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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Fiscal Year Ended December 31, 2003
-- OR --
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
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Commission File Number 333-91935
Oncor Electric Delivery Transition Bond Company LLC
(Exact Name of Registrant as Specified in its Charter)
A Delaware Limited Liability Company 75-2851358
(State of Incorporation) (I.R.S. Employer Identification No.)
500 N. Akard Street, Dallas, Texas 75201 (214) 486-2000
(Address of Principal Executive Offices) (Registrant's Telephone Number)
(Zip Code)
------------------------------------------
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: None
----------------------------------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ---
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act). Yes No X
--- --
As of March 19, 2004, all outstanding common membership interests in Oncor
Electric Delivery Transition Bond Company LLC were held by Oncor Electric
Delivery Company.
Oncor Electric Delivery Transition Bond Company LLC meets the conditions set
forth in General Instructions (I) (1) (a) and (b) of Form 10-K and is therefore
filing this report with the reduced disclosure format.
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TABLE OF CONTENTS
- -----------------------------------------------------------------------------------------------------------------------------
Page
----
Glossary............................................................................................ ii
PART I
Item 1. BUSINESS ...................................................................... 1
LEGISLATIVE BACKGROUND ....................................................... 1
REQUIRED REPORTS ............................................................. 3
Item 2. PROPERTIES..................................................................... 3
Item 3. LEGAL PROCEEDINGS.............................................................. 3
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............................ 3
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS............................................................ 4
Item 6. SELECTED FINANCIAL DATA........................................................ 4
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS............................................ 4
Item 7a. QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK.............................................................. 4
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.................................... 4
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE............................................ 4
Item 9a. CONTROLS AND PROCEDURES........................................................ 4
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT............................. 5
Item 11. EXECUTIVE COMPENSATION......................................................... 5
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT..................................................................... 5
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS................................. 5
Item 14. PRINCIPAL ACCOUNTING FEES AND SERVICES......................................... 5
PART IV
Item 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON
FORM 8-K....................................................................... 5
Periodic reports on Form 10-K and Form 10-Q and current reports on Form 8-K that
contain financial information of Oncor Electric Delivery Transition Bond Company
LLC will be made available to the public, free of charge, on the Oncor Electric
Delivery Company website at http://www.oncorgroup.com, shortly after they have
been filed with the Securities and Exchange Commission. Oncor Electric Delivery
Transition Bond Company LLC will provide copies of current reports not posted on
the website upon request.
i
GLOSSARY
When the following terms and abbreviations appear in the text of this report,
they have the meanings indicated below.
1999 Restructuring Legislation.......legislation that restructured the electric
utility industry in Texas to provide for
competition
Commission...........................Public Utility Commission of Texas
Company..............................Oncor Electric Delivery Transition Bond
Company LLC, a wholly-owned bankruptcy
remote financing subsidiary of Oncor
Financing Order......................the financing order issued by the
Commission on August 5, 2002 to Oncor, its
successors and assigns that provide
transmission and distribution service
Moody's..............................Moody's Investors Services, Inc.
Oncor................................Oncor Electric Delivery Company, a
subsidiary of US Holdings and parent of
the Company
REP..................................retail electric provider
S&P..................................Standard & Poor's, a division of the
McGraw Hill Companies
Settlement...........................regulatory settlement plan agreed to by the
Commission in 2002
Settlement Plan......................regulatory settlement plan that received
final approval by the Commission in
January 2003
SFAS.................................Statement of Financial Accounting Standards
issued by the Financial Accounting
Standards Board
SFAS 71..............................SFAS No. 71, "Accounting for the Effects
of Certain Types of Regulation"
US GAAP..............................accounting principles generally accepted
in the United States of America
US Holdings..........................TXU US Holdings Company, a subsidiary of
TXU Corp.
ii
PART I
Item 1. BUSINESS
BUSINESS
--------
The Company is a bankruptcy remote special purpose Delaware limited
liability company, wholly-owned by Oncor. Oncor is a wholly-owned subsidiary of
US Holdings, which is a wholly-owned subsidiary of TXU Corp. Oncor is a
regulated electricity transmission and distribution company principally engaged
in providing delivery services to REPs that sell electricity in the
north-central, eastern and western parts of Texas.
The Company was organized in November 1999 for the sole purpose of
purchasing and owning transition property acquired from Oncor. The Company had
no operations until August 2003. In connection with the acquisition of the
transition property, the Company has agreed to (a) register and issue one or
more series of transition bonds, each of which may be comprised of one or more
classes, (b) pledge its interest in the transition property and other transition
bond collateral to secure the transition bonds, (c) make debt service payments
on the transition bonds, and (d) perform other activities that are necessary,
suitable or convenient to accomplish these purposes. The Company is structured
and is operated in a manner such that in the event of bankruptcy proceedings
against Oncor, the assets of the Company will not be consolidated into the
bankruptcy estate of Oncor. Oncor is not the owner of the transition property
described herein, and the assets of the Company are not available to pay
creditors of Oncor or any of its affiliates.
In accordance with the Settlement, Oncor received a financing order
authorizing the issuance of transition bonds in the aggregate principal amount
of up to $1.3 billion to recover regulatory assets and other qualified costs as
discussed below. In August 2003, the Company issued and sold the first series of
transition bonds in an aggregate principal amount of $500 million. The net
proceeds from the sale of the transition bonds were used to acquire transition
property. The Company pledged its interest in the transition property and other
transition bond collateral to secure the transition bonds. A second issuance of
approximately $790 million is expected to be completed in the first half of
2004. The principal and interest on the transition bonds is recoverable through
a delivery fee surcharge (transition charge) to all REPs.
LEGISLATIVE BACKGROUND
In September 1999, the Texas legislature passed the 1999 Restructuring
Legislation to restructure the electric utility industry in Texas. The 1999
Restructuring Legislation provided for a transition to competition in the retail
and generation markets for electricity beginning in January 2002, and provided
for recovery of certain costs previously incurred by electric utilities. These
costs consist of generation-related regulatory assets as well as stranded costs,
which represent the excess of net book value over market value of generation
assets (as such regulatory and generation assets are defined by the 1999
Restructuring Legislation). Recovery of these costs is provided through
irrevocable, nonbypassable "transition charges" assessed on substantially all
existing and future retail electric customers within a utility's certificated
service territory as it existed on May 1, 1999. The 1999 Restructuring
Legislation authorized the Commission to issue a "financing order" approving the
issuance of "transition bonds" to facilitate the recovery of generation-related
regulatory assets and stranded costs.
Transition Property - The 1999 Restructuring Legislation and the financing
order permit an electric utility to transfer its rights and interests in the
financing order, including the right to collect transition charges pursuant to
the 1999 Restructuring Legislation, to a special purpose entity formed by the
electric utility to issue debt secured by the right to receive revenues arising
from the transition charges. The electric utility's right to receive the
transition charges and its other rights and interests under the financing order
constitute "transition property" once transferred to the Company. The transition
property represents the irrevocable right to impose, collect and receive
transition charges in an amount sufficient to pay the interest, fees, and
expenses associated with the transition bonds, and the aggregate principal
amount of the transition bonds.
1
Transition Charges - Oncor and the Company have entered into a servicing
agreement. Transition charges are assessed by the servicer. The servicer
manages, services, bills and collects payments in respect of the transition
property under the terms of the servicing agreement. Transition charges are
billed based on a retail customer's actual consumption of electricity. However,
transition charges for demand customers are based on the maximum amount of
electricity that such customers are expected to consume based on their actual
consumption during the prior year. Transition charges are collected by the
servicer from REPs that collect transition charges from retail customers as part
of its normal collection activities. The Commission reviews and adjusts
transition charges at least once a year. This review is used to adjust any over
or under collections during the preceding 12 months and to provide for recovery
of amounts sufficient to pay all debt service and other required amounts and
charges in connection with the transition bonds.
Servicing Fees - As long as Oncor or its affiliate or agent acts as
servicer, the annual aggregate servicing fee will be the greater of $400,000 for
all series of outstanding transition bonds or 0.05% per year of the initial
principal amount of all series of outstanding transition bonds. If a successor
servicer that is not affiliated with Oncor is appointed, it will be entitled to
receive a servicing fee not in excess of 0.60% per year of the initial principal
amount of each series of outstanding transition bonds. The servicing fee will be
recovered by the Company through the transition charges. In addition, under the
servicing agreement, Oncor, as servicer, must seek interim and non-standard
true-up adjustments when certain conditions are met.
Administration Fees - Oncor and the Company have also entered into an
administration agreement, whereby Oncor provides administrative services to the
Company, such as clerical, secretarial and other accounting services, at a fixed
fee per year. As long as Oncor or its affiliate or agent, act as administrator,
the annual administration fee will be $50,000, payable in arrears on each
payment date. Oncor, as administrator, is limited under the terms of the
administration agreement to total compensation in the form of the annual
administration fee of $50,000 plus any fees paid to third parties on behalf of
the Company.
Operating Expenses - The Company can recover annual operating expenses,
including the annual administration fee to Oncor, of $185,000 annually through
the transition charges.
2
REQUIRED REPORTS
The Company has included in this annual report on Form 10-K or furnished
on its website at www.oncorgroup.com, as indicated, the following information in
respect of each series of outstanding transition bonds, as required by the terms
of the indenture relating to the transition bonds. Exhibits that are filed as a
part of this Form 10-K are listed in Appendix B.
Required Item Filed as Exhibit or Furnished on Website
- --------------------------------------------------- -------------------------------------------
Monthly servicer reports (for the latest quarter) Exhibit 99 (d)
A statement reporting the balance in the collection Exhibit 99 (e)
account as of the end of each quarter
A statement showing the balance of outstanding Exhibit 99 (f)
bonds that reflects the actual periodic payments
made on the bonds
The semi-annual servicer's certificate which is Exhibit 99 (g)
required to be submitted pursuant to the
Servicing Agreement
The true-up filing in respect of the series of Website
outstanding bonds and the results of
each true-up filing:
Interim true-up of transition charges for the Series
2003 Bonds, filed as of January 15, 2004
A quarterly statement affirming that, in all material Exhibit 99 (h)
respects, for each materially significant REP,
(a) each REP has been billed in compliance
with the requirements outlined in the
Financing Order; (b) each REP has made
payments in compliance with the
requirements outlined in the Financing
Order, and (c) each REP satisfies the
creditworthiness requirements of the
Financing Order.
Item 2. PROPERTIES
The Company does not own any tangible property, other than books and
records. The primary asset of the Company is the transition property described
in Item 1. Business.
Item 3. LEGAL PROCEEDINGS
None.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
3
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Not applicable. All outstanding common membership interests in the
Company are held by Oncor.
Item 6. SELECTED FINANCIAL DATA
Item 6 is not presented herein as Oncor meets the conditions set forth in
General Instruction (I) (1) (a) and (b).
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The information required hereunder for the Company in its reduced
format as allowed for under the General Instruction (I)(1)(a) and (b) is set
forth under Management's Discussion and Analysis of Financial Condition and
Results of Operations included in Appendix A to this report.
Item 7a. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
None.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required hereunder for the Company is set forth under
Independent Auditors' Report, Statements of Income, Statements of Cash Flows,
Balance Sheets, Statements of Membership and Notes to Financial Statements
included in Appendix A of this report.
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
Item 9a. CONTROLS AND PROCEDURES
An evaluation was performed under the supervision and with the
participation of the Company's management, including the principal executive
officer and principal financial officer, of the effectiveness of the design and
operation of the disclosure controls and procedures in effect as of December 31,
2003. Based on the evaluation performed, the Company's management, including the
principal executive officer and principal financial officer, concluded that the
disclosure controls and procedures were effective.
4
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT
Item 10 is not presented herein as the Company meets the conditions set
forth in General Instruction (I) (1) (a) and (b).
Item 11. EXECUTIVE COMPENSATION
Item 11 is not presented herein as the Company meets the conditions set
forth in General Instruction (I) (1) (a) and (b).
