Utility companies once turned to the securitization industry to recover what it called stranded costs - actually stranded profits - as they surrendered monopolies in their respective markets through mandatory deregulation.
Many of those deals were called stranded cost securitizations. Puget Sound Power & Light Co. was credited with completing one of the first ABS deals backed by surcharges on utility customer bills, when it did a $200 million transaction in June 1995. That deal and several imitators were called demand-side management securitizations, according to information to Saber Partners.
Twelve years later, the sector has adapted the financing in several ways to meet the specific needs of the company issuing the bonds. Under the umbrella term "ratepayer-backed bonds," utility companies and their financial advisors have come up with several variations on the same theme, including stranded cost, utility fees and rate reductions.
Now, several pending transactions emphasize one of the most pressing priorities of the utility industry today - repairing damaged equipment and restoring energy supplies after powerful storms as well as upgrading equipment to stay in compliance with stricter environmental standards. In Louisiana, Cleco Power just named an underwriter for a securitization that could be as high as $190 million. Those proceeds will be used to cover costs incurred while repairing storm damage and restoring service after Hurricanes Katrina and Rita in 2005. The bonds will be secured by a surcharge on customer's bills. When the company announced its plan last September, Cleco said it had already collected $20 million of storm surcharges from customers through an interim financing plan. A securitization is expected by year end.
Cleco Power might issue the bonds in this quarter, according to a request for proposal issued by the Louisiana Public Service Commission and its advisor on the transaction, Charlotte, N.C.-based Pathfinder Capital Advisors. The Louisiana Commission approved the financing plan, as is typical in all ratepayer-backed ABS deals.
"This has been a two-year process to create this financing framework, but our efforts have enabled us to keep our commitment to lower storm recovery costs for our customers," said Michael Madison, president and CEO of Cleco Power, when the deal was announced in September. "Absent federal assistance, this is the best option for our customers."
Likewise, Entergy Louisiana received an approval to complete a securitization, with proceeds going for finance storm recovery costs. It is planning to float $970 million in ABS bonds, according to market sources. CenterPoint Energy in Houston is using securitization the old-fashioned way, as a means of stranded cost recovery. Market sources say the company is planning to issue $500 million in ratepayer-backed bonds.
"We are starting to see new applications of an older technology - that is through storm recovery and environmental [upgrades]," said Cristal E. Jones, a Standard & Poor's analyst. "We believe there will be more transactions, similarly, on the horizon."
Industry observers readily admit that putting an estimate on future deal volume is virtually impossible, because each state must pass legislation authorizing securitization as a funding source. After that, state public service commissions must issue a financing order to authorize each transaction. They can also set limits on the amount of debt raised through securitization.
"Given the length of time for the legislation and financing orders, it is impossible to predict future deal volume," said Jennifer San Cartier, a senior director at Fitch Ratings. However, "we expect to see this structure used by utilities for varied funding purposes in the future."
The size of individual issuances are determined by negotiations between the state officials and the utility companies because there are no concrete pools of assets paying receivables into a trust, says Joe Fichera, president and CEO of Saber Partners. That company has acted as financial advisor to many state public service commissions on securitizations within their states. Instead of identifying a pool of contracts or other assets whose receivables will be pledged to repay the bonds, the utility companies can set an amount that they want to recoup, depending on their needs.
Informal limits can be imposed on deals, however. One example of a cap would be a rating agency's unwillingness to give triple-A ratings to securities, if the charge securing the bonds exceeded 20% of the total bills, said Fichera.
Market observers do know the current amount of outstanding ratepayer-backed bonds, however. According to Fitch Ratings, a total of $39.8 billion of bonds have been issued since 2005. Of the bonds rated by Fitch (which make up about 99% of total issuance from the asset class), about $19.6 billion is outstanding.
Generating Interest
This year, issuers in the sector have not come forward with a plethora of deals, but the transactions that have been completed have brought interesting developments to the table. That will change as time goes on, say market sources.
"There is a tremendous need for capital now versus before," said Fichera. "People are looking for ways to avoid rate shocks and higher costs to get passed through to customers."
On top of that, organizations and companies are increasingly concerned about the impact of energy production on the environment. About 50% of all power production in the U.S. still involves coal, which is prompting concerns about global warming. The cost of addressing climate issues is just being realized, Fichera said.
"The desire for renewable energy has been increased," Fichera said, adding that environmental groups want to ensure that as energy production increases to meet consumption needs, the production is not damaging to the environment. "The country does not want to grow dirty."
Last April, a set of twin special-purpose entities from Monongahela Power (MP) and Potomac Edison (PE) issued bonds that funded the upgrade of facilities in West Virginia, which are owned by Allegheny Power. The company installed so-called scrubber technology on the plant, which would allow it to burn more of the type of coal with higher sulfur content.
Shedding light on the issues
The MP and PE issuances also raised some technical questions about how those particular bonds - and any subsequent similarly structured securities - should be labeled, marketed and, ultimately, priced. The structure has a so-called joint and several liability feature, which means that at any point throughout the term of the deal all existing and future utility customers will pay a surcharge on their bills. That surcharge will secure the bonds. Also called a true-up mechanism, the joint and several liability feature is not present in other traditional ABS deals, according to Fichera.
The MP and PE issuances have had maturities of 20 years, and they have a 20% risk weighting under Basel I and Basel II, says Fichera, also unlike traditional ABS deals.
The Securities and Exchange Commission weighed in briefly. In a September no-action letter, the regulator said that "MP Funding and PE Funding are not asset-backed issuers and the Bonds are not asset-backed securities within the meaning of Item 1101 of Regulation AB."
Other securitization market professionals disagree. Calling those differences of opinion a debate would be a stretch, though, according to some. "From S&P's standpoint, these are securitizations," Jones said. There ends the heated discussion.
Investors are already weighing in on the issue. By mid-October, 10-year, fixed-rate spreads on triple-A stranded assets were at 65 basis points. Investors, who buy those bonds and similar credit card ABS deals, priced the latter at 45 basis points over, according to spreads information from Citigroup Global Markets.
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