Stranded cost ABS is expected to pick up in the near term, according to Lehman Brothers, with the bulk of supply coming from New Jersey and Texas - the most favorable states from which to buy RRB ABS. Depending on the legal challenges Lehman estimates that stranded cost ABS issuance could top $3 billion, should all the expected utilities hit the market this year.
Spurring the spate of supply, particularly in New Jersey, is legislation that allows utilities to re-tap the market to recoup additional stranded costs in the years following previous securitizations. In New Jersey, the state legislature passed a law allowing for the recovery of differentials in the retail and wholesale energy rates. Four New-Jersey based utilities - including first-timer Rockland Electric - are planning to tap the market for almost $900 million in securitizations under the new measure. If regulatory approval is received in the next three months, the securitizations could happen toward the end of this year.
In Texas, the legal framework and structural enhancement built into the deals gives RRB issuers the opportunity to true-up costs that they had not initially accounted for after a period of time, following the closing of a deal. Lehman notes that this deadline is September 2004, with the regulatory determination of stranded costs to be securitized in March 2005. Also, Texas' self sufficiency as an energy producer - with just 1% of power imported - buttresses Texas-based utilities bonds.
Additionally, TXU Corp. unit Oncor Electric Delivery Co. is expected to securitize $1.3 billion of stranded costs in two parts over the next two years, following regulatory approval being granted in January.
In Michigan, CMS Energy Corp. subsidiary Consumers Energy recently won approval to recoup $544 million in stranded costs, although that number is less than half of the $1.1 billion it initially sought, Lehman adds.
As expected, spread performance of RRB ABS has been positive, depending on headline risk and supply. While the troubles experienced during the California energy crisis and consumer opposition in New Jersey and Michigan led to volatility, the drop-off in supply since May 2001 (see ASR 5/14/01), has fed the dramatic spread tightening throughout 2002, which led Lehman to call stranded cost ABS "a core holding."
Goldman Sachs researchers point to the lack of supply of late as a driving factor in the spread tightening, bolstered by the fundamental strengths of the sector. "In addition to offering consumer credit diversification, RRBs involve significantly less prepay or early amortization risk than do autos, home equities, and credit cards," Goldman says in a recent report. "We also like RRBs as an attractive source of longer duration in the ABS market."
Goldman reports that RRB spreads have tightened from wide levels of 20 basis points over swaps (for three-year paper) seen in 4Q02, to current spreads inside of 10 basis points to swaps, still at a discount to comparable credit card ABS. Lehman concurs, and although "the likelihood of tightening is low," and investors should consider total outstanding deal size when considering RRBs, "since liquidity is less favorable."