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File No. 70-09469
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
AMENDMENT NO. 2
TO
FORM U-1
APPLICATION OR DECLARATION
UNDER
THE PUBLIC UTILITY HOLDING COMPANY ACT OF 1935
West Penn Power Company
800 Cabin Hill Drive
Greensburg, PA 15601
(Name of company or companies filing this statement and addresses
of principal executive offices)
Allegheny Energy, Inc.
(Name of top registered holding company parent of each applicant
or declarant)
Thomas K. Henderson, Esq.
Vice President
Allegheny Energy, Inc.
10435 Downsville Pike
Hagerstown, MD 21740-1766
(Name and address of agent for service)
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TABLE OF CONTENTS
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Item 1. Description of Proposed Transaction 1
A. Introduction 1
B. Background of Competition and Regulatory
Environment in Pennsylvania 2
C. Mechanics of Securitization 5
D. Requested Authority 6
1. Formation of Newco and Transfer of
ITP and Associated ITC Revenue
Stream 6
2. Formation of Special Purpose LLC and
Transfer of ITP and Associated ITC
Revenue Stream 7
3. Issuance of Transition Bonds 9
4. Loan 10
5. Servicing Agreement 10
E. Service Agreement with APSC 12
F. Formation of New Subsidiaries Will Benefit
Shareholders and Will Not Unduly
Complicate the Holding Company Structure 12
G. Use of Proceeds 15
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1. Applicants hereby amend Item No. 1. Description of Proposed
Transaction by deleting it in its entirety and substituting the
following therefor:
Item No. 1. Description of Proposed Transaction
A. Introduction
West Penn Power Company, a public utility subsidiary of
Allegheny Energy, Inc., a registered holding company, hereby
requests authority to engage in the following transactions from
time to time, as applicable, through December 31, 2007: (a) to
form a new domestic subsidiary corporation ("Newco"); (b) to
transfer intangible transition property and the associated
intangible transition charges revenue stream (both as defined and
discussed below), to Newco in exchange for Newco's stock; (c) for
Newco to acquire all the limited liability interests in a wholly-
owned limited liability company ("Special Purpose LLC") in which
Newco would own all the equity; (d) for Newco to transfer the
intangible transition property and the associated intangible
transition charges revenue stream to Special Purpose LLC in
exchange for the net proceeds from the sale of Transition Bonds
(as defined below); (e) for Newco to loan the net proceeds from
the sale of the Transition Bonds to West Penn; (f) for West Penn
to issue a note of up to $670 million to Newco; and (g) for
Special Purpose LLC to issue Transition Bonds to the public, with
a final maturity no later than January 2, 2010, as discussed
below.
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West Penn further requests that the Commission grant
such other authorizations as may be necessary in connection with
the transactions described herein.
B. Background of Competition and Regulatory
Environment in Pennsylvania
As the Commission is aware, deregulation of generation
has begun and competition at the retail level is now a reality in
Pennsylvania. Pennsylvania is the state in which West Penn is
incorporated and where its entire service territory is located.
The Electricity Generation Customer Choice and Competition Act,
66 Pa. C.S. Section 2801 et seq. (together with regulatory
interpretations, the "Competition Act"), was enacted in December
1996, and provided for the restructuring of the electric utility
industry in Pennsylvania. The Competition Act required the
unbundling of electric services into separate supply,
transmission, and distribution services with open retail
competition for supply. Electric distribution services remain
regulated by the Pennsylvania Public Utility Commission ("PUC").
Transmission services will be provided pursuant to a FERC-filed
Open Access Transmission Tariff. The Competition Act required
utilities to submit restructuring plans to the PUC, including
transition costs which result from competition. Transition costs
include regulatory assets, long-term purchased power commitments,
and other costs, including investment in generating plants, spent-
fuel disposal, retirement costs and reorganization costs, for
which an opportunity for recovery is allowed in an amount
determined by the PUC to be just and reasonable. These costs,
after mitigation by the utility, are to be recovered through a
Competitive Transition Charge ("CTC") approved by the PUC and
collected from distribution customers for up to nine years from
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the date of enactment (or for an alternate period determined by
the PUC for good cause shown). During that period, the utility
is subject to rate caps which provide that, for a significant
portion of that period, total charges to customers cannot exceed
the rates in place as of December 31, 1996, subject to certain
exceptions.
