These asset-backed securities, variously called "stranded cost, "rate reduction," or "transition" bonds, were secured by a property right to collect an irrevocable tariff (transition charge or TC) from electric customers of Oncor Electric Delivery Company, a Texas electric utility. The bonds, which were issued in four classes, shared equally in the collateral. The expected maturities of the classes varied from approximately four years to 12 years, each with an additional two years to legal final maturity.

The bonds were rated AAA although Oncor itself was rated only BBB. According to Fitch, the ratings agency, the 'AAA' rating was supported by the strength and stability of the underlying tariff cash flows as established by the Texas Electric Utility Restructuring Act and the financing order issued by the Public Utility Commission of Texas (PUCT). The Act and the financing order defined bondholders' property rights to the collateral. Most importantly, they provided an annual tariff adjustment mechanism ("true-up") to keep principal amortization and funding of the overcollateralization account in line with expected balances. Additional credit enhancement was provided by a capital account equal to 0.5% of the original principal balance, funded at closing, and overcollateralization equal to an additional 0.5% of the original principal balance funded throughout the term of the transaction. Oncor acts as servicer for bonds and as such was be responsible for the forecasting and collection of the TC amounts from retail electric providers (REPs) who, in turn, bill the customers.

This deal, Oncor Electric's first stranded cost securitization, was a landmark for the stranded cost sector, which at the time had yet to fully mature. While roughly three years old, stranded cost ABS, or rate reduction bonds (RRBs), had been brought primarily by one-off issuers, who had no intention of ever returning. And although called rate reduction bonds, most issuers were more concerned with recovering costs associated with prior investments made in a pre-deregulated environment.

In addition to increasing transparency for investors through reporting, Oncor utilized a "performance based" underwriting fee, rewarding lead and co-managers for broadening investor distribution and tightening spreads. According to Joseph Fichera , CEO of advisory firm Saber Partners: "In Oncor's offering we created additional relative value through the structure, increased disclosure and transparency and broader liquidity by expanding the buyer base. For the bookrunners and co-managers, we tied compensation to performance on price and distribution so that everyone's incentives were aligned — the investor buying the bonds and the ratepayer paying for the bonds received the best deal possible at the time."

The result was broad distribution to non-traditional ABS investors, with heavy corporate overlap. Also, Oncor priced at the tightest levels the sector had seen to date, pricing just behind the largest and most liquid asset classes of the ABS market, rather than a "one-off" collateral type.

1. From the point of view of the investor, how do the payments on the bonds work? Explain with the aid of a diagram.
2. Would it make sense for other regulated companies to use this technique? When and when not? Explain.