In the News: Recent Developments

February 23, 2012

Consumer Rates Climb After Deregulation Goldman Sachs Funded

By Darrell Preston

Houston consumers were supposed to get lower electricity rates from deregulation. Instead, they pay some of the nation’s highest prices, partly because of bonds Goldman Sachs Group Inc. recently sold for a local utility.

The Wall Street bank marketed $1.7 billion of securities for Houston-based CenterPoint Energy Inc. last month at higher yields than most of the company’s similar long-term debt, according to data compiled by Bloomberg. That raised costs borne by 2.2 million Houston-area consumers by about $47 million.

The sale shows how deregulation in Texas backfired, driving up costs for those promised savings. Texans paid some of the lowest rates in the country before the changes, according to the U.S. Energy Information Administration. Now they pay the fifth- highest electricity prices. The policy shift toward competition has also misfired in other states including California.

“This whole thing has been tragic for ratepayers,” said Thomas Brocato, a lawyer in Austin for the Gulf Coast Coalition of Cities, a group of 34 municipalities served by CenterPoint, whose share price beat the Standard & Poor’s utilities index by about 2-to-1 in the past year. The bond issue’s cost “makes it still worse,” he said.

Began in 2002

In Texas, the second most-populous U.S. state, deregulation began with the market served by nongovernment power companies starting in 2002, a move designed to foster competition. The enabling law let utilities recover so-called stranded costs, or investments made before deregulation, from customers. For CenterPoint, that has led to $5.4 billion in bond sales.

The policy will produce at least one more deal, a sale by an American Electric Power Co. unit, AEP Texas Central Co. in Columbus, Ohio. The Texas Public Utility Commission on Jan. 12 said it could borrow $800 million to cover stranded costs, according to a statement from the utility. AEP serves about 1 million people in southern and western parts of the state.

Even though the law permits the recovery of expenses made before the market changes, the commission has a duty to keep the effects on ratepayers, who cover such debt, at a minimum.

Consumers in areas of Texas touched by deregulation pay higher electricity prices than those in other areas both in and out of state that weren’t affected by changing laws, according to the Texas Coalition for Affordable Power, an advocacy group in Austin. Their rates are also higher than in other states where competition was brought to power markets, partly because of the stranded-cost recovery system, the group says.

Policy Works

Deregulation has worked, according to the Association of Electric Companies of Texas, an industry organization in Austin. The policy lets consumers shop for a low-price supplier, while rates are influenced by such items as the cost of power-plant fuel and the amount of capital invested in the system, said John Fainter, the group’s chief executive officer.

“We disagree that there has been no benefit to electric consumers,” said Fainter. “It’s providing access to a needed service at a reasonable price.”

In the decade before deregulation, Texans paid 6.4 percent less than the national average, according to the coalition. In the 10 years since, they’ve paid 8.7 percent more.

“People in deregulated areas of Texas consistently pay higher prices,” said Jake Dyer, a coalition policy analyst. “The stranded costs have increased the cost of electricity.”

Historical Perspective

For most of the history of electric power, utilities operated as monopolies with rates set by public authorities to ensure that their costs were covered and they got a “fair” return on invested capital, while protecting consumers from price gouging. In the 1990s, states began trying to foster competition, letting several suppliers contend for the business with a goal of improving efficiency and lowering costs.

It hasn’t always worked. Some states have pulled back while others haven’t moved forward with creating competitive markets. Enron Corp., the Houston-based company that went bankrupt in 2001, manipulated power markets in California as consumers endured blackouts in 2000 and 2001, with traders bragging about “stealing money from ‘Grandma Millie,'” according to the California Justice Department.

Municipalities and local taxpayers haven’t always been well-served when government officials put their financial fate in the hands of Wall Street banks. In Jefferson County, Alabama, home to Birmingham, the state’s biggest city, out-of-control costs tied to sewer financing guided by JPMorgan Chase & Co. led to the largest U.S. municipal bankruptcy on record last year. County residents have shouldered rising sanitation prices and may take on more to cover the cost of related debt.

Victimizing Cities

For more than five years, the U.S. Justice Department has led a probe that has revealed Wall Street banks, during the same years when they were sowing the seeds of the financial crisis, were also cheating cities, states and school districts across the U.S. and using the unregulated derivatives markets to hide kickbacks paid in the schemes. About 100 municipalities in 36 states were victimized by just one of the participants, UBS AG of Zurich, which has agreed to reimburse the communities.

