Oncor Electric's first stranded cost securitization was a landmark for the stranded cost sector, which at the time had yet to fully mature. While roughly three years old, stranded cost ABS, or rate reduction bonds (RRBs), had been brought primarily by non-programmatic issuers, with the intention of never returning. And although called rate reduction bonds, most issuers were more concerned with recovering costs associated with prior investments made in a pre-deregulated environment.
With the combined efforts of Public Utilities Commission of Texas (PUCT), and advisory firm Saber Partners, Oncor changed the stranded cost ABS landscape - creating investor reporting standards. Issuers in Texas - the state with the most potential supply - must allow investors to fully understand and gauge performance of this relatively new asset class. The goal of the PUCT, Oncor and Saber was to achieve the most inexpensive all-in cost for the issuer, and in turn keep charges to the consumer as low as possible.
In addition to increasing transparency for investors through reporting, Oncor utilized an unheard of "performance based" underwriting fee, rewarding lead and co-managers for broadening investor distribution and tightening spreads.
Joseph Fichera, CEO of Saber Partners calls the performance-based compensation "revolutionary."
"In Oncor's offering we created additional relative value through the structure, increased disclosure and transparency and broader liquidity by expanding the buyer base," Fichera said. "For the bookrunners and co-managers, we tied compensation to performance on price and distribution so that everyone's incentives were aligned - the investor buying the bonds and the ratepayer paying for the bonds received the best deal possible at the time."
The result was broad distribution to non-traditional ABS investors, with heavy corporate overlap. Also, Oncor priced at the tightest levels the sector had seen to date through secondary RRB spreads, pricing just behind the largest and most liquid asset classes of the ABS market, rather than a "one-off" collateral type. Moreover, in the weeks following Oncor's pricing, the entire $30 billion stranded cost sector tightened four to 10 basis points, depending on maturity, and has remained at those levels throughout the year.
"The concept is essentially investment bankers earning their compensation during the underwriting and sales process, as opposed to being guaranteed compensation before a single bond is sold," Fichera added. "We wanted an incentive-based compensation plan that prevented the bookrunners from controlling everything while giving the co-managers a greater incentive to work."
ABS technology comes together
A close runner-up to Oncor, Cendant Corp.'s Terrapin Funding vehicle was described as "ABS cashflow analysis superimposed over CDO technology." Structured and led by Lehman Brothers, Terrapin enhanced both past and future offerings, including $1 billion of senior notes that have priced since.
Sources close to the structuring of Terrapin compared the de-linkage to the credit card trusts that have emerged from Citibank, Capital One Financial and MBNA America Bank. There are also nuances of Cendant's mortgage warehousing facility Bishops Gate Residential Mortgage Trust, such as a funds availability feature allowing Cendant to extend the term of the Terrapin B and C classes, albeit at a greater spread.
The corporate exposure inherent to the portfolio prompted the addition of diversity and average rating factors, used primarily in the CDO market.
Cendant's fleet-lease portfolio consists of more than 1,800 obligors, 80% of which were rated investment-grade by both Moody's Investors Service and Standard & Poor's. The diversity score for the lease portfolio is estimated by Moody's to be "around 50," a relatively low score, due to the assumption that lease obligors in the same industry be correlated and counted as one.
While Moody's rated 75% of the lessees, the rating agency also shadowed the unrated entities two notches below where it felt the entity would be rated.