Municipal bond buyers are getting their first taste of stranded cost ABS, as the state of Connecticut is in the market with the first stranded cost securitization marketed to municipal bond buyers. The bonds, the proceeds for which are being used to fill a projected budget deficit, achieved tax-exempt status - thanks to funding utilities payments toward state-sponsored conservation spending, sources said.
"This act of legislation was implemented specifically to impose a brand-new non-recourse charge on ratepayers," said a source at Lehman Brothers. The law is a response to the looming deficit. Rather than opting to reduce the conservation expenditures, this new charge offsets that possible reduction.
The $204 million series 2004-A transaction, named State of Connecticut Special Obligation Rate Reduction Bonds, has 14 triple-A tranches ranging in tenor from six months to seven years. The charge being securitized came about as the result of a law passed last year, allowing the state to offset roughly $200 million of the budget gap anticipated over the next two years. Lehman is underwriting the deal.
While the state is the actual issuer, it is not a bill collector. To overcome this hurdle, electric distributors Connecticut Light & Power and United Illuminating Co. will handle 80.58% and 19.42% of the servicing, with CL&P calculating the collection amounts and potential true-up for both, according to a Fitch Ratings presale report.
CL&P, which securitized $1.4 billion of stranded cost ABS in 2001, is owned by holding company Northeast Utilities. Northeast Utilities carries senior, unsecured debt ratings of BBB' by Fitch Ratings, Baa1' by Moody's Investors Service and A-' by Standard & Poor's. United Illuminating, a unit of UIL Holdings, has no debt outstanding and is not rated.
Unlike any standard securitizations, the cash for this offering will not pass through a bankruptcy remote special purpose entity. Instead, the state pledges the assets to the trustee, Wachovia Bank, which in turn receives collections from the respective servicers.
Also noted by Fitch, "Since the issuer is not subject to bankruptcy, the creation of a special purpose entity is not necessary for the purpose of owning the transition
Credit enhancement comes in the form of a 10% reserve account, which is not allowed to dip below $20.4 million, 125% of the average annual debt service requirement or the maximum annual debt service requirement.
The true-up has been mandated to be reset up to four times a year, with at the very least, an annual resetting, according to Fitch. Should the reserve account dip below $17.5 million following any June 30 interest payment date, the servicers are authorized to implement the true-up.
Timing for pricing is unclear, as the deal is being marketed to an investor base unfamiliar with securitization. Settlement is slated for sometime in June. The bonds are expected to price cheaply compared to triple-A rated municipal
debt, due to the unfamiliarity of
the investor base with stranded
The main risks, as outlined by Fitch, include "rapid, significant declines in power consumption." The structure is able to withstand a 36.8% variance in electricity consumption in the first year of the transaction's life, 37.1% in year three and 38.7% in year five, based upon CL&P's electricity consumption forecasts. "Despite the extreme variances in each case,
the bonds are still able to pay all debt service at each stated
maturity date," Fitch adds in its report.
Fitch assumed a 20% forecast error, a more conservative assumption than the five times historical peak - 14.5% for CL&P and 11% for United Illuminating - due to the historical differences between residential and commercial consumers. The 20% error assumption is then increased by 1.5% each year, topping out at 29% in year seven, according to Fitch.
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