In Texas, the recent CenterPoint sale’s extra interest expense adds to the $1.7 billion that the utility’s customers must repay for the latest sale and the $3.7 billion of such debt they already were covering. The Texas Supreme Court decided last year that the company would get to collect the extra amount, overruling the state utility commission’s rejection of the cost.

Added to Rate

As a result, CenterPoint’s ratepayers will have $2.39 per 1,000 kilowatt-hours tacked on to their monthly bills from the latest sale, the company said in a statement. They already pay $5.08 per 1,000 kilowatt-hours each month for the earlier deals.

“The real tragedy is that the ratepayers are going to have to pay an extra $1.7 billion,” said Brocato of the Gulf Coast Coalition.

The situation in Houston is an example of a policy that forces consumers to cover the costs of facility investments that can’t be recouped in a competitive market. About $40 billion of such debt had been sold in 12 states by July 2009, according to S&P. The state utility commission’s guarantee that ratepayers will cover the costs underpins S&P’s AAA rating on the latest CenterPoint debt issue.

The power company, with more than 5 million metered customers around the U.S., operates a distribution utility in Houston as well as natural-gas sales and distribution systems in other parts of the U.S. Compared with earlier CenterPoint stranded-cost debt, the yields set by bankers in the recent deal were higher, relative to benchmarks.

January Sale

CenterPoint offered the securities Jan. 11 through banks led by Goldman Sachs at rates averaging 2.5 percent, which was the lowest ever for such a bond sale, according to the utility commission. Still, the costs to be borne by consumers could have been kept even lower than the 3.03 percent coupon on the bond maturing in October 2025.

The top-rated issue’s relative yield compared with a benchmark swap index was triple that of most similar longer-term issues from the company, according to data compiled by Bloomberg. A bigger yield means higher electricity rates are needed to repay the debt.

“Investors like this paper,” Weili Chen, an S&P analyst in New York, said by telephone. “For the same rating you earn a higher yield.”

Moved Market

A Citigroup Inc. analysis showed the market moved after the deal, widening the spread, or difference, in yield for similar 10-year, AAA rated debt against swap indexes the bank uses by as much as two-thirds — a sign that the Houston-based utility’s sale carried a higher interest rate than the market demanded. The spread had barely moved during the previous year.

“They sold a AAA utility like a Baa deal,” Joseph Fichera, chief executive officer of New York-based Saber Partners LLC and a former Texas adviser on stranded-cost deals, said by e-mail. Ten-year Commonwealth Edison Co. bonds rated Baa1 by Moody’s Investors Service, seven steps below Aaa, priced to yield 2.83 percent Jan. 18, or 0.93 percentage point over benchmark U.S. Treasuries, Bloomberg Bond Trader prices show.

Tiffany Galvin, a spokeswoman for Goldman Sachs in New York, declined to comment.

“There’s always going to be Monday-morning quarterbacking by those not involved in the process,” said Terry Hadley, a spokesman for the state utility agency. “The commission remains pleased by the process and the results.”

Splitting Industry

As Texas began deregulating its electricity market in the 1990s, corporate-owned public utilities were split into separate companies to generate, transport and sell power to consumers. To level the playing field, the law lets utilities recover stranded investments made when they engaged in all three businesses.

Securing debt with government-guaranteed surcharges may become a model for “tens of billions” of financings in the U.S. to pay for such things as environmental equipment, S&P’s Chen said. They also may be used to pay some operating costs.

In Ohio, lawmakers passed a bill that would make it possible for Columbus-based American Electric to borrow against deferred fuel costs, said Tammy Ridout, a spokeswoman. The company expects to complete its Texas stranded-cost sale next month, according to Pat D. Hemlepp, a spokesman in Columbus.

Houston-area consumers that use 1,000 kilowatt-hours of electricity each month, enough for the average home, will pay the additional $2.39 a month for about 13 years to retire the CenterPoint debt sold Jan. 11, according to the company.

Oversight Ends

Jim Rourke, a lawyer in the state Public Utility Counsel Office, said his agency, which represents consumer interests before the utility commission, follows planning for stranded- cost bond sales until the offerings are approved. After that, it has no oversight role. “We haven’t been following it,” Rourke said of the CenterPoint deal. “Once the securities are issued, we don’t have any role.”

