In the News: Recent Developments

Feb 4, 2005

PG&E Sells $1.9 Billion of Bonds, Completing Recovery (Correct)

By David Russell and Greg Chang

PG&E Corp., the parent of California’s Pacific Gas & Electric utility, sold $1.9 billion of bonds today in the final stage of its recovery from the state’s energy crisis almost five years ago.

PG&E sold five asset-backed securities maturing in one year to about 7.7 years, paying interest of 3.32 percent to 4.47 percent, according to Bloomberg data. The “energy-recovery” bonds will be paid with surcharges on customer electricity bills, giving them top credit ratings, at least eight levels above those of Pacific Gas or the State of California.

“It’s one more step along the road to recovery for this company,” said Philip Smyth, an analyst who covers the utility at Fitch Ratings in New York. “I don’t think there’s anything else that needs to be done.”

The new five-year notes pay interest of 4.14 percent and priced at 99.96 cents on the dollar, resulting in a yield of 4.17 percent. The yield exceeds that of U.S. Treasuries of comparable maturity by about 41 basis points. A basis point is 0.01 percentage point. Citigroup Inc., Lehman Brothers Holdings Inc. and Morgan Stanley managed today’s debt sale.

The so-called spread is tighter than three other AAA rated asset-backed securities tracked by Merrill Lynch & Co. that mature in 2010. The spread is also narrower than the 42-basis-point average for similar bonds in Merrill Lynch’s Asset-Backed Securities Utility Index.

Texas utility owner TXU Corp. issued $790 million of similar asset-backed securities in May. TXU, based in Dallas, sold three-year notes at a spread of 47 basis points more than Treasuries and seven-year notes at a 62-basis-point spread. TXU also issued 10-year securities with a spread of 66 basis points.

Lower Rates

Some of the money from PG&E’s sale will be used to strengthen the finances of the utility unit and enable PG&E to pay its first stock dividend since January 2001. Pacific Gas emerged from bankruptcy in April, four years after incurring about $9 billion in debt by buying power for more than it could charge customers under the state’s electricity deregulation. Pacific Gas and PG&E are based in San Francisco.

Pacific Gas sought Chapter 11 bankruptcy protection in April 2001. The company borrowed $6.7 billion on March 18, in last year’s largest corporate debt sale. The transaction helped the company pay about $12 billion of creditor claims, and it emerged from bankruptcy protection less than a month later.

Pacific Gas recorded on its balance sheet a “regulatory asset” of about $2.2 billion as part of an agreement with regulators. Cash from today’s bond sale will replace the regulatory asset, cutting its overall capital. The lower capital will reduce by $1 billion over about seven years the rates the company needs to collect from consumers, said company spokeswoman Renee Parnell.


Today’s sale will also let Pacific Gas increase its capital to 52 percent of equity from about 50 percent on Sept. 30. Increasing equity will satisfy one of the requirements of the agreement with regulators, letting PG&E resume quarterly dividend payments of 30 cents a share as soon as this month, the company said in an Oct. 22 statement.
“We have to reach the equity ratio in the capital structure before PG&E Corp. can bring back the dividend,” said Parnell. She said she didn’t know how much of the proceeds from the bond sale will be used to increase equity at Pacific Gas, and how much will be returned to shareholders.

PG&E on Dec. 16 said it would buy back $975 million of stock by June 30, 2006, following a $350 million buyback announced in August. By reducing the shares outstanding, the company will also reduce the overall cost of paying the dividend. Dividend payments were eliminated in March 2001.

High Ratings

The notes have the highest credit ratings because they’re backed by surcharges on customer bills, not by Pacific Gas or the state of California. As they are paid from consumer electricity use instead of by the company, the bonds are considered asset-backed securities and not corporate debt.

Pacific Gas’s corporate bonds are rated Baa2 by Moody’s Investors Service, BBB by Standard & Poor’s and BBB+ by Fitch, in the lower third of 10 investment-grade ratings. California’s debt is rated A3 by Moody’s and A by S&P in the middle tier of the investment grades.

Pacific Gas’s ratings fell as low as B3 at Moody’s, six levels below investment grade, following the energy crisis. S&P cut the rating to D, indicating the company defaulted on some of its debt. The ratings were in the middle tier of investment-grade as late as January 2001.

Because they have higher credit ratings, the bonds being offered will yield less than other Pacific Gas debt securities. The 4.14 yield for the five-year AAA rated bond is less than the 4.40 percent yield on Pacific Gas’s 4.2 percent notes maturing in 2011, according to Merrill Lynch & Co. pricing data.

Won’t Buy

Michael Dunlop, manager of structured securities at 40/86 Advisors Inc. in Carmel, Indiana, said he didn’t buy the new Pacific Gas bonds because they yielded too little.

The spread on “everything has gotten to ridiculous levels,” said Dunlop, who manages about $7 billon of assets including asset-backed securities and mortgage bonds.

The debt Pacific Gas sold in March is secured by a first mortgage on utility properties. The 30-year bonds were priced to yield 140 basis points, or 1.40 percentage points, more than U.S. Treasuries of comparable maturity, and the 10-year notes yielded a spread of 109 basis points. The seven-year notes were priced to yield 104 basis points more than Treasuries. The five-year notes priced at a spread of 94 basis points.

Other AAA rated asset-backed securities issued by utilities traded at a spread of 42 basis points yesterday, according to Merrill Lynch index data. The bonds have given investors a 0.23 percent return so far this year, including interest payments. During the same period, Treasuries returned 0.71 percent and AAA rated corporate bonds returned 0.58 percent.

Power Crisis

The power crisis stemmed from flaws in California’s 1996 deregulation law, which capped rates utilities could charge customers, even as wholesale prices soared as much as 100-fold.

“The wholesale markets were deregulated and wholesale prices skyrocketed,” said Smyth of Fitch. “You can’t sell something at less than what it costs you for very long before you go out of business.”

PG&E shares fell 19 cents to $35.05 as 4:17 p.m. in New York Stock Exchange composite trading. The stock has gained 29 percent in the past year. The shares fell as low as $6.50 on April 9, 2001, the lowest since at least 1986, according to Bloomberg data.

Southern California Edison, the state’s other main utility, averted bankruptcy after regulators allowed it to collect $3.58 billion in power-buying losses with customer surcharges.

Cheap Protection

On Feb. 3, AAA rated company bonds yielded 61 basis points less that BBB rated company bonds, down from 70 basis points on May 28, according to Merrill data. On Dec. 30, the spread was 53 basis points.

“This is a great deal for investors,” said Joseph Fichera, Chief Executive of Saber Partners LLC, which advises states and businesses on bond sales, said of the Pacific Gas offering. “They bought credit protection very cheaply.”

Fichera, a former investment banker at Bear Stearns Cos. and Smith Barney, said the 26-basis-point difference in yield between Pacific Gas’s top-rated new bonds and its BBB-rated 2011 notes was too narrow. Fichera advised the Texas Public Utilities Commission on the TXU bond sale.

Since May 28, the overall spread for corporate bonds with the highest credit ratings narrowed 7 basis points to 55 basis points, according to Merrill Lynch index data. For similar asset-backed securities sold by utilities, the spread has narrowed 2 basis points to 42 basis points, according to Merrill Lynch.

–With reporting by Dan Taub in Los Angeles. Editor: Pittman, Burgess, Pittman, Goldenberg.
To contact the reporter on this story:

David Russell in New York (1) (212) 940-1045 or or
Greg Chang in San Francisco (1) (415) 743-3526

To contact the editor responsible for this story:
Robert Burgess at (1) (212) 318-2945 or

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