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Item 12 is not presented herein as the Company meets the conditions set
forth in General Instruction (I) (1) (a) and (b).
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Item 13 is not presented herein as the Company meets the conditions set
forth in General Instruction (I) (1) (a) and (b).
PART IV
Item 14. FINANCIAL ACCOUNTING FEES AND SERVICES
Not applicable.
Item 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
Page
----
(a) Documents filed as part of this Report:
Financial Statements (included in Appendix A to this report):
Management's Discussion and Analysis of Financial Condition and Results of
Operations............................................................................. A-2
Independent Auditors' Report............................................................. A-20
Statement of Income for the year ended December 31,2003.................................. A-21
Statement of Cash Flows for the year ended December 31, 2003............................. A-22
Balance Sheets, December 31, 2003 and 2002............................................... A-23
Statement of Member's Equity for each of the three years in the period
ended December 31, 2003............................................................... A-24
Notes to Financial Statements............................................................ A-25
The financial statements schedules are omitted because of the absence of
the conditions under which they are required or because the required information
is included in the consolidated financial statements or notes thereto.
5
(b) Reports on Form 8-K:
None
(c) Exhibits furnished or filed as a part of this report:
Included in Appendix B to this report.
6
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, Oncor Electric Delivery Transition Bond Company LLC has
duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
ONCOR ELECTRIC DELIVERY
TRANSITION BOND COMPANY LLC
Date: March 25, 2004 By: /s/ M.S. GREENE
------------------------------------
(M. S. Greene, President and
Chief Executive)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of Oncor
Electric Delivery Transition Bond Company LLC and in the capacities and on the
date indicated.
Signature Title Date
--------- ----- ----
/s/ M.S. GREENE Principal Executive March 25, 2004
- ----------------------------------------------------------- Officer and Manager
(M. S. Greene, President and Chief Executive)
/s/ SCOTT LONGHURST Principal Financial Officer March 25, 2004
- -----------------------------------------------------------
(Scott Longhurst, Senior Vice President and
Principal Financial Officer)
/s/ H. DAN FARELL Manager March 25, 2004
- -----------------------------------------------------------
(H. Dan Farell)
/s/ ERIC H. PETERSON Manager March 25, 2004
- -----------------------------------------------------------
(Eric H. Peterson)
/s/ C. JOHN WILDER Manager March 25, 2004
- -----------------------------------------------------------
(C. John Wilder)
7
CERTIFICATION
I, Scott Longhurst, Senior Vice President and Principal Financial Officer of
Oncor Electric Delivery Company, the servicer under the transition property
servicing agreement, certify that:
1. I have reviewed this annual report on Form 10-K and all other reports
containing distribution information filed for the period covered by this annual
report;
2. To the best of my knowledge, the information in these reports does
not contain any untrue statement of a material fact or omit to state a material
fact necessary to make the statements made, in light of the circumstances under
which such statements were made, not misleading;
3. To the best of my knowledge, the financial information required to be
provided to the trustee by the servicer under the transition property servicing
agreement is included in these reports; and
4. I am responsible for reviewing the activities performed by the
servicer under the transition property servicing agreement and based upon the
review required under the transition property servicing agreement the servicer
has fulfilled its obligations under the transition property servicing agreement.
Date: March 25, 2004
By: /s/ Scott Longhurst
-------------------------------------------
(Scott Longhurst, Senior Vice President and
Principal Financial Officer of Oncor
Electric Delivery Company)
8
Appendix A
ONCOR ELECTRIC DELIVERY TRANSITION BOND COMPANY LLC
INDEX TO FINANCIAL INFORMATION
December 31, 2003
Page
Management's Discussion and Analysis of Financial Condition and Results of Operations....... A- 2
Independent Auditors' Report................................................................ A-20
Financial Statements:
Statement of Income.................................................................... A-21
Statement of Cash Flows................................................................ A-22
Balance Sheets......................................................................... A-23
Statement of Member's Equity........................................................... A-24
Notes to Financial Statements.......................................................... A-25
A-1
ONCOR ELECTRIC DELIVERY TRANSITION BOND COMPANY LLC
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
BUSINESS
The Company is a bankruptcy remote special purpose Delaware limited
liability company, wholly-owned by Oncor. Oncor is a wholly-owned subsidiary of
US Holdings, which is a wholly-owned subsidiary of TXU Corp. Oncor is a
regulated electricity transmission and distribution company principally engaged
in providing delivery services to REPs that sell electricity in the
north-central, eastern and western parts of Texas.
The Company was organized in November 1999 for the sole purpose of
purchasing and owning transition property acquired from Oncor. The Company had
no operations until August 2003. In connection with the acquisition of the
transition property, the Company has agreed to (a) register and issue one or
more series of transition bonds, each of which may be comprised of one or more
classes, (b) pledge its interest in the transition property and other transition
bond collateral to secure the transition bonds, (c) make debt service payments
on the transition bonds, and (d) perform other activities that are necessary,
suitable or convenient to accomplish these purposes. The Company is structured
and is operated in a manner such that in the event of bankruptcy proceedings
against Oncor, the assets of the Company will not be consolidated into the
bankruptcy estate of Oncor. Oncor is not the owner of the transition property
described herein, and the assets of the Company are not available to pay
creditors of Oncor or any of its affiliates.
RESULTS OF OPERATIONS
In August 2003, the Company issued and sold the first series of transition
bonds in an aggregate principal amount of $500,000,000. The proceeds from the
sale of the transition bonds were used to acquire transition property from
Oncor. Such property represents the irrevocable right to impose, collect and
receive transition charges in an amount sufficient to pay the interest, fees,
and expenses associated with the transition bonds, as well as the aggregate
principal amount of the transition bonds. The Company pledged its interests in
the transition property and other transition bond collateral to secure the
transition bonds.
Also in August 2003, Oncor made a capital contribution of $6,346,154 to
the Company, of which $2,500,000 is held by the indenture trustee and pledged as
collateral to the first series of transition bonds, and the remaining $3,846,154
is held by the indenture trustee in a reserve account to be used to fund any
future fees and expenses of the indenture trustee not recovered from the
transition charges.
In December 2003, Oncor contributed an additional $6,153,846, which was
also placed in the reserve account with the indenture trustee, to cover any
future trustee fees and expenses associated with the transition bonds.
In September 2003, Oncor, on behalf of the Company, began billing REPs the
initial transition charges approved by the Commission to collect the funds
needed to make scheduled principal and interest payments on the transition bonds
issued in August 2003. Operating revenues of $19,482,393 include $2,534,155 of
accrued unbilled revenues, as well as interest income on those funds collected.
A-2
In connection with the issuance of the first series of transition bonds,
the Company began accruing interest on the $500,000,000 aggregate principal
amount of such bonds. For the year ended December 31, 2003, interest expense
totaled $7,777,756.
In September 2003, the Company commenced amortization of the transition
property in accordance with the amortization schedule approved by the Commission
and based on expected collections of transition charges over the life of the
bonds. Such amortization for the year ended December 31, 2003 was $5,748,164.
The transition charges billed to REPs are designed to, over time, be
sufficient to repay the interest costs, the principal of the bonds, represented
in the income statement as amortization of the transition property, and other
related costs. However, transition charge revenues are expected to vary from
projected amounts due to variations in power usage and the effects of unbilled
revenue accruals, resulting in temporary over or under recovery of transition
charges. In 2003, the Company recorded over recovery of transition charges
expense and an offsetting regulatory liability of $5,770,918. The Commission
reviews and adjusts transition charges at least once a year. This review is used
to adjust any over or under collections during the preceding 12 months and to
provide for recovery of amounts sufficient to pay the debt service and related
costs.
Servicing and administration fees provided by and accrued to Oncor,
totaled $169,793 for the year ended December 31, 2003. This amount is expected
to increase once the remaining series of transition bonds of approximately
$790,000,000 are issued, which is expected to be completed in the first half
of 2004.
Oncor will be required to contribute approximately $3,950,000 upon the
issuance of the next series of transition bonds (approximately $790,000,000) in
the Capital Sub-account to be pledged as collateral for that series of
transition bonds.
FINANCING ACTIVITIES
The Company's financial needs are limited to issuance of up to $1.3
billion in transition bonds. There is no provision to allow for any other
borrowings.
Financial Covenants, Credit Rating Provisions and Cross Default Provisions
- -- The terms of the indenture contain financial covenants that require
maintenance of specified collateral deposits in proportion to the aggregate
principal amount of the bonds outstanding. As of December 31, 2003, the Company
was in compliance with such covenants.
A-3
FORWARD-LOOKING STATEMENTS
This report and other presentations made by the Company contain
forward-looking statements within the meaning of Section 21E of the Securities
Exchange Act of 1934, as amended. Although the Company believes that in making
any such statement its expectations are based on reasonable assumptions, any
such statement involves uncertainties and is qualified in its entirety by
reference to the risks discussed below under "RISK FACTORS" and the following
important factors, among others that could cause the actual results of the
Company to differ materially from those projected in such forward-looking
statements:
o state or federal legislative or regulatory developments,
o national or regional economic conditions,
o the accuracy of the servicer's estimates of market demand and prices
for energy,
o the accuracy of the servicer's estimates of industrial, commercial and
residential growth in Oncor's service territory, including related
estimates of conservation and electric usage efficiency,
o weather conditions and other natural phenomena affecting retail
electric customer energy usage,
o acts of sabotage, terrorist activities or other catastrophic events,
o the speed, degree and effect of continued electric industry
restructuring,
o the operating performance of Oncor's facilities and third-party
suppliers of electric energy in Oncor's service territory,
o the accuracy of the servicer's estimates of the payment patterns of
retail electric customers, including the rate of delinquencies and any
collections curves, and
o the operational and financial ability of REPs to bill and collect
transition charges and make timely payments of amounts billed by the
servicer to the REPs for transition charges.
Any forward-looking statement speaks only as of the date on which such
statement is made, and the Company undertakes no obligation to update any
forward-looking statement to reflect events or circumstances after the date on
which such statement is made or to reflect the occurrence of unanticipated
events. New factors emerge from time to time and it is not possible for the
Company to predict all of such factors, nor can it assess the impact of each
such factor or the extent to which any factor, or combination of factors, may
cause actual results to differ materially from those contained in any
forward-looking statement.
RISK FACTORS
The following risk factors are being presented in consideration of
industry practice with respect to disclosure of such information in filings
under the Securities Exchange Act of 1934, as amended.
Some important factors that investors should consider carefully before
deciding whether to purchase transition bonds of any series or class include:
Material Payment Delays or Losses on Transition Bonds May be Experienced
Due to the Limited Sources of Payment for the Transition Bonds and Limited
Credit Enhancement
Material payment delays or losses on transition bonds may be experienced
if the assets securing transition bonds are insufficient to pay the principal
amount of such transition bonds and accrued interest on those transition bonds
in full. The only source of funds for payments of interest on and principal of
the transition bonds of a particular series will be the related Collateral for
that series. The Collateral for a particular series of transition bonds will be
limited to:
A-4
o the related transition property, including the right to impose, collect
and receive the related transition charges from customers and to adjust
the transition charges at least annually;
o available funds on deposit in the applicable trust accounts held by
the indenture trustee;
o contractual rights under the applicable sale agreement, the applicable
servicing agreement and other applicable contracts for such series;
and
o any other credit enhancements described in the applicable prospectus
supplement related to such series of transition bonds.
Any floating rate bonds will also have the proceeds of any swap agreement
available as a payment source.
The transition bonds will not be insured or guaranteed by Oncor, including
in its capacity as servicer, or by its ultimate parent, TXU Corp., any of its
affiliates (other than the Company), the indenture trustee or any other person
or entity. Thus, reliance for payment of the transition bonds must be based upon
collections of the related transition charges, available funds on deposit in the
applicable trust accounts held by the indenture trustee and any other credit
enhancement described in the applicable prospectus supplement related to a
series of transition bonds. A series of transition bonds will be payable only
from Collateral that secures such series and not from transition charges imposed
and collected for any other series of transition bonds. The organizational
documents of the Company will restrict the right to acquire other assets
unrelated to the transactions described herein.
