ITEM 1. BUSINESS
Unless the context otherwise indicates, all references to “Transition Funding,” “we,” “us” or “our” herein mean PSE&G Transition Funding LLC, a Delaware limited liability company located at 80 Park Plaza, Newark, New Jersey 07102.
We were formed under the laws of the State of Delaware on July 21, 1999 and operate pursuant to a limited liability company agreement with Public Service Electric and Gas Company (PSE&G) as our sole member. PSE&G is an operating electric and gas utility and is a wholly-owned subsidiary of Public Service Enterprise Group Incorporated (PSEG). We were organized for the sole purpose of purchasing and owning bondable transition property (BTP) of PSE&G, issuing transition bonds (Bonds), pledging our interest in BTP and other collateral to a debt/security trustee (Trustee) to collateralize the Bonds, and performing activities that are necessary, suitable or convenient to accomplish these purposes.
Following the enactment of the New Jersey Electric Discount and Energy Competition Act (Energy Competition Act), the New Jersey Board of Public Utilities (BPU) rendered a Final Order (Final Order) in August 1999 relating to PSE&G’s rate unbundling, stranded costs and restructuring proceedings providing, among other things, for PSE&G to recover up to $2.94 billion (net of tax) of its generation-related stranded costs including the securitization of $2.4 billion (plus an estimated $125 million of associated transaction costs). The stranded costs represent various generation-related investments and other obligations that were anticipated to be unrecoverable through market-based rates in a competitive electricity generation retail market.
Following the issuance of the Final Order, the BPU issued the Bondable Stranded Cost Rate Order (Finance Order) approving PSE&G’s petition relating to the securitization transaction which authorized, among other things, the imposition of a non-bypassable transition bond charge (TBC) on PSE&G’s customers; the sale of PSE&G’s property right in such charge to a bankruptcy-remote financing entity; the issuance and sale of $2.525 billion of Bonds by such entity as consideration for such property right, including an estimated $125 million of transaction costs; and the application by PSE&G of the Bond proceeds to retire outstanding debt and/or equity.
On January 31, 2001, we issued $2.525 billion of Bonds in eight classes with stated maturities ranging from one year to fifteen years, of which $1.784 billion in five classes remain outstanding as of December 31, 2006. The net proceeds of the issuance were utilized to acquire PSE&G’s property right in the TBC. The Bonds are collateralized by the BTP created under the Energy Competition Act and the related Finance Order. The BTP represents the irrevocable right to recover, through a TBC billed by PSE&G to its retail electric customers within PSE&G’s service territory, an amount sufficient to pay:
the interest, fees, expenses, costs, charges, credit enhancement and premiums, if any, associated with the Bonds; and
the principal amount of the Bonds.
Approximately $230 million of issuance costs were incurred in connection with the securitization transaction, including costs of a hedging arrangement as permitted by the Finance Order. The $105 million in costs in excess of the $125 million of estimated transaction costs included in the BTP were capitalized as provided for in the Finance Order and are being recovered on a subordinated basis by us through the TBC. The initial TBC rate became effective on February 7, 2001, in accordance with the Final Order.
As the TBC is a usage-based charge based on access to PSE&G’s transmission and distribution system, the customers will be assessed regardless of whether the customers purchase electricity from PSE&G or a third party supplier. Also, if on-site generation facilities that are connected to PSE&G’s transmission and distribution system produce power that is delivered to off-site retail electric customers in PSE&G’s service territory, the TBC applies to the sale or delivery of that power.
Payments are made to the bondholders on a quarterly basis. Principal and interest on the Bonds and the excess issuance costs will be paid from the following sources:
TBC collections remitted by the servicer (PSE&G) to the issuer (us);
amounts from any third party credit enhancement;
investment earnings on amounts held in accounts established under the indenture agreement;
amounts payable to the issuer under any interest rate swap agreements; and
other amounts available in the trust accounts held by the trustee.
To the extent that TBC collections are deficient or in excess of the principal and interest on the Bonds, the TBC rate will be adjusted in the following year.
We have no employees. Under the servicing agreement entered into by PSE&G and us, PSE&G, as servicer, is required to manage and administer our BTP and to collect the TBC on our behalf. We pay an annual servicing fee to PSE&G equal to 0.05% of the initial balance of Bonds outstanding. The servicing fee is recovered through the TBC. In addition we pay miscellaneous operating expenses to PSE&G up to $100 thousand per quarter, administration fees up to $31 thousand per quarter and trustee fees up to $4 thousand per quarter. Interest earned on funds in the Capital Subaccount results in Net Income for us and will be periodically remitted to PSE&G in the form of a dividend.
ITEM 1A.
ITEM 1A. RISK FACTORS
The following Factors should be considered when reviewing the business of Transition Funding. These factors could impact the business and cause results to differ materially from those expressed in any statements made by, or on behalf of Transition Funding.
Source of Funds for Payment on the Bonds
The only source of funds for payments on the Bonds will be our assets. These assets are limited to:
the BTP, including the right to collect the TBC and to adjust the TBC at least annually;
the funds on deposit in the trust accounts held by the trustee; and
contractual rights under various contracts.
