December 3, 2010

Securitized bonds a capital markets bright spot in economic downturn

By Abby Gruen

— Investor demand for ratepayer-backed securitization bonds is exceeding supply. These ugly ducklings of utility finance, associated with restructuring and stranded costs, have performed spectacularly during the economic downturn, according to capital markets experts. In fact, these bonds have traded better than many AAA rated asset-backed securities, according to Standard & Poor's Ratings Services.

It was not always this way. While the cost of these financings has always been relatively low, before 2007, spreads were wider than credit card ABS — considered the best benchmark for pricing — and remained higher until the economic downturn

"As an asset class, tens of billions of dollars through the downturn has probably performed the strongest simply because, in the end, it is not just consumer credit, it is also almost unlimited taxing power on ratepayers," said Weili Chen, a senior director in the structured finance group at S& P.

In a report by Chen published in July 2009, he found that some five-year "stranded-utility" bonds were trading around 75 basis points inside the spreads of AAA rated credit card ABS of the same duration. Chen also found 10-year ratepayer obligation charge bonds trading closer to benchmark government-sponsored-entity securities.

"We're definitely seeing the transformation of the use of securitization from recovering sunken costs to financing discretionary items in terms of storm recovery, to certain prospective investments," Chen said.

As utilities are beginning to plan for new capital expenditure investments, there has been more discussion about securitization, according to Joseph Fichera, CEO of Saber Partners, a Wall Street financial advisory boutique, who has participated in 11 securitizations totaling more than $8 billion in five states since 2001.

"We've always thought environmental mandates and smart grid investments, anything that is mandated, are natural for ratepayer obligation charge bonds," Fichera said.

S& P expects the financing technique will play a larger role in the funding of future energy-related and other public projects, such as securitizations for renewable portfolio standards and CO2 emission credits; even to fund the construction of a nuclear power plant, as has been proposed by Progress Energy Inc. subsidiary Progress Energy Florida, legally known as Florida Power Corp., according to their 2009 report.

Originally created in the late 1990s to pay for stranded costs related to deregulation, 10 states in the U.S. issued close to $40 billion of stranded utility securities, according to S& P.

Today, 20 states have laws enabling securitization. Three have never issued securitization bonds and in one state, Illinois, securitizations were once approved and are no longer permissible.

Since their invention two decades ago, ratepayer securitizations have been issued for other purposes, under a variety of names, including ratepayer obligation charge bonds, stranded cost bonds, rate-reduction bonds, energy bonds, storm recovery bonds, environmental trust bonds, investment recovery bonds, ratepayer bonds and tariff bonds. All of these financings rely on an irrevocable promise made by state statute that repayment will come from electric fees collected from customers.

Recent legislative actions supporting securitizations include the West Virginia Public Service Commission's approval of a request by Allegheny Power to use securitization for incremental scrubber costs in October 2009, approval in May of a budget by Connecticut lawmakers that made use of a fee collected on consumers' electric bills that had been earmarked to pay off electric company stranded costs, and approval July 6 by Louisiana Gov. Bobby Jindal of a bill to permit utilities to securitize costs related to, among other things, canceled construction of generation and transmission projects, certain capital investments in excess of $350 million, long-term fuel supplies, and storage of spent nuclear fuel.

While ratepayers should theoretically benefit from the lower cost of capital securitization offers, there are still risks associated with it, said Pennsylvania Consumer Advocate Sonny Popowsky.

"The trade off is that securitization locks a state to a particular path, which reduces flexibility over time, so if there is some change in circumstances that would require under ordinary rate making some change in the commission's policy, you are basically locked in to that securitized level of rates," Popowsky said.

"Three Mile Island Unit 2 operated for about a week," Popowsky said. "It went into rate base, and it was taken out of rate base a month later. Had we securitized Three Mile Island Unit 2, I'm not sure what would have happened."