Judicial, Legislative or Regulatory Actions That May Adversely Affect an
Investment in Transition Bonds
Legal Action May Reduce the Value of an Investment in Transition Bonds.
The transition property is created pursuant to the Restructuring Act and a
financing order issued by the Commission. Investing in bonds payable from an
asset that depends for its existence on recently enacted legislation with a
limited history and judicial interpretation and regulatory implementation and
interpretation is risky. The Restructuring Act was adopted in June 1999 by a
vote of 142-4 in the Texas House and 28-3 in the Senate and signed into law by
Governor George W. Bush.
On December 31, 2001, a settlement plan was filed on behalf of US Holdings
which, among other things, resolved all issues related to US Holdings' stranded
cost recovery and securitization of Oncor's regulatory assets. On August 5,
2002, the Commission issued the Financing Order, pursuant to the settlement
plan, authorizing the issuance of transition bonds relating to recovery of
Oncor's regulatory assets. The Commission's order approving the settlement plan
and the Financing Order were appealed by certain nonsettling parties to the
Travis County, Texas District Court in August 2002. In January 2003, US Holdings
concluded a settlement of these appeals, and they were dismissed. Thus, the
settlement became final.
A portion of the Restructuring Act was challenged in Texas state court.
This portion of the Restructuring Act was upheld and is no longer subject to
appeal, as is discussed below. Notwithstanding the Texas state court's decision,
a future Texas state or federal court decision might overturn the Restructuring
Act or the Financing Order. Because the securitization financing is a creation
of statute, any alteration affecting the validity of the relevant underlying
legislative provisions could directly impact the transition bonds. For example,
if the provisions that create transition property were invalidated, the validity
of the principal assets securing the transition bonds could be eliminated. As
another example, if the provisions that allow for the transition charge true-up
adjustment process were invalidated, the servicer could be prevented from
ensuring that sufficient funds are deposited with the indenture trustee for the
scheduled payments on the transition bonds. If an invalidation of any relevant
underlying legislative provision or financing order provision occurs, some or
all of the investment in the transition bonds may be lost or delays may be
experienced in recovering the investment. The Restructuring Act or any of its
provisions, including the provisions relating to securitization, may be directly
contested in courts or otherwise become the subject of litigation.
The constitutionality of the securitization provisions of the
Restructuring Act under the Texas Constitution was challenged in connection with
a securitization request made by Central Power and Light Company. The
constitutionality of the challenged provisions of the Restructuring Act was
affirmed by the Travis County, Texas District Court in July 2000. This judgment
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was appealed directly to the Texas Supreme Court. On June 6, 2001, the Texas
Supreme Court affirmed the judgment of the Travis County, Texas District Court
denying this appeal and finding that the securitization provisions are
constitutional. The Texas Supreme Court denied rehearing, with a corrected
opinion that did not affect the substance of the original ruling, on August 30,
2001. No petition for writ of certiorari was filed with the United States
Supreme Court prior to the deadline for such a filing.
If in the future a state or federal court were to determine that the
relevant provisions of the Restructuring Act or the Financing Order are unlawful
or invalid, that decision could adversely affect the validity of the transition
bonds or the Company's ability to make payments on the transition bonds. In that
case, a loss on or delay in recovery of the investment in the transition bonds
may be experienced. If the Restructuring Act is overturned, the limitation on
appealing the Financing Order may also be overturned. The Company cannot assure
that another lawsuit challenging the validity of the Restructuring Act will not
be filed in the future or that, if filed, such lawsuit would not be successful.
Other states have passed electric utility deregulation laws similar to the
Restructuring Act, and some of these laws have been challenged by judicial
actions. To date, none of these challenges has succeeded, but future judicial
challenges could be made in other states. An unfavorable decision regarding
another state's law would not automatically invalidate the Restructuring Act or
the Financing Order, but it might provoke a challenge to the Restructuring Act
or the Financing Order. In addition, an unfavorable court decision with respect
to another state's statute may establish a legal precedent for a successful
challenge to the Restructuring Act depending on the similarity of the other
statute and the applicability of the legal precedent to the Restructuring Act.
Furthermore, legal action in other states could heighten awareness of the
political and other risks of the transition bonds, and in that way may limit the
liquidity and value of the transition bonds. Therefore, legal activity in other
states may indirectly affect the value of an investment in transition bonds.
Neither the Company nor Oncor nor any successor seller will indemnify an
investor for any changes in the law, including any amendment or repeal of the
Restructuring Act, that may affect the value of the transition bonds. Oncor or a
successor seller may have to indemnify the Company, however, if legal action
based on law in effect at the time of the issuance of the transition bonds
invalidates the transition property.
Further Legislative Action May Reduce the Value of An Investment in
Transition Bonds. The value of an investment in transition bonds may decline due
to legislative action. For example:
(a) Future Texas Legislative Action May Invalidate the Transition Bonds or
the Transition Property which is the Primary Source of Payments on the
Transition Bonds. Unlike many other states (including California,
Massachusetts and Michigan), the citizens of the State of Texas do not
have the constitutional right to adopt or revise laws by initiative or
referendum. Thus, absent any amendment of the constitution of the
State of Texas, the Restructuring Act cannot be amended or repealed by
direct action of the electorate. The Texas legislature may repeal the
Restructuring Act, or amend the Restructuring Act in a way that limits
or alters the transition property so as to reduce its value. However,
under the Restructuring Act, the State of Texas has pledged for the
benefit and protection of Oncor and all financing parties that it
(including the Commission) will not take or permit any action to be
taken that would impair the value of the transition property.
Hunton & Williams LLP has rendered its opinion to the Company and Oncor
in connection with the issuance of the first series of the transition bonds, and
will render a similar opinion to the Company and Oncor in connection with the
second series of transition bonds, that under the laws of the State of Texas and
the United States, holders of the transition bonds could successfully challenge
under the Federal Contracts Clause and the Texas Contracts Clause the
constitutionality of any legislation passed by the State of Texas, including the
Commission, which becomes law that repeals or amends the Restructuring Act in
such a manner that substantially impairs the value of the rights of the holders
of the transition bonds or the transition charges prior to the time that the
transition bonds are fully paid and discharged, unless it was determined that
such repeal or amendment was a legitimate and reasonable exercise of the State
of Texas' sovereign powers and reasonable and necessary to serve a significant
and legitimate public purpose. Further, Hunton & Williams LLP will render to the
Company and Oncor its opinion that a court would conclude that adverse action by
the Texas legislature or the Commission that repeals the State of Texas' pledge
to the holders of the transition bonds or otherwise adversely affects the
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transition property would constitute a compensable "taking" under the Takings
Clauses of the United States and Texas Constitutions, if the court determines
that any such action is an intentional action by the Texas legislature or the
Commission, effects a regulatory taking of the transition property and is for
public use. There is no assurance, however, that, even if a court were to award
just compensation, it would be sufficient to pay the full amount of principal
and interest on the transition bonds.
It may be possible for the Texas legislature to enact legislation that
would impair the rights and remedies of bondholders without violating the
State's pledge, if the legislature acts in order to serve a significant and
legitimate public purpose, such as protecting the public health and safety or
otherwise acts in the valid exercise of the state's police power. Even if the
legislature provides an investor with an amount deemed to be just compensation,
it may not be sufficient to fully recover the investment. The Company cannot
assure an investor of the likelihood or legal validity of any action of this
type by the Texas legislature, or whether the action would be considered a
taking. As of the date of this report, the Company is not aware of any pending
legislation in the Texas legislature that would affect any provisions of the
Restructuring Act related to transition property or transition charges or the
provisions of the Financing Order.
The Company cannot assure an investor that a repeal or amendment to the
Restructuring Act will not be sought or adopted or that any action by the State
of Texas adverse to an investment in the transition bonds will not occur. In any
such event, costly and time-consuming litigation might ensue. Any litigation of
this type might adversely affect the price and liquidity of the transition bonds
and delay the payment of interest and principal and, accordingly, the weighted
average lives of the transition bonds.
(b) The Restructuring Act May be Overturned by the Federal Government
Without Full Compensation. The United States Congress or a federal
agency may decide that it can preempt the Texas legislature and pass
a law or adopt a rule or regulation prohibiting or limiting the
collection of transition charges, or otherwise affecting the energy
industry. A prohibition of this nature could negate the existence of
transition property. One bill was introduced in the 107th Congress
possibly prohibiting the recovery of wholesale stranded costs
through charges similar to the transition charges provided for in the
Restructuring Act. As of the date of this report, neither the House
nor the Senate committees having primary relevant jurisdiction have
considered, or indicated an intent to consider, the prohibition of
the recovery of stranded costs or transition charges. The Company
cannot predict whether any future bills that prohibit the recovery
of stranded costs or regulatory assets, or securitized financing for
the recovery of stranded costs, will become law or, if they become
law, what their final form or effect will be. The Company can give
no assurance that a court would consider the preemption by federal
law of the Texas Restructuring Act a taking of property from the
Company or from the holders of transition bonds. Moreover, even if
this preemption of the Restructuring Act and/or the Financing Order
by the federal government were considered a taking under the U.S.
Constitution for which the government had to pay the estimated market
value of the taken transition property at the time of the taking, the
Company can give no assurance that this compensation would be
sufficient to pay the full amount of principal of and interest on
the transition bonds or to pay such amounts on a timely basis.
The Company and Oncor have agreed to take legal or administrative action
as may be reasonably necessary to block or overturn any attempts to cause a
repeal, modification or amendment to the Restructuring Act, the Financing Order
or the transition property.
Neither the Company, Oncor nor any successor seller or servicer will
indemnify an investor for any changes in the law that may affect the value of
the transition bonds. In addition, any action by the United States Congress or
Texas legislature, even if the action is ultimately determined to be invalid,
and even if full compensation is ultimately provided to the holders of
transition bonds, might result in costly and time-consuming litigation. Any
litigation of this type might adversely affect the price and liquidity of the
transition bonds and the dates of payment of interest and principal. Moreover,
given the lack of judicial precedent directly on point, and the novelty in Texas
of transition property as security for transition bonds, the Company cannot
predict the outcome of any litigation with certainty. Accordingly, an investor
may suffer a loss on or delay in recovery of an investment in the transition
bonds.
A-7
(c) The Commission May Take Future Actions Which May Reduce the Value of
an Investment in Transition Bonds. The Restructuring Act provides
that the Financing Order is irrevocable upon issuance and is not
subject to reduction, impairment or adjustment by further action of
the Commission, except for the true-up adjustments. The State of
Texas (including the Commission) has pledged that it will not take or
permit any action to amend, alter or impair the value of transition
property created under the Financing Order, except as permitted in
true-up adjustments, until the principal, interest and premium, if
any, and any other charges incurred and contracts to be performed in
connection with the transition bonds have been paid and performed in
full. The Commission guarantees that it will take specific regulatory
actions pursuant to the Financing Order, as expressly authorized by
the 1999 Restructuring Legislation, to ensure that transition charge
revenues are sufficient to pay principal and interest on the
transition bonds. However, the Commission retains the power to adopt,
revise or rescind rules or regulations affecting the seller or a
successor utility. The Commission also retains the power to interpret
the Financing Order. Any new or amended regulations or orders by the
Commission, for example, could affect the ability of the servicer to
collect the transition charges in full and on a timely basis. The
seller has agreed to take legal or administrative action to
resist any Commission rule, regulation or decision that would reduce
the value of the transition property. The Company cannot assure an
investor that the seller would be successful in its efforts. Thus,
future Commission rules, regulations or decisions may adversely affect
the rating of the transition bonds, their price or the rate of
transition charge collections and, accordingly, the amortization of
transition bonds and their weighted average lives. As a result, an
investor could suffer a loss in connection with an investment in
transition bonds.