The Bonds are not insured or guaranteed by PSE&G in any capacity, or by PSEG, any of its affiliates, the trustee or any other entity. Furthermore, it is not anticipated that the Bonds will have the benefit of any liquidity facility or of any third party credit enhancement, such as letters of credit or insurance, although the servicer may obtain insurance or a letter of credit in support of its obligation to remit TBC collections to the trustee. Thus, we must rely for payment of the Bonds solely upon collections of the TBC and funds on deposit in the accounts held by the trustee.
Judicial, Legislative Or Regulatory Action That May Adversely Affect Your Investment
PSE&G has agreed to take legal or administrative actions as may be reasonably necessary to block or overturn any attempts to cause a repeal, modification or supplement to the Energy Competition Act, the BPU financing order or the rights of bondholders, and to resist proceedings of third parties, which, if successful, would result in a breach of PSE&G's representations concerning the BTP, the BPU financing order or the Energy Competition Act. However, there is no assurance that any action PSE&G takes would be successful.
The Law Which Underpins The Bonds Might Be Invalidated By Judicial Action. The Energy Competition Act was adopted in February 1999 and amended in September 2002. In January 2001, PSE&G became the first utility to issue bonds pursuant to the Energy Competition Act. The BTP is a creation of statute. If a court were to determine that the relevant provisions of the Energy Competition Act or the BPU financing order are unlawful, invalid or unenforceable in whole or in part, it could adversely affect the validity of the Bonds or the BTP, or our ability to make payments on the Bonds. Although a judicial determination of that kind will cause PSE&G to indemnify you, the amount of any indemnification might not be sufficient for you to recover all of your loss on the Bonds.
Laws with financing provisions similar to the Energy Competition Act have been enacted in other states, including California, Connecticut, Florida, Illinois, Massachusetts, Michigan, Montana, New Hampshire, Pennsylvania, Texas, West Virginia and Wisconsin. The validity of such legislation has been upheld in those states where court challenges have been made and the judicial process has been completed. A court might yet overturn a similar statute in another state, which might give rise to a challenge to the Energy Competition Act or the BPU financing order. Therefore, legal activity in other states might indirectly affect the value of your investment.
The Energy Competition Act Might Be Overturned By the Federal Government Without Full Compensation. In the past, bills have been introduced in Congress prohibiting the recovery of stranded costs, and Congress could negate the existence or reduce the value of the BTP. Even if this preemption of the Energy Competition Act or the BPU financing order by the federal government were considered a "taking" under the U.S. Constitution for which the government had to pay just compensation to bondholders, there is no assurance that this compensation would be sufficient to pay principal of and interest on the Bonds on a timely basis.
The State, Through Future Legislative Action Might Attempt to Invalidate the Bonds or Their Underlying Assets. Unlike the citizens of the States of California, Massachusetts and some other states, the citizens of the State of New Jersey do not have the constitutional right to adopt, repeal or revise laws by initiative or referendum.
Under the Energy Competition Act, the State of New Jersey has pledged not to impair the BTP. Despite this pledge, the State legislature might attempt in the future to repeal or amend the Energy Competition Act, or, as described below, the BPU may take certain actions that impair the BTP. Costly and time-consuming litigation might ensue from such actions, which might adversely affect the price and liquidity, or the weighted average lives, of the Bonds. Given the lack of judicial precedent, the outcome of any litigation cannot be predicted with certainty and, accordingly, bondholders could incur a loss of their investment.
To our knowledge, no cases addressing these issues in the context of Bonds have been decided. There have been cases in which courts have applied the contract clause of the United States (U.S.) Constitution and parallel state constitutional provisions to strike down legislation reducing or eliminating taxes, parkway tolls, public charges or other sources of revenues servicing bonds issued by public instrumentalities or private issuers, or otherwise reducing or eliminating the security for bonds. Contracts of a state, such as the State Pledge, receive greater protection under federal law than private contracts. Based upon this case law, under the contract clause of the U.S. Constitution, and under the contract clause of the New Jersey Constitution, the State of New Jersey, including the BPU, could not take any action of a legislative character, including the repeal or amendment of the Energy Competition Act, that would substantially limit, alter or impair the BTP or other rights vested in the bondholders pursuant to the BPU financing order, or substantially limit, alter, impair or reduce the value or amount of the BTP, unless that action is (in the context of the State Pledge as a contract of the State) a reasonable exercise of the State of New Jersey's sovereign powers and of a character reasonable and appropriate to the public purpose justifying that action. For example, notwithstanding the State Pledge, it might be possible for the New Jersey legislature, without violating the contract clause of the U.S. Constitution or the contract clause of the New Jersey Constitution, to amend the Energy Competition Act in a manner which temporarily limits the rights of the bondholders in order to serve a significant and legitimate public purpose, such as responding to a national or regional catastrophe affecting PSE&G's service area generally.
Moreover, under the takings clauses of the U.S. and New Jersey Constitutions, the State of New Jersey could not repeal or amend the Energy Competition Act, or take any other action in contravention of the State Pledge, without paying just compensation to the bondholders, if doing so would constitute a permanent appropriation of a substantial property interest of the bondholders in the BTP and deprive the bondholders of their reasonable expectations arising
from their investments in the Bonds. There is no assurance, however, that, even if a court were to award just compensation, it would be sufficient for payment of the Bonds.