In August 1997, West Penn was required to file a
restructuring plan with the PUC, which, among other things,
unbundled generation from transmission and distribution. The
restructuring plan was contested and became the subject of
hearings, which finally resulted in a settlement that was
approved by the PUC on November 19, 1998. (See the settlement
agreement, and the PUC's Final Opinion and Order approving such
settlement, attached as Exhibits.) The PUC's Order authorized and
provided state regulatory pre-approval for the transactions
described herein.
In Pennsylvania, full electric generation competition
is being phased in. For West Penn, its settlement called for one-
third of each customer class to have direct retail access on
January 1, 1999, and for an additional one-third to have direct
retail access on January 2, 1999. Retail access for the
remaining one-third will occur on January 2, 2000.
The Competition Act also authorized the PUC to adopt
Qualified Rate Orders ("QRO") to approve the issuance of
Transition Bonds (as defined below) by a utility, a subsidiary of
a utility, or a third-party assignee of a utility, as a mechanism
to mitigate transition costs and reduce customer rates. Under
the Competition Act, proceeds of Transition Bonds are required to
be used principally to reduce qualified stranded costs and the
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related capitalization of the utility. To the extent a QRO and
the rates and other charges authorized thereunder are declared to
be irrevocable, the irrevocable QRO issued by the PUC will create
"Intangible Transition Property" ("ITP") by contract which can be
used to secure the Transition Bonds. The Transition Bonds are
repayable from irrevocable Intangible Transition Charges ("ITC")
which are collected in lieu of CTC.
ITCs are generally defined as amounts authorized to be
imposed on all customer bills, pursuant to an irrevocable QRO,
for the purpose of recovering the principal and interest on the
Transition Bonds, costs to cover credit enhancements, cost of
retiring existing debt and equity, costs of defeasance, servicing
fees and other related fees, taxes, costs and expenses
("Qualified Transition Expenses" or "QTEs"). ITCs are collected
through non-bypassable charges imposed by an electric utility
that provides electric transmission and distribution services to
a customer located in its certificated territory, regardless of
whether that customer continues to purchase electricity from that
electric utility. The ITC will be a specified dollar amount on
each customer bill determined by applying certain rates per
kilowatthour of usage and, in some cases, per kilowatt of demand,
to each customer's bill. The collection of the ITC will likely
be dependent upon, among other things, the utility's ability to
forecast by customer class: 1) number of customers and/or usage;
2) delinquencies and charge-offs; and 3) payment lags. In the
QRO, the PUC may provide for periodic adjustments to the ITC
("true-ups") in accordance with the Competition Act and the QRO.
Once the QRO declares the ITC to be irrevocable, none of the
utility, the PUC, the Commonwealth of Pennsylvania, nor any
instrumentality thereof, has any right to modify the ITC, except
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in accordance with the specific terms of the QRO and the
Competition Act.
C. Mechanics of Securitization
As discussed above, the Competition Act provides for
the use of securitization as a form of transition cost
mitigation. For purposes of the securitization, an electric
utility's ITP and related ITC revenue stream are isolated from
the risks of the electric utility through their transfer to a
bankruptcy-remote assignee (in this case, Special Purpose LLC in
the transfer from Newco). Special Purpose LLC will issue
Transition Bonds secured by the ITP and the ITC revenue stream.
The Competition Act provides that a transfer of ITP by an
electric utility in a transaction approved in a QRO shall be
treated as an absolute transfer of all of the utility's right,
title and interest in the ITP as in a true sale, and not as a
pledge or other financing, other than for Federal and state
income and franchise tax purposes.
