NARUC COMMITTEE ON ELECTRICITY: SECURITIZATION

SECURITIZATION Joseph Fichera

NARUC COMMITTEE ON ELECTRICITY: SECURITIZATION David Sapper

NARUC COMMITTEE ON ELECTRICITY: SECURITIZATION David Svanda

NARUC COMMITTEE ON ELECTRICITY: SECURITIZATION Peter Toomey

NARUC Committee on Electricity – February 14, N A R U C WINTER COMMITTEE MEETINGS February 12-15, 2006 Washington, DC COMMITTEE ON ELECTRICITY SECURITIZATION: The AP experience in West Virginia Peter E. Toomey Director, Rates Allegheny Power

NARUC Committee on Electricity – February 14, AP Background AP had previous experience with securitization from PA stranded cost recovery 2004 Situation –Coal power plant emissions –Depleting allowance bank –Needed to scrub; allowance prices escalating –Capital expenditures needed would be very large

NARUC Committee on Electricity – February 14, Ft. Martin - emissions Source: CPCN filing, March 2005

NARUC Committee on Electricity – February 14, Emissions Allowances Price forecast Source: CPCN filing, March 2005

NARUC Committee on Electricity – February 14, Situation, continued –AP’s overall financial condition severely damaged during the period –Access to traditional utility capital markets was impaired WV Background Non-traditional financing was a good fit for AP, and would result in lowest rate impacts for WV consumers

NARUC Committee on Electricity – February 14, Allegheny approach Introduction of concept* –WV Commission, Staff and CAD –Key legislators, governor –Local grass roots campaign *Included asset ownership transfers for wholly-owned Ft. Martin

NARUC Committee on Electricity – February 14, Legislation Modeled after Wisconsin –AE, PSC Staff, CAD, West Virginia Energy Users Group Presented to sponsor –Draft provided to WV Commission –WV PSC and CAD supportive Bill passed in one legislative session (2005)

NARUC Committee on Electricity – February 14, Regulatory Applications Certificate of Need filed March 2005 –To build wet scrubbers at Ft. Martin plant Most cost effective environmental compliance, vs. switching to PRB or dry scrubbing –Start late 2006, done by Dec –Estimated capital cost $338 million

NARUC Committee on Electricity – February 14, Regulatory Applications Financing application filed May 2005 –Contained proposed details of securitization financing –Estimated bond issuance dates, terms –Itemization of financing costs –Description of mechanics (e.g., adjustment formulae) –Estimated rate impacts by customer class

NARUC Committee on Electricity – February 14, Regulatory Update Extensive negotiations resulted in filing of a settlement on January 11, 2006: –Added a PSC Financial Advisor (FA) role –Structured FA/PSC review process WV PSC Approval pending

NARUC COMMITTEE ON ELECTRICITY: SECURITIZATION Ellen Lapson

Utility Tariff Bonds: Credit Perspectives Ellen Lapson, Fitch Ratings Managing Director NARUC Winter Committee Meeting, Washington DC, February, 2006

Summary >Fitch Ratings is an acknowledged expert on the credit aspects of Utility Tariff Bonds >When properly structured, Tariff Bonds are an effective financing tool that can satisfy the objectives of two sets of investors –Asset-backed securities (ABS) investors –Utility corporate investors and creditors

ABS Investors’ Perspective A Different Breed of ABS Conventional ABSUtility Tariff Bonds Assets A pool of receivables incurred by specific obligors A right to collect special tariffs that will be allocated to future customers based on a law and/or financing order Risks Delinquent collections; charged-off receivables; recovery risk Legal or regulatory overturn; Extreme change in customer base or demand for service Credit SourceStructuring features: over- collateralization, subordination, cash reserve, excess spread Periodic resetting of the dedicated tariff (true-up) PerformanceVariesLimited history. Since 1995, no defaults and fared well under stress.

ABS Investors’ Perspective Checklist: Essential Features Non-bypassable charge for delivery network service Irrevocable by future legislatures or PUC orders Special tariff is a legal property right ‘True sale’ of the asset to a bankruptcy-remote financing vehicle > Any successor to the utility must continue to bill and collect the tariff Tariff true-up mechanism Cash flow model passes Fitch ‘AAA’ stress case

ABS Investors and Utility Corporate Investors Limit the Size of Special Tariff The tariff true-up is most effective when the total special tariff component is a small part of customer’s total cost –In 58% of ‘AAA’ transactions, the total special tariff billing component amounted to 8% or less of total customer cost. –Fitch expects that the special tariffs in ‘AAA’ transactions will aggregate well below 20% of the total customer utility cost.

Utility Corporate Investors’ Perspective Potential Effects of Tariff Bond Financing Positive Removes uncertainty about an intangible asset Positive If utility needs cash: Provides immediate cash Positive If utility would otherwise not earn a profit on the regulatory asset: Eliminates a non-earning asset Positive And does so at relatively low cost to utility consumers Neutral Fitch deconsolidates the Tariff Bonds and the related interest expense and revenues when calculating corporate credit ratios. Negative If utility would otherwise earn a return on the regulatory asset: Eliminates an earning asset Negative If a large charge, reduces pricing future flexibility and subordinates unsecured bondholders, so don’t overdo it. (Consistent with ABS investor concerns)

Potential Applications for Tariff Bonds Favorable >Storm recovery >Environmental remediation or societal benefit investments Questionable > gas costs; deferred energy costs >Permanent layer of utility capital structure

For more information: >“Utility Tariff Monetization Bonds Revisited”, Criteria Report, Aug. 22, 2005 >“Utility Tariff Monetization Bond Performance Review”, Special Report, Aug. 22, 2005 >“U.S. Power and Gas 2006 Outlook”, Special Report, Dec. 15, 2005 >“U.S. Power and Gas Outlook for Key Credits”, Special Report, Jan. 11, 2006 >“Rising Unit Costs – A Threat to Utility Industry Credit”, Special Report, Nov. 4, 2005

Fitch Ratings London Eldon House 2 Eldon Street London EC2M 7UA UK New York One State Street Plaza New York, NY FITCH The Fitch GroupFitch Ratings Algorithmics Fitch Training

NARUC COMMITTEE ON ELECTRICITY: SECURITIZATION