SECURITIES AND EXCHANGE COMMISSION
(Release No. 35-27821; 70-10193)
Pennsylvania Electric Company, et. al.
Order Authorizing Formation of Special Purpose Entity and Sale of Customer Accounts Receivables
March 24, 2004
Metropolitan Edison Company ("Met-Ed") and Pennsylvania Electric Company ("Penelec"), each of Akron, Ohio and direct wholly-owned public-utility subsidiaries of FirstEnergy Corp. ("FirstEnergy"), a registered holding company under the Public Utility Holding Company Act of 1935, as amended ("Act"), and Pennsylvania Power Company ("Penn Power") of Akron, Ohio, an indirect wholly-owned public-utility subsidiary of FirstEnergy, have filed with the Securities and Exchange Commission ("Commission") an application/declaration under sections 6(a), 7, 9(a)(1), 10, and 12(b) of the Act and rules 43, 45, 46 and 54 under the Act ("Declaration"). Met-Ed, Penelec and Penn Power are referred to individually as an "Applicant," and collectively as the "Applicants." The Commission issued a notice of the filing of the Declaration on February 12, 2004 (Holding Company Act Release No. 27802). No request for hearing was received.
The Applicants seek authority to form and acquire all of the membership interests in separate Delaware limited liability companies (each an "SPE" and collectively "SPEs") to which Met-Ed, Penelec and Penn Power will sell their respective customer accounts receivables ("Receivables"). Each SPE will be a single-member limited liability company, will have nominal capital (except as described below) and will not conduct any business operations or own any assets other than the Receivables purchased from, or contributed by, its parent. The SPEs are intended to be bankruptcy-remote vehicles that will enable the Applicants to isolate their Receivables so that they will not be generally available to creditors of the Applicants. The Applicants believe that the transactions will be treated as secured borrowings and, as a result, the Receivables and the associated indebtedness of the Purchasers (defined below) will be reflected on the Applicants' respective consolidated financial statements.
Each Applicant will enter into a substantially identical Receivables Sale Agreement ("RSA") with its respective SPE. Each SPE, in turn, will enter into a Receivables Purchase Agreement ("RPA") under which the SPE will fund its purchase of Receivables by selling, on a revolving basis, undivided ownership interests in the pool of Receivables that it owns to a conduit established to issue and sell commercial paper ("Conduit") and/or one or more financial institutions (collectively, "Purchasers") through Bank One, NA, acting as agent ("Agent"). The maximum purchase commitment of the Purchasers under the RPAs is $80 million in the case of Met-Ed, $75 million in the case of Penelec, and $25 million in the case of Penn Power.
Under each RSA, an Applicant will sell and assign to its respective SPE all of its right, title and interest to its Receivables (together with any security that may have been obtained from customers and collections by the Applicant on the Receivables). The Receivables will be sold to the SPE without recourse (except as described below), at a discount using a discount factor to be determined from time to time based on, among other factors, the SPE's cost of funds (as described below), which takes into account the Applicant's credit rating, and the risk of non-payment by the obligors on the Receivables (i.e., the Applicant's loss experience on its accounts receivable).
Although Receivables will be sold by each Applicant to its respective SPE without recourse, the SPE will be entitled to a credit equal to any reduction in the amount of any Receivables resulting from (1) any defective or rejected goods or services, any discount or any adjustment or otherwise in the amount of any Receivable, or (2) any setoff in respect of any claim affecting the Receivables. In addition, if any of the representations or warranties made by the Applicant in the RSA are no longer true with respect to any Receivable, the SPE will be entitled to a credit against the purchase price for the Receivable in an amount equal to its outstanding balance. Each Applicant has the right to terminate the RSA upon giving fifteen business days written notice to the SPE.
Each SPE will finance the purchase of the Receivables, first, using the funds obtained from Purchasers under the related RPA (as described below), second, by delivery of the proceeds of a subordinated revolving loan by the SPE's parent (a "Subordinated Loan"), and third, by accepting a contribution of Receivables to its capital from its parent in an amount equal to the remaining balance of the purchase price for the Receivables. The note evidencing the Subordinated Loan will bear interest at a rate, which is the higher of (1) the rate of interest per annum determined by the Agent from time to time as its prime commercial lending rate and (2) the federal funds effective rate plus .50%.