As ITCs are imposed and collected, such amounts will be
used to pay principal and interest on the Transition Bonds, as
well as fees and expenses related to the transaction. To the
extent ITCs prove insufficient (or more than sufficient) to fund
credit enhancement requirements and to pay QTEs, including
interest and principal on the Transition Bonds, the Competition
Act provides for true-ups through filings with the PUC. Aside
from these ITC adjustments, the Competition Act generally
provides that the Commonwealth of Pennsylvania will not reduce
the value of the ITP or the ITC until the Transition Bonds are
discharged.
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The components of the securitization transaction
outlined above will increase the creditworthiness of the
Transition Bonds because the underlying securitized assets (the
ITP and its associated ITC revenue stream) are isolated from the
risks associated with the other assets of an electric utility,
upon being transferred to a bankruptcy remote special purpose
entity (the Special Purpose LLC). The creditworthiness of these
assets is further enhanced by the Commonwealth's agreement under
the Competition Act and by its issuance of an irrevocable QRO,
not to reduce the value of the ITP or ITC until the Transition
Bonds are discharged, and by the PUC's issuance of an irrevocable
QRO that specifies the QTEs to be recovered through the ITC and
approves a methodology for periodic adjustments to the ITC.
These aspects of the securitization transaction will enable most
of the Special Purpose LLC's Transition Bonds to obtain a higher
credit rating than the debt instruments of West Penn (although
the class of Transition Bonds with the latest expected maturity
date may have an equal or lower rating because of the short time
between the expected maturity date and the legal final maturity
date).
D. Requested Authority
In accordance with the procedures set forth in the
Competition Act, on November 19, 1998, the Pennsylvania PUC
adopted a final QRO in response to West Penn's application,
authorizing the recovery of transition costs by West Penn of $670
million (or $630 million in the event of a merger with DQE,
Inc.). No litigation concerning the QRO is presently pending and
the time for filing appeals has passed.
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1. Formation of Newco and Transfer
of ITP and Associated ITC Revenue Stream
In connection with the November 19, 1998 QRO, or any
other subsequent QRO adopted by the Pennsylvania PUC, West Penn
requests authority to form a new, wholly-owned subsidiary
("Newco"). The transactions for which authorization under the
Act is sought hereunder include: (1) the completion of the steps
necessary for the formation of Newco, a corporation to be
organized under the laws of a state other than Pennsylvania, as a
new, wholly-owned subsidiary of West Penn; (2) the issuance by
Newco and the acquisition by West Penn of all of Newco's stock.
Pursuant to a transfer agreement, West Penn will transfer the ITP
and associated ITC revenue stream created by that QRO to Newco in
exchange for the Newco stock, which will be treated as a capital
contribution or a true sale, but not as a secured financing for
bankruptcy purposes. Newco initially will be capitalized (at
least 0.5% of the total principal amount of the Transition Bonds)
through some form of capital contribution by West Penn.
2. Formation of Special Purpose
LLC and Transfer of ITP and Associated ITC
Revenue Stream
West Penn also requests authority to form a new, wholly-
owned limited liability subsidiary of Newco ("Special Purpose
LLC"). In connection with the formation of Special Purpose LLC,
the transactions for which authorization under the Act is sought
hereunder include: (1) the completion of the steps necessary for
the formation of Special Purpose LLC, a limited liability
corporation to be formed under the laws of Delaware; and (2) the
issuance by Special Purpose LLC of limited liability interests
and the acquisition by Newco of all of the limited liability
interests in Special Purpose LLC. Newco also requests authority
to transfer the ITP and associated ITC revenue stream to its
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newly-created, bankruptcy remote, wholly-owned Special Purpose
LLC company. The Special Purpose LLC requests authority to issue
debt securities ("Transition Bonds") secured by the ITP and the
associated ITC revenue stream. The Special Purpose LLC will be
capitalized (at least 0.5% of the total principal amount of the
Transition Bonds) through some form of capital contribution by
Newco. The Special Purpose LLC will deposit that amount into a
"Capital Subaccount."
