The FirstEnergy bankruptcy filing has ensnared $2.1 billion of municipal bonds.

First Energy Solutions Corp., its subsidiaries, and FirstEnergy Nuclear Operating Co. filed for Chapter 11 in Akron, Ohio on March 31.

FES has roughly $612 million of secured tax-exempt debt and $1.5 billion of unsecured tax-exempt debt issued through Pennsylvania’s Beaver County Industrial Development Authority, the Ohio State Air Quality Development Authority and the Ohio Water Development Authority, according to Moody's Investors Service.

Signage at the FirstEnergy Corp. Bruce Mansfield coal-fired power plant in Shippingport, Pennsylvania on Dec. 6, 2017. FirstEnergy Solutions, its subsidiaries and FirstEnergy Nuclear Operating Company filed for Chapter 11 bankruptcy on March 31, 2018.
The Chapter 11 filing of FirstEnergy Solutions and FirstEnergy Nuclear Operating Company includes $2.1 billion of municipal bonds. Bloomberg News

The private power plant operator sold the debt to fund air and water pollution control facilities and sewage and solid waste facilities at its power generation plants. Under Internal Revenue Service rules, bonds for such pollution control projects qualify for tax exemption.

"The debt restructuring process for First Energy Solutions bondholders will be messy,” said Dean Myerow, municipal bond portfolio manager at NatAlliance Securities LLC. “FES’ assets may be difficult to sell as the company seeks to shed its debt. The coal and nuclear power plant assets suffer from stiff competition especially from other energy generating plants around the country that use cheaper forms of fuel such as natural gas.”

Myerow said that the bankruptcy process could take 18 to 36 months to sort out.

“The senior lien holders with claims on specific assets will surely try to secure their piece of the asset pie, while unsecured bondholders duke it out in court,” he said.

On Monday Moody’s downgraded the Beaver County Industrial Development Authority senior secured and unsecured revenue Bonds, to Caa3 from B3 and to C from Ca, respectively. The senior secured and unsecured revenue bonds issued via the Ohio Air Quality Development Authority were downgraded to Caa3 from B3 and to C from Ca, respectively. Senior secured and unsecured bonds issued through the Ohio Water Development Authority were downgraded to Caa3 from B3 and to C from Ca, respectively.

The ratings action follows the Chapter 11 filing and a previous rating action on Jan. 23 when Moody’s downgraded the debt of FES to Ca from Caa1.

S&P Global Ratings Monday lowered its issuer credit rating on FES to D from CCC-minus and lowered all issue-level ratings to D.

“To the degree that the debt is secured based on the value of the collateral they should get paid the value of that collateral,” said James Spiotto, a municipal restructuring expert and co-publisher of MuniNet Guide. “If it isn’t sufficient to pay the secured amount in full they will have a deficiency claim which becomes part of the unsecured claims pool.” Spiotto said that for pollution control, to the degree that regulations have changed much of the equipment may no longer be needed and therefore has very little value.

Parent FirstEnergy Corp. announced in November 2016 that it planned to exit the competitive generation business. The entities that filed for bankruptcy operate two coal-fired plants, one dual fuel gas/oil plant, one pet-coke fired plant and three nuclear power plants in the competitive, or non-regulated, power-generation industry.

FirstEnergy Corp. itself, which owns 10 regulated electric utilities in five states, is not part of the bankruptcy.

The $2.1 billion in outstanding debt issued by First Energy Solutions is the responsibility of First Energy Solutions alone. FirstEnergy Corp. does not back the debt and the conduit issuers of the municipal bonds do not guarantee the debt.

James Spiotto is Managing Director of Chapman Strategic Advisors LLC and a board member of the Retirement Security Initiative organization.
"To the degree that the debt is secured based on the value of the collateral they should get paid the value of that collateral,” said municipal restructuring expert James Spiotto. Retirement Security Initiative

“FirstEnergy Corp. has, for the past 18 months, sought to trim its holdings to focus exclusively on its regulated operations,” S&P said. “Consequently, there has been no meaningful parent company support in that time. We no longer attribute any support from FirstEnergy in our corporate credit rating on the competitive entities, and we evaluate their recovery prospects on a stand-alone basis. That said, FirstEnergy does have about $200 million in guarantees and other obligations that it is obliged to support.”

The filing entities collectively have over $550 million in cash, which they believe is sufficient liquidity to continue normal operations and meet post-petition obligations to employees, suppliers and customers as they come due.

Myerow said that prices on unsecured municipal bonds of First Energy Solutions have slid further into deeply distressed territory since the beginning of the year.

“At the beginning of 2018, more actively traded CUSIPs like 074876HM8 for the Ohio State Air Quality Development Authority bonds were changing hands in the mid-30 to low-40 cent on the dollar range,” Myerow said. “It remains to be seen since the filing this week were prices are headed, but early indications in thin trading have begun to trend toward the 20 cent on the dollar mark.” Those bonds, from a 2014 refunding deal, traded near par into 2016.

FirstEnergy Solutions struggled due to the competition from low cost solar and natural gas powered plants that have brought about weak power prices. “For FES' fleet of coal and nuclear assets, this has especially potent, leading to weakening cash flows,” S&P said.

Prior to filing, the company had already announced plans to shut the three nuclear plants and has closed several coal-fired generators since 2012. On March 29 it filed an application with U.S. Secretary of Energy Rick Perry seeking federal intervention to save the company’s unregulated coal and nuclear plants. The proposed intervention would be a "grid emergency" that would force the electric grid operator to guarantee profit for the firm's coal and nuclear generators, according to Bloomberg News.

“The Chapter 11 filing represents our best path forward as we continue to pursue opportunities for restructuring, asset sales and legislative and regulatory relief,” Donald R. Schneider, president of FirstEnergy Solutions, said in a statement. “We believe that this decision will best serve our customers, employees and business partners."

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