The BPU Might Attempt to Take Action Which Reduces the Value of the Bonds. Pursuant to the Energy Competition Act, the BPU financing order issued to PSE&G is irrevocable and the BPU may not directly or indirectly, by any subsequent action, rescind or amend the BPU financing order or reduce or impair the amount of bondable stranded costs authorized to be recovered under the BPU financing order. Apart from the BPU financing order, the BPU retains the power to adopt, revise or rescind rules or regulations affecting PSE&G or a successor servicer. Any new or amended regulations or orders by the BPU could affect the ability of the servicer to collect the TBC on a full and timely basis and might affect the rating of the Bonds, their price or the amortization of Bonds and their weighted average lives, and may not trigger any obligation of PSE&G to indemnify you. As a result, you could suffer a decline in value of your investment.
PSE&G, as servicer, is required to file with the BPU, on behalf of us, periodic adjustments of the TBC, intended to provide for timely payment of the Bonds, including scheduled payments of principal. The BPU may challenge PSE&G's calculation of a proposed adjustment, which may cause delay, or refuse to permit an adjustment to take effect, on the ground that the adjustment contains a manifest error; that is, an arithmetic error evident on the face of the filing. Any such delay in the implementation of the adjustment could cause a delay in the payments on the Bonds. PSE&G has agreed to take legal or administrative actions, including instituting and prosecuting legal actions, as may be reasonably necessary to block or overturn any attempts to cause a repeal, modification or supplement to the Energy Competition Act, or the BPU financing order, or the letter to be delivered by PSE&G to the BPU within five business days following issuance of each series of Bonds specifying the terms of that series (referred to as an issuance advice letter), or the rights of bondholders. PSE&G has also agreed to resist proceedings of third parties, which, if successful, would result in a breach of its representations concerning the BTP, the BPU financing order or the Energy Competition Act. However, there is no assurance that any action PSE&G takes would be successful.
Servicing Risks
Inaccurate Consumption Forecasting or Unanticipated Delinquencies or Charge-Offs Might Reduce Scheduled Payments on the Bonds. The TBC is assessed and collected by the servicer and adjusted at least annually, as provided in the Energy Competition Act, the BPU financing order and the servicing agreement.
A shortfall of payments arising from the TBC might result if the servicer inaccurately forecasts electricity consumption or underestimates consumer delinquencies or charge-offs when setting the TBC, and delayed payments on the Bonds could follow.
Inaccurate forecasting of electricity consumption by the servicer might result from, among other things: unanticipated weather or economic conditions; natural disasters; technological changes; changes in the market structure of the electric industry; increased conservation efforts; or consumers switching to self-generated power without being required to pay TBCs.
Inaccurate forecasting of delinquencies or charge-offs by the servicer might result from, among other things: sudden and unexpected deterioration of the economy or the occurrence of a natural disaster; sudden and unexpected regulatory changes that make it more difficult for the servicer to disconnect nonpaying consumers, or that require the servicer to apply more lenient credit standards in accepting consumers; sudden and unexpected limitations on termination of service during the heating season; or the introduction into the energy markets of less creditworthy third party energy suppliers. In the future, consumers might pay the TBC to third parties who supply them with electric power. These third parties are obligated to forward the charge to PSE&G, as servicer, and to pay PSE&G the TBC even if they fail to collect the charge from retail electric consumers. A default by a third party that collects from a large number of retail consumers might have a greater impact than a default by a single retail consumer. PSE&G will have limited rights to collect the TBC directly from consumers who receive their electricity bills from a third party, but will not pay any shortfalls resulting from the failure of any third party supplier to forward collections to PSE&G, as servicer. The servicer might not be able to mitigate credit risks relating to third party suppliers to the same extent to which it mitigates the risks relating to its consumers.
Billing and Collection Practices Might Reduce the Collections Available for Payments on the Bonds. The methodology of determining the amount of the TBC to each consumer is specified in the BPU financing order. Although PSE&G may not change this methodology, PSE&G, as servicer, may set, and may change, its own billing and collection arrangements with each consumer. For example, to recover part of an outstanding electricity bill, PSE&G may agree to extend a consumer's payment schedule or to write off the remaining portion of the bill. Similarly, the BPU may require changes to these practices. Under the methodology specified in the BPU financing order, this might result in an extension of the consumer's payment of TBCs. Thus, any changes in billing and collection practices or regulations might make it more difficult for the servicer to collect the TBC, and might adversely affect the value of the Bonds and their weighted average lives.
The Risks Associated With Potential Bankruptcy Proceedings
Risks that might arise in the bankruptcy of PSE&G are described below and could cause delayed payments or a loss, or decline in value, of your investment.
If the Servicer Defaults or Becomes Bankrupt, It Might Be Difficult to Find a Successor Servicer and Payments on the Bonds Might Be Suspended. PSE&G, as servicer, will be responsible for billing and collecting the TBC and for filing with the BPU to adjust this charge. If PSE&G ceased servicing the BTP, it might be difficult to find a successor servicer. Upon a servicer default based upon the commencement of a case by or against the servicer under the U.S. Bankruptcy Code, referred to as the Bankruptcy Code, or similar laws, the trustee and the issuer might be prevented from effecting a transfer of servicing. Upon a servicer default because of a failure to make required remittances, the issuer or the trustee would have the right to apply to the BPU for sequestration of TBCs. However, the Bankruptcy Code might prevent the BPU from issuing or enforcing this order. In either case of a servicer default, payments on the Bonds might be suspended.