Pursuant to a "Sale Agreement" between Newco and the
Special Purpose LLC, in exchange for the proceeds of the
Transition Bonds, Newco will transfer the ITP and associated ITC
revenue stream to the Special Purpose LLC in a transfer which
will be regarded as a true sale for bankruptcy purposes. It is
anticipated that most of the Transition Bonds will be rated
higher than the senior unsecured long-term debt of West Penn by
at least two nationally recognized rating agencies (the class of
Transition Bonds with the latest expected maturity date may have
an equal or lower rating because of the short time between the
expected maturity date and the legal final maturity date).
The ITC charge will be set to provide for recovery of
an excess amount (the "Overcollateralization Reserve Required
Amount") over that needed to pay expected costs and debt service
on the Transition Bonds. Collections of this additional amount
will be deposited into an "Overcollateralization Subaccount." To
enhance the creditworthiness of the Transition Bonds, this amount
will be expected to be collected over the expected term of the
Transition Bonds.
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West Penn, as the "servicer" of the ITCs, will remit
monthly (or more frequently) all amounts collected in respect of
the ITCs to a collection account maintained by the indenture
trustee for the benefit of the holders of the Transition Bonds
(the "Collection Account"). Quarterly or semiannually, the
Special Purpose LLC will pay out of the Collection Account, among
other things authorized by the QRO, the trustee fees, servicing
fees, administrative costs, operating expenses, accrued but
unpaid interest on all classes of the Transition Bonds, and
principal (to the extent scheduled) on the Transition Bonds. Any
remaining balance in the Collection Account will be used to
restore the Capital Subaccount, fund and replenish the
Overcollateralization Subaccount (to the extent scheduled), and
then be added to reserves (the "Reserve Subaccount"). Because
the QTEs include West Penn's costs of retiring its own debt and
equity, as such costs are incurred, the Special Purpose LLC may
also use funds in the Reserve Subaccount to make payments to West
Penn for this purpose, to the extent that such costs are included
as QTEs and have not previously been recovered by West Penn.
3. Issuance of Transition Bonds
West Penn requests authority for the Special Purpose
LLC to issue up to $670 million in Transition Bonds. The Special
Purpose LLC may issue Transition Bonds in the form of debt
securities in one or more series, and each such series may be
issued in one or more classes. Different series may have
different maturities and coupon rates and each series may have
classes with different maturities and coupon rates. Overall, the
characteristics of the Transition Bonds will be substantially
similar to bonds issued by other issuers in other contexts; it is
the Competition Act and the procedures set forth therein which
add complexity to the proposed transaction rather than the terms
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of the Transition Bonds. Each series will be entitled to
recover, through the ITC approved by one or more QROs, QTEs,
based on a specified principal amount of Transition Bonds for
such series, including interest at the coupon rate or rates
applicable to such series. There will be a date on which each of
the Transition Bonds is expected to be repaid and a legal final
maturity date by which the Transition Bonds must be repaid.
Neither the expected final maturity nor the legal final maturity
will be later than January 2, 2010. The expected final maturity
date may vary from the legal final maturity date due to the fact
that the ITC is calculated by taking into account such variables
as the anticipated level of charge-offs, delinquencies, and
usage, which may differ from the amounts actually incurred or
achieved.
4. Loan
Newco requests authority to loan West Penn up to $670
million (the proceeds from the sale of the ITP and associated ITC
revenue stream). West Penn requests authority to issue a note of
up to $670 million to Newco, at a market interest rate. The loan
will have interest rates and maturities that are designed to
provide a return to Newco of not less than Newco's effective cost
of capital. The note will be subordinated to all outstanding
West Penn debt.
5. Servicing Agreement
Pursuant to a "Servicing Agreement" between West Penn
and the Special Purpose LLC, West Penn will act as the "servicer"
of the ITC revenue stream and, in this capacity, West Penn will,
among other things, (a) bill customers and make collections on
behalf of the Special Purpose LLC, and (b) file with the
Pennsylvania PUC for adjustment to the ITC to achieve a level
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which allows for full recovery of QTEs in accordance with the
amortization schedule for each series of Transition Bonds. It
should be noted that West Penn may subcontract with other
companies to carry out some of its servicing responsibilities, so
long as the ratings of the Transition Bonds are neither reduced
nor withdrawn. West Penn will be retained under the Servicing
Agreement to collect and manage the ITP and associated ITC
revenues and to make appropriate filings with the Pennsylvania
Public Utility Commission.
