by Simone Baribeau
The backing for FirstEnergy subsidiaries’ unsecured municipal debt is more diverse than the secured debt, according to a hedge fund manager and a company spokesperson, leading to disparate prices among unsecured debt.
The importance of the difference between the debt has come to the forefront after First Energy President Charles E. Jones raised the specter of bankruptcy for First Energy Solutions (FES), the competitive energy subsidiary of First Energy, on an investors’ call last month.
FES and its subsidiaries have USD 141.3m in secured municipal debt outstanding on the open market and JPMorgan held another USD 470.9m as of the August remarket, according to a Debtwire Municipals’ review of FES’s official statements and regulatory filings. By contrast, it has some USD 1.7bn in unsecured municipal debt, issued by four different entities, the review found. Most of the issuers sold debt backed by both FE Generation, which runs coal-powered facilities, and FE Nuclear Generation, which runs FE’s nuclear facilities. Debtwireidentified outstanding bonds using a 30 June long-term debt summary and more recent regulatory filings.
Universal problems, unique severity
The entire utility industry faces the same problems as First Energy: As natural gas prices have fallen—and are expected to remain low—the price of electricity has dropped, said a holder of FE Generation’s secured municipal debt. That has left unregulated electricity producers, who more often sell on the spot market rather than using long-term contracts, at the mercy of price volatility. This leaves them in a weak negotiating position whenever their existing contracts expire, the current bondholder said.
“[This impacts] the whole electric utility sector, it’s really not them,” a former holder of FES subsidiaries’ municipal debt said. “They just happen to be the worst of the worst [largely because of] where their geographic footprint is. They got caught at a bad place at a bad time; it doesn’t mean it can’t happen to other utilities.”
FES is also in a weaker position than its sister subsidiary Allegheny Energy Supply (AES) Company, because it has more contracts that are set to end in the next year or two, leaving it subject to low spot prices, said the current bondholder.
“First Energy is on this extreme side of being an independent power producer,” said the current bondholder. “The market is heavily weighted to believe they’ll have to restructure.”
While the secured debt has a mortgage loan on all of First Energy Generations assets, the unsecured debt is backed by revenues the authorities collect from the companies under different loan agreements – so not all unsecured debt is the same. One similarity between all unsecured debt though: FES, First Energy Generation, and First Energy Nuclear Generation cross guarantee all of the municipal debt.
Secured debt is trading at much higher prices than unsecured debt: A USD 141.3m tranche due in 2018 last sold in round lots on 7 December at 92.5, yielding 11.3%, according to Electronic Municipal Market Access (EMMA).
The most dramatic difference between the debt is whether it has a mortgage lien on FES assets or not. The debt secured by the property has lost much less of its value.
In a bankruptcy, liens on assets are generally respected, and the sale of the asset or revenue generated by it, would likely go to the bondholders, said Jim Spiotto, managing director of Chapman Strategic Advisors LLC and Kenneth Klee, who represented Jefferson County in its Chapter 9, and Judge Steven Rhodes, who oversaw Detroit’s bankruptcy. Where those liens don’t exist, money would trickle down through the waterfall of company obligations.
“The secured debt has a lien on collateral that’s available to debt service, unsecured just has residual on the estate,” Klee said. “So there’s a huge difference.”
But that doesn’t mean all unsecured debt is acting the same: there’s a plethora of different issuers for unsecured debt for First Energy and its subsidiaries. First Energy Generation, for instance, has USD 214.7m in pollution control bonds outstanding sold through the Beaver County Industrial Development Authority; USD 69m through the Pennsylvania Economic Development Financing Authority; USD 461.5m through the Ohio Air Quality Development Authority; and USD 90.1 through the Ohio Water Development Authority, according to Debtwire’sanalysis.
On the nuclear side, FE Nuclear Generation has USD 335.5m in unsecured debt outstanding through the Beaver County Industrial Development Authority, USD 88.8m through the Ohio Air Quality Development Authority; and USD 417.4m through the Ohio Water Development Authority.
The last round lot trades for the four tranches of FE Generation that sold this month ranged from 44.5 cents to 50 cents, according to EMMA. Most of the yields were unavailable. The last round lot trades for the two tranches of FE Nuclear Generation that traded this month ranged from 46 cents to 46.25 cents, according to EMMA. No yields were available.
Debtwire’s analysis does not include the 690.8m in corporate debt sold by First Energy Solutions. It also considers only debt secured by a mortgage lien to be secured debt.
The agreements for the unsecured debt differs, said the FE spokesperson. A FY15 10-K says that some agreements related to the facilities are “substantially similar” but differentiates between at least three agreements.
The loan agreements may not be tied directly to the revenue streams at any particular facility: one loan agreement, available on page 471 of a 551 page 2006 10-Q, for FirstEnergy Generation Corps’ Ohio Water Development Authority’s USD 90.1m issuance does not say that facility revenue backs the loan payment and identifies no specific revenue stream.
Rather, it says that FE Generation “agrees to repay the loan made by the issuer under Section 4.1 in installments which, as to amount, shall correspond to the payments of principal on the bonds and, if applicable, any redemption price and shall bear interest at the rate or rates and at the times payable on the bonds.”
Even so, the specific loan agreements that back the debt may not matter much in the event of a bankruptcy, said the former bondholder. The debt is likely to be thrown into the same pot, the former bondholder predicted, an event known as substantive consolidation.
“Once you pay off the secured the rest are going to be fighting over what’s left,” the former bondholder said.
AES is generally seen as a stronger company than FES. They both have unregulated components, but the stress that FES is under is greater because of its location and because it has fewer long-term contracts, said the current bondholder. But that doesn’t mean AES would remain entirely untouched: AES will likely offer to sell its Pleasants nuclear plant to Mon Power, a separate West Virginia facility that is short on power, Jones said. The company is also open to selling or shutting down gas and hydro units at AES, he said.
A spokesperson for First Energy decline to say whether an FES bankruptcy could affect its affiliates, saying that it “wouldn’t be appropriate to speculate about hypothetical bankruptcies.” But, she noted, “FES, AES, and FE Corp are each separate and distinct legal entities.”
And they’re trading differently too: A USD 142m tranche of unsecured Series 2007F 5.25% AES municipal debt sold by the Pleasants County West Virginia Pollution Control Authority last traded in round lots yesterday (8 December) at 97, yielding 5.492, a far stronger price than First Energy Generation’s secured or unsecured debt.
But in the event that FES filed for bankruptcy protection and AES didn’t, AES may still be affected, said Spiotto and Klee. If there are any debts owed between the facilities or to the parent company, that debt can be modified in bankruptcy, and potentially subordinated if the related company is found to be a “controlled person,” said Spiotto.
Corporate debt—ostensibly parity debt with FES’ unsecured munis—has also been trading at a discount. One possible reason is that municipal debt may be treated as senior in a restructuring, said the former bondholder and a distressed debt analyst. While all the debt is guaranteed by FES, FG and FNG, muni debt could be viewed as closer to the assets, and therefore treated better, the former bondholder and the distressed debt analyst said.
But that would mean that the corporate debt should be selling at near zero, said the current bondholder. More likely, the corporate bondholders have been faster to react to the risks than muni bondholders have, the current bondholder said.
“[The] muni market is sluggish; it doesn’t move as fast as the corporate market,” the current bondholder said.
Another possible reason for the difference in trading is that bondholders are hedging: going short on corporate debt while going long on munis, which could be driving the price of the corporate debt down.
CLICK HERE to view the FirstEnergy Generation, LLC and FirstEnergy Nuclear Generation, LLC capital structures.