October 7, 2009

Securitizing Green Investments

By Courtney Barry

On September 10, the Texas Public Utility Commission approved securitization in the form of “ROC” (ratepayer obligation charge) bonds totaling nearly $540 million for Entergy Texas in damage recovery costs. Entergy says it will use the proceeds to recoup its costs resulting from hurricanes that struck its service territory in Texas and Louisiana in 2008. (The bonds include carrying costs of roughly $43.5 million, calculated at 10.86 percent per annum for 14 years.)

Just how are such bonds perceived by customers, the industry, and moreover, Wall Street? Quite favorably, as reflected by a Standard & Poor’s report this summer, noting that even during recessionary times, ROC bonds outperform ABS asset classes and are “insulated from the periodic budgetary process.” Additionally, S&P notes, the political environment “may be shifting in favor of ROC bonds as ratepayers recognize the projected lower funding costs associated with the bonds’ AAA ratings.”

But arguably ROC bonds benefit utilities most of all. “Ever hear the joke about the breakfast of ham and eggs? It’s similar,” says Joseph Fichera of Saber Partners, a Wall Street financial advisory firm. “The chicken is involved but the pig is committed. Here, the company is involved (Entergy), but the ratepayer is committed, and so is the commission.”

Fichera explains that the structure insulates Entergy from liability, because the company will get the proceeds from the bonds but it won’t get the bill. In this case, Entergy set up a special purpose transition funding entity called “BondCo” to handle the transition charges, issue the bonds, and then transfer proceeds back to Entergy.

Fichera adds that utility securitization bond characteristics sometimes are misunderstood. “Some people have labeled them as ‘asset-backed securities’ and have drawn comparisons with securitizations in the corporate market and the financial sector (i.e., credit card and mortgaged-back securities) that are inappropriate in comparison,” Fichera says. ROC bonds are “better,” he says, and are more comparable to government supported bonds. “These bonds have a particular government statutory guarantee,” he says.

However, association with other types of securitized financing instruments makes them particularly attractive to investors. ROC bonds deliver a better yield than their credit quality otherwise might support, because they’re sold in the securitization market, as opposed to the broader market for utility debt.

The Roots of ROC

ROC bonds for storm securitization costs started with Florida, then later in Texas and Louisiana. In Florida, FP&L originally asked for $1.7 billion in damage recovery requests for hurricanes in 2004 and ’05. The Florida Public Service Commission set recovery at $1.13 billion. Later, through a bond hearing, FP&L secured an additional $652 million. There was dissention because FP&L wanted to bump up the reserve much more than some interveners thought was necessary. But, says Charlie Beck, of Florida’s Office of Public Counsel, “Once they went to bonding, everyone was fairly supportive.” The commission initially reduced FP&L’s total allotment partly because it included surcharges that had been in effect for some time, and the commission wasn’t sure how to handle it in the novel ROC structure. “This being the first on the bonds, it took a long time to get it,” Beck said.

The question on the table now is: Why is this financing technique being used only to recover out-of-pocket costs for storm recovery? This was a hot topic over the summer at NARUC meetings.

“This is a very efficient, very low cost mechanism,” Fichera says. “Commissioners, ratepayer groups and others are asking, ‘Why aren’t we using this more, for traditional things like nuclear plants, capital expenditures, environmental mandates?’”

In fact some utilities are doing just that. For example, the West Virginia Public Service Commission recently approved Allegheny Energy’s request for $105 million in ratepayer obligation charge bonds to fund a scrubber project. However, few companies are likely to pursue ROC funding for anything beyond storm recovery and a narrow class of investments to meet clean air compliance obligations. This is because the ROC structure requires utilities to give up earnings with the project being financed, which creates a disincentive for companies that otherwise would prefer to build their rate base with traditional investment recovery mechanisms.

However, given growing cost pressures and government-mandated investment requirements, state commissions, ratepayer advocates and other stakeholders might start pushing utilities to use ROC funding more frequently. For example, in March 2009 the Natural Resources Defense Council suggested that the state of New York should establish a securitized-debt fund to finance conservation investments related to utilities’ efforts to achieve Regional Greenhouse Gas Initiative (RGGI) targets.

“Given potential rate shocks coming from capital expenditures to meet environmental and renewable energy mandates, this financing tool should be part of the mix with conventional financing,” Fichera says. With so many investment needs on the table, the industry might work toward a compromise approach, allowing both ratepayers and shareholders to share in potential savings and get deals done.-CB