The amount of Receivables originated by an Applicant will vary from month to month based on electricity usage by its customers. As a result of this and other factors, the funds available to an SPE to purchase Receivables may not match the cost of Receivables available for sale. The use of the Subordinated Loan/capital contribution mechanism is intended to address this periodic mismatch. When the amount of Receivables available for sale by an Applicant exceeds the amount of cash its SPE has available, the excess will be purchased by the SPE with the proceeds of a Subordinated Loan and/or by accepting a capital contribution of Receivables. Conversely, if, after payments of all amounts due the Agent and the Purchasers, an SPE develops a cash surplus due to collections of previously purchased Receivables (or Receivables received as a contribution) exceeding the balance of newly created Receivables available for purchase, the surplus funds will be used to repay the Subordinated Loan and/or make a cash distribution. Through this mechanism, it is expected that the SPEs will not retain substantial cash balances at any time and that substantially all cash realized from the collection of the Receivables (net of the costs of the program) will be made available to the Applicants.
Under each RPA, the SPE is obligated to pay: (1) the Agent various fees (including fees paid to the Agent and the Conduit under a fee letter); (2) fees and costs to each Applicant for the service provided in billing and collecting on the Receivables the Applicant sold to the SPE (described further below); (3) amounts required to reduce the interests in the Receivables purchased by the Purchasers, (4) amounts required if the representations and warranties regarding the Receivables are no longer true; (5) broken funding costs (e.g., damages incurred to prepay any London Interbank Offered Rate ("LIBOR") borrowings); (6) default fees; and (7) amounts payable as yield ("Yield") on the capital at any time associated with the undivided interest in purchased Receivables. The Yield for any interest accrual period that will be applied to capital provided by financial institutions that are Purchasers shall be an amount equal to the product of the applicable bank rate (either (1) LIBOR, plus a spread (that will vary depending on the then current ratings by Standard and Poor's Ratings Services and Moody's Investor Service, Inc. for the senior secured long-term debt securities of the Applicants, not to exceed 3.50% per annum) or (2) a rate, which is the higher of (a) the rate of interest per annum determined by the Agent from time to time as its prime commercial lending rate and (b) the federal funds effective rate plus .50%), multiplied by the capital invested. The Yield for each month that will be applied to capital provided by the Conduit shall be an amount based on the effective cost of funds on promissory notes issued by the Conduit in the commercial paper market.
Each Applicant is designated as the servicer under the RPA to which it is a party. Thus, the transactions described above will have no effect on the services each Applicant provides to its customers. Among other things, each Applicant will continue to bill and collect all of its utility service accounts receivable in accordance with its current credit and collection policies. As compensation for the services it renders, each Applicant (as servicer) will be paid a monthly servicing fee equal to .25% of the aggregate outstanding balance of all Receivables during the month. Upon the occurrence of certain events, including, among others, a failure by an SPE to pay indebtedness or other fees when due or to perform or observe certain covenants under the RPA, an event of insolvency affecting an SPE or an Applicant, or the failure by an Applicant to maintain certain debt coverage and capitalization ratios, the Agent would have the right to designate a new servicer.
The proposed transaction will provide the Applicants with an additional source of funds, and will save Met-Ed and Penelec approximately 50-125 basis points over the cost of conventional financing and Penn Power approximately 40-115 basis points over the cost of conventional financing. Based on present market conditions, the Applicants estimate that the current cost of the funds available under the Receivables program is 1.545% in the case of Met-Ed and Penelec and 1.645% in the case of Penn Power, as compared to the estimated costs to the Applicants of bank financing (2.75%) and a one-year floating rate note (approximately 2%).
Proceeds of the Receivables sale program will be used by the Applicants for general corporate purposes.
Each Applicant represents that it will not sell any Receivable to its SPE unless, at the time of any sale and taking into account the application of any sale proceeds, common equity as a percentage of consolidated capitalization of the Applicant (as reflected on the balance sheet contained in each Applicant's most recent report on Form 10K or Form 10Q filed with the Commission under the Securities Exchange Act of 1934, as amended, and including short-term debt and the current maturities of long-term debt) is 30% or higher. Applicants request the Commission to reserve jurisdiction over the proposed transactions in those circumstances where any Applicant does not comply with the 30% common equity criteria.
The proposed transactions are subject to the requirements of rules 53 and 54 under the Act. Under rule 53(a), the Commission shall not make certain specified findings under sections 7 and 12 in connection with a proposal by a holding company to issue securities for the purpose of acquiring the securities of, or other interest in, an exempt wholesale generator ("EWG"), or to guarantee the securities of an EWG, if each of the conditions in paragraphs (a)(1) through (a)(4) of rule 53 are met, provided that none of the conditions specified in paragraphs (b)(1) through (b)(3) of rule 53 exists. Rule 54 provides that the Commission shall not consider the effect of the capitalization or earnings of subsidiaries of a registered holding company that are EWGs or foreign utility companies ("FUCOs") in determining whether to approve other transactions if rule 53 (a), (b) and (c) are satisfied.
