November 30, 2011
Testimony Regarding Senate Bill 248 “Best Practices” From Joseph S. Fichera Before The Ohio Senate Public Utilities Committee
By Joseph Fichera
Chairman Daniels and Members of the Committee:
Thank you for the opportunity to address you with respect to SB 248 and thank you to Senator Balderson for his sponsorship of the legislation.
I am the Chief Executive Officer of Saber Partners, LLC located in New York City. I am also a Visiting Lecturer in Public Affairs at Princeton University’s Woodrow Wilson School of Public and International Affairs and a Senior Advisor to The Williams Capital Group.
Saber Partners is an independent advisory firm and does not participate in the underwriting, sale or trading of securities such as securitization bonds. Rather our role is as an independent expert and trusted advisor to our clients to create value through rigorous due diligence and informed representation of interested parties in negotiating with underwriters, investors and other service providers. As President Reagan once said, “Trust but verify.”
As an independent financial advisor, Saber Partners has completed 11 utility securitizations for over $8 billion. We have worked with 5 different commissions and 7 different utilities including American Electric Power (AEP).
Our work has involved close coordination with all three major rating agencies to achieve a top-rating, financial modeling and active representation and negotiation with underwriters and investors throughout the United States as well as in Europe and Asia. This has included assignments in Texas, Wisconsin, Vermont, New Jersey and West Virginia as well as Florida. In each case, we have had a fiduciary duty to the commission and to ratepayers.
Representing the Saber Partners team in utility securitizations are a former utility regulator, Rebecca Klein, former chief financial officers of major investor-owned utilities, Mike Noel and Hyman Schoenblum, as well as myself, a former underwriter and current investment banker, Joseph Fichera
Proper Use of Utility Securitization Can Help Create Jobs
Low and stable electricity rates are important to creating a robust business investment climate. As representatives of AEP have testified, securitization dramatically lowers utilities’ cost of funds, costs which are passed along directly to businesses and other ratepayers. We have advised on securitization for deferred balances as is proposed here, and also for storm recovery costs as well as for costs of environmental facilities. The Ohio legislature should consider such expanded uses of securitization. At the same time, the Ohio legislature should be sure to balance shareholder interests in earning a fair return on investments when their capital is at risk. It would be very appropriate to invite all interested parties to discuss and propose an appropriate mix of securitization and traditional financing – expanding the use of securitization but limiting it to a set percentage of total utility project financing, for example, 10-20%.
The rating agencies have written on this and even cited some of Saber Partners’ work on pricing in their reports. I have published on the use of utility securitization to finance environmental costs, costs of smart grid improvements and other uses.
Balance the Interests and Create a Level Playing Field for Consumers In Structuring, Marketing And Pricing: Create a Fair Transaction Without Overpaying
Particularly after the 2008 credit crisis, the capital markets require very careful attention to incentives, risks, conflicts of interest and costs of doing business. It is essential that the Ohio legislature create a securitization structure that eliminates for all practical purposes and circumstances any risk of non-payment for the investors. But in doing so, the consumers responsible for paying the bonds should not overpay the investors, underwriters or others. This is not an “off the shelf” financing.
The Proposed Legislation Creates a Unique Financing Tool That Requires Safeguards from the Credit Markets
The fundamental characteristic of these securitization financings — versus all other financings — is that the full economic burden of repayment falls squarely on ratepayers — not a penny of shareholder funds is spent … less than ½ of 1% is even at risk.
My testimony focuses on the unique situation this creates for the Ohio legislature and the Commission to consider. Perhaps up to $1 billion or more will be raised (though AEP’s initial proposal is for just over $600 million) and the natural question for the people who will be responsible for paying it back is —“at what cost”? What is the rate, what are the payment terms, and are they as favorable as possible? If you told your brother-in-law that you would agree to pay his mortgage, wouldn’t you want to have final say over the interest rate and terms?