Commingling Might Obstruct Access to a Portion of Our Funds In Case of Bankruptcy of PSE&G. PSE&G will not segregate the TBCs from the other funds it collects from its consumers. The TBCs will be segregated only after PSE&G pays them to the trustee. PSE&G will be permitted to remit collections on a monthly basis only if it has the requisite credit ratings from the rating agencies or provides credit enhancement satisfactory to the rating agencies or otherwise obtains rating agency approval regarding how frequently it remits collections. Otherwise, PSE&G will be required to remit collections within two business days of the estimated collection date. Despite these requirements, PSE&G might fail to pay the full amount of the TBCs to the trustee on a timely basis.
The Energy Competition Act provides that our rights to the BTP are not affected by the commingling of these funds with PSE&G's other funds. In a bankruptcy of PSE&G, however, a bankruptcy court might rule that federal bankruptcy law does not recognize our right to TBCs that are commingled with other funds of PSE&G as of the date of bankruptcy. If so, the collections held by PSE&G as of the date of bankruptcy would not be available to pay amounts owing on the Bonds. In this case, we would have a general unsecured claim against PSE&G for those amounts.
Bankruptcy of PSE&G Might Impair the Operation of the Energy Competition Act. The Energy Competition Act and the BPU financing order provide that as a matter of New Jersey state law:
BTP constitutes presently existing property of PSE&G for all purposes;
PSE&G may sell, assign and otherwise transfer that property and PSE&G or we may pledge or grant a security interest in the property as collateral for Bonds; and
a transfer of the BTP from PSE&G to us is a sale or other absolute transfer of the BTP, not a pledge of the BTP to secure a financing by PSE&G, and this characterization will not be affected by treatment of the transfer as a financing for tax or financial reporting purposes.
These three provisions are important to maintaining payments on the Bonds in accordance with their terms during any bankruptcy of PSE&G. In addition, the transaction has been structured with the objective of keeping us separate from PSE&G in the event of a bankruptcy of PSE&G.
PSE&G and we will treat the transaction as a sale under applicable law, although for financial reporting and federal and state tax purposes the Bonds will be treated as a financing. In the event of a bankruptcy of PSE&G, a party in interest in the bankruptcy might assert that the sale of the BTP to the issuer was a financing transaction and not a "sale or other absolute transfer" and that the treatment of the transaction for financial reporting and tax purposes as a financing and not a sale lends weight to that position.
A bankruptcy court generally follows state property law on issues such as the three provisions described above, unless it determines that the state law is contrary to a paramount federal bankruptcy policy or interest. If a bankruptcy court in a PSE&G bankruptcy refused to enforce one or more of the state property law provisions described above, the effect of this decision on you as a bondholder would be similar to the treatment you would receive in a PSE&G bankruptcy if the Bonds had been issued directly by PSE&G. A decision by the bankruptcy court that, despite the separateness of PSE&G and the issuer, the two companies should be consolidated, would have a similar effect on you as a bondholder.
Other Risks Associated With An Investment In The Bonds
Absence of Secondary Market for Bonds Might Limit Your Ability to Resell Bonds. The underwriters for the Bonds might assist in resales of the Bonds but they are not required to do so. A secondary market for the Bonds may not develop or continue or be sufficiently liquid to allow you to resell your Bonds.
We or Another Entity May Issue Additional Series of Bonds Whose Holders Have Conflicting Interests. We may issue other series of Bonds without your prior review or approval. These series may include terms unique to that particular series. A new series of Bonds may not be issued if it would result in the credit ratings on any outstanding series of Bonds being reduced or withdrawn. Moreover, PSE&G may sell BTP to one or more entities other than us to secure a new series of Bonds. In that case, PSE&G will need to obtain a separate financing order, which will specify an additional amount of bondable transition charges to be collected from consumers for the additional series of Bonds. Any additional series of Bonds issued by the us or another entity will have an equal right to share in TBC collections with your Bonds. Sharing collections could cause delays in payments on your Bonds.
In addition, some matters may require the vote of the holders of all series and classes of Bonds. Your interests in these votes may conflict with the interests of the bondholders of another series or of another class. Thus, these votes could result in an outcome unfavorable to you.
The Ratings Do Not Assess the Expected Rate of Payment of Principal on the Bonds. The Bonds will be rated by one or more established rating agencies. The ratings merely analyze the probability that the we will repay the total principal balance of each class of the Bonds at its final maturity and will make timely interest payments. The ratings do not otherwise assess the speed at which we will repay the principal of the Bonds. Thus, we may repay the principal of your Bonds later than you expect, which may materially reduce the value of your investment. A rating is not a recommendation to buy, sell or hold Bonds. The rating may change at any time. A rating agency may revise or withdraw its rating based solely upon its own judgment.
PSE&G's Obligation to Indemnify Us for a Breach of a Representation or Warranty Might Not Be Sufficient to Protect Your Investment. If PSE&G breaches a representation or warranty in the sale agreement, it is obligated to indemnify us and the trustee for any liabilities, obligations, claims, actions, suits or payments resulting from that breach, as well as any reasonable costs and expenses incurred. In addition, PSE&G is obligated to indemnify us and the trustee, for itself and on behalf of the bondholders, for:
required payments of principal and interest on the Bonds in accordance with their terms and
required deposits of amounts with us,
in each case, required to have been made, which are not made when so required as a result of a breach of a representation or warranty.