West Penn will be entitled to compensation, in the form
of a "servicing fee", for its servicing activities and
reimbursement for certain of its expenses in the manner set forth
in the documentation applicable to each series. In order to
satisfy the rating agency requirements for a "bankruptcy remote"
entity, the servicing fee must be an "arms-length" fee, which
would be reasonable and sufficient for a third party performing
similar services. The rating agency requirement is meant to
assure that the subsidiaries would be able to stand on their own
and accordingly the fee must be sufficient to retain a third
party servicer if for any reason West Penn could not continue to
perform these services. As a result, the servicing fee will be
set at an annual level of not more than 2% of the outstanding
amount of the Transition Bonds. As additional servicing
compensation, West Penn will retain all investment earnings on
ITC collections from the time of collection until the time of
remittance to the Collection Account.
Any successor to West Penn pursuant to any merger,
consolidation, bankruptcy, reorganization or other insolvency
proceeding will be required to assume West Penn's obligations
under the Sale and Servicing Agreement and under the Competition
Act. Amounts collected by West Penn in respect of the ITC will
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be remitted monthly (or possibly more frequently if required by
the rating agencies) to the Collection Account.
E. Service Agreement with APSC
Personnel employed by Allegheny Power Service
Corporation ("APSC") will provide ministerial services on an as-
needed basis to the Special Purpose LLC and Newco pursuant to
administrative service agreements ("Service Agreements") to be
entered into between Special Purpose LLC and APSC, and Newco and
APSC. The services to be provided will consist primarily of
corporate housekeeping matters relating to the Special Purpose
LLC and Newco such as providing notices required under its
Transition Bond documentation, maintaining corporate books and
records and maintaining authority to do business in appropriate
jurisdictions. Under the Service Agreements, Special Purpose LLC
and Newco will reimburse APSC for the cost of services provided,
computed in accordance with Rules 90 and 91 under the Act, as
well as applicable rules and regulations.
F. Formation of New Subsidiaries Will
Benefit Shareholders and Will Not Unduly
Complicate the Holding Company Structure___
In order to receive a high rating on the Transition
Bonds, and thereby achieve all of the benefits of securitization,
the ITP must be transferred to a bankruptcy remote entity in a
true sale. However, the transfer of the ITP in a sale
transaction raises associated federal and state income tax
concerns, principally whether the transfer is a sale or exchange
that causes recognition of taxable income. In some similar
transactions, ITP has been sold to a limited liability company
which was wholly-owned by the transferor without an intermediate
transfer to another entity. Those transactions are not
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recognized as sales for federal income tax purposes because the
limited liability company elects to be taxed as a division of its
single member, the transferor, rather than as a separate
taxpaying corporation. Therefore, the sale is recognized as a
true sale for bankruptcy purposes, but is disregarded for federal
income tax purposes. The election of a limited liability company
to be treated as a division of its single member has broader tax
implications, in that the two companies are taxed as one on an
ongoing basis.
Pennsylvania follows the federal income tax approach
with respect to the taxation of single member limited liability
companies. As a result, if West Penn were to transfer the ITP to
a single member limited liability company that it owned,
Pennsylvania would ignore the true sale of the ITP between West
Penn and its wholly-owned limited liability company for state
corporate income tax purposes. However, the income that Special
Purpose LLC would receive from the ITC collections would be
combined with West Penn's income for both federal and
Pennsylvania income tax purposes. At 9.99%, Pennsylvania has one
of the highest corporate income tax rates in the United States.
