In the News: Recent Developments

July 1, 2004

Texas Transition Bonds win Favorable UK Regulatory Treatment on Securities Issued by TXU Electric Delivery Transition Bond Co.

UK Ruling Promises to Expand International Market for Innovative Securities backed by Unique Government Guarantee

(New York, New York) UK banking supervisors have informed a UK-regulated institutional investor that a 20% regulatory capital risk weight is appropriate for a recent bond offering issued by a subsidiary of TXU Electric Delivery Corp. (NYSE: TXU) and backed by a unique government guarantee from the Public Utility Commission according to Saber Partners, LLC, the state’s current financial advisor on the transaction.

The confirmation came in the form of “individual guidance” from UK banking supervisors after an inquiry from the institution, according to a report made by a Merrill Lynch bookrunning manager to Saber and the Texas Commission. The TXU bond issue provides recovery of stranded generating plant costs for the utility allowed by a change in the law that introduced competition to the state’s electricity market.

“While these bonds with this new type of government guarantee are a very simple security, they are not always well understood by the market” said Joseph S. Fichera, CEO of Saber Partners. “Many bankers have incorrectly compared these bonds to more complex — and lesser quality — securities they trade. But as the UK regulatory authority confirmed, once you strip back the layers, these innovative bonds are among the highest quality, government-supported securities available in the U.S. and international capital markets.” Saber Partners and its advisor, the Promontory Financial Group, provided briefings to the UK supervisors on the nature and structure of the securities.

Other Texas utilities (NYSE: TNP, CNP, AEP) expect to sell an additional $4-6 billion of similar bonds over the next 12-18 months. Expansion of the market for these bonds within Europe and Asia on favorable terms to the foreign investor vis-a-vis other alternatives available to them promises to lower borrowing costs for utilities and should save ratepayers millions in interest expense on future issuances, Fichera explained.

“It is our duty of care not to take a ‘business as usual’ approach to this program” Fichera said. “Higher borrowing costs go directly to the customer’s bottom-line: their electric bill. By clearing the way for this type of bond financing — and by working to expand the international markets for these securities — Texas has demonstrated its commitment to the aggressive protection of ratepayers’ best interests.”

Under special legislation passed in 1999 restructuring the Texas electric utility industry, the Public Utility Commission authorized a special and irrevocable charge on all 2.9 million customer electric bills in the TXU service territory and guarantees that the charges will be increased periodically to whatever level necessary to repay the bonds. The State further pledged never to impair the rights of bondholders to the charge. This guarantee and the state’s pledge made it possible for these TXU bonds to receive a “triple-A” rating from all three rating agencies, indicating the bonds are among the safest securities in the market.

The recent UK individual guidance is similar to an IRS private letter ruling in the U.S. in that it may be relied upon only by the party to whom it is addressed. The UK guidance marks the first time a utility bond backed by this type of government guarantee has received a 20% risk based capital weighting outside the United States. The only other corporate issuers to receive this favorable treatment are U.S. agencies such as Fannie Mae and Freddie Mac. About $30 billion of similar transition bonds have been issued by investor-owned utilities in 9 states over the past 7 years. However, the structure in many cases is slightly differently, and none of them has ever been assigned a 20% risk weight in Europe.

International capital standards known as the Basel Accord require that banks must hold a certain amount of capital in reserve for every dollar invested in certain types of securities. The “risk weight” is the percentage amount of this capital that must be set aside for each asset. Outside of the U.S., it ranges from 0% for obligations of a central government such as U.S. Treasury securities to 100% for any corporate or asset-backed securities regardless of their credit rating. All else being equal, the lower the capital risk weight assigned, the greater the investor’s return on capital and the more willing the investor will be to accept lower nominal interest rates which would benefit the Texas ratepayers who back the bonds.

“This is a big development and is clearly a breakthrough for Texas and these utility bonds. It distinguishes Texas from anything similar in the market both in the US and abroad,” said Jack Montgomery, who oversees $2 billion in fixed-income investments for Highmark Capital Management in San Francisco. Montgomery purchased the recent TXU offering. “I like it because it expands liquidity by opening up a new and large investor base for the Texas bonds. I know of no other corporate utility bond able to accomplish this or even attempt this.”


For more information:
Contact Joseph Fichera at 212-461-2370

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