The servicer is required to file with the Commission, on behalf of the
Company, any requested adjustments of the transition charges. There is
uncertainty associated with investing in transition bonds whose timely payment
of principal and interest may depend on true-up adjustments because of the
limited judicial or regulatory experience implementing and interpreting the
provisions of the Restructuring Act providing for true-up adjustments. The
Company cannot assure that the foregoing adjustment procedures and adjustments
will not be challenged. Such challenges could result in costly and time
consuming litigation. A shortfall or material delay in transition charge
collections due to inaccurate forecasts, delayed implementation of true-up
adjustments or the failure to implement a true-up adjustment could result in
payments of principal of and interest on the transition bonds not being paid
according to the expected amortization schedule, lengthening the weighted
average life of the transition bonds, or in payments of principal and interest
not being made at all. As a result, an investor could suffer a loss in
connection with an investment.
On May 20, 2003, various electric cooperatives and municipally-owned
utilities in Oncor's service territory filed a petition for rulemaking with the
Commission requesting that the Commission adopt a rule regarding the billing and
collection of transition charges from end-use customers in multiply-certificated
service areas who switched electricity providers after May 1, 1999. Oncor
believes that the number of such customers is less than one hundred. The rule
proposed by the petitioners only involves the method of collecting transition
charges, including the liability in connection therewith, and would require the
transition charges to be billed directly to those customers by the servicer,
rather than by the applicable electric cooperative or municipally-owned utility.
Oncor has filed a response to the petition stating that the proposed rule would
violate the Restructuring Act and the Financing Order and has filed a complaint
with the Commission requesting that the Commission order the electric
cooperatives and municipally-owned utilities to implement the current procedure.
The Commission has denied the rulemaking petition and indicated that it will
initiate a separate rulemaking later. The complaint proceeding is currently
abated to allow Oncor and the petitioners to pursue settlement negotiations.
Inasmuch as the petitioners assert that the issue in this proceeding does not
involve the legality of the recovery of the transition charges or the amount
thereof, Oncor does not believe the result of this proceeding will be materially
adverse to holders of the transition bonds; however, Oncor cannot predict the
outcome.
Servicing Risks
Inaccurate Forecasting or Unanticipated Delinquencies Could Result in
Insufficient Funds to Make Scheduled Payments on the Transition Bonds. The
transition charges are generally assessed based on customer usage, which
A-8
includes kilowatts demanded and kilowatt-hours of electricity consumed by retail
customers in Oncor's service area. Oncor will calculate the transition charges
for each series of transition bonds according to the methodology approved by the
Financing Order authorizing those transition charges. In addition, Oncor, as
servicer, is required to file with the Commission periodic adjustment
calculations for the transition charges. These adjustments are intended to
provide, among other things, for timely payment of the transition bonds, but the
frequency of these adjustments is limited to once per year for a standard
true-up, no more than semi-annually (if payment dates on transition bonds are
semi-annual) or not more than once every three months (if payment dates on the
transition bonds are quarterly) for an interim true-up, but can be more
frequently for a non-standard true-up. Oncor will generally base its adjustment
calculations on any shortfalls or excess in collections from customers during
the prior adjustment period and on projections of future electricity use and
customers' ability to pay their electric bills. If the servicer inaccurately
forecasts electricity consumption or demand or underestimates customer
delinquencies or charge-offs when setting or adjusting the transition charges,
or if the effectiveness of the adjustments is delayed for any reason, there
could be a shortfall or material delay in transition charge collections. A
shortfall or material delay in transition charge collections could result in
payment of principal of and interest on the transition bonds not being made
according to the expected amortization schedule, thus lengthening the weighted
average life of the transition bonds, or in payments of principal and interest
not being made at all.
Inaccurate forecasting of electricity consumption by the servicer could
result from, among other things:
o warmer winters or cooler summers, resulting in less electricity
consumption than forecasted;
o general economic conditions being worse than expected, causing
customers to migrate from Oncor's service territory or reduce their
electricity consumption;
o the occurrence of a natural disaster, such as a tornado, or an act of
war or terrorism or other catastrophic event unexpectedly disrupting
electrical service and reducing usage;
o problems with energy generation, transmission or distribution
resulting from the change in the market structure of the electric
industry;
o customers ceasing business or departing Oncor's service territory;
o dramatic changes in energy prices resulting in decreased consumption;
o customers consuming less electricity because of increased conservation
efforts or increased electric usage efficiency; or
o customers switching to alternative sources of energy, including
self-generation of electric power.
Inaccurate forecasting of delinquencies or charge-offs by the servicer
could result from, among other things:
o unexpected deterioration of the economy or the occurrence of a natural
disaster, or an act of war or terrorism or other catastrophic event or
the declaration of a heat moratorium causing greater charge-offs than
expected or forcing Oncor or a successor distribution company to grant
additional payment relief to more customers;
o a change in law that makes it more difficult for Oncor or a successor
distribution company or a REP to terminate service to nonpaying
customers, or that requires Oncor or a successor distribution company
or REP to apply more lenient credit standards in accepting customers;
o the introduction into the energy markets of REPs who collect payments
arising from the transition charges, but who may fail to remit retail
customer charges to the servicer in a timely manner; or
A-9
o the failure of REPs to submit accurate and timely information to the
servicer regarding their collections and charge-offs. See "It May Be
Difficult to Collect the Transition Charges from REPs."
There are Uncertainties Associated with Collecting the Transition Charges,
and There is Unpredictability Associated with a Deregulated Electricity Market.
Oncor has only limited experience in calculating transition charges for
customers, which commenced recently following the issuance of the first series
of transition bonds. The predictions associated with billing and collecting
transition charges are based primarily on historical collection of payments and
forecasted energy usage for which Oncor has records available. These usage and
collection records, however, may not reflect customers' payment patterns or
energy usage in the competitive market, as competition was introduced in Texas
for the first time on January 1, 2002. These records also reflect limited
experience with consolidated billing to REPs. Because that kind of billing is
new in Texas, unforeseen factors may adversely affect collection of payments.
Therefore, the records that Oncor has to date may have limited value in
calculating the initial transition charges and the proposed true-up adjustments.
Furthermore, Oncor, as servicer, has only limited experience administering
transition charges, which commenced recently following the issuance of the first
series of transition bonds. Risks are associated with Oncor's inexperience in
calculating, billing and collecting the transition charges and in managing
customer payments on the Company's behalf. A shortfall or material delay in
collecting transition charges could result in payments of principal not being
paid according to the expected amortization schedule, lengthening the weighted
average life of the transition bonds, or in payments of principal and interest
not being made at all. As a result, an investor could suffer a loss in
connection with the investment.
An Investment in Transition Bonds Relies on Oncor or its Successor Acting
as Servicer of the Transition Property. Oncor, as servicer, will be responsible
for billing and collecting transition charges from REPs and for filing with the
Commission to adjust these charges. If Oncor ceases servicing the transition
property, it might be hard to find a successor servicer and any transfer of
servicing to a successor servicer may adversely affect an investor. Any
successor servicer may have less experience than Oncor and may have less capable
billing and/or collection systems than Oncor and may experience difficulties in
collecting transition charges and determining appropriate adjustments to
transition charges. A successor servicer might charge fees that, while permitted
under the Financing Order, are higher than the fees paid to Oncor as servicer.
If Oncor were to be replaced as servicer, any of these factors and others could
delay the timing of payments and may reduce the value of an investment in
transition bonds. Also, a change in servicer may cause billing and/or payment
arrangements to change, which may lead to a period of disruption in which
customers continue to remit payments according to the former arrangement,
resulting in delays in collection that could result in delays in payment on the
transition bonds. Under the Oncor servicing agreements, no servicer default may
be waived without the written consent of both the Commission and holders of a
majority of the applicable series of outstanding transition bonds. The servicing
agreements will also grant the independent right to the Commission, in addition
to the right of the indenture trustee on behalf of the transition bondholders,
to require transfer of the servicing to a successor servicer in the event of any
such servicer default.
Upon a default under a servicing agreement based upon the commencement of
a case by or against the servicer under the United States Bankruptcy Code or
similar laws, the indenture trustee and the Company may be prevented from
effecting a transfer of servicing. The Restructuring Act provides that upon a
default under the transition bonds, which may result from servicer's failure to
make required remittances, the indenture trustee would have the right to apply
to the Commission for an order that amounts arising from transition charges be
transferred to a separate account, and to apply to the district court of Travis
County, Texas for an order for sequestration and payment of revenues arising
from the transition charges. However, in the event that the servicer becomes
subject to a bankruptcy proceeding, federal bankruptcy law may prevent the
Commission or the Texas court from issuing or enforcing these orders. The
indenture requires the indenture trustee to request an order from the bankruptcy
court to permit the Commission or the Texas court to issue and enforce these
orders. However, the bankruptcy court may deny the request. The failure of the
servicer to make required remittances would likely result in a default under the
indenture.
Under the intercreditor agreement among the Company, Oncor, the transition
bond parties and the parties to TXU Corp.'s receivables financing program, a
replacement servicer would require the agreement of both the trustee and the
other parties to the intercreditor agreement. If the trustee and the other
parties are unable to agree on a replacement servicer within 10 business days,
Oncor's independent auditors would appoint the replacement servicer.
A-10
It May Be Difficult to Collect the Transition Charges from REPs. As part
of the restructuring of the Texas electric industry, retail customers in Oncor's
service territory began, as of January 1, 2002, or in limited circumstances by
participating in a pilot project, sooner, purchasing electricity and related
services from REPs rather than Oncor. Oncor is no longer permitted to sell
electricity directly to retail customers. US Holdings currently has organized an
affiliated REP to provide electricity and related services to retail customers
in Oncor's service territory. In the future, US Holdings may establish
additional affiliated REPs or divest itself of one or more affiliated REPs.
REPs, including US Holdings' affiliated REP, issue a single bill to retail
customers purchasing electricity from a REP. The Restructuring Act requires
Oncor to allow each REP, including US Holdings' affiliated REP, pursuant to a
tariff to be filed by Oncor and approved by the Commission, to issue a single
bill to customers purchasing electricity from that REP. This single bill
includes all charges related to purchasing electricity from the REP, including
delivery services from Oncor and the applicable transition charges. Retail
customers will pay transition charges to REPs who supply them with electric
power. The REPs will be obligated to remit payments of transition charges to the
servicer less a specified percentage allowance for charge-offs or delinquent
customer accounts whose service has been terminated, within 35 days of billing
from the servicer, even if the REPs do not collect the charges from retail
customers. The charge-off percentage will initially be based on the servicer's
system-wide charge-off percentage but will then be recalculated annually for
each REP in conjunction with the true-up adjustment process. Each REP's recourse
for transition charge payments remitted to the servicer but not collected
ultimately from customers will be limited to a credit against future transition
charge payments unless the REP and the servicer agree to alternative
arrangements, but in no event will the REP have recourse to the Company or the
Company's funds for such payments. In the event that the REP does not pay the
transition charges to the servicer, the servicer will have the right to collect
transition charges directly from those retail customers who receive their
electricity bills from a REP and have not paid the REP. REPs will bill most
retail customers for the transition charges, and as a result we will have to
rely on a relatively small number of entities for the collection of the bulk of
the transition charges. The servicer will not pay any shortfalls resulting from
the failure of any REP to forward transition charge collections. This may
adversely affect an investment in transition bonds because:
o REPs might use more permissive standards in bill collection and credit
appraisal than US Holdings historically used, and/or Oncor's
affiliated REP uses, with respect to its customers, or might be less
effective in billing and collecting. As a result, those REPs may not
be as successful in collecting the transition charges as the servicer
anticipated when setting the transition charge.
o If a REP defaults, the REP must either (i) allow the provider of last
resort ("POLR") or another certified REP of the customer's choosing
to assume responsibility for billing and collecting transition charges
from the REP's retail customers, (ii) implement other mutually
agreeable arrangements with the servicer or (iii) arrange at the REP's
own expense for all amounts owed by its customers to be paid into a
lock box controlled by the servicer. In no event may the servicer
directly bill a retail customer for service that was previously
billed by the REP and previously paid by that customer to the REP. In
addition, if a replacement REP assumes the billing and collecting
responsibility during the period of a REP default, billing and
collections may be delayed due to the need to convert to such
replacement provider's systems or because such replacement provider
may not have adequate or complete information.
o A default by a REP which collects from a large number of customers
would have a greater impact than a default by a single customer.
o The bankruptcy of a REP may cause a delay in or prohibition of the
enforcement of rights against the REP, including the right to payment
to the servicer of transition charges previously collected by the REP,
or to comply with financial provisions of the Restructuring Act or
other state law.
o Any security deposit or other form of credit support made or deposited
by a REP may not be sufficient to cover any shortfalls resulting from
a failure of that REP to forward transition charges to Oncor as
servicer.
