Utilities Seek Perfect Comparables

Two Ohio utility rate reduction bonds that priced this summer rekindle a debate as to the appropriate benchmark for these securities, which are backed by fees charged to consumers to recover the cost associated with deregulation, fund major investments or repair extensive damage.

Historically, fixed income research departments and ratings agencies have compared rate reduction bonds to triple-AAA rated securities backed by credit card receivables or to traditional, investment grade corporate debt, but the two Ohio deals were priced relative to comparatively riskier bonds.

In July, Ohio Power Company, a wholly-owned subsidiary of American Electric Power Company (AEP), priced a $267.4 million deal called Ohio Phase-In-Recovery Funding LLC. The transaction was led by Citigroup and RBC Capital Markets and rated by Moody’s Investors Service.

The ‘Aaa’-rated, 2.25-year notes priced at a spread of 40 basis points over the interpolated swaps curve and the ‘Aaa’-rated, 5.08-year notes priced at 52 basis points over swaps.

Ohio Power Company said the pricing resulted in $18.6 million in nominal savings and $23.82 million in present value savings, which compares favorably to the $21.9 million and $28.8 million savings estimate, respectively that was included in the securitization financing order.

The bonds were issued to refinance the Deferred Asset Recovery Rider balance of Ohio Power Company at a lower cost than the authorized rate of return.

In June, FirstEnergy priced a $445 million deal that was also rated by Moody’s and was underwritten by Goldman Sachs, Citigroup, Credit Agricole and Barclays.  The ‘Aaa’-rated, 1.6-year notes priced at 25 basis points over swaps; the ‘Aaa’-rated, 2.5-year notes priced at 40 basis points; and the ‘Aaa’-rated 13.69-year notes priced at 70 basis points.

FirstEnergy said the deal allowed it to cut rate payer costs by $106 million through 2035; that exceeded the $104 million nominal cost saving that was included in the securitization financing order.
Despite these savings, the two utility deals priced wide of deals backed by consumer loans during the same time period.

Money Left on the Table

Saber Partners, a financial advisory firm for corporate and public-sector entities, published an analysis in August that was critical of the AEP deal. It said that, as a result of using the wrong structure and an “unusual and inappropriate bond comparable in its analysis and decision making process,” pricing on the AEP deal resulted in the utility paying at least $1.3 million more in interest and up to $1.6 million in excess servicing costs.

Unlike securities backed by consumer debt, rate reduction bonds have relatively little credit risk. The bonds are backed by the future collections of special charges applied to electric utility bills; these charges are based on power usage and can vary from year to year, based on the weather or economic conditions.

To protect bondholders from fluctuations in collection, the deals are structured with a “true-up” mechanism that adjusts tariff charges to existing and future retail electric customers to ensure timely payment of the bonds.

Typically the securitization benchmark has priced rate reduction bonds in line with ‘AAA’ rated credit-card ABS. That is because credit card securitizations have, at least in the past, been viewed as a “flight to quality” kind of trade. John McElravey, director of consumer ABS research at Wells Fargo, said this is partly because card deals are issued by bank sponsors with deep pockets.

Before the financial crisis, the rate reduction bonds were typically three to five basis points behind credit cards; during the financial crisis, credit cards were priced wider than the rate reduction bonds. 

For example, the January 2008 CenterPoint Energy Houston Electric bond led by Citigroup priced its five-year notes at 64 basis points over swaps; the 10.52-year notes priced at 94 basis points. Citigroup said in a report at the time, that “each tranche in the CEHE III offering priced approximately 15 to 25 basis points inside of like-maturity credit card securities.”

By contrast, the two Ohio deals priced wide of three July credit cards deals. AEP, for example, cleared its five-year note at 52 basis points.  American Express issued  a five-year, floater that priced at 42 basis points over the one-month LIBOR, Chase did a five-year, fixed-rate card at 42 basis points over swaps and Discover priced a five-year floater at 45 basis points over one-month LIBOR.

McElravey at Wells said that because the AEP deal was a fixed-rate coupon, it probably gave a few basis points of concession when compared to floating-rate paper; nevertheless, the deal still priced 10 basis points wide of the fixed rate credit card paper.

PRAG-Oxford, the financial advisor on the AEP deal, chose the unusual benchmark.