FirstEnergy currently meets all of the conditions of rule 53(a), except for clause (1). By order dated October 29, 2001 (Holding Company Act Release No. 35-27459) ("Merger Order"), as modified by order dated June 30, 2003 (Holding Company Act Release No. 35-27694) ("June 2003 Order"), the Commission, among other things, authorized FirstEnergy to invest in EWGs and FUCOs as long as FirstEnergy's aggregate investment, as defined in rule 53(a)(1) does not exceed $5 billion. The $5 billion amount is greater than the amount which would be permitted by rule 53(a)(1) which, based on FirstEnergy's consolidated retained earnings, as defined in rule 53(a)(1), of $1.6 billion as of December 31, 2003 would be $800 million. The Merger Order, as modified by the June 2003 Order also specifies that this $5 billion amount may include amounts invested in EWGs and FUCOs by FirstEnergy and GPU, Inc., at the time of the Merger Order ("Current Investments") and amounts relating to possible transfers to EWGs of certain generating facilities owned by certain of FirstEnergy's operating utilities ("GenCo Investments").
Under the Merger Order, the Commission reserved jurisdiction over investment in EWGs and FUCOs, other than the Current Investments and GenCo Investments, that exceed $1.5 billion. As of December 31, 2003, and on the same basis as set forth in the Merger Order, FirstEnergy's aggregate investment in EWGs and FUCOs was approximately $1.13 billion. Additionally, as of December 31, 2003, FirstEnergy's consolidated retained earnings were $1.6 billion. By way of comparison, FirstEnergy's consolidated retained earnings as of December 31, 2002 were $1.52 billion.
With respect to rule 53(b), none of the circumstances enumerated in subparagraphs (1), (2) and (3) have occurred. For the reasons given above, the requirements of rule 53(c) are satisfied.
As a result, the Commission has considered the effect on the FirstEnergy system of the capitalization or earnings of any FirstEnergy subsidiary that is an EWG or FUCO in determining whether to approve the proposed transactions. Applicants state that since the date of the Merger Order, there has been no material adverse impact on FirstEnergy's consoliated capitalization resulting from its investments in EWGs and FUCOs, and the proposed transactions will not have any material impact on FirstEnergy's capitalization. As of December 31, 2003, FirstEnergy's consolidated capitalization consisted of 40.1% common equity, 1.6% cumulative preferred stock, 55.8% long-term debt and 2.5% short-term debt. As of December 31, 2001 those ratios were as follows: 30.3% common equity, 3.1% cumulative preferred stock, 63.1% long-term debt and 3.5% short-term debt.
Since the date of the Merger Order, FirstEnergy's investments in EWGs and FUCOs have contributed positively to its level of earnings, other than for the negative impact on earnings due to FirstEnergy's writedowns of its investments in Avon Energy Partners Holdings and GPU Empresa Distribuidora Electrica Regional S.A. Finally, since the date of the Merger Order, and, after taking into account the effects of FirstEnergy's acquisition of GPU, there has been no material change in FirstEnergy's level of earnings from EWGs and FUCOs. On February 2, 2004 FirstEnergy announced that it had completed the sale of all of its remaining operating FUCO assets.
Applicants state that no state or federal commission, other than this Commission and the Pennsylvania Public Utility Commission ("PaPUC") have jurisdiction over the proposed transactions. Applicants state that the PaPUC has jurisdiction over and has approved certain of the transactions described in the Declaration.1 Applicants state that the fees, commissions and expenses incurred in connection with the proposed transactions (excluding the funding costs and other costs incurred by the SPEs, as described above) are estimated not to exceed $45,000.
Due notice of the filing of the Declaration has been given in the manner prescribed by rule 23 under the Act, and no hearing has been requested of, or ordered by, the Commission. Based on the facts in the record, the Commission finds that, as to the proposed transactions the applicable standards of the Act are satisfied and no adverse findings are necessary.
IT IS ORDERED, under the applicable provisions of the Act and rules under the Act, that the Declaration is permitted to become effectively immediately, subject to the terms and conditions prescribed in rule 24 under the Act.
For the Commission, by the Division of Investment Management, pursuant to delegated authority.
Margaret H. McFarland
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