requirement as well. Chugach subsequently filed a motion to stay the Order (Feb. 13, 2003), which the RCA granted in part, and also filed a Petition for Reconsideration on Feb. 28, 2003. Several RCA orders followed which reversed and/or clarified Rate Order No. 26. Key changes to Order No. 26, which were generally positive for Chugach, included: recoverable variable rate debt interest expense was returned to 3.8% level, recovery of certain legal expenses was allowed, and approved retail rate increase of 3.5% and wholesale rate decrease of 7.9% (+0.8 million annually, in aggregate). Conversely, the RCA did not alter the lowering of overall TIER to 1.30x, the lowering of wholesale customers' TIER to 1.10x, and the requirement that capitalized interest be offset against interest expense includable in the revenue requirement. The RCA's approved final rates on November 7, 2003, and Chugach does not plan to file any new rate requests with the RCA for sometime.

On a net basis, Chugach is projecting net margins of $8.0 million for 2003, and approximately $6 million per year through 2006. (Based on the 2003-2007 Business Plan projections) TIER is estimated at 1.34x for 2003, and 1.20x-1.25x for 2004-2006 (Based on current financial projections contained in the 2003-2007 Business Plan). Equity to total capitalization is projected to be rise from 25% currently to 28% by 2006. Actual equity levels will vary, however, depending upon annual operating results, capital expenditure levels and patronage capital distributions. (Currently, a 2004-2008 Business Plan is being developed.) For 2003, patronage capital distributions are zero, due to lack of net margins generated in the prior year.

There are three new commissioners (and new associated staff) among the 5-member appointed RCA. As a result, given the untested and uncertain direction of the new members of the RCA, the regulatory risk remains a concern. Partially offsetting this risk are the following factors: Based on current financial projections, Chugach should not need rate relief until 2006, Chugach is working with RCA and the legislature to address the power supply issues facing the state. While Chugach has the option under Alaska statute to request its members' approval to eliminate regulation by the RCA, Fitch believes this may be very challenging. Lastly, while Chugach's financial performance ratios are reasonable and not out-of-line with straight 'A' level cooperatives, the regulatory uncertainty and certain ongoing wholesale customer discontent brings the rating down to the 'A-' level, with a Stable Outlook.

Chugach is the largest electric utility provider in Alaska, serving either directly or through wholesale sales roughly two-thirds of all electric customers in the state, or approximately 175,000 users.