As such, West Penn would be faced with the prospect of incurring
this high corporate income tax rate on the collections of the ITC
by Special Purpose LLC. In order to be more tax efficient, West
Penn is seeking authority to transfer the ITP to a wholly-owned
domestic corporation domiciled in a state other than Pennsylvania
("Newco"), in exchange for stock of Newco. Newco would then
transfer the ITP to Special Purpose LLC, a single member limited
liability company that it owns, in a true sale. For state income
tax purposes, the transfer of the ITP to Special Purpose LLC
would be ignored because Special Purpose LLC would elect to taxed
as a division of Newco. Moreover, the income from the
collections of the ITP by Special Purpose LLC would be combined
with the income of Newco for tax purposes in a state which has
little or no corporate income tax.
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This transaction, and transfers of the ITP, would
satisfy the true sale requirements of bankruptcy law, while
providing savings from federal and state income tax standpoints.
The QRO authorizes West Penn to recover $670 million ($630
million in the event of merger with DQE, Inc.) plus interest
thereon, through ITC collections. The state income tax savings
of the proposed transaction would be 9.99% (the Pennsylvania
corporate income tax rate), less the tax rate, if any, in Newco's
state of domicile, multiplied by the amount of ITC collections.
These savings are expected to exceed $65 million dollars over a
nine-year period.
The use of multiple entities to effectuate
securitization is not unprecedented. In California, each utility
sold its transition property to a wholly-owned special purpose
Delaware limited liability company ("Note Issuer"). Each Note
Issuer issued bonds, secured by the transition property, to a
Delaware business trust ("Trust") formed for the purpose of each
transaction. Each Trust, in turn, issued certificates of
beneficial ownership to the public, the proceeds of which were
used to purchase the bonds issued by Note Issuer. This two-
entity structure was created in response to the California
statute authorizing the issuance of what were called rate
reduction bonds. West Penn likewise desires to utilize multiple
entities in order to comply with the statutory framework of its
state of domicile, including Pennsylvania's corporate tax
structure.
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In the future, Newco will also provide a vehicle for
investment in unregulated activities outside of West Penn's
regulated public utility entity. This is becoming common as the
industry confronts deregulation.
The creation of Newco and Special Purpose LLC will not
unduly complicate the holding company structure of Allegheny in
that they are necessary in order to create the true sale required
by the rating agencies, while providing the income tax
efficiencies described above. Moreover, Newco and Special
Purpose LLC will be wholly-owned by West Penn, and will be
included in West Penn's consolidated financial statements. They
will have no debt or securities issued to the public or non-
Allegheny affiliates, other than the Transition Bonds. The costs
of operating Newco will be minimal. West Penn anticipates that
the costs would be under $10,000 per year. In light of these
small costs, the limited purposes and activities of each company,
West Penn believes that the creation of Newco and Special Purpose
LLC will not unduly complicate the holding company structure of
Allegheny, and accordingly requests authorization to create Newco
and Special Purpose LLC and engage in the transactions described
above.
G. Use of Proceeds
West Penn currently anticipates using the gross
proceeds from the sale of ITP funded by the $670 million (or $630
million in the event of a merger with DQE, Inc.) of Transition
Bonds as follows. West Penn will utilize the gross proceeds to
pay issuance and refinancing costs. West Penn will use the
remaining proceeds principally to reduce its transition or
stranded costs by reducing its existing capitalization through
the retirement of outstanding debt, the retirement and repurchase
of preferred stock and the reduction of common shareholder equity
through stock buy backs and/or dividends.
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The specific steps taken by West Penn to reduce its
capitalization will depend, in large part, on the date on which
the proceeds from the sale of Transition Bonds become available,
the then prevailing market conditions, and circumstances at that
time, including but not limited to the overall financial
circumstances of West Penn and other financial activities that
may be in progress or planned, as well as the advice of West
Penn's financial advisors.
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SIGNATURE
Pursuant to the requirements of the Public Utility
Holding Company Act of 1935, the undersigned company has duly
caused this statement to be signed on its behalf by the
undersigned thereunto duly authorized.
WEST PENN POWER COMPANY
By /s/ Thomas K. Henderson
Thomas K. Henderson, Esq.
Vice President
Dated: April 29, 1999