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REPs who do not have a long-term unsecured credit rating of at least
"BBB-" and "Baa3" (or the equivalent from S&P and Moody's, respectively), will
be required to provide (i) a cash deposit, (ii) an affiliate guarantee, surety
bond or letter of credit or (iii) some combination of these forms of credit
support to the indenture trustee. The amount of such credit support will equal
two months' maximum expected collections of transition charges, as determined by
the servicer and agreed to by the REP, and any cash deposits will be deposited
in a REP security deposit subaccount. Credit support other than cash must be
provided by an investment grade entity. Documents representing any other form of
credit support will be held by the indenture trustee. Although the indenture
trustee will maintain the REP security deposit subaccounts, it will not have an
ownership interest in such subaccounts. However, the indenture trustee will have
a security interest in the Company's rights with respect to such subaccounts and
Oncor, as servicer, has agreed to use its reasonable best efforts to obtain a
security agreement from each REP with respect to such REP's security deposit
subaccount. In the event that a REP defaults in remitting transition charges,
the servicer may direct the indenture trustee to withdraw or seek recourse for
the amount of the payment default or, if less, withdraw the full amount of that
REP's security deposit from the REP security deposit subaccount or seek full
recourse against any other form of credit support provided for deposit into the
general subaccount of the applicable series.
In addition, the Restructuring Act provides for one or more REPs in each
designated geographical area to be designated the POLR for such area or for
specified classes of customers in such area. The Restructuring Act requires the
POLR to offer a standard retail service package of basic electric service to
retail customers in its designated area at a fixed, nondiscountable rate
approved by the Commission, regardless of the creditworthiness of the customer.
The REP serving as the POLR may face greater difficulty in bill collection than
other REPs, and therefore the servicer may face greater difficulty in collecting
transition charges from the REP serving as the POLR.
As noted above, REPs issue a single bill to retail customers purchasing
electricity from a REP. This single bill includes all charges related to
purchasing electricity from the REP, delivery services from the transmission and
distribution utility and the applicable transition charges. This may increase
the risk that customers who have claims against the REP will attempt to offset
those claims against transition charges payable to the servicer or the Company.
This also increases the risk that a bankruptcy court in the event of a
bankruptcy of a REP would find that the REP has an interest in the transition
property and may make it more difficult to terminate a bankrupt REP or collect
transition charges from its customers.
Adjustments to transition charges and, in some cases, credit enhancements
(other than swap agreements) will be available to compensate for a failure by a
REP to pay transition charges over to the servicer. However, the amount of
credit enhancement funds may not be sufficient to protect an investment.
Customers Have Limited Experience in Paying the Transition Charges and
Paying Through REPs. The transition charges were introduced to customers for the
first time beginning with the billing period following the issuance of the first
series of transition bonds. As a result, customers may be confused by changes in
customer billing and payment arrangements. This confusion may cause the
misdirection or delay of collections of transition charges. Generation and
related services, including billing and collections, began to be provided by
REPs as part of a pilot project in July 2001. All customers in areas of Texas
subject to retail electric choice began to receive such services from REPs in
January 2002. Given the relatively recent introduction of customer choice, there
is limited information available as to how implementation is proceeding. Any
problems arising from new and untested systems or any lack of experience on the
part of the REPs with customer billing and collections could also cause delays
in billing and collecting transition charges. These delays could result in
shortfalls in transition charge collections and reduce the value of an
investment in transition bonds. As of March 12, 2004, Oncor has not experienced
any material problems with respect to its billing and collections of these
transition charges from REPs.
The Introduction of Competition to Metering Services in January 2004 May
Produce Unexpected Problems. Since January 2004, a commercial or industrial
retail customer may choose to own its own meter or may choose to have its meter
owned by a REP, the transmission and distribution utility, or another person
authorized by the customer. Until other entities are authorized by the
Commission, a transmission and distribution utility will continue to provide
A-12
metering services relating to the installation and removal of meters, meter
maintenance, meter testing and calibration, data collection, and data
management, including the transfer of meter data to the settlement agent. ERCOT
is required by the Commission's substantive rules to file with the Commission
quarterly updates on the operational readiness of the support systems necessary
for the Commission to authorize an entity other than the transmission and
distribution utility to provide the metering services described in the preceding
sentence. Should the Commission allow third parties to perform those metering
services in Oncor's service territory, there may be unforeseen problems in
converting to the third party's metering system, in taking accurate meter
readings and in collecting and processing accurate metering data. Inaccurate
metering data may lead to inaccuracies in the calculation and imposition of
transition charges and could give rise to disputes between the servicer and REPs
regarding payments and payment shortfalls. A shortfall or material delay in
collecting transition charges because of the foregoing could result in payments
of principal of the transition bonds not being paid according to the expected
amortization schedule, lengthening the weighted average life of the transition
bonds or payments of principal and interest not being made at all.
Changes to Billing and Collection Practices May Reduce the Value of An
Investment in Transition Bonds. The Financing Order issued to Oncor under the
Restructuring Act sets forth the methodology for determining the amount of the
transition charges the Company may impose on each customer. The servicer cannot
change this methodology without approval from the Commission. However, Oncor, as
servicer, may set its own billing and collection arrangements with REPs and with
those customers from whom it collects the transition charges directly, provided
that these arrangements comply with Commission customer safeguards. For example,
to recover part of an outstanding bill, Oncor may agree to extend a REP's or a
customer's payment schedule or to write off the remaining portion of the bill
including transition charges. Also, Oncor, or a successor to Oncor as servicer,
may change billing and collection practices. Any change to billing and
collection practices may have an adverse or unforeseen impact on the timing and
amount of customer payments and may reduce the amount of transition charge
collections and thereby limit the Company's ability to make scheduled payments
on the transition bonds. Separately, the Commission may require changes to these
practices. Any changes in billing and collection regulation might adversely
affect the billing terms and the terms of remittances by REPs to the servicer or
make it more difficult for the servicer to collect the transition charges. These
changes may adversely affect the value of the transition bonds and their
amortization, and, accordingly, their weighted average lives.
Limits on Rights to Terminate Service May Make it More Difficult to
Collect Transition Charges. An important element of an electric utility's
policies and procedures relating to credit and collections is the right to
terminate or disconnect service on account of nonpayment. The Financing Order
provides that the sale of transition property by Oncor includes all rights of
Oncor to authorize disconnection of electric service for nonpayment of
transition charges. The Financing Order provides that, if the servicer is
billing customers for transition charges, the servicer shall have the right to
terminate service for nonpayment of transition charges pursuant to the
Commission rules. Nonetheless, Texas statutory requirements and the rules and
regulations of the Commission, which may change from time to time, regulate and
control the right to terminate service. In August 2002, the Commission adopted
new rules that significantly changed POLR service. Under the new POLR rules,
instead of being transferred to the POLR, non-paying residential and small
non-residential customers served by affiliated REPs are subject to
disconnection. Non-paying residential and small non-residential customers served
by non-affiliated REPS are transferred to the affiliated REP. Non-paying large
non-residential customers can be disconnected by any REP if the customer's
contract does not preclude it. Thus, within the new POLR framework, the POLR
provides electric service only to customers who request POLR service, whose
selected REP goes out of business, or who are transferred to the POLR by other
REPs for reasons other than non-payment. No later than October 1, 2004, the
Commission must decide whether all REPs should be permitted to disconnect all
non-paying customers. Oncor's affiliated REP and the other REPs may not
terminate service to a customer on (1) a weekend day, (2) a day when the
previous day's high temperature did not exceed 32 degrees Fahrenheit and is
predicted to remain at or below that level for the next 24 hours or (3) a day
for which the National Weather Service issues a heat advisory for any county in
the service territory, or when a heat advisory has been issued for either of the
two prior calendar days. As a result, REPs must provide service to these
customers during this period without recouping transition charges from these
customers. This could cause a REP to go out of business, which may reduce the
amount of transition charge collections available for payments on the transition
bonds, although any associated reduction in payments would be factored into the
transition charge true-up adjustments.
A-13
Future Adjustments to Transition Charges by Customer Class May Result in
Insufficient Collections. The customers who will be responsible for paying
transition charges are divided into customer classes. Transition charges will be
allocated among customer classes and assessed in accordance with the formula
required under the Restructuring Act and specified in the Financing Order. This
allocation is based in part upon the existing rate structure of each customer
class. Adjustments to the transition charges will also be made separately to
each customer class. A shortfall in collections of transition charges in one
customer class may be corrected by making adjustments to the transition charges
payable by that customer class and any other customer class. Some customer
classes have a significantly smaller number of customers than other customer
classes. If customers in a class fail to pay transition charges, the servicer
may have to substantially increase the transition charges for the remaining
customers in that customer class and for other customer classes. The servicer
may also have to take this action if customers representing a significant
percentage of a class cease to be customers. These increases could lead to
further failures by the remaining customers to pay transition charges, thereby
increasing the risk of a shortfall in funds to pay the transition bonds.
The large industrial and the interruptible customer classes consist of a
small number of large customers. The failure of the customers in these customer
classes to pay transition charges could lead to increases in transition charges
to other members of this class as well as other customer classes. In addition,
with the issuance of each additional series of transition bonds, the transition
charges imposed on each customer class may increase. These increases could lead
to failures by customers to pay transition charges. In either case, these
increases could increase the risk of a shortfall in funds to pay the transition
bonds.
Risks Associated with the Unusual Nature of the Transition Property
Oncor May Not Recover Transition Charges More Than 15 Years from the
Original Issue Date of the Series of Transition Bonds Relating to Those
Transition Charges. Oncor, or any successor servicer, will be prohibited from
recovering transition charges after the fifteenth anniversary of the date of
issuance of the related transition bonds, but the Company may continue to
recover transition charges incurred during the applicable 15-year period through
the use of judicial process. Amounts collected from transition charges imposed
for electricity consumed through the fifteenth anniversary of the date of
issuance of the related transition bonds, or from credit enhancement funds, may
not be sufficient to repay the transition bonds in full. If that is the case, no
other funds will be available to pay the unpaid balance due on the transition
bonds.
Foreclosure of the Indenture Trustee's Lien on the Transition Property May
Not Be Practical. Under the Restructuring Act and the indenture, the indenture
trustee or the bondholders have the right to foreclose or otherwise enforce the
lien on transition property securing the transition bonds. However, in the event
of foreclosure, there is likely to be a limited market, if any, for the
transition property. Therefore, foreclosure may not be a realistic or practical
remedy, and the value of an investment in transition bonds may be materially
reduced.
The Risks Associated with Potential Bankruptcy Proceedings
The Servicer Will Commingle the Transition Charges with Other Revenues,
Which May Obstruct Access to the Transition Charges in Case of the Servicer's
Bankruptcy. The servicer will not segregate the transition charges from its
general funds. The transition charges will be segregated only when the servicer
pays them to the indenture trustee and the indenture trustee deposits them to
the applicable collection account. The servicer will be permitted to remit
collections on a monthly basis if Oncor or a successor to Oncor's electric
public utility business remains the servicer, no servicer default has occurred,
and if:
o the servicer meets the credit ratings requirements of the applicable
rating agencies; or
o the servicer provides credit enhancement satisfactory to the
applicable rating agencies to assure remittance by the servicer to
the indenture trustee of the transition charges it collects.
A-14
If these conditions are not satisfied, the servicer will be required to
remit collections to the indenture trustee within two business days of receipt.
