John Ferguson, CDP, comments on Joe Rosebrock’s article in April issue and Mr. Rosebrock responds.
Solution in Search of a Problem
Securitization fails the test for financing environmental capex.
The capital outlays required to comply with impending EPA regulations, and the associated impacts on utility customer rates, have increased interest in securitization financing as an alternative to the traditional mix of debt and equity used to finance utility capital expenditures. States like Wisconsin and West Virginia already have passed legislation allowing the use of securitization bonds to fund environmental upgrades, and several others have or are considering it.
Certain stakeholders claim that financing 100 percent of the cost of environmental retrofits with highly rated securitized debt reduces the overall cost to ratepayers. However, securitizing productive, long-lived utility assets is an extreme remedy that should be pursued only by utilities that can’t reasonably access traditional capital markets. This is because securitization 1) might not provide any rate benefits to customers; 2) has the potential to negatively affect investors and corporate credit ratings; and 3) risks several unintended consequences.
Securitization is a debt financing structure that relies on the use of government-sponsored debt as a substitute for the mix of traditional debt and equity commonly used to finance utility capital expenditures. The fundamental purpose of securitization is to achieve a lower cost of capital through the use of very highly-rated debt—almost always AAA—to finance 100 percent of a utility project. 1 The high debt rating and lower cost of debt is achieved through the use of a set of credit enhancements initiated by legislative action. Three primary credit enhancement features that facilitate the transaction are: a financing act (from the state legislature), a financing order (from the state public utility commission or other regulatory body) and a true-up mechanism (administered by the public utility commission and the utility).
Since 1995, more than $43 billion of utility securitizations have been issued in 53 transactions across at least 15 states. The vast majority of these securitizations have been used to finance stranded costs related to electric industry restructuring. Figure 1 summarizes the number and amount of securitizations that have been issued for these purposes.
Securitized bonds are most appropriate to finance the remaining book balances of assets that are no longer required to provide service, address financial challenges affecting access to intermediate-term capital, and recover a balance that’s known with certainty. Stranded costs that resulted from electric restructuring satisfied these criteria, and the use of these bonds has been expanded to include hurricane cost recovery in the past several years. The proceeds weren’t used to construct earning assets, but to replace them. In only one case to date, securitized bonds were used to finance construction required to meet environmental regulations. The issuing entities were the West Virginia subsidiaries of Allegheny Energy, entities whose poor financial profile made reasonable access traditional capital markets unattainable. 2
Financing Environmental Capex
Assessing the appropriateness of securitizing environmental capital expenditures must begin by recognizing that the circumstances that justify securitization aren’t present in financing environmental compliance investments.
First, most utilities aren’t locked out of the capital markets, or in