The State of Ohio is considering utilizing its powerful regulatory authority in ways that have not been done previously in Ohio. This bill would allow the Commission to forego its future regulatory review in order to create a bond of unusual credit strength, a completely separate credit from that of the utility and the State.
The reason for this is that, in doing so, you expect to get the lowest cost of funds available in the market at the time. If the best deal possible doesn’t matter, then we can save much time and trouble by just selling these bonds at whatever rate and terms underwriters and investors want.
But of course, cost does matter to the Commission, to the utilities and especially to consumers. Affordable energy is a key economic driver for businesses in the State, and low cost electricity can have a direct impact on job creation and economic development. It is a testament to the utilities’ concern that they have proposed this financing technique in the first place. And I am sure that through proper safeguards for shareholders and ratepayers, this financing tool could be expanded to promote robust economic growth throughout Ohio1.
Nevertheless, the unique characteristics of this financing tool give rise to a unique need to protect the interests and needs of consumers during negotiations with the sophisticated and sometimes highly self-motivated participants in the capital markets, including underwriters, traders and investors whose interests are in fundamental conflict with interests of the rate-paying public. And because the utility is not on the hook for paying back any of the costs, the utilities’ interests are not directly aligned with the interests of ratepayers.
So it is important that the Commission have the tools it needs to balance the interests of utilities (who might want to gain access to funds in the capital markets quickly and with minimal bother), underwriters and big investors (who might want to profit quickly) with the interests of ratepayers to get the lowest cost of funds for the long-term.
Require Informed and Conflict-Free Representation of Consumer Interests “At the Negotiating Table”
The capital markets are often thought of as a “black box” of buyers and sellers rapidly exchanging millions of dollars. They produce efficient results because each participant pursues its own economic interest and because prices are determined through competition and the free flow of information.
The capital markets work best when there is a balance of competing interests in any negotiation. In these utility securitization transactions, the balance can be broken unless careful attention is paid as the transaction is structured, marketed and priced. If the utility were playing only with its shareholders’ dollars, the State could sit back and allow market forces to work as sophisticated utilities and capital markets investors negotiate at arm’s length. But under this bill, the utility is securitizing ratepayer dollars, so the State’s interest in striking this balance is heightened. With the proper tools, we believe the Commission can ensure this balance is struck.
Hire Experienced Independent Representatives Who Do Not Participate in Underwriting or Trading of Bonds Directly or Through Affiliates
Those responsible for repaying the securitized bonds, the ratepayers, should be represented at the negotiating table by experienced and independent financial advisors. Unless the Commission acts affirmatively to represent and protect those interests throughout the process of structuring, marketing and pricing the bonds, the results are likely to be skewed against ratepayers’ interests because that’s how the capital markets work. To be in a position to perform these tasks effectively, the capabilities and determination of a committed Commission need to be initially complemented with advice from an independent financial advisor with experience in structuring, marketing and pricing securitized bonds for utilities in other states.
It is important to recognize that all top rated securities, even AAA securities, do NOT price the same; there are differing views. Nothing is automatic in the capital markets except that informed self-interest rules. This lack of informed and experienced representation of ratepayer interests can affect the pricing, the transaction documents and every aspect of the deal.
These transactions call for hard work and collaborative efforts of all the parties involved to achieve the lowest cost of funds for ratepayers. The utility and the Commission’s staff and advisors can and should work together cooperatively to create the balance necessary to create and manage competition among underwriters and investors.
Savings from Informed Representation and Negotiation Have Been Documented in the Tens of Millions of Dollars
11 states have done these utility securitized bond transactions, and it has been a learning process.
Saber Partners has participated in 11 securitized bond transactions which have involved five different utility commissions. In these transactions, Saber’s efforts have saved ratepayers tens of millions of dollars compared to independent benchmarks. The Wisconsin Public Service Commission, the Florida and West Virginia Commissions, and even Citigroup have independently verified savings from these Saber Partners efforts.
