10-Q 1 pett9-01q.txt PETT 9-01 10Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 FORM 10-Q THE REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTION H(1) (a) AND (b) OF FORM 10-Q AND IS THEREFORE FILING THIS FORM WITH THE REDUCED DISCLOSURE FORMAT [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2001 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OF 15(d) OF THE SECURITIES ACT OF 1934 Commission file number: 333-58055 PECO Energy Transition Trust (Exact name of registrant as specified in its charter) Delaware 51-0382130 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) c/o First Union Trust Company, N. A. One Rodney Square, 920 King Street Wilmington, Delaware 19801 (Address of principal executive offices) (Zip Code) (302) 888-7532 (Registrant's telephone number, including area code) 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 ____ PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS

See Notes to Financial Statements. 2 PECO ENERGY TRANSITION TRUST STATEMENTS OF NET ASSETS AVAILABLE FOR TRUST ACTIVITIES (Unaudited) (in millions)

See Notes to Financial Statements. 3 PECO ENERGY TRANSITION TRUST NOTES TO FINANCIAL STATEMENTS 1. BASIS OF PRESENTATION The accompanying financial statements as of September 30, 2001 and for the three and nine months then ended are unaudited, but include all adjustments that PECO Energy Transition Trust (PETT) considers necessary for a fair presentation of such financial statements. All adjustments are of a normal, recurring nature. Certain prior year amounts have been reclassified for comparative purposes. These notes should be read in conjunction with PETT's Notes to Financial Statements included in its Annual Report on Form 10-K for the year ended December 31, 2000. 2. TRANSITION BONDS On March 1, 2001, PETT refinanced approximately $805 million of floating rate Series 1999-A Transition Bonds through the issuance of fixed-rate transition bonds (Series 2001-A Transition Bonds). Approximately 72% of the Class A-3 and 70% of the Class A-5 Series 1999-A Transition Bonds were redeemed. The Series 2001-A Transition Bonds are non-callable, fixed-rate securities with an interest rate of 6.52%. The Series 2001-A Transition Bonds have an expected final payment date of September 1, 2010 and a termination date of December 31, 2010. The Series 2001-A Transition Bonds are solely obligations of PETT, secured by intangible transition property (ITP) sold by PECO Energy Company (PECO) to PETT concurrently with the issuance of the Series 1999-A and Series 2000-A Transition Bonds and certain other related collateral. The Series 1999-A, Series 2000-A and Series 2001-A Transition Bonds are referred to collectively as the "Transition Bonds". 3. ADOPTION OF NEW ACCOUNTING PRINCIPLE On January 1, 2001, PETT adopted Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivatives Instruments and Hedging Activities," as amended, and recorded a transition adjustment decreasing Net Assets Available for Trust Activities by $19 million. The transition adjustment related to the interest rate swaps. As of September 30, 2001, the fair value of interest rate swaps decreased $4 million to an exposure of $23 million. This exposure is reflected as Interest Rate Swaps on PETT's Statements of Net Assets Available for Trust Activities. As of September 30, 2001, the expected impact on net assets available for trust activities over the next twelve months is a $2 million loss. 4. SIGNIFICANT AGREEMENTS AND RELATED PARTY TRANSACTIONS Pursuant to the Amended and Restated Intangible Transition Property Sale Agreement by and between PECO and PETT, dated March 25, 1999, as amended on May 2, 2000 and March 1, 2001 (Sale Agreement), PETT purchased ITP from PECO. Under the Sale Agreement, PECO makes certain representations and warranties about the ITP and indemnifies PETT for losses caused by the breach of such representations and warranties. To the extent a breach concerns the existence of the ITP or the ability to charge intangible transition charges (ITC) in the amounts sufficient to meet a pre-set amortization schedule for the Transition Bonds, PECO must pay liquidated damages equal to the lost principal and interest of the amortization schedule. 4 For financial reporting purposes and Federal and Commonwealth of Pennsylvania income and franchise tax purposes, the transfer of ITP to PETT is treated as a financing arrangement and not a sale. The Series 2001-A Transition Bonds were issued pursuant to the Indenture dated March 1, 1999, as supplemented by the series supplements (Indenture). Under the Indenture, PETT has pledged all of its property, including the ITP, to secure the Transition Bonds. The Indenture prohibits PETT from selling, transferring, exchanging, or otherwise disposing of any of the collateral unless directed to do so by the trustee; from claiming any credit or making any deduction from the principal, premium, if any, or interest on Transition Bonds or against any