However, the amount of any indemnification paid by the seller might not be sufficient for you to recover all of your loss on the Bonds. PSE&G will not be obligated to indemnify any party for any changes of law. In addition, PSE&G will not be obligated to repurchase the collateral in the event of a breach of any of its representations and warranties, and neither the trustee nor the bondholders will have the right to accelerate payments on the Bonds as a result of a breach of any of PSE&G's representations and warranties, absent an event of default under the indenture. If PSE&G becomes obligated to indemnify bondholders, the ratings on the Bonds will likely be downgraded as a result of the circumstances causing the breach and the fact that the bondholders will be unsecured creditors of PSE&G with respect to any of those indemnification amounts.
PSE&G's Ratings Might Affect the Market Value of the Bonds. A downgrading of the credit ratings on the debt of PSE&G might have an adverse effect, at least temporarily, on the market value of your Bonds.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
Not Applicable.
We do not own any real property. Our primary asset is the BTP as described in Item 1. Business above.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
None.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Omitted pursuant to conditions set forth in General Instruction I of Form 10-K.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY,
RELATED STOCKHOLDER MATTERS AND ISSUER
PURCHASES OF EQUITY SECURITIES
All of our outstanding equity interests are owned by PSE&G.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
Omitted pursuant to conditions set forth in General Instruction I of Form 10-K.
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Unless the context otherwise indicates, all references to “Transition Funding,” “we,” “us” or “our” herein mean PSE&G Transition Funding LLC, a Delaware limited liability company located at 80 Park Plaza, Newark, New Jersey 07102.
On December 20, 2004, PSEG entered into an Agreement and Plan of Merger (Merger Agreement) with Exelon Corporation (Exelon) providing for a merger of PSEG with and into Exelon (Merger). On September 14, 2006, PSEG received from Exelon a formal notice of termination of the Merger under the provisions of the Merger Agreement. The termination has not affected our operations.
The following analysis of our financial condition and results of operations is in an abbreviated format pursuant to General Instruction I of Form 10-K. Such analysis should be read in conjunction with the Financial Statements and Supplementary Data.
RESULTS OF OPERATIONS
Operating Revenues
Transition Bond Charge (TBC) revenues decreased approximately $14 million or 5% for the year ended December 31, 2006 as compared to the year ended December 31, 2005 due to a 3% decrease in sales volume combined with the decline in the TBC rate from 2005. In January 2006, as a result of the annual true-up approved by the State of New Jersey Board of Public Utilities (BPU), the TBC rate decreased to 0.6586 cents per Kilowatt-hour (kWh) from 0.6723 cents per kWh in 2005.
As a result of the annual true-up approved by the BPU in January 2007, the TBC rate for 2007 decreased from 0.6586 cents per kWh to 0.6405 cents per kWh. Any increases or decreases in the TBC rate are designed to maintain the Capital Subaccount and the Overcollateralization account at appropriate levels and have adequate funds to meet our scheduled repayments of the deferred issuance costs to Public Service Electric & Gas Company (PSE&G), as servicer of the bonds.
TBC revenues increased approximately $6 million or 2% for the year ended December 31, 2005 as compared to the year ended December 31, 2004 due to a 3% growth in sales volume paritially offset by the decline in the TBC rate from 2004. In January 2005, as a result of the annual true-up approved by the BPU, the TBC rate decreased to 0.6723 cents per kWh from 0.6862 cents per kWh in 2004.
Operating Expenses
Amortization of Bondable Transition Property (BTP)
Amortization of BTP decreased approximately $3 million or 2% for the year ended December 31, 2006 as compared to the year ended December 31, 2005, primarily due to the changes in Operating Revenues and Interest Expense. As a regulated entity, we amortize an amount equal to what we record as revenue for the portion of the TBC relating to the BTP.
Amortization of BTP increased approximately $16 million or 12% for the year ended December 31, 2005 as compared to the year ended December 31, 2004, primarily due to the changes in Operating Revenues and Interest Expense.
Servicing and Administrative Fees
PSE&G withholds from the TBC collections an annual servicing fee equal to 0.05% of the initial balance of the Bonds issued and charges an additional fee for various administrative costs. Servicing and Administrative Fees increased $114 thousand or 8% for the year ended December 31, 2006 as compared to the year ended December 31, 2005, due to increases in administrative expenses billed to us by the Servicer, PSE&G.
Servicing and Administrative Fees decreased $41 thousand or 3% for the year ended December 31, 2005 as compared to the year ended December 31, 2004, due to decreases in administrative expenses billed to us by the Servicer, PSE&G.
Interest Income
Interest Income increased approximately $1,180 thousand or 75% for the year ended December 31, 2006 as compared to the year ended December 31, 2005, primarily due to higher interest rates and higher average cash balances in 2006.
Interest Income increased approximately $972 thousand or 162% for the year ended December 31, 2005 as compared to the year ended December 31, 2004, primarily due to higher interest rates and higher average cash balances in 2005
Interest Expense
Interest expense decreased approximately $10 million or 7% for the year ended December 31, 2006 as compared to the year ended December 31, 2005, due to a reduction in the total amount of debt outstanding.
Interest expense decreased approximately $9 million or 6% for the year ended December 31, 2005 as compared to the year ended December 31, 2004, due to a reduction in the total amount of debt outstanding.