“Best Practices” for Ohio to Consider
Saber Partners has helped establish new securitization programs in 4 states in the last 10 years. In fact, for both of the transactions that AEP referenced in their testimony in Texas, Saber Partners was the Financial Advisor to the Public Utility Commission of Texas who established the program and served as a joint decision maker with AEP.
These “best practices” cover three principal areas and are usually contained in an “issuance advice letter” process covering the scope of the transaction:
- Ratepayer representation and protection
- The decision-making standard
- Written certifications
The first element is effective REPRESENTATION of the interests of the Commission and ratepayers at every step through the conclusion of the process. Decisions affecting ratepayers should be made in conjunction with someone with a specific and direct fiduciary duty to ratepayers. AEP proposed this form of participation and final decision-making role of the Commission with the Commission’s financial advisor if it chooses to have one in their testimony on securitization in Texas.
Decision Making Standard
The next element is the DECISION MAKING STANDARD, a critical element. The standard should be the best possible deal for ratepayers at the time of pricing, the lowest possible cost of funds consistent with then-prevailing market conditions. Anything less, allows for less than optimal results….why is this?
Simple common sense, without a lowest cost, best price standard “why bother?” There is little incentive for any additional effort. We have worked under regimes where this decision standard was in legislation or was in the financing order. The decision standard in legislation does not harm the process in any way.
I have been an investment banker underwriter for almost 30 years. I served on the other side of the table from issuers and investors. I have been intimately involved in every aspect of the offering process in 11 ratepayer-backed securitized bond transactions. The capital markets are full of risks and opportunities. The facts are that unless you negotiate hard on your own behalf with Wall Street, with sophisticated and large investors who have differing views, you will leave substantial amounts of money on the table; in this case, ratepayer money. Each side is looking out for its own economic interests.
So, without a clear standard and a negotiating position that includes the potential for saying “no” when evaluating offers, underwriters and investors will have the negotiating leverage to dictate a final cost to ratepayers.
Remember, the best way to lose control of the sale price of your house is to tell prospective buyers that you must sell your house today because you really need the money now. Pricing leverage will quickly shift. AEP recognized this in their proposal in Texas, and Saber Partners worked cooperatively with AEP on that basis to complete cost-effective securitization transactions in Texas in 2002 and 2006.
The final element is for key transaction participants — the utility, underwriters, and financial advisors — to deliver WRITTEN REPRESENTATIONS to the Commission, certifying that what they have done has in fact led to the lowest cost of funds consistent with market conditions at the time of pricing. It’s a basic business principle — “put it in writing.”
Any prudent person would want it in writing…for example, investors want documentation before they give up their money…they don’t rely solely on oral representations before investing… With Sarbanes Oxley and a heightened need to maintain public confidence in business, certifications increasingly have become a part of normal business “best practices.”
This certification process through an ‘issuance advice letter” and the ability for the Commission to disapprove the transaction within 2 business days of the initial pricing has been employed successfully in Texas, West Virginia Florida and New Jersey, and is required in Wisconsin. 7 major underwriters have delivered these certificates on our transactions, along with all 7 utilities including AEP in Texas. Ohio ratepayers deserve no less.
A Level Playing Field Produces a Fair Transaction at the Lowest Cost to Consumers
We are completely committed to working with the Commission, Commission Staff, utilities and underwriters to make these successful and timely transactions.
Our goal is to work cooperatively in a collaborative process with all parties, but to help the Commission make informed decisions and to never sacrifice ratepayers’ interests for mere sake of expediency.
We believe that the legislation should make clear that Commission should be the final decision maker in the structure, marketing and sale of the bonds with the close cooperation of the utility.
Ohio Senate Public Utilities Committee, November 30, 2011
1 Saber Partners has been a leading advocate of this approach in published articles and presentations to the National Association of Regulatory Commissions, Edison Electric Institute, National Association of State Utility Consumer Advocate, Asset-Backed conferences and the like. The rating agencies have endorsed this concept in their publications.