Despite these requirements, the servicer might fail to pay the full amount of
the transition charges to the indenture trustee or might fail to do so on a
timely basis. This failure, whether voluntary or involuntary, could materially
reduce the amount of transition charge collections available to make payments on
the transition bonds.
The Restructuring Act provides that the Company's rights to the transition
property are not affected by the commingling of these funds with any other funds
of the servicer. In a bankruptcy of the servicer, however, a bankruptcy court
might rule that federal bankruptcy law takes precedence over the Restructuring
Act and does not recognize the Company's right to collections of the transition
charges that are commingled with other funds of the servicer as of the date of
bankruptcy. If so, the collections of the transition charges held by the
servicer as of the date of bankruptcy would not be available to pay amounts
owing on the transition bonds. In this case, the Company would have only a
general unsecured claim against the servicer for those amounts. This decision
could cause material delays in payment or losses on the transition bonds and
could materially reduce the value of an investment in transition bonds.
REPs Will Commingle the Transition Charges with Other Revenues, Which May
Obstruct Access to the Transition Charges in Case of a REP's Bankruptcy. A REP
is not required to segregate the transition charges it collects from its general
funds, either on a series basis or otherwise, but will be required to remit to
the servicer amounts billed to it for transition charges, less an amount
relating to expected customer charge-offs, within 35 days of billing by the
servicer. A REP nonetheless might fail to pay the full amount of the transition
charges to the servicer or might fail to do so on a timely basis. This failure,
whether voluntary or involuntary, could materially reduce the amount of
transition charge collections available to make payments on one or more series
of transition bonds.
The Restructuring Act provides that the Company's rights to the transition
property are not affected by the commingling of these funds with other funds. In
a bankruptcy of a REP, however, a bankruptcy court might rule that federal
bankruptcy law takes precedence over the Restructuring Act and does not
recognize the Company's right to receive the collected transition charges that
are commingled with other funds of a REP as of the date of bankruptcy. If so,
the collected transition charges held by a REP prior to or as of the date of
bankruptcy would not be available to the Company to pay amounts owing on the
transition bonds. In this case, the Company would have only a general unsecured
claim against that REP for those amounts. This decision could cause material
delays in payment or losses on the transition bonds and could materially reduce
the value of an investment in transition bonds, especially with respect to a
default by TXU Energy Retail, the largest REP in Oncor's service territory.
If a REP Enters Bankruptcy Proceedings, Transition Charge Payments Made
by that REP to the Servicer May Constitute Preferences, and the Servicer May be
Required to Return such Funds to the Bankruptcy Estate of the REP. In the event
of a bankruptcy of a REP, a party in interest may take the position that the
remittance of funds prior to bankruptcy to the servicer, pursuant to the
Financing Order, constitutes a preference under bankruptcy law. If a court were
to hold that the remittance of funds constitutes a preference, any such
remittance within 90 days of the filing of the bankruptcy petition could be
avoidable, and the funds could be required to be returned to the bankruptcy
estate of the REP by the Company or the servicer. To the extent that transition
charges have been commingled with the general funds of the REP, the risk that a
court would hold that a remittance of funds was a preference would increase. The
Company, or the servicer may be considered an "insider" with any REP that is
affiliated with the Company or the servicer. If the servicer or the Company are
considered to be an "insider" of the REP, any such remittance made within one
year of the filing of the bankruptcy petition could be avoidable as well if the
court were to hold that such remittance constitutes a preference. In either
case, the Company or the servicer would merely be an unsecured creditor of the
REP. If any funds were required to be returned to the bankruptcy estate of the
REP, the Company would expect that the amount of any future transition charges
would be increased through the true-up mechanism to recover the amount returned.
If the Servicer Enters Bankruptcy Proceedings, the Collections of the
Transition Charges Held By the Servicer as of the Date of Bankruptcy May
Constitute Preferences, Which Means These Funds Would Be Unavailable to Pay
Amounts Owing on the Transition Bonds. In the event of a bankruptcy of the
servicer, a party in interest may take the position that the remittance of funds
A-15
prior to bankruptcy of the servicer, pursuant to the Financing Order,
constitutes a preference under bankruptcy law. If a court were to hold that the
remittance of funds constitutes a preference, any such remittance within 90 days
of the filing of the bankruptcy petition could be avoidable, and the funds could
be required to be returned to the bankruptcy estate of the servicer. To the
extent that transition charges have been commingled with the general funds of
the servicer, the risk that a court would hold that a remittance of funds was a
preference would increase. In such case, the Company would merely be an
unsecured creditor of the servicer. If any funds were required to be returned to
the bankruptcy estate of the servicer, the Company would expect that the amount
of any future transition charges would be increased through the true-up
mechanism to recover the amount returned.
Bankruptcy of Oncor or any Successor Seller Could Result in Losses or
Delays in Payments on the Transition Bonds. The Restructuring Act and the
Financing Order provide that as a matter of Texas state law:
o the rights and interests of a selling utility under a financing
order, including the right to impose, collect and receive transition
charges, are contract rights of the seller;
o the seller may make a present transfer of its rights under a
financing order, including the right to impose, collect and receive
future transition charges that retail customers do not yet owe;
o upon the transfer to the Company, the rights will become transition
property and transition property constitutes a present property
right, even though the imposition and collection of transition
charges depend on further acts that have not yet occurred; and
o a transfer of the transition property from the seller, or its
affiliate, to the Company is a true sale of the transition property,
not a pledge of the transition property to secure a financing by the
seller.
These four provisions are important to maintaining payments on the
transition bonds in accordance with their terms during any bankruptcy of Oncor.
In addition, the Company has structured the transaction with the objective of
keeping the Company legally separate from Oncor and its affiliates in the event
of a bankruptcy of Oncor or any such affiliate.
A bankruptcy court generally follows state property law on issues such as
those addressed by the state law provisions described above. However, a
bankruptcy court has authority not to follow state law if it determines that the
state law is contrary to a paramount federal bankruptcy policy or interest. If a
bankruptcy court in an Oncor bankruptcy refused to enforce one or more of the
state property law provisions described above for this reason, the effect of
this decision on a beneficial owner of transition bonds might be similar to the
treatment to be received in an Oncor bankruptcy if the transition bonds had been
issued directly by Oncor.
The Company has taken steps together with Oncor, as the seller, to reduce
the risk that in the event the seller or an affiliate of the seller were to
become the debtor in a bankruptcy case, a court would order that the Company's
assets and liabilities be substantively consolidated with those of Oncor or an
affiliate. These steps include the fact that the Company is a separate special
purpose limited liability company, and the Company's organizational documents
prevent the Company from commencing a voluntary bankruptcy case without the
unanimous affirmative vote of all the Company's managers, including the managers
independent of Oncor. Nonetheless, these steps may not be completely effective,
and thus if Oncor or an affiliate of the seller were to become a debtor in a
bankruptcy case, a court might order that the Company's assets and liabilities
be consolidated with those of Oncor or an affiliate. A decision by the
bankruptcy court that, despite the separateness of the Company and Oncor, the
two companies should be consolidated, would have a similar effect on a
beneficial owner of transition bonds. Either decision could cause material
delays in payment of, or losses on, the transition bonds and could materially
reduce the value of an investment in such bonds. For example:
o the indenture trustee could be prevented from exercising any remedies
against Oncor on an investor's behalf, from recovering funds to repay
the transition bonds, from using funds in the accounts under the
indenture to make payments on the transition bonds or from replacing
Oncor as servicer, without permission from the bankruptcy court;
A-16
o the bankruptcy court could order the indenture trustee to exchange
the transition property for other property, which might be of lower
value;
o tax or other government liens on Oncor's property that arose after
the transfer of the transition property to the Company might
nevertheless have priority over the indenture trustee's lien and
might be paid from transition charge collections before payments on
the transition bonds;
o the indenture trustee's lien might not be properly perfected in
transition property collections that were commingled with other funds
Oncor collected from its customers or REPs prior to or as of the date
of Oncor's bankruptcy or commingled in the general funds of Oncor's
affiliated REP as of the date of that REP's bankruptcy, or might not
be properly perfected in all of the transition property, and the lien
could therefore be set aside in the bankruptcy, with the result that
the transition bonds would represent only general unsecured claims
against Oncor;
o the bankruptcy court might rule that neither the Company's property
interest nor the indenture trustee's lien extends to transition
charges in respect of electricity consumed after the commencement of
Oncor's bankruptcy case, with the result that the transition bonds
would represent only general unsecured claims against Oncor;
o neither Oncor nor the Company may be obligated to make any payments
on the transition bonds during the pendency of the bankruptcy case
and/or pay interest accruing after the commencement of the case;
o Oncor may be able to alter the terms of the transition bonds as part
of its plan of reorganization;
o the bankruptcy court might rule that the transition charges should
be used to pay a portion of the cost of providing electric service;
or
o the bankruptcy court might rule that the remedy provisions of the
applicable sale agreement are unenforceable, leaving the Company with
a claim of actual damages against Oncor that may be difficult to
prove.
Furthermore, if Oncor enters into bankruptcy, it may be permitted to stop
acting as servicer and it may be difficult to find a third party to act as
servicer. The failure of a servicer to perform its duties or the inability to
find a successor servicer may cause payment delays or losses on an investment in
transition bonds. Also, the mere fact of a servicer or REP bankruptcy proceeding
could have an adverse effect on the resale market for the transition bonds and
on the value of the transition bonds.
The Sale of the Transition Property Could Be Construed as a Financing and
Not a Sale in a Case of Oncor's Bankruptcy Which Could Delay or Limit Payment on
the Transition Bonds. The Restructuring Act provides that the characterization
of a transfer of transition property as a sale or other absolute transfer will
not be affected or impaired in any manner by treatment of the transfer as a
financing for federal or state tax purposes or financial reporting purposes. The
Company and Oncor will treat the transaction as a sale under applicable law,
although for financial reporting and federal and state income and franchise tax
purposes the transaction is intended to be treated as a financing and not a
sale. In the event of a bankruptcy of Oncor, a party in interest in the
bankruptcy may assert that the sale of the transition property to the Company
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. In a recent bankruptcy
court case involving LTV Steel Company, the debtor obtained an interim emergency
motion to use collections from accounts and inventory that it had sold on the
grounds that the sales were in fact disguised financings. The circumstances
under which the LTV Steel Company ruling would be followed by other courts are
not certain. If a court were to adopt reasoning similar to that of the court in
the LTV Steel case or were otherwise to characterize the transaction as a
financing, the Company would be treated as a secured creditor of Oncor in the
bankruptcy proceedings. Although the Company would in that case have a security
interest in the transition property, the Company would not likely be entitled to
access to the transition charge collections during the bankruptcy and would be
A-17
subject to the typical risks of a secured creditor in a bankruptcy case,
including the possible bankruptcy risks described in the immediately preceding
risk factor. As a result, repayment on the transition bonds could be
significantly delayed and a plan of reorganization in the bankruptcy might
permanently modify the amount and timing of payments to the Company of
transition charge collections and therefore the amount and timing of funds
available to the Company to make payments on the transition bonds.
Claims Against Oncor or any Successor Seller May Be Limited in the Event
of a Bankruptcy of the Seller. If the seller were to become a debtor in a
bankruptcy case, claims, including indemnity claims, by the Company against the
seller under the applicable sale agreement and the other documents executed in
connection with the applicable sale agreement would be unsecured claims and
would be subject to being discharged in the bankruptcy case. In addition, a
party in interest in the bankruptcy may request that the bankruptcy court
estimate any contingent claims that the Company have against the seller. That
party may then take the position that these claims should be estimated at zero
or at a low amount because the contingency giving rise to these claims is
unlikely to occur. If the seller were to become a debtor in a bankruptcy case
and the indemnity provisions of the applicable sale agreement were triggered, a
party in interest in the bankruptcy might challenge the enforceability of the
indemnity provisions. If a court were to hold that the indemnity provisions were
unenforceable, the Company would be left with a claim for actual damages against
the seller based on breach of contract principles. The actual amount of these
damages would be subject to estimation and/or calculation by the court. The
Company cannot give any assurance as to the result if any of the above-described
actions or claims were made. Furthermore, the Company cannot give any assurance
as to what percentage of their claims, if any, unsecured creditors would receive
in any bankruptcy proceeding involving the seller.