LIQUIDITY AND CAPITAL RESOURCES
The principal amount of the Bonds, interest, fees and funding of the overcollateralization subaccount are being recovered through the TBC payable by retail customers of electricity within PSE&G’s service territory who receive electric delivery service from PSE&G. As part of PSE&G’s responsibility as servicer under the Servicing Agreement, PSE&G remits the TBC collections to the debt/security trustee (Trustee) to make scheduled payments on the Bonds.
During 2006, all required payments of bond principal, interest and all related expenses were made by the Trustee on March 15, 2006, June 15, 2006, September 15, 2006 and December 15, 2006 totaling approximately $72 million, $69 million, $75 million and $77 million, respectively, including funding of the Capital Subaccount and the Overcollateralization account to required levels. During 2005, payments of bond principal, interest and all related
expenses were made by the Trustee on March 15, 2005, June 15, 2005, September 15, 2005 and December 15, 2005 totaling approximately $72 million, $69 million, $75 million and $77 million, respectively. These payments were primarily funded from our TBC collections and interest earned on those funds. Also in 2005, cash dividends of $162 thousand were paid to PSE&G.
ACCOUNTING ISSUES
Critical Accounting Policies
Unbilled Revenues
Electric and gas revenues are recorded based on services rendered to customers during each accounting period. PSE&G records unbilled revenues for the estimated amount customers will be billed for services rendered from the time meters were last read to the end of the respective accounting period. Unbilled usage is calculated in two steps. The initial step is to apply a base usage per day to the number of unbilled days in the period. The second step estimates seasonal loads based upon the time of year and the variance of actual degree-days and temperature-humidity-index hours of the unbilled period from expected norms. The resulting usage is priced at current rate levels and recorded as revenue. Each month the prior month’s unbilled amounts are reversed and the current month’s amounts are accrued. Using benchmarks other than those used in this calculation could have a material effect on the amounts accrued in a reporting period. The resulting revenue and expense reflect the service rendered in the calendar month.
ITEM 7A.
ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK
The market risk inherent in our Bonds is the potential loss arising from adverse changes in interest rates. We have entered into an interest rate swap on our sole class (Class A-4) of floating rate Bonds (see Note 2. The Bonds). The interest rate swap effectively converts the existing floating rate debt into fixed rate borrowings at 6.2875% . Any gain or loss on this financial instrument will be recovered from or refunded to PSE&G’s customers.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
To the Sole Member and Board of Managers of
PSE&G Transition Funding LLC:
We have audited the accompanying balance sheets of PSE&G Transition Funding LLC (the “Company”) as of December 31, 2006 and 2005, and the related consolidated statements of income, member’s equity and cash flows for each of the three years in the period ended December 31, 2006. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2006 and 2005, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2006, in conformity with accounting principles generally accepted in the United States of America.
/s/ DELOITTE & TOUCHE LLP
Parsippany, New Jersey
March 14, 2007
PSE&G TRANSITION FUNDING LLC
STATEMENTS OF INCOME
(THOUSANDS)
See Notes to Financial Statements.
PSE&G TRANSITION FUNDING LLC
BALANCE SHEETS
(THOUSANDS)
See Notes to Financial Statements.
PSE&G TRANSITION FUNDING LLC
STATEMENTS OF CASH FLOWS
(THOUSANDS)
See Notes to Financial Statements.
PSE&G TRANSITION FUNDING LLC
STATEMENTS OF MEMBER’S EQUITY
(THOUSANDS)
See Notes to Financial Statements.
NOTES TO FINANCIAL STATEMENTS
Note 1. Organization, Basis of Presentation and Significant Accounting Policies
Organization
Unless the context otherwise indicates, all references to “Transition Funding,” “we,” “us” or “our” herein mean PSE&G Transition Funding LLC, a Delaware limited liability company located at 80 Park Plaza, Newark, New Jersey 07102.
We were formed under the laws of the State of Delaware on July 21, 1999 and operate pursuant to a limited liability company agreement with Public Service Electric and Gas Company (PSE&G) as our sole member. PSE&G is an operating electric and gas utility and is a wholly-owned subsidiary of Public Service Enterprise Group Incorporated (PSEG). We were organized for the sole purpose of purchasing and owning bondable transition property (BTP) of PSE&G, issuing transition bonds (Bonds), pledging our interest in BTP and other collateral to a debt/security trustee (Trustee) to collateralize the Bonds, and performing activities that are necessary, suitable or convenient to accomplish these purposes.
BTP represents the irrevocable right of PSE&G, or its successor or assignee, to collect a non-bypassable transition bond charge (TBC) from retail electric customers pursuant to a Final Order in PSE&G’s rate unbundling and restructuring proceedings (Final Order) and a bondable stranded cost rate order (Finance Order), which were issued on August 24, 1999 and September 17, 1999, respectively, by the State of New Jersey Board of Public Utilities (BPU) in accordance with the New Jersey Electric Discount and Energy Competition Act enacted in February 1999. These orders are a matter of public record and are available from the BPU. The Finance Order authorizes the TBC to be sufficient to recover $2.525 billion aggregate principal amount of Bonds, plus an amount sufficient to provide for any credit enhancement, to fund any reserves and to pay interest, redemption premiums, if any, servicing fees and other expenses relating to the Bonds.
Our organizational documents require us to operate in a manner so that we should not be consolidated in the bankruptcy estate of PSE&G in the event PSE&G becomes subject to a bankruptcy proceeding.
