SOURCE: Saber Partners, LLC

Saber Partners Sees Strong Investor Demand for FirstEnergy Pass-Through Certificates

Very Low Coupons But Will High Quality Get Credit Spreads They Deserves

NEW YORK, May 21, 2013 -- According to a Securities and Exchange Commission filing, three Ohio subsidiaries of FirstEnergy Corp. - The Cleveland Electric Illuminating Company, Ohio Edison Company and The Toledo Edison Company - are planning to offer up to $505 million of Pass-Through Certificates. The certificates represent undivided interests in a trust that includes debt instruments issued by three separate special purpose vehicles formed to facilitate the transaction.  See "FirstEnergy Ohio PIRB Special Purpose Trust 2013"


Traditional but Complex

The new offering is a form of "utility securitization" first introduced to the market in 1997 according to Saber Partners, LLC a New York advisory firm that has participated in the structure, marketing and pricing of about $8 billion of similar offerings in 5 states.  In 2011, the Ohio legislature passed special legislation to allow the Public Utilities Commission of Ohio to authorize and approve Ohio utilities to sell bonds to recover certain costs incurred in providing electric services.


While the First Energy's proposed structure is more complex than almost all previous utility securitizations, it appears to follow the basic rules for utility securitizations:


  1. A special ratepayer obligation charge ("ROC") is imposed on certain consumers' electric bills which can't be avoided;
  2. A mechanism to adjust that ROC periodically as needed to ensure payments of interest and principal when due; and
  3. Special legal protections to make the adjustment mechanism irrevocable and enforceable for the benefit of bondholders.

High Credit Quality

The bond certificates will likely receive the highest investment grade ratings from the rating agencies.  Given that, as the recent Apple Corp. debt offering (only AA rated) demonstrated, there is strong investor demand for high-quality, fixed-rate investments, Saber believes this offering should be well received.


Market participants judge the real success of any bond offering by the narrowness of the credit spread (the interest rate premiums above US treasury benchmarks} that investors require to own a security,  Current credit spreads for corporate and utility bond offerings - the best comparables to this bond - are historically narrow or "tight.".  Institutional investors are looking for high-quality fixed income investments, and there is a limit to the amount of US treasuries and U.S. Agency debt that they want to buy. 


In the lower rated Apple offering, credit spreads were particularly narrow. In that multi-tranche offering, investors accepted rates only 0.20% percent higher than three-year US Treasuries and just 0.75% higher than 10-year U.S. treasuries.  Even at these levels, the bonds were still three times oversubscribed suggesting that the spreads could have been even lower.   


West Virginia Utilities Show the Path for Tight Pricing Post-Credit Crisis


In addition to Apple and Johnson & Johnson (AAA/Aaa), the 2009 and 2007 utility securitizations in neighboring West Virginia provide excellent comparables for the FirstEnergy offering. About $600 million AAA/Aaa utility securitization bonds were issued by Potomac Edison (through "PE Environmental Funding") and Monongahela Power (through "MP Environmental Funding"), subsidiaries of then Allegheny Energy.  (FirstEnergy owns these subsidiaries now.)


Rather than use the more complex pass-through certificates structure, the two West Virginia issuers each sold Environmental Control Bonds (ECB) ROC bonds directly to investors. FirstEnergy may be trying to increase tranche sizes as smaller tranches sometimes require higher credit spreads. However, this was not the West Virginia experience. 


Furthermore, unlike the pending FirstEnergy certificates, MP and PE Funding did not sell their bonds as "asset-backed securities" as defined by the SEC.  This helped expand the market for the 2007/2009 MP and PE Funding bonds because some investors compare utility securitizations to bonds backed by receivables like credit cards and require higher spreads. The West Virginia Bonds were also TRACE eligible to provide transparency and had a favorable "risk weighting" under the Basel accords that helped bring foreign investors into the distribution.


Long-Dated Utility Securitizations in Demand

Both the 2009 and 2007 Allegheny Energy ECB offerings received the narrowest credit spreads ever for a AAA/Aaa utility securitization of similar maturities.  The 2009 offering was also the longest maturity of any utility securitization (19 year weighted average life), and credit spreads were similar to where AAA-rated Johnson & Johnson bonds were trading at the time - or 0.62% above 30-year US Treasuries.  The spread to AAA US Agency debt was even tighter: only 0.18% above comparable US Agency bonds. It was even much narrower than shorter-term utility securitizations sold in Texas around the same time for Entergy (ETR) and CenterPoint (CNP).


The FirstEnergy Ohio bond structure is more complex, and its description and disclosure of the various components comprising the securitization are different from the MP and PE Funding transactions.  How investors will react to these differences remains an open question.


Higher Cost for Electricity Customers on Some Items Don't Affect Bondholders


A possible indication of the complexity of the upcoming transaction is that FirstEnergy will receive two times the normal fee seen in previous utility securitizations for acting as servicer of the bonds.  Customers will pay the utilities 10 basis points on the principal amount per year vs. 5 basis points for the MP and PE Funding ROC bond transactions.  (There also does not seem to be a corresponding offset above actual cost associated with other utility customer rates that were a part of the West Virginia transactions.)


Coupons on the FirstEnergy pass through certificates should be historically low for utility securitizations given the historically low prevailing rates for benchmark U.S. Treasury and U.S. Agency debt thanks to the Federal Reserve.  But the key indicator to watch is whether their credit spreads will match the historical lows achieved in the West Virginia transaction and improved market conditions.


Future Looking Good for More Supply of Utility Securitizations


However, for investors looking for high quality, stable cash flow investments, these bonds are hard to beat and aren't offered frequently.  They are generally "museum pieces" for "buy and hold" investors not looking for a trading vehicle.


Saber Partners expects more utility securitizations to occur.  Utilities, their regulators and state legislators want to lower electricity costs to consumers.  Securitization can used to recover storm related costs from Superstorm Sandy as well as environmental and other costs.  Properly structured and marketed, Saber Partners believes this is the best financing vehicle available for utilities and their customers.           


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SOURCE Saber Partners, LLC


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