Securitization Transactions

Securitization Transactions

October 01, 2005

Securitization transactions by utilities are okay in some circumstances, the IRS said, but the agency said it will not rule on others.

Many utilities in the United States were left with “stranded costs” when US electricity markets deregulated in the 1990s. Utilities recover the costs of their assets over time through the rates they charge their customers. Electric and gas utilities have historically had a monopoly on the supply of electricity or gas in their service territories. As part of deregulation, some states let customers buy from other suppliers. This left the utilities with too little base to collect fully for existing assets. Some states let utilities add surcharges to utility bills to collect for their stranded costs. The utilities converted these future revenue streams into cash immediately by borrowing against them.

One issue in such transactions is whether the utility must report the accelerated rate recovery — through the securitization transaction — as income. The IRS said no in a series of private letter rulings to individual utilities and then ultimately in a “revenue procedure” in 2002 on which all utilities could rely.

The IRS revised the revenue procedure in August.

The new revenue procedure makes clear that securitization transactions can also be done on other types of charges that utilities are allowed by their regulators to collect, but the IRS said the transactions must be structured to fit in a “safe harbor.” Transactions that fall outside the safe harbor are out of luck; the IRS will not issue any more rulings.

To fit in the safe harbor, the securitization can only cover specific charges that the utility has been authorized by a state legislature in special legislation to recover. The special legislation must say five things described in the new revenue procedure. In addition, the financing entity set up to borrow under the securitization must be wholly-owned — directly or indirectly — by the utility. The utility must have an equity interest in it of at least 0.5% of the money raised. Debt service payments on the securitization loan must be made on a quarterly or semiannual basis. The new rules are in Revenue Procedure 2005-61.

Keith Martin