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Perspective

Fortnightly Magazine - October 1 1998

any securitization deal. Thus is born Assembly Bill 1890, the California restructuring statute. A state agency, the California Infrastructure and Economic Development Bank, is given the role of conduit for the securitization.

Statutes soon show up in several other states, although some question whether California's lead should serve as "the model." Pennsylvania and Montana follow with statutes that differ from California's in most ways. About a year later, Massachusetts, Illinois and Connecticut follow suit, showing even greater divergence from the California approach.

Most of the rate savings attendant on the California deregulation are derived from the sunset of the Standard Offer 4 contracts for independent power producers and the lengthening of cost recovery periods on nuclear assets from the shortened lives adopted in recent rate proceedings. In other words, the California Public Utilities Commission had first shortened recovery periods to push the utilities toward competition, only to lengthen them again to cut current rates. Securitization provided less than 20 percent of the savings mandated under the law. However, securitization can provide meaningfully higher levels of savings than those that arose in California, subject to various interplays between capital structure, asset recovery periods and credit ratings.

Whether effective or not, the California rate reduction bonds proved oversubscribed when the deals came in December. The demand - 10 to 15 times greater than supply - drove the interest rates down through the prevailing rate for credit-card receivables, a previous benchmark.

The part of the story that follows is not rosy, and suggests the pitfalls new legislation provides. In Pennsylvania, PECO Energy saw its securitization deal become bogged down at the commission and in court. The trouble stemmed from several factors, including the company's own modest proposal for rate cuts, which inspired the Enron bid. More than a year later, however, PECO appears somewhat back on track. In Montana, Enron sued to stop securitization, alleging that the PSC had not followed the technicalities of the new law. The Massachusetts, Illinois and Connecticut legislatures all adopted legislation that provides a format for securitization but in many ways discourages it, since many see it as a form of utility bailout. In Illinois, securitization does not address standard costs at all, but just adds it as a financing technique.

Bypassing the Legislature

What about securitization without enabling legislation? Can that strategy achieve 'AAA' debt financing for utilities?

Many major investment banks are now discussing administrative securitization with their clients who have stranded cost exposure. While the concept was at first questioned by the financial and utility community, research papers and meetings with rating agencies have succeeded in promoting and assuring the existence and validity of this new financing tool for securitization under existing law. Any legal opinion must be researched state by state. Some states may lack all the necessary elements, but preliminary analysis shows that most states have all the tools they need to adopt this form of transaction and provide the rate reductions that flow from it. In fact, protocols for new orders and findings that would make non-legislative securitization transactions bulletproof are now being crafted.