On December 20, 2004, PSEG entered into an Agreement and Plan of Merger (Merger Agreement) with Exelon Corporation (Exelon) providing for a merger of PSEG with and into Exelon (Merger). On September 14, 2006, PSEG received from Exelon a formal notice of termination of the Merger under the provisions of the Merger Agreement.
Basis of Presentation
The financial statements included herein have been prepared pursuant to Generally Accepted Accounting Principles in the United States of America (GAAP) and the rules and regulations of the SEC.
Significant Accounting Policies
Accounting for the Effects of Regulation
The application of GAAP by us as a regulated entity differs in certain respects from applications by non-regulated businesses. We prepare our financial statements in accordance with the provisions of Statement of Financial Accounting Standards (SFAS) No. 71 “Accounting for the Effects of Certain Types of Regulation” (SFAS 71). In general, SFAS 71 recognizes that accounting for rate-regulated enterprises should reflect the economic effects of regulation. As a result, a rate regulated entity is required to defer the recognition of costs (a regulatory asset) or the recognition of obligations (a regulatory liability) if it is probable that, through the rate-making process, there will be a corresponding increase or decrease in future rates. Accordingly, we have deferred certain costs, which will be amortized over various future periods.
NOTES TO FINANCIAL STATEMENTS
Cash
Cash consists primarily of highly liquid marketable securities and money market funds.
Restricted Cash
Revenues collected through the TBC by PSE&G from its retail electric customers are remitted to the Trustee and must be used to pay the principal, interest and other expenses associated with the Bonds and are classified as Restricted Cash in Current Assets on the Balance Sheet. In addition, as required by the Finance Order, we deposited an amount equal to 0.5% of the initial principal amount of the bonds, which was contributed by PSE&G, into the Capital Subaccount with the Trustee to be drawn in the event collections and other reserve funds are insufficient to make scheduled payments. The funds deposited into the Capital Subaccount and the Overcollateralization Account, discussed below, are classified as Restricted Cash in Noncurrent Assets on the Balance Sheet.
BTP
Our regulatory asset for BTP was recorded at the acquired cost and is being amortized over the life of the Bonds, based on TBC revenues, interest expenses and other fees. The BTP is solely our property.
Deferred Issuance Costs
The securitization transaction issuance costs in excess of the $125 million provided for in the Finance Order were funded by PSE&G and are recovered on a subordinated basis through the TBC. These costs were capitalized and are being amortized to interest expense over the life of the Bonds utilizing the effective interest method.
Regulatory Assets - Interest Rate Swap
For a description of the regulatory asset and the corresponding derivative liability related to the interest rate swap on our sole class of floating rate debt, see Note 2. The Bonds.
Regulatory Liabilities - Overcollateralization
The overcollateralization account is funded ratably from collections of TBC over the term of each series of Bonds. The account is held by the trustee as a credit enhancement to fund payments in the event of a collection shortfall.
Revenues
Revenues are recorded on a calendar month basis, based on services rendered by PSE&G to its customers during each accounting period at the current rate (including the TBC) and also include estimates for usage not yet billed. PSE&G records unbilled revenues for the estimated amount customers will be billed for services rendered from the time meters were last read to the end of the respective accounting period. The unbilled revenue is estimated each month based on weather factors, line losses, estimated customer usage by class, and applicable customer rates based on regression analyses reflecting significant historical trends and experience.
Amortization Expense
Amortization expense is recorded on the BTP using the effective interest method. Amortization expense is also adjusted based on the TBC revenue recorded and the deferred issuance costs.
Interest Income
Interest Income consists of interest earned on TBC collections deposited with the Trustee and interest earned on funds in the Capital Subaccount. Interest earned on deposited TBC funds reduce the BTP and will affect the
NOTES TO FINANCIAL STATEMENTS
calculation of future TBC rates. Interest earned on funds in the Capital Subaccount results in Net Income for us and is periodically dividended to PSE&G.
Interest Expense
Interest Expense consists primarily of interest on the Bonds. Also included in Interest Expense is the amortization of the deferred issuance costs and related interest on the payable to PSE&G.
Income Taxes
We are a single-member limited liability company. Accordingly, all Federal and State income tax effects of our activities accrue to PSE&G.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions. These estimates and assumptions affect the reported amount of revenues, expenses, assets and liabilities, as well as the disclosure of contingencies. Actual results could differ from these estimates.
Note 2. The Bonds
On January 31, 2001, we issued $2.525 billion of Bonds in eight classes with stated maturities ranging from one year to fifteen years, of which $1.784 billion in five classes remain outstanding as of December 31, 2006. The fair value of the bonds was $1.907 billion as of December 31, 2006. The net proceeds of the issuance were remitted to PSE&G as consideration for the property right in the TBC.
Under applicable law, the Bonds are not an obligation of PSE&G or secured by the assets of PSE&G, but rather the Bonds are only recourse to us and are collateralized on a pro rata basis by the BTP and our equity and assets. TBC collections are deposited at least monthly by PSE&G with the Trustee and are used to pay our expenses, to pay our debt service on the Bonds and to fund any credit enhancement for the Bonds. We have also pledged the capital contributed by PSE&G to secure the debt service requirements of the Bonds. The debt service requirements include an overcollateralization subaccount, a capital subaccount and a reserve subaccount which are available to bond holders. Any amounts collateralizing the Bonds will be returned to PSE&G upon payment of the Bonds.
