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Securitization, Mach II

Green investments require bulletproof financing.

Fortnightly Magazine - August 2008

using such network, and not readily avoided by electing utility services that are not subject to such charges;

• The characterization, as a separate property right, of the right to levy and collect the charges—and any increases required to true-up the amounts to be levied and collected to ensure full and timely repayments of the bonds backed by such charges;

• The “true sale” of the related property rights to the issuer in the related securitization to secure or otherwise back the issuer’s securitization; and

• A pledge by the applicable state not to impair such property right or securitization.

Additionally, as a practical matter, the charges (and any likely required increase for true-up amounts) should be sufficiently modest to reduce the risk of later impairment from customer or political objections. 6

The legal effect of such a state pledge, and applicable limitations on it, depend on constitutional protections under the contract clause 7 and against improper takings 8 ). Questions might arise about the degree to which prior orders of one regulatory authority bind a later regulatory authority, or the deference the prior order will receive in any subsequent regulatory proceedings. 9 However, the rating agencies apparently have become comfortable with these risks, since they rate these transactions in their highest rating categories.

On June 28, 2002, the Internal Revenue Service (IRS) issued Revenue Procedure 2002-49 10 (Rev. Proc.02-49) to clarify the conditions under which a state-regulated electric utility can securitize customer charges without recognizing immediate tax gain. Rev. Proc. 02-49 also expedited stranded-cost securitizations by eliminating the issuer’s need to seek a private letter ruling. Later, on September 12, 2005, Rev. Proc. 05-62, 11 expanded the scope of Rev. Proc. 02-49 beyond stranded costs, removing the requirement for level payments and adding a requirement that securitization payments be made at least semi-annually.

Historical performance of these stranded-cost securitizations generally has been sound 12 and, accordingly, prior investor experience with them has been positive. Notably, this history has included a related utility bankruptcy (Pacific Gas & Electric) and a utility merger (Northwestern’s acquisition of Montana Power).

Securitizing Pollution Control

Recently, utilities have used additional transactions utilizing stranded-cost securitization methodologies to finance mandated pollution-control equipment and to recover storm recovery and reconstruction costs. The rating agencies have duly noted these opportunities. 13

Perhaps the first attempt to extend stranded-cost securitization techniques to mandated pollution-control requirements was the proposed $490 million of so-called “environmental trust bonds” authorized 14 for issuance by Wisconsin Electric Power Co. (WEPCO) in October 2004 under 2003 Wisconsin Act 152. 15 This Act authorizes Wisconsin utilities to use environmental trust bonds to finance environmental improvements on utility facilities. It calls for the environmental trust bonds to be repaid from revenues collected from a specified fee, and states that the bond issue is governed by a Wisconsin Public Service Commission’s financing order, which among other things, creates a property right to the collection of the fees from utility customers and to the collected revenues. The Act also provides that the utility will transfer this right to a third party, which