Exelon 2002 Annual Report Download - page 75

In addition to the impairment of the financial swap asset, if
Dynegy were unable to fulfill its obligations under the financial
swap agreement and the tolling agreement, we would likely
incur a further impairment associated with the Independence
plant. Depending upon the timing of Dynegy’s failure to fulfill
its obligations and the outcome of any restructuring initiatives,
we could realize an after-tax charge of between $0 and $130 mil-
lion. In the event of a sale of our investment in Sithe to a third
party, proceeds from the sale could be negatively impacted by
approximately $100 million, or approximately $65 million net
of income taxes.
Additionally, the future economic value of AmerGen’s
purchased power arrangement with Illinois Power Company, a
subsidiary of Dynegy, could be impacted by events related to
Dynegy’s financial condition.
Generation participates in the following established, real-
time energy markets,which are administered by ISOs: PJM,New
England ISO, New York ISO, California ISO, Midwest ISO, Inc.,
Southwest Power Pool, Inc. and Texas, which is administered by
the Electric Reliability Council of Texas. In these areas, power is
traded through bilateral agreements between buyers and sellers
and on the spot markets that are operated by the ISOs. In areas
where there is no spot market, electricity is purchased and sold
solely through bilateral agreements.For sales into the spot mar-
kets administered by the ISOs, the ISO maintains financial
assurance policies that are established and enforced by those
administrators.The credit policies of the ISOs may under certain
circumstances require that losses arising from the default of one
member on spot market transactions be shared by the remain-
ing participants. Non-performance or non-payment by a major
counterparty could result in a material adverse impact on our
financial condition, results of operations or net cash flows.
Our consolidated balance sheet includes a $445 million net
investment in a direct financing lease as of December 31, 2002.
The investment in direct financing leases represents future
minimum lease payments due at the end of the thirty-year life
of the lease of $1,492 million, less unearned income of $1,047
million.The future minimum lease payments are supported by
collateral and credit enhancement measures including letters
of credit, surety bonds and credit swaps issued by high credit
quality financial institutions. Management regularly evaluates
the credit worthiness of our counterparties to this direct
financing lease.
Interest Rate Risk
We use a combination of fixed rate and variable rate debt to
reduce interest rate exposure. We also use interest rate swaps
when deemed appropriate to adjust exposure based upon
market conditions. Additionally, we use forward starting inter-
est rate swaps and treasury rate locks to lock in interest rate
levels in anticipation of future financing. These strategies are
employed to achieve a lower cost of capital. As of December 31,
2002,a hypothetical 10% increase in the interestrates associated
with variable rate debt would result in a $5 million decrease in
pre-tax earnings for 2003.
We have entered into fixed to floating interest rate swaps
in order to maintain our targeted percentage of variable rate
debt, associated with ComEd’s debt issuances in the aggregate
amount of $485 million. At December 31, 2002, these interest
rate swaps, designated as fair value hedges, had a fair market
value of $41 million based on the present value difference
between the contract and market rates at December 31, 2002.
If we had not had the fair value hedges in place at ComEd,
we would have recognized an additional $14 million in interest
expense in 2002.
During 2002 and 2001, ComEd entered into forward starting
interest rate swaps,with an aggregate notional amount of $830
million and $250 million, respectively, in anticipation of the
issuance of debt. In connection with bond issuances in 2002,
ComEd settled forward starting interest rate swaps in the
aggregate notional amount of $450 million, resulting in a $10
million pre-tax loss recorded as a regulatory asset, which is
being amortized over the life of the related debt in interest
expense. At December 31, 2002, ComEd had $630 million of
forward starting interest rate swaps outstanding. These inter-
est rate swaps, designated as cash flow hedges, had a fair
market value exposure of $52 million at December 31, 2002. As
it remained probable that the debt issuances, the forecasted
future transactions these swaps were hedging, would occur,
although the issuances had been delayed, we continued to
account for these interest rate swap transactions as hedges. In
connection with ComEd’s January 22,2003 issuance of $700 mil-
lion in First Mortgage Bonds,we settled swaps,in the aggregate
notional amount of $550 million, for a payment of $43 million,
which will be recorded as a regulatory asset and amortized over
the life of the debt issuance.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
exelon corporation and subsidiary companies
73