By the Numbers
Stranded asset securitizations as a long-duration alternative
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.
For benchmarked ABS managers, Bloomberg’s decision last October to add stranded asset securitizations to the ABS index extended overall ABS index duration by more than half a year and increased the average OAS by 5 bp. ABS managers now have to grapple with this longer duration, and that invites an interesting relative value discussion of stranded assets as a ‘AAA’ alternative to lower-rated utility bonds.
Background on stranded asset securitization
Stranded asset securitization originated in the mid-1990’s as a tool for utility companies that owned aging or obsolete assets. Those assets could include coal and nuclear power facilities, analog metering technology, or natural gas facilities. Driven in part by an accelerating transition to lower-emission power, those assets could end up getting ‘stranded’ as infrastructure upgrades made them obsolete. Policymakers wanted to give utilities incentives to upgrade and recognized a public interest in bearing the cost. Many state legislatures passed laws allowing utilities to charge customers fees to cover the financing cost of upgrades and then securitize the stream of fees.
A stranded asset trust property, created through an irrevocable and non-bypassable financing order issued by the associated state legislature, represents the right to impose, collect, and receive securitization charges from electric customers in an amount sufficient to pay principal and interest. The charges show up as a separate fee on a customer’s monthly utility bill, are collected by the respective utility company and are assigned to the trust. These charges are amended periodically through the transaction structure’s ‘true-up’ mechanism to account for shortfalls in collections, underpinning the stability of monthly trust receipts, and consequently, timely noteholder repayment. This typically gives the utility access to ‘AAA’ financing.
A surge in issuance
A confluence of factors—from increasingly frequent bouts of extreme weather to a more constructive policy backdrop for renewable energy—has catalyzed the primary market for stranded asset ABS. Issuance in 2022 topped $21 billion, four times the aggregate volume seen in the preceding eight years (Exhibit 1). And 2023 has already priced $5 billion across two deals.
Exhibit 1: A surge in primary market volume in stranded asset ABS
Source: Finsights, Amherst Pierpont Securities
Initial performance
Comparing the total return performance for stranded asset ABS since last October, when Bloomberg added the sector to the ABS index, highlights the return potential. Stripping out duration and looking strictly at the spread performance, stranded assets tightened almost 13 bp while the overall ABS index widened by 4 bp (Exhibit 2). In comparison to the albeit lower quality Bloomberg Utilities Index, spread performance on stranded assets lagged by roughly 11 bp. But the longer duration of stranded assets helped the sector outperform the total return on the utilities index by 81 bp through the first three months of this year and by 103 bp over the last six months.
Exhibit 2: Index statistics and performance as of 3/31/23
Source: Bloomberg, Santander US Capital Markets
Recently issued 10-year stranded asset ABS looks especially compelling versus similar-maturity first mortgage utility debt (Exhibit 3). As of March 14, the Entergy Corp-sponsored ABS that priced in late March picks up 14 bp in OAS and 15 bp in yield compared to Centerpoint Energy’s first mortgage bonds that had priced the day before.
Exhibit 3: Secondary pricing as of 4/14/23
Source: Bloomberg, Santander US Capital Markets
Relative value to other longer assets
With virtually no index-eligible ABS structures extending beyond a 5-year legal final maturity, stranded asset securitizations are one of the few tools available for ABS managers to express a meaningful relative value view against other long-duration assets across a fixed income portfolio.
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