Ring Around the Subsidiary

Embattled California utilities use controversial way to protect assets from bankruptcy.

PG&E Corp. has steadfastly denied any subterfuge, but in April, Pacific Gas and Electric Co. filed for bankruptcy. Although the utility is responsible for 80 percent of PG&E Corp.’s revenues, neither the holding company nor the ring-fenced NEG joined the filing. “What we did has been audited by the California Public Utilities Commission and the State Senate Oversight Committee, and every audit has reported back that we have done everything legally and above board,” says Cooper. “We feel very comfortable that [ring fencing] was the right thing to do.”

Lockyer clearly didn’t agree. In July, he appealed to a higher power, asking the Securities and Exchange Commission to review PG&E Corp. “for potential holding-company abuses in the transfer of billions of dollars from its now bankrupt California subsidiary, Pacific Gas and Electric Co.”

“There is a lot of political positioning going on in California now,” responds Cooper. “A lot of political people are pointing fingers. We are pretty confident on legal grounds that we did everything correctly.” In fact, if Pacific Gas and Electric Co. enlists the support of its creditors for its reorganization plan and wins approval from the judge, Lockyer may be forced to drop his effort to break the ring fence.

Doing a Deal

Was it financial engineering or political ham-handedness that got PG&E Corp. in trouble? Lockyer has made no move against the two ring-fenced subsidiaries of Rosemead, California-based Edison International, which has had much better relations with the governor. Just one day after Pacific Gas and Electric Co. officials declared bankruptcy and blamed it on stalled negotiations with Davis, Edison officials signed a memorandum of understanding with him to participate in a state-led bailout.

Edison International also put up its first ring fence, around its Edison Mission Energy subsidiary, in January, just four days before Lockyer tried to block FERC approval of the ring fence around NEG. Like the PG&E Corp. subsidiary, Edison Mission builds, owns, and operates power plants, and also trades power.

The ring fence protected Edison Mission from the danger threatening the parent company and its utility subsidiary, Southern California Edison. The parent had $1.2 billion in maturing debt, explains CFO Ted Craver, and unless he could find a way to pay off that debt, it was likely to tip it and SoCalEdison into Chapter 11 when it came due. Says Craver, “Our ability to go out and raise $1.2 billion with a double-C credit rating was nil.”

So Craver created another entity, Mission Energy Holding Co., in June. The new, ring-fenced entity could raise the needed capital because it was bankruptcy-remote from its troubled parent and sister utility, and secured entirely with stock from the already ring-fenced Edison Mission Energy.

The strategy paid off. On June 11, Standard & Poor’s Corp. assigned a double-B-minus rating to Mission Energy Holding’s offering of $1.2 billion in senior secured notes. “I wouldn’t have minded a slightly cheaper rate on the financing,” says Craver, “but we were pleased with that.” He should be thrilled — both subsidiaries have higher ratings than the parent they are working to save. “Ring-fenced subsidiaries rarely achieve ratings appreciably higher than their parents,” S&P’s analysts noted at the time.

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