Why is Wall Street Waiting? - Saber Partners, LLC

By Joseph S. Fichera
Published in:

November 1997

It’s no wonder utility executives are feeling unusually besieged these days. The debate over stranded-cost recovery has them between a rock and a hard place. On one side are extreme consumer advocates blasting utilities for having made the wrong investment decisions in the past — with the blessing of state regulators. On the other is Wall Street, which says utilities should issue securities backed by the cash flow from stranded assets, thus creating a source of low-cost capital.

Ideally, argue these financial pundits, the securitization should happen with special authorizing legislation in each state. No alternatives to legislation have yet come from “The Street,” and many securities firms seem satisfied to wait for state legislatures to speak before developing their own low-cost financing product for utilities.

They might be waiting a while. While utilities prepare for competition, bills authorizing recovery of stranded costs continue to run aground. The issue has become a political lightning rod in many states. From coast to coast, politicians and special interest groups have leaped at the opportunity to “go negative” on stranded-cost legislation and utilities.

Utilities must play politics as they prepare to compete. Isn’t there a better way to handle the stranded-cost securitization issue?

According to published reports, US Rep Tom Delay (R-Tex) has told the conservative Heritage Foundation that stranded costs are “anti-competitive.” In Pennsylvania, legislators have used the issue to try to finagle rate reductions in their districts. Low-cost energy suppliers haven’t wasted any time jumping on the anti-utility bandwagon either Even Ralph Nader has taken sides in the securitization debate. He has joined Harvey Rosenfeld, author of California’s landmark auto-insurance rollback, in a group called Californians Against Utility Taxes, or CUT. CUT hopes to derail the issuance of $9-billion in utility rate reduction bonds next year, and even scrap the state’s restructuring law.

Gone — but not forgotten

It wasn’t so long ago that Washington Public Power Supply System (WPPS), Richland, Wash, defaulted on $2.25 billion in bonds — the biggest AAA-rated municipal bond failure ever Because of the confusion over WPPS, critics of securitization erroneously believe that legislation is always needed. Nothing could be further from the truth.

Given the current climate of skepticism, many utilities believe that they have no choice but to step up their legislative lobbying. As part of this strategy, utilities are also keeping tabs on securitization legislation in other states that may impact public perception before a local bill can be drafted.

Unfortunately, playing political hardball is forcing utilities to face a steady diet of brush back pitches. For example, this May, PECO Energy, Philadelphia, PA, had to settle for the right to securitize just $1.1-billion of its $6.8-billion in stranded costs now, while it waits for a later ruling on the remainder. Intervenors in the PECO case included IPALCO Enterprises, the parent of low-cost utility Indianapolis Power & Light Co and the publisher of a scathing white paper titled, “The Securitization Swindle.” For the partial authorization, PECO had to agree to competition one year sooner, and advance its timetable for caps on transmission and distribution rates by two and a half years. For many utilities, the costs of fighting for securitization on the political battlefield may outweigh the benefits ultimately gained from the fight.

Lawmakers and regulators in Illinois also agreed to delay their final ruling on stranded costs, but for a different reason. In a report requested by the state legislature, the Illinois Commerce Commission concluded that because stranded costs cannot easily be quantified in advance of competition, the issue will require ongoing review and adjustment. For utilities, this translates to an even more uncertain business climate on the eve of deregulation.

Although California — so far — represents a success in using politics to address the stranded-cost issue, there is little indication that this approach will be repeated elsewhere. But what if it turns out that new laws authorizing securitization are not needed, and that existing laws are sufficient? This is the question utilities should ask before committing resources to fight political battles. Utilities willing to seek the advice of appropriate counsel may find that they already have meaningful alternatives.

Two surprising findings

Wall Street can help break the stranded-cost logjam by doing what it does best: Developing original solutions to difficult financing problems and presenting a good, understandable story to investors.

At Prudential Securities, we asked the same question, and the answers surprised us. Our corporate finance professionals and sales and trading specialists teamed up and conducted a thorough due diligence. In addition, we consulted with our parent company (which has a long-standing relationship with utilities), met with all of the rating agencies, and consulted with legal counsel on a variety of strategies.

One clear finding from our efforts:

The legal structures of the states vary tremendously, and there is almost nothing that can be said about stranded costs and utility regulation that would hold true in all states. “Cookie-cutter” solutions, such as legislation designed to make securitization look like credit cards, are bound to create problems for this reason. Instead, utilities need custom solutions designed specifically for their state’s regulatory and legislative particulars.

Just as clear and surprising was another finding:

Securitization doesn’t necessarily require new legislation. In some states — Arizona for instance — the regulator clearly has the power to make decisions on issues like stranded costs without interference from the state legislature. Reason: Under the state constitution, the Arizona Public Service Commission is considered a separate branch of government and, as such, does not require sanction by the legislature. Other states present other possibilities and solutions.

We believe that Wall Street can help break the stranded-cost logjam by doing what it does best: Developing original solutions to difficult financing problems and presenting a good, understandable story to investors. Wall Street may be spooked by the specter of WPPS, but there is no reason to think that these securitization bonds would go down the same path. Under the umbrella of asset-backed securities, new classes of securities have evolved to meet particular needs under a variety of frameworks. Properly constructed and presented, investors have understood and accepted complex stories and structures.

Generally, structured transactions require expert legal counsel and thorough due diligence. There is no reason to think that state legislatures have some special knowledge of securitization deals; indeed there may be ample reason to believe the opposite. The case can be made that legislatures should stick to narrow questions of competition and leave the specifics of asset securitization to the experts.

In short, we believe that there is a better way. For utilities who worry about being turned into sausage by legislative politics, this could be a reason to celebrate.