A Bankruptcy of Oncor or Any Successor Seller Would Limit the Remedies
Available to the Indenture Trustee. Upon an event of default under the
indenture, the Restructuring Act permits the indenture trustee to enforce the
security interest in the transition property in accordance with the terms of the
indenture. In this capacity, the indenture trustee is permitted to request a
Travis County, Texas district court to order the sequestration and payment to
bondholders of all revenues arising with respect to the transition property.
There can be no assurance, however, that the Travis County, Texas district court
would issue this order after a seller bankruptcy in light of the automatic stay
provisions of Section 362 of the United States Bankruptcy Code. In that event,
the indenture trustee would be required to seek an order from the bankruptcy
court lifting the automatic stay to permit this action by the Texas court, and
an order requiring an accounting and segregation of the revenues arising from
the transition property. There can be no assurance that a court would grant
either order.
Other Risks Associated with an Investment in the Transition Bonds
Absence of a Secondary Market for Transition Bonds Could Limit the
Ability to Resell Transition Bonds. The underwriters for the transition bonds
may assist in resales of the transition bonds, but they are not required to do
so. If a secondary market does develop, it may not continue or there may not be
sufficient liquidity to allow investors to resell any of their transition bonds.
The Company does not anticipate that any transition bonds will be listed on any
securities exchange.
Issuance of Additional Transition Bonds May Adversely Affect
Outstanding Bonds. Under the terms of the Settlement Plan with the Commission
and the Financing Order, the Company may issue up to $800,000,000 in principal
amount of additional transition bonds in 2004 or later. Any new series may
include terms and provisions that would be unique to that particular series. The
Company may not issue additional transition bonds if the issuance would result
in the credit ratings on any outstanding series of transition bonds being
reduced or withdrawn. However, the Company cannot assure investors that a new
series would not cause reductions or delays in payments on their transition
bonds. In addition, some matters relating to the transition bonds require the
vote of the holders of all series and classes of transition bonds. An investor's
interests in these votes may conflict with the interests of the beneficial
owners of transition bonds of another series or of another class. Thus, these
votes could result in an outcome that is materially unfavorable to an investor.
A-18
Oncor's Obligation to Indemnify the Company for a Breach of a
Representation or Warranty May Not Be Sufficient to Protect an Investor's
Investment. If the seller breaches a representation or warranty in the
applicable sale agreement, or the servicer (initially Oncor) breaches a
representation or warranty under the applicable servicing agreement, it is
obligated to indemnify the Company and the indenture trustee for any liability,
obligation, claim, action, suit or payment resulting from that breach, as well
as any reasonable costs and expenses incurred. Oncor will not be obligated to
repurchase the transition property in the event of a breach of any
representation or warranty regarding the transition property, and neither the
indenture trustee nor the holders of transition bonds will have the right to
accelerate payments on the transition bonds because of such a breach (absent an
event of default under the indenture). The sale agreements will provide that any
change in the law by legislative enactment, constitutional amendment or voter
initiative that renders any of the representations and warranties untrue would
not constitute a breach under each sale agreement. Oncor or any successor entity
acting as seller or servicer may not have sufficient funds available to satisfy
its indemnification obligations to the Company and to the indenture trustee;
therefore we may not be able to pay investors amounts owing on the transition
bonds in full. If Oncor becomes obligated to indemnify holders of transition
bonds, the ratings on the transitions bonds will likely be downgraded since
holders of transition bonds will be unsecured creditors of Oncor with respect to
any of these indemnification amounts. Oncor will not indemnify any person for
any liability, obligation, claim, action, suit or payment resulting solely from
a downgrade in the ratings on the transition bonds.
Risks Associated With the Use of Credit Enhancements, Hedge or Swap
Transactions. The Company may enter into certain forms of credit enhancement,
interest rate swaps or hedge arrangements with respect to a series or class of
floating rate transition bonds that entail additional kinds of risks, including
the risk associated with the credit of any party providing the credit
enhancement, interest rate swap or hedge.
An Investor Might Receive Principal Payments Later, or Earlier, Than
Expected. The amount and the rate of collection of transition charges that Oncor
will collect from each customer class will partially depend on actual
electricity usage and the amount of collections and write-offs for that customer
class. The amount and the rate of collection of transition charges, together
with the transition charge adjustments described above, will generally determine
whether there is a delay in the scheduled repayments of transition bond
principal. If Oncor collects transition charges at a slower rate than expected
from any customer class or REP, it may have to request adjustments to the
transition charges. If those adjustments are not timely and accurate, investors
may experience a delay in payments of principal and interest or a material
decrease in the value of their investment. If there is an acceleration of the
transition bonds before maturity, all classes will be paid pro rata, therefore
some classes may be paid earlier than expected and some classes may be paid
later than expected.
Technological Change May Make Alternative Energy Sources More
Attractive. The continuous process of technological development may result in
the introduction for an increasing number of retail consumers of economically
attractive alternatives to purchasing electricity through Oncor's distribution
facilities. Previously, only the largest industrial and institutional users with
large process steam requirements could use cogeneration or self-generation
installations cost-effectively. However, manufacturers of self-generation
facilities continue to develop smaller-scale, more fuel-efficient generating
units which can be cost-effective options for retail consumers with smaller
electric energy requirements. If such facilities have rated capacities of 10
megawatts or less, consumers that rely on such facilities do not generally have
to pay transition charges under provisions of the Restructuring Act. Consumers
may avoid a portion of their overall transition charge bill by installing new
on-site generation of over 10 megawatts that reduces consumption through Oncor's
transmission and distribution system up to 12.5%. Technological developments may
allow greater numbers of retail consumers to avoid transition charges under such
provisions, which may reduce the total number of retail consumers from which
transition charges will be collected. A reduction in the number of payers of
transition charges could result in delays or a failure to make payments of
interest on and principal of the transition bonds.
A-19
INDEPENDENT AUDITORS' REPORT
Oncor Electric Delivery Transition Bond Company LLC:
We have audited the accompanying balance sheets of Oncor Electric Delivery
Transition Bond Company LLC (the "Company") as of December 31, 2003 and 2002
and the related statements of income and cash flows for the year ended
December 31, 2003 and the related statement of member's equity for each of the
three years in the period ended December 31, 2003. These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes 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 at December 31, 2003 and 2002,
and the results of its operations and cash flows for the year ended December 31,
2003, in conformity with accounting principles generally accepted in the United
States of America.
DELOITTE & TOUCHE LLP
Dallas, Texas
March 25, 2004
A-20
ONCOR ELECTRIC DELIVERY TRANSITION BOND COMPANY LLC
STATEMENT OF INCOME
Year Ended
December 31,
2003
------------
Operating revenues:
Transition charge revenue............................... $19,461,574
Investment income....................................... 20,819
-----------
Total operating revenues.............................. 19,482,393
Operating expenses:
Interest expense........................................ 7,777,756
Amortization of transition property..................... 5,748,164
Over-recovery of transition charges..................... 5,770,918
Servicing fees, administrative and general expenses..... 185,555
-----------
Total operating expenses.............................. 19,482,393
-----------
Net income................................................... $ --
===========
See Notes to Financial Statements
A-21
ONCOR ELECTRIC DELIVERY TRANSITION BOND COMPANY LLC
STATEMENT OF CASH FLOWS
Year Ended
December 31,
2003
--------------
Cash flows - operating activities:
Net income....................................... $ --
Adjustments to reconcile net income to cash
provided by operating activities:
Amortization of transition property......... 5,748,164
Over-recovery of transition charges......... 5,770,918
Changes in operating assets...................... (7,486,087)
Changes in operating liabilities................. 8,372,923
-----------
Cash provided by operating activities....... 12,405,918
-----------
Cash flows - investing activities:
Purchase of transition property.................. (500,000,000)
Deposit of restricted funds with indenture trustee (24,904,918)
-----------
Cash used by investing activities........... (524,904,918)
-----------
Cash flows - financing activities:
Issuance of transition bonds..................... 500,000,000
Equity contribution from parent.................. 12,500,000
-----------
Cash provided by financing activities....... 512,500,000
-----------
Net increase in cash and cash equivalents............. 1,000
Cash and cash equivalents, beginning of period........ --
-----------
Cash and cash equivalents, end of period.............. $ 1,000
===========
See Notes to Financial Statements
A-22
ONCOR ELECTRIC DELIVERY TRANSITION BOND COMPANY LLC
BALANCE SHEETS
December 31, December 31,
2003 2002
------------ ------------
ASSETS
Current assets:
Cash and cash equivalents......................................... $ 1,000 $ --
Restricted cash................................................... 12,392,207 --
Transition charge receivable:
Affiliates...................................................... 5,581,423 1,000
Trade........................................................... 1,905,664 --
------------ ----------
Total current assets............................................ 19,880,294 1,000
Investments:
Restricted funds held in trust.................................... 12,512,711 --
Transition property, net of accumulated amortization
of $5,748,164................................................... 494,251,836 --
Unamortized debt issuance costs..................................... -- 1,136,183
------------ ----------
Total assets.................................................... $526,644,841 $1,137,183
============ ==========
LIABILITIES AND MEMBER'S EQUITY
Current liabilities:
Long-term debt due currently...................................... $22,543,239 $ --
Accounts payable - affiliate...................................... 169,793 1,136,183
Accrued interest.................................................. 7,777,756 --
Other current liabilities......................................... 425,374 --
------------ ----------
Total current liabilities....................................... 30,916,162 1,136,183
Transition bonds.................................................... 477,456,761 --
Regulatory liability................................................ 5,770,918 --
------------ ----------
Total liabilities............................................... 514,143,841 1,136,183
Member's equity..................................................... 12,501,000 1,000
------------ ----------
Total liabilities and member's equity........................... $526,644,841 $1,137,183
============ ==========
See Notes to Financial Statements
A-23
ONCOR ELECTRIC DELIVERY TRANSITION BOND COMPANY LLC
STATEMENT OF MEMBER'S EQUITY
Member's Equity December 31, 2000, 2001
and 2002.......................................... $ 1,000
Equity contribution from parent - August 2003......... 6,346,154
Equity contribution from parent - December 2003........ 6,153,846
--------------
Member's Equity December 31, 2003...................... $ 12,501,000
==============
A-24
ONCOR ELECTRIC DELIVERY TRANSITION BOND COMPANY LLC
NOTES TO FINANCIAL STATEMENTS
1. BUSINESS AND BASIS OF PRESENTATION
Business - The Company is a bankruptcy remote special purpose Delaware
limited liability company, wholly-owned by Oncor. Oncor is a wholly-owned
subsidiary of US Holdings, which is a wholly-owned subsidiary of TXU Corp. Oncor
is a regulated electricity transmission and distribution company principally
engaged in providing delivery services to REPs that sell electricity in the
north-central, eastern and western parts of Texas.
The Company was organized in November 1999 for the sole purpose of
purchasing and owning transition property acquired from Oncor. The Company had
no operations until August 2003. In connection with the acquisition of the
transition property, the Company has agreed to (a) register and issue one or
more series of transition bonds, each of which may be comprised of one or more
classes, (b) pledge its interest in the transition property and other transition
bond collateral to secure the transition bonds, (c) make debt service payments
on the transition bonds, and (d) perform other activities that are necessary,
suitable or convenient to accomplish these purposes. The Company is structured
and is operated in a manner such that in the event of bankruptcy proceedings
against Oncor, the assets of the Company will not be consolidated into the
bankruptcy estate of Oncor. Oncor is not the owner of the transition property
described herein, and the assets of the Company are not available to pay
creditors of Oncor or any of its affiliates.
Basis of Presentation -- The financial statements of the Company have been
prepared in accordance with US GAAP and on the same basis as the audited
financial statements for the year ended December 31, 2002. In the opinion of
management, all adjustments (consisting of normal recurring accruals) necessary
for a fair presentation of the financial position have been included therein.