The significant terms of the Bonds issued by Transition Funding as of December 31, 2006 are as follows:
During the years ended December 31, 2006 and 2005, Transition Funding made principal payments on the bonds of $155 million and $146 million, respectively.
NOTES TO FINANCIAL STATEMENTS
We expect to make principal payments of approximately $161 million, $169 million, $178 million, $186 million and $195 million for the years ended December 31, 2007, 2008, 2009, 2010 and 2011, respectively.
We have entered into an interest rate swap on our sole class of floating rate Bonds (Class A-4). The interest rate swap effectively converts the existing floating rate debt into fixed rate borrowings at 6.2875% . The notional amount of the interest rate swap is $497 million and is indexed to the three-month LIBOR rate. The fair value of the interest rate swap, which was approximately $(4) million as of December 31, 2006 and $(11) million as of December 31, 2005, was recorded as a derivative liability, with an offsetting amount recorded as a regulatory asset on the Balance Sheet. The fair value of this swap will vary over time as a result of changes in market conditions. This amount is deferred and is expected to be recovered from PSE&G customers.
We incurred approximately $230 million in issuance costs, $125 million of which were included in BTP with the balance in deferred issuance costs, in connection with the securitization transaction, including $201 million of costs of a hedging arrangement as permitted by the Finance Order. Costs in excess of the $125 million of transaction costs provided for in the Finance Order were paid by PSE&G and are being recovered on a subordinated basis by us through the TBC and remitted to PSE&G with interest at a rate of 6.48% .
Note 3. Significant Agreements and Related Party Transactions
Under the servicing agreement entered into by PSE&G and us, concurrently with the issuance of the first Series of Bonds, PSE&G, as servicer, is required to manage and administer our BTP and to collect the TBC on our behalf. Under the Finance Order, PSE&G withholds from the TBC collections an annual servicing fee equal to 0.05% of the initial balance of Bonds issued. In addition we pay miscellaneous operating expenses to PSE&G up to $100 thousand per quarter, administration fees up to $31 thousand per quarter and trustee fees up to $4 thousand per quarter. Servicing and administrative fees paid to PSE&G were approximately $1.6 million for the year ended December 31, 2006 and approximately $1.5 million for each of the years ended December 31, 2005 and 2004.
As of December 31, 2006 and December 31, 2005, we had a receivable from our member, PSE&G, of approximately $55 million and $59 million, respectively, related to TBC billings. As of December 31, 2006 and December 31, 2005 our payable to our member was approximately $82 million and $88 million, respectively, which primarily relates to the costs in excess of the $125 million of transaction costs provided for in the Finance Order that were paid by PSE&G and billed to us. Interest Expense relating to this payable to PSE&G for each of the years ended December 31, 2006, 2005 and 2004 was approximately $6 million. As of December 31, 2005, we had a payable of approximately $1.2 million for funds deposited with us on behalf of our affiliate, PSE&G Transition Funding II LLC which was paid during the first quarter of 2006.
In addition to the payments above, interest earned on funds in the Capital Subaccount is periodically dividended to PSE&G. No dividends were paid in 2006. During 2005 and 2004, we paid dividends of approximately $162 thousand and $434 thousand, respectively, to PSE&G.
Note 4. Selected Quarterly Data (Unaudited)
The information shown below, in the opinion of Transition Funding includes all adjustments, consisting only of normal recurring accruals, necessary to a fair presentation of such amounts.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE
NONE.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
We have established and maintain disclosure controls and procedures which are designed to provide reasonable assurance that material information is made known to the Chief Executive Officer and Chief Financial Officer by others within the entity. We have established a disclosure committee which is made up of several key management employees and which reports directly to the Chief Financial Officer and Chief Executive Officer. The committee monitors and evaluates the effectiveness of the disclosure controls and procedures. The Chief Financial Officer and Chief Executive Officer have evaluated the effectiveness of the disclosure controls and procedures as of December 31, 2006 and, based on this evaluation, have concluded that the disclosure controls and procedures were effective in providing reasonable assurance during the period covered in this annual report.
Internal Controls
There have been no changes in internal control over financial reporting that occurred during the fourth quarter of 2006 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
NONE.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE
REGISTRANT
Omitted pursuant to conditions set forth in General Instruction I of Form 10-K.
Omitted pursuant to conditions set forth in General Instruction I of Form 10-K.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
OWNERS AND MANAGEMENT AND RELATED
STOCKHOLDER MATTERS
Omitted pursuant to conditions set forth in General Instruction I of Form 10-K.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Omitted pursuant to conditions set forth in General Instruction I of Form 10-K.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Not Applicable.
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(A) The following documents are filed as part of this report:
Statements of Income for the years ended December 31, 2006, 2005 and 2004 on page 12.
Balance Sheets as of December 31, 2006 and 2005 on page 13.
Statements of Cash Flows for the years ended December 31, 2006, 2005 and 2004 on page 14.
Statements of Member’s Equity for the years ended December 31, 2006, 2005 and 2004 on page 15.
Notes to Financial Statements on pages 16 through 19.
(B) A listing of exhibits being filed with this document is as follows. Certain Exhibits previously filed with the Commission and the appropriate securities exchanges are indicated as set forth below. Such Exhibits are not being refiled, but are included because inclusion is desirable for convenient reference.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
EXHIBIT INDEX
A listing of exhibits being filed with this document is as follows: