N.J. Utility Shows How to Offset Deregulation Costs

Why the CFO of PSE&G says his asset-backed issue will help him to avoid the fate of California's utilities.
Ed ZwirnJanuary 30, 2001

A $2.5 billion asset-backed security (ABS) by PSE&G Transition Funding, a special vehicle of New Jersey’s Public Service Electric & Gas, is the latest example of a new use increasingly being given to an existing funding mechanism.

The deal, which priced Jan. 25, effectively reimburses the utility up front for some of the costs incurred by the state’s “deregulation” program, which started last year.

The offering is the first ABS tried by the New Jersey utility, and, according to CFO Robert Busch, will greatly help the firm trim costs and easily avoid the kinds of problems experienced by some of its counterparts in other states where deregulation has been attempted, particularly in California.

Many ABS Uses, Some Novel

The ABS market, which is expected to reach a total $230 billion of issuance in the U.S. this year, has long been used to give an “up front” payout to an individual or corporation not wanting to wait for an anticipated cash flow to trickle in.

In general, a multi-tranche bond issue is constructed giving the issuer the present value of various future cash flows. In return for the promise to turn over these flows, with interest, the issuer gets the total face value of the bonds, less any fees.

Common uses have been to give firms quick cash in return for leases they hold, their credit- card receivables and vehicle loans. Other novel uses include so-called Bowie bonds, named after the rock star David Bowie, who first sold them in exchange for his future royalties; and lottery and “structured settlement” deals, which give Quick Pick winners and those expecting a windfall payout over the next, say 20 years, a smaller payoff up front.

The Stranded Cost Conundrum

Another recent ABS use is now coming to the fore as a result of the many attempts by states to “deregulate” their utility markets.

Issuance of stranded utility cost transaction ABS should reach $10 billion this year, up from $1 billion in 2000. This type of deal is so named because it helps utilities avoid negative cash flow on assets that are “stranded,” meaning that a return on investment is no longer guaranteed for them (as was the case when they were built) and they no longer generate a profit.

PSE&G, New Jersey’s largest utility was left with more than $3 billion of such stranded assets last year as a result of deregulation, says Busch.

The “lion’s share” of this total consists of the company’s Salem, Hope Creek, Peach Bottom and Limerick nuclear power plants.

Of this, Busch tells, state regulators allowed for the recovery of $2.9 billion, $400 million through rate increases and the rest from the utility being able to write off the remaining life of the facilities.

“Certain facilities that were put in place before the opening up to a free market have costs,” Busch says.

New Jersey Is No California

The use of ABS, which as a secured lending mechanism allows the issuer to tap the market with a triple-A-rating, has done better than to help PSE&G hold the line on costs. Part of the money will be used to grant a 2 percent consumer rate decrease, to take effect in February.

The offering, which was lead-managed by Lehman, consisted of eight-tranches with estimated average lives ranging from one year to just over 14 years. Yields vary by maturity, with the shortest segment–$102.9 million–paying 5.462 percent, while the $372.5 million eighth tranche yields 6.947 percent, according to Kevin White at Lehman’s ABS syndicate desk.

Far from being a stopgap funding measure of the kind being proposed for Southern California Edison and Pacific Gas and Electric, Busch says that the new bond is “a strategy that has developed as various states in the U.S. wrestle with [deregulation and stranded costs].”

In addition to New Jersey and California, he says there are similar packages in the works in other states such as Illinois, Massachusetts and Pennsylvania.

But beyond that, the similarities, at least between New Jersey and California, end there, the CFO says.

“New Jersey has a very robust and liquid power market,” he maintains, noting that his state has an 18 percent excess power capacity, while the figure for California is 6 percent.

“There have been more power plants built in New Jersey in the last two years that California has built over the last 12 years,” he says.