Transition Bond holder; permitting the validity of effectiveness of the Indenture to be impaired or permitting the lien of the Indenture to be amended, hypothecated, subordinated, terminated, or discharged; permitting any person to be released from any of the covenants or obligations with respect to Transition Bonds, except as expressly permitted by the Indenture; permitting any liens, charges, or claims, security interest or mortgage (other than the lien created by the Indenture) to be created in or extended to or otherwise arise upon or burden the collateral or any part thereof; or permitting the lien of the Indenture not to constitute a valid, first priority security interest in the collateral. Under the Amended and Restated Master Servicing Agreement by and between PETT and PECO, dated March 25, 1999, as amended on May 2, 2000 and March 1, 2001, PECO, as servicer, manages and administers the ITP sold to PETT and collects the ITC related thereto on behalf of PETT. For the nine months ended September 30, 2001 and 2000, PETT recorded $464 million and $318 million of ITC collections, respectively. The increase of $146 million is primarily due to the issuance of the 2000-A Transition Bonds. For the nine months ended September 30, 2001 and 2000, PETT recorded $9 million and $8 million, respectively, in servicing fees based upon the outstanding principal amount of the Transition Bonds. As of September 30, 2001 and December 31, 2000, the Due from Related Party balance was $92 million and $81 million, respectively. The Due from Related Party balance represents ITC billings by PECO that have not yet been collected of $87 million and $77 million, respectively, and ITC collections by PECO that have not yet been remitted to PETT of $6 million and $5 million, respectively. These amounts are partially offset by servicing fees of $1 million that have not been paid to PECO by PETT. As of September 30, 2001 and December 31, 2000, the Due to Related Party balance of $129 million, represents cumulative advances from PECO for initial capital requirements and operating expenses that are not considered to be currently due and payable by PETT. 5 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following analysis of the financial condition and results of activities of PECO Energy Transition Trust (PETT) is in an abbreviated format pursuant to Instruction H of Form 10-Q. Such analysis should be read in conjunction with the Financial Statements and Notes to Financial Statements included in Item 1 above, and PETT's Annual Report on Form 10-K for the year ended December 31, 2000. PETT was formed under the laws of Delaware pursuant to a trust agreement between PETT, PECO Energy Company (PECO) as grantor, First Union Trust Company, N.A., acting thereunder not in its individual capacity but solely as issuer trustee of PETT, and two beneficiary trustees appointed by PECO. PETT is currently governed by an amended and restated trust agreement among the same parties. On March 1, 2001, PETT refinanced $805 million of floating rate Series 1999-A Transition Bonds through the issuance of fixed-rate transition bonds (Series 2001-A Transition Bonds). Approximately 72% of the Class A-3 and 70% of the Class A-5 Series 1999-A Transition Bonds were redeemed. The Series 2001-A Transition Bonds are non-callable, fixed-rate securities with an interest rate of 6.52%. Excluding the effects of the issuance of the Series 2001-A Transition Bonds, the issuance of the Series 2000-A Transition Bonds and the purchase of intangible transition property (ITP) from PECO, additions for the nine months ended September 30, 2001 and September 30, 2000 were $483 million and $369 million, respectively. These additions include the recovery of intangible transition charges (ITC). The increase of $114 million is primarily due to $103 million of additional collections related to the issuance of the Series 2000-A Transition Bonds, and an $11 million prepayment of competitive transition charges by a large customer. Deductions for the nine months ended September 30, 2001 and September 30, 2000, on the same basis were $520 million and $345 million, respectively. The increase of $175 million is primarily attributable to amortization of intangible transition property of $147 million and higher interest expense of $18 million associated with the issuance of the Series 2000-A Transition Bonds and an increase related to the interest rate swaps fair value adjustment, including the SFAS 133 transition adjustment of $23 million. 