FERC Sets Conditions For Utility Debt Issues

CLEVELAND -- - The Federal Energy Regulatory Commission (FERC) must approve the issuance of securities by some utilities subject to its jurisdiction.

In an order dated February 20, 2003, FERC imposed stringent new conditions on these debt issues, which it said will be applicable to all future cases.

FERC stated that, in order to prevent public utilities from borrowing substantial amounts of money and diverting the proceeds to finance non-utility businesses, the new conditions will apply to all issuances of secured and unsecured debt authorized by the Commission.

The conditions are designed to ensure that future issuances of debt are compatible with the public interest and will not impair a public utility's ability to perform its duties and provide appropriate ratepayer protection.

The new conditions were announced in a decision approving the issuance of up to $650 million in long-term, unsecured debt by Westar Energy, Inc. The Commission directed Westar, the largest electric utility in Kansas, to file quarterly status reports detailing its financial condition and debt-reduction efforts. The FERC proceeding drew intervenors including the Kansas Corporation Commission and MBIA Insurance Company, a bond insurance company that insures a significant amount of Westar obligations.

The new conditions announced by the Commission are:

- Public utilities seeking authorization to issue debt backed by a utility asset must use the proceeds of the debt for utility purposes only.

- If any utility assets that secure debt issuances are "spun off," the debt must follow the asset and also be spun off.

- If any of the proceeds from unsecured debt are used for non-utility purposes, the debt must follow the non-utility assets.

- If the non-utility assets are spun off, then a proportionate share of the debt must follow the spun-off non-utility asset.

- If utility assets financed by unsecured debt are spun off to another entity, then a proportionate share of the debt must also be spun off.

The Commission's authority over utilities' issuance of securities or assumption of liabilities is found in section 204 of the Federal Power Act. Section 204 only applies to electric utilities regulated by FERC. Under that section, the Commission must find that the proceeds of the issue will be used for a lawful purpose, that the request is compatible with the public interest, and that the utility is financially viable.

The new conditions could have a significant impact on electric utilities seeking to disaggregate their generation or transmission assets. Bondholders may not accept provisions that would allow the utility to move the debt from one entity to another to meet FERCs conditions. Unless the debt can be assumed by the transferee of transferred assets, it likely will be necessary for the utility to retire the obligations. This could involve paying expensive pre-payment penalties. Utilities that are subject to the new FERC conditions and that may want to restructure their operations will have to evaluate carefully any new debt issue to determine what impact it may have on their future plans or flexibility.

The Commissions rules may have relatively limited impact because many utility debt issuances are exempt from FERC approval. Under Section 204, an issuance is exempt from FERC approval if it is approved by applicable state public utility commission. Most state commissions have jurisdiction to approve long-term debt issuances by electric utilities, whether or not the debt is secured. Many state commissions lack authority to approve short-term debt, and so utilities generally must seek FERC approval for such issuances. Thus, the new conditions may be applicable to a greater number of short-term debt issues, but the impact on corporate restructuring would likely not be as great because the short-term debt would be easier to retire or refinance in connection with a restructuring than would be the case for long-term debt.

Another class of utility exempted from the new FERC conditions will be electric utility subsidiaries of holding companies registered under the Public Utility Holding Company Act of 1935 ("PUHCA"). Under Section 318 of the Federal Power Act, if a utilitys security issuance is subject to approval by the Securities and Exchange Commission under PUHCA, it is exempt from FERC approval.

The SEC has been imposing increasingly tight restrictions on its approvals of securities issuances by registered holding companies and their subsidiaries for many of the same reasons cited by FERC in its February 20th decision. To date, however, the SEC has not focused on the "debt follows the assets" tests now imposed by FERC.

The collapse of Enron and the financial troubles of many utilities and marketers are resulting in numerous changes in the regulation of electric utilities. This FERC order is the latest, but probably not the last, in a line of new, tougher financial requirements.