Comparable income statements and statements of cash flows are not presented
because there were no operations prior to August 2003 even though the Company
existed. The year ended December 31, 2002 included non-cash items of
$1,136,183.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Use of Estimates -- The preparation of the Company's financial
statements requires management to make estimates and assumptions about future
events that affect the reporting and disclosure of assets and liabilities at the
balance sheet dates and the reported amounts of revenue and expense. In the
event estimates and/or assumptions prove to be different from actual amounts,
adjustments are made in subsequent periods to reflect more current information.
No material adjustments, other than those disclosed elsewhere herein, were made
to previous estimates during the current year.
Regulatory Assets and Liabilities -- The Company's business meets the
applicability criteria of SFAS 71. This accounting standard recognizes the
cost-based rate making process, which may result in differences in the
application of generally accepted accounting principles between regulated and
non-regulated entities.
Revenue Recognition -- Transition charges are billed to REPs by Oncor, as
servicer, on behalf of the Company. These transition charges are recorded as
revenue by the Company. Transition charges are recognized when delivery services
are provided to customers on the basis of periodic cycle meter readings and
include an estimated accrual for the transition charge from the meter reading
date to the end of the period. The accrued transition charge is based on actual
daily billings for the most recent metered period applied to the number of
unmetered days through the end of the period.
Amortization -- The transition property acquired from Oncor is amortized
over the life of the transition bonds based on revenues from transition charges,
interest accruals and other expenses. In accordance with SFAS 71, amortization
is adjusted for over/under collection of transition charges.
A-25
Investment Income -- The Company earns investment income on funds held by
the indenture trustee, including the indenture trustee reserves established to
cover any future trustee fees and expenses associated with the transition bonds.
These funds held by the trustee are invested as allowed by the indenture.
Investment income on transition charge collections is recognized as earned and
serves to increase the over-recovery of transition charges by a corresponding
amount since it will be used to make payments on the transition bonds.
Investment income on the capital account (Member's Equity) is recognized on
payment dates. When it is determined that such income is not required to satisfy
payment obligations, Oncor is entitled to such revenues.
Income and Other Taxes -- The Company is organized as a single-member
limited liability company and will not be subject to United States federal
income tax as an entity separate from Oncor. In addition, the Company's receipt
of transition property, transition charges and short-term earnings from
investments of the transition charges will not be subject to state and local
tax. Accordingly, there is no provision for federal, state or local taxes.
Comprehensive Income-- There are no other components of comprehensive
income besides net income.
3. RELATED PARTY TRANSACTIONS
Notwithstanding the non-recourse nature of the transactions, Oncor
(individually, as servicer or otherwise) is required under the transaction
documents (i) to make certain representations and warranties with respect to,
among other things, the validity of the Company's and its assignees' title to
the transition property and (ii) to observe certain covenants for the benefit of
the Company and its assignees. Oncor is also required to indemnify the Company
against breach of such representations and warranties and its failure to perform
its covenants and to protect holders of the bonds against certain other losses,
which result from actions or inactions of Oncor.
Oncor provides billing, payment processing, management and administrative
services to the Company pursuant to administration and servicing agreements
between the Company and Oncor. Under these agreements, Oncor furnishes to the
Company, at a fixed fee per year, billing, payment processing, collection,
clerical, secretarial and other accounting services, which are reflected as
administrative and general expenses in the income statement. Servicing and
administration fees provided by and accrued to Oncor, totaled $169,793 for the
year ended December 31, 2003. This amount is expected to increase once the
second series of approximately $790,000,000 of transition bonds are issued,
which is expected to be completed in the first half of 2004.
All transition bond issuance costs incurred through June 2003, aggregating
$1,817,852, were paid by Oncor and are currently included with the transition
property related to the first series of transition bonds. As of December 31,
2003, Oncor has paid an additional $2,839,178 of qualified costs related to the
issuance of the second series of transition bonds expected to be issued in the
first half of 2004.
During 2003, transition charges billed to TXU Energy, and reflected in
revenues, totaled $14,177,528. The balance of accounts receivable due from TXU
Energy at December 31, 2003 was $5,581,423.
4. TRANSITION BONDS
At December 31, 2003, the long-term debt of the Company consisted of the
following:
2.26% Fixed Series 2003 Transition Bonds due in bi-annual installments through
February 15, 2007................................................................ $103,000,000
4.03% Fixed Series 2003 Transition Bonds due in bi-annual installments through
February 15, 2010................................................................ 122,000,000
4.95% Fixed Series 2003 Transition Bonds due in bi-annual installments through
February 15, 2013................................................................ 130,000,000
5.42% Fixed Series 2003 Transition Bonds due in bi-annual installments through
August 15, 2015.................................................................. 145,000,000
------------
Total........................................................................... 500,000,000
Less amount due currently.......................................................... 22,543,239
------------
Total long-term debt............................................................... $477,456,761
============
The transition property sold to the Company as described above, is pledged
as collateral for the bonds, as well as restricted cash in the Capital
Sub-account at December 31, 2003 of $2,505,172. Collections of transition
A-26
charges will be used to pay the principal, interest and associated costs of the
transition bonds. The Company is required to maintain restricted cash pledged
as collateral for the bonds in an amount equal to 0.5% of the initial aggregate
principal amount of bonds outstanding. Should the transition charges collected
through the specified payment dates listed above not provide adequate funds to
make the scheduled payments of principal and interest, the transition charges
can continue to be collected for approximately two years before the bond goes
into default for non-payment.
Maturity requirements for the years 2004 through 2008 and thereafter under
long-term debt instruments outstanding at December 31, 2003, were as follows:
Year
2004 ........................................... $ 22,543,239
2005 ........................................... 35,760,468
2006 ........................................... 36,576,586
2007 ........................................... 37,514,014
2008 ........................................... 39,023,742
Thereafter...................................... 328,581,951
-------------
Total...................................... $ 500,000,000
=============
The fair value of the outstanding transition bonds as of December 31,
2003 was approximately $516,000.000.
Financial Covenants -- The terms of the indenture contain financial
covenants that require maintenance of specified collateral deposits in
proportion to the aggregate principal amount of the bonds outstanding. As of
December 31, 2003, the Company was in compliance with such covenants.
5. MEMBER'S INTEREST
In August 2003, Oncor contributed cash of $2,500,000 to the Company, which
is pledged as collateral for the first series of transition bonds in a Capital
Sub-account established to meet shortfalls in transition charge collections.
Oncor will be required to contribute approximately $3,950,000 upon the issuance
of the next series of transition bonds (approximately $790,000,000) in the
Capital Sub-account to be pledged as collateral for that series of transition
bonds.
Also in August 2003, Oncor contributed $3,846,154 to the Company, which
was placed in a reserve account with the indenture trustee to cover any future
trustee fees and expenses associated with the transition bonds. In December
2003, Oncor contributed an additional $6,153,846, which was also placed in the
reserve account with the indenture trustee to cover any future trustee fees and
expenses associated with the transition bonds.
6. SUBSEQUENT EVENT
Since the implementation of transaction charges pursuant to the Financing
Order, Oncor has experienced lower than projected sales, which has resulted in a
lower level of transition charge collections than was projected. The initial
transition charges, which were based on estimates, were previously approved by
the Commission with the intent to collect sufficient revenues to service the
principal, interest and other expenses related to the initial $500,000,000 in
transition bonds that the Company issued. The Company anticipates that payments
related to the bonds totaling $44,349,342 by August 16, 2004 will exceed
projected collections of transition charges by approximately $2,429,069, which
would require use of substantially all of the balance of the Capital Sub-account
established to meet such shortfalls in transition charge collections. As a
result, on January 15, 2004, Oncor filed, on behalf of the Company, an interim
true-up adjustment with the Commission in respect of the first series of
transition bonds. Oncor requested the Commission increase the authorized
transition charges to generate sufficient funds to make the full payment of
scheduled principal and interest in respect of the first series of transition
bonds on August 16, 2004, and to replenish the Capital Sub-account for the first
series of transition bonds to the required $2,500,000 level. That interim
true-up adjustment was effective automatically on January 15, 2004 for use in
the first cycle billing in February.
..
A-27
Oncor Electric Delivery Transition Bond Company LLC Exhibits to 2003 Form 10-K
APPENDIX B
Previously Filed*
-----------------
With File As
Exhibits Number Exhibit
- --------- ------ -------
3(i) Articles of Incorporation.
3(a) 333-91935 4(b) -- Amended and Restated Certificate of Formation of Oncor
Form 8-K (filed Electric Delivery Transition Bond Company LLC, dated as of
August 21, 2003) August 11, 2003.
3(ii) By-laws.
3(b) 333-91935 4(a) -- Amended and Restated Limited Liability Company Agreement of
Form 8-K (filed Oncor Electric Delivery Transition Bond Company LLC, dated
August 21, 2003) and effective as of August 21, 2003.
(4) Instruments Defining the Rights of Security Holders, Including Indentures.
4(a) 333-91935 4(c) -- Indenture, dated as of August
21, 2003.
Form 8-K (filed
August 21, 2003)
4(b) 333-91935 4(d) -- Series 2003-1 Supplement, dated as of August 21, 2003.
Form 8-K (filed
August 21, 2003)
(10) Material Contracts.
10(a) 333-91935 10(a) -- Series 2003-1 Transition Property Purchase and Sale
Form 8-K Agreement, dated as of August 21, 2003.
(filed August 21,
2003)
10(b) 333-91935 10(b) -- Series 2003-1 Transition Property Servicing Agreement, dated
Form 8-K as of August 21, 2003.
(filed August 21,
2003)
10(c) 333-91935 10(c) -- Administration Agreement, dated as of August 21, 2003.
Form 8-K
(filed August 21,
2003)
10(d) 333-91935 10(d) -- Intercreditor Agreement, dated as of August 21, 2003.
Form 8-K
(filed August 21,
2003)
10(e) 333-91935 10(e) -- Account Agreement, dated as of August 21, 2003.
Form 8-K
(filed August 21,
2003)
B-1
Previously Filed*
-----------------
With File As
Exhibits Number Exhibit
- --------- ------ -------
(23) Consents of Experts and Counsel.
23 -- Consent of Deloitte & Touche LLP, Independent Auditors for
Oncor Electric Delivery Transition Bond Company LLC.
(32) Section 1350 Certifications.
32(a) -- Certification of M.S. Greene, principal executive officer of
Oncor Electric Delivery Transition Bond Company LLC,
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32(b) -- Certification of Scott Longhurst, principal financial
officer of Oncor Electric Delivery Transition Bond Company
LLC, pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
(99) Additional Exhibits.
99(a) 333-91935 99(a) -- Financing Order pertaining to the transition bonds, dated
Form S-3 (filed July August 5, 2002.
1, 2003)
99(b) 333-91935 99(b) -- Internal Revenue Service Private Letter Ruling pertaining to
Form S-3 (filed July the transition bonds, dated May 21, 2002.
1, 2003)
99(c) 333-91935 99(c) -- Internal Revenue Service Private Letter Ruling pertaining to
Form S-3 (filed July the transition bonds, dated February 18, 2000.
1, 2003)
99(d)(1) -- Monthly servicer report for October 2003
99(d)(2) -- Monthly servicer report for November 2003
99(d)(3) -- Monthly servicer report for December 2003
99(e) -- A statement reporting the balance in the Collection account
as of December 31, 2003
99(f) -- A statement showing the balance of outstanding bonds that
reflects the actual periodic payments made on the bonds
99(g) -- The semi-annual servicer's certificate which is required to
be submitted pursuant to the Servicing Agreement
99(h) -- A quarterly statement affirming that, in all material
respects, for each materially significant REP,
(a) each REP has been billed in compliance
with the requirements outlined in the
Financing Order; (b) each REP has made
payments in compliance with the
requirements outlined in the Financing
Order, and (c) each REP satisfies the
Creditworthiness requirements of the
Financing Order.
- -------------------------
* Incorporated herein by reference.
B-2