6 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK PETT's activities expose it to market risks primarily related to the effects of changes in interest rates. These financial exposures are monitored and managed by PETT as an integral part of its overall risk-management program. PETT's interest-rate risk management strategy includes the use of derivative instruments to minimize significant, unanticipated earnings and cash flow fluctuations caused by interest-rate volatility. Interest rate swaps may be used to adjust exposure when deemed appropriate, based on market conditions. These strategies are employed to minimize the cost of capital. By using derivative financial instruments to hedge exposures to changes in interest rates, PETT exposes itself to credit risk and market risk. Credit risk is the risk of a counterparty failing to perform according to contract terms. When the value of a contract is positive, the counterparty owes PETT which creates repayment risk for PETT. When the value of a derivative contract is negative, PETT owes the counterparty and the derivative contract does not create repayment risk. PETT minimizes the credit (or repayment) risk by (1) entering into transactions with high-quality counterparties, (2) limiting the amount of exposure to each counterparty, (3) monitoring the financial condition of its counterparties, and (4) seeking credit enhancements to improve counterparty credit quality. Market risk is the effect on the value of PETT's commitments that result from a change in interest rates. The market risk associated with interest rates is managed by the establishment and monitoring of parameters that limit the types and degree of market risk that may be undertaken. PETT's derivatives activities are subject to the management, direction, and control of Exelon Corporation's (Exelon) Risk Management Committee (RMC). Exelon is the ultimate parent company of PECO. The RMC is chaired by Exelon's chief risk officer and includes the chief financial officer, general counsel, treasurer, vice president of corporate planning and officers from each of the business units. The RMC reports to the board of directors on the scope of Exelon's derivative activities including those of PETT. The RMC (1) sets forth risk management philosophy and objectives through a corporate policy and (2) establishes procedures for control and valuation, counterparty credit approval, and the monitoring and reporting of derivative activity. In 1999, PETT entered into interest rate swaps relating to the Class A-3 and Class A-5 Series 1999-A Transition Bonds in the aggregate notional amount of $1.1 billion with an average interest rate of 6.65%. In connection with the refinancing, PETT cancelled $800 million of interest rate swaps. At September 30, 2001, the aggregate notional amount of these swaps was $326 million. At September 30, 2001, the fair market value exposure of these instruments was $23 million based on the present value difference between the contracted rate and the market rates at that date. If the derivative instruments had been terminated at September 30, 2001, the estimated fair value represents the amount to be paid by PETT to the counterparties. 7 A hypothetical 50 basis point increase in the spot yield at September 30, 2001 would have resulted in an aggregate fair market value exposure of these interest rate swaps of $18 million. If the derivative instruments had been terminated at September 30, 2001, the estimated fair value represents the amount to be paid by PETT to the counterparties. A hypothetical 50 basis point decrease in the spot yield at September 30, 2001 would have resulted in an aggregate fair market value exposure of these interest rate swaps of $29 million. If the derivative instruments had been terminated at September 30, 2001, the estimated fair value represents the amount to be paid by PETT to the counterparties. On January 1, 2001, PETT adopted Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivatives Instruments and Hedging Activities," as amended, and recorded a transition adjustment decreasing Net Assets Available for Trust Activities by $19 million. The transition adjustment related to the interest rate swaps. As of September 30, 2001, the fair value of interest rate swaps decreased $4 million to an exposure of $23 million. This exposure is reflected as Interest Rate Swaps on PETT's Statements of Net Assets Available for Trust Activities. As of September 30, 2001, the expected impact on net assets available for trust activities over the next twelve months is a $2 million loss. 8 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS None. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS Omitted with respect to PETT pursuant to Instruction H of Form 10-Q. ITEM 3. DEFAULTS UPON SENIOR SECURITIES Omitted with respect to PETT pursuant to Instruction H of Form 10-Q. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Omitted with respect to PETT pursuant to Instruction H of Form 10-Q. ITEM 5. OTHER INFORMATION None. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits None (b) During the quarter ended September 30, 2001, the PETT filed the following Current Reports on Form 8-K: None 9 PECO ENERGY TRANSITION TRUST SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Date: November 14, 2001 By: /s/ George R. Shicora ---------------------------- George R. Shicora Beneficiary Trustee 10

PECO ENERGY TRANSITION TRUST 10-Q