The below questions relate to rate reduction bonds. Answer each one
What asset is the collateral?
What will be an ideal response?
Rate reduction bonds are backed by a special charge (tariff) included in the utility bills of utility customers in. The charge, called the competitive transition charge (or CTC), is effectively
a legislated asset. It is the result of the movement to make the electric utility industry more competitive by deregulating the industry. More details are supplied below.
Prior to deregulation, electric utilities were entitled to set utility rates so as to earn a competitive return on the assets on their balance sheet. After deregulation, the setting of utility rates to recover a competitive return was no long permissible. As a result, many electric utilities had a substantial amount of assets that they acquired prior to deregulation that would likely become uneconomic and utilities would no longer be assured that they could charge a high enough rate to recover the costs of these assets. These assets are referred to as "stranded assets" and the associated costs referred to as "stranded costs." For this reason, rate reduction bonds are also known as stranded cost bonds or stranded asset bonds. Some market participants refer to this sector of the ABS market as the "utilities" sector.
The CTC is collected by the utility over a specific period of time. Because the state legislature designates the CTC to be a statutory property right, it can be sold by a utility to an SPV and securitized. It is the legislative designation of the CTC as an asset that makes rate reduction bonds different from the typical asset securitized.
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