Pacific Gas & Electric Co., the electric utility company that was forced into a Chapter 11 bankruptcy in 2001, in the wake of the California energy crisis, is looking to bring its first stranded cost securitization in seven years to the market before year-end. PG&E hopes to price the offering sooner rather than later, according to records, and currently plans to forge ahead despite having yet to receive Internal Revenue Service clearance to price the deal.

The offering, to be led by Morgan Stanley, will total $1.8 billion, with another $1.2 billion reportedly in the pipeline for 2005. Both deals will help refinance the company's high cost debt it incurred as is sunk into bankruptcy, sources said. The securitization program was outlined as part of the restructuring agreement.

PG&E's only previous securitization was a $2.9 billion offering brought in Nov. 1997, also via Morgan Stanley. Throughout the company's trials, these bonds sustained their original rating of triple-A, even as the California energy crisis spiraled out of control. Of the initial eight classes sold, six have since paid down fully and the remaining two are slated to do so in 2008 and 2009.

Currently, the company is waiting for a response from the IRS regarding the tax-exempt status of the true sale of the assets, in the form of the private letter ruling. While most view the private letter ruling as just a mere formality, including the company and the California Public Utilities Commission, PG&E's mandate to sell the bonds is conditional upon receiving IRS approval.

"The final condition is that PG&E must obtain, or determine that it does not need, a private letter ruling from the IRS which states [the true sale of assets] will not result in presently taxable income to PG&E," the financing order states.

But, should the IRS refuse to grant tax-exempt status to the asset sale, PG&E has requested state regulatory permission to pass any taxes, plus interest assessed by the IRS, on to rate payers after the fact. The draft decision issued by PG&E to regulators requests, "the resulting taxes, including interest assessed by the IRS, and carrying costs on the tax principal and IRS Interest, will be borne by ratepayers since ratepayers receive the full benefit of the [bonds]."

Why the rush?

Like many bond issuers, PG&E is hoping to tap the market prior to a run up in interest rates. Compounding the dilemma, the private letter ruling from the IRS may not arrive until March 2005, the company estimates.

"The bonds should be issued as soon as possible in order to take advantage of the historically low interest rates and to flow through the bond-related benefits to ratepayers as soon as possible," the draft decision states.

Every other state that has sold stranded cost ABS has received a private letter ruling from the IRS conferring tax-exempt status on stranded cost ABS, and many participants expect that California will be no different.

Should the IRS deny the tax-exempt status of the offering, P&GE, which by that time will, in all likelihood, have priced and settled its planned offering, plans to true-up the unanticipated taxes plus interest, which may even lead to a third securitization, one source speculated.

Unlike traditional stranded cost ABS, these bonds do not recoup losses incurred in a pre-deregulation economic environment. In June, Governor Schwarzenegger authorized PG&E to collect $2.21 billion "from its electric ratepayers over a nine-year period. PG&E was authorized to collect the Regulatory Asset from its ratepayers on a level, mortgage-style basis," according to the finance order.

PG&E estimates the transaction will save its consumers roughly $1 billion, on a nominal basis, over the life of the deal and $694 million on a net present value basis.

In the relatively unlikely event that the IRS does not issue the private letter ruling, PG&E is requesting it be allowed to recoup the tax plus interest by exercising the true-up mechanism inherent in stranded cost ABS, via the second offering in the series.

Copyright 2004 Thomson Media Inc. All Rights Reserved.

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