The sale produced the highest spread to a generic 10-year swap index among the company’s stranded-cost deals, according to data compiled by Bloomberg. The 13-year maturity’s spread rose 64 basis points to 97 basis points compared with the swaps rate, or triple the previous 32 basis-point unweighted average on earlier deals. A basis point is 0.01 percentage point.

In light of the issue’s AAA rating, a higher-than-necessary yield “is something we’d be concerned about,” the Gulf Coast Coalition’s Brocato said. “They should be getting the best price.

Better for Investors

The wider spread means investors who bought the bonds got a higher return than if the company had borrowed at a price closer to the average.

“The capital markets evaluate cost more by an interest- rate spread to a benchmark than a coupon,” said Saber’s Fichera, who also teaches finance at Princeton University in New Jersey. “Given even the conservative research on securitization bonds by Citigroup and others, this was an even better deal for investors.”

When he worked for the state on stranded-cost debt sales earlier in the previous decade, Fichera typically compared prospective yields to standard benchmarks such as swaps or Treasuries to provide pricing advice, according to documents on his website.

Even as the company and the utility commission took advantage of near record-low market rates, the spread on 10-year stranded-cost bonds moved to 90 basis points from 55 a week earlier, according to Citigroup’s Jan. 19 Consumer ABS Weekly report by analysts including Eugene Belostotsky. He declined to comment when reached by telephone.

First Southwest

Texas was advised on the January deal by First Southwest, a unit of Dallas-based PlainsCapital Corp. First Southwest was the third-largest financial adviser in the municipal-bond market last year, according to data from Thomson Reuters.

During the two-day pricing period, First Southwest’s “input and feedback” were “invaluable,” according to a memo sent last month to utility commissioners by Darryl Tietjen, the agency’s rate regulation division director who went to New York for the sale. Tietjen didn’t respond to written questions about what he did to assure the lowest cost for ratepayers.

The utility commission didn’t call for proposals to find a sale adviser, choosing instead to use First Southwest under an arrangement between the bank and the Texas Public Finance Authority, said Hadley, the utility commission spokesman. The company advises the agency on state-level municipal-bond deals, he said. The firm also has advised on prior issues, he said.

‘Comfortable’ With Deal

Michael Bartolotta, First Southwest’s vice chairman, described the firm as a “full-service investment banking firm with active participation in both the taxable and tax-exempt markets,” in an e-mail.

“First Southwest is comfortable with the resources and methodology we employed,” Bartolotta said, while declining to discuss the specifics of the deal. “We feel the pricing was appropriate based on all relevant factors.”

Nothing changed in the credit quality of the CenterPoint securities compared with those already on the market that would have influenced the price, said Du Trieu, a Fitch Ratings analyst. His Jan. 5 report gave top AAA ratings to the CenterPoint bonds.

“From a risk standpoint, I don’t think it is any riskier than it has been in the past,” Trieu said. “Our analysis was identical to that on other deals.”

While leading the marketing of the debt, Goldman Sachs also advised CenterPoint on how to structure the issue, according to offering documents. Other banks were Citigroup, Morgan Stanley, Bank of America Corp., Barclays Plc, JPMorgan Chase, Loop Capital Markets LLC and Royal Bank of Scotland Group Plc. The bonds were sold through CenterPoint Energy Transition Bond Co. IV LLC, an entity set up for the stranded-cost debt issue.

Higher Cost

The average interest rate on the deal was lower than for 11 previous sales, the utility commission said Jan. 12 in a statement. The offering may have saved ratepayers $720 million over 13 years because without it, the company would have faced a 7.7 percent interest rate and that would have translated to higher consumer fees, according to the agency.

Under Texas rules, utilities can pass on the “carrying” cost of such expenses. The 7.7 percent was estimated based on staff research, Hadley of the utility commission said.

“We’re pleased to have been involved in the lowest-cost securitization ever,” Floyd LeBlanc, a CenterPoint spokesman, said by telephone.

Stranded-cost bonds, including CenterPoint’s, were among the few asset-backed securities to come through the financial crisis and recession with top ratings intact, S&P’s Chen said.

“This asset class has always been AAA and has never been downgraded,” said Chen. “It has performed extremely well.”

Meanwhile, ratepayers in Houston and other parts of Texas are left to cover the cost, the Affordable Power coalition’s Dyer said. “It’s something we’re stuck with.”

© 2015, Bloomberg News, February 23, 2012

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