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Credit Rating Firms Savor Restructuring, Search for a New Formula

Fortnightly Magazine - February 1 1997

stranded investment and related regulatory policies affect credit ratings.

Importantly, D&P notes that the obligation of the electric distributor to collect a surcharge or other levy for stranded costs should have no impact on its credit quality. But for a stand-alone generating company, a transition cost charge would dampen cash flow volatility during the collection period. Ironically, that means that generating companies with large stranded asset positions and high transition charge levels should demonstrate a lower level of cash flow volatility than their less-burdened peers, making them appear financially stronger in the early years of cost recovery.

Regulators and legislators in a number of states are now or have considered various proposals for "securitizing" stranded costs (em i.e., creating an enforceable obligation to pay transition costs that is supported by tariffs and that can be pledged as collateral to provide financing to utilities. Two examples stand out: 1) California, where Assembly Bill 1890 (signed into law) will provide for rate reduction bonds issued by the state's Infrastructure and Economic Development Bank, and 2) New York state, where Governor Pataki has proposed the Electric Ratepayers Relief Act %n2%n to securitize stranded costs.

Lisa B. Metros, a vice president

at Duff and Phelps, notes that securitization can "accelerate the recovery of stranded costs, or provide a more certain recovery, allowing utilities to pay down transition-related debt, or make other balance sheet improvements." %n3%n One benefit, she notes, comes from the lower cost of capital made possible by using a trust structure to finance transition costs.

In the California example, utilities would receive the proceeds from a proposed $5 billion revenue bond issued by a state trust, and the legislation would designate as an irrevocable property right the future competitive transition charge revenues received from smaller retail customers. The revenues, received from monthly transition-related surcharges on monthly customer bills, would become the collateral and funding for the trust debt service.

As Metros explains, the primary assets of the trust are the statutory rights to receive nonbypassable future transition revenues. While utilities act as servicing agents to make collections of the transition charges, they would sell the rights to the future revenues to the trust, and therefore, any associated collection risks.

George Leung, Moody's Managing Director for State Ratings, notes, however, that the California bonds should not qualify as direct, general obligations of the state of California. Thus, Moody's views these bonds as "pure conduit financings," not necessarily reflecting the credit of the state as a

public institution. The nonbypassable charge pledged to the bonds in California is not a tax, says Leung, but a responsibility of ratepayers. Leung also points out the potential for political pressure or risk of change to the legislation should it not achieve its intended purpose of reducing electric rates by 10 percent by 1998. The possibility of legislative impairment, especially as it relates to the

nonbypassable charge, represents a potential credit risk, says Leung.

Leung's comments point out the importance of scrutinizing any securitization scheme. So what does a rating agency look for when rating a securitization backed by revenues