California’s $11.9 Bln Bond Sale Includes Record Reserves

Tuesday, August 20, 2002

California’s $11.9 Bln Bond Sale Includes Record Reserves

By Dennis Walters

Sacramento, California, Aug. 20 (Bloomberg) — A quarter of California’s planned $11.9 billion bond sale to repay debts caused by last year’s energy shortage will be held in reserve to address risks the state won’t get out of the energy-buying business or delay raising utility rates that back the securities.

Regulatory filings for the sale, the biggest municipal bond offering in U.S. history, said credit rating companies pushed for more reserves to protect investors. The California Department of Water Resources, which will sell the bonds, said a bigger cushion will translate into a better credit rating and lower borrowing costs. It’s also a penalty, analysts and investors said.

Setting aside about $3 billion in reserve will prompt investors to ask “why is it necessary and what does it mean about the underlying credit,” said Joseph Fichera, chief executive of Saber Partners LLC, who advised Governor Gray Davis on energy issues last year.

The sale will let the water department repay the state’s general fund for a $6.6 billion loan for last year’s energy costs, pay off a $3.5 billion balance remaining on bank loans and cover other power-related expenses. The department said Friday in a report for the California Public Utilities Commission that it expects to sell the bonds next month or in October.

The filings provide the most detailed picture to date of the sale once planned for last September. Regulators delayed approving a plan to repay the debt until February, after the state agreed to seek lower costs on multiyear energy contracts negotiated in 2001.

Energy Crisis

The Department of Water Resources began buying energy in January 2001 after the state’s two largest utilities, PG&E Corp.’s Pacific Gas & Electric and Edison International’s Southern California Edison, became insolvent paying more for electricity than they could charge customers under state law.

A portion of the revenue generated by the two utilities and a unit of Sempra Energy will back the bonds and reimburse the department for its energy-related spending.

Rating companies required the bigger reserve partly because of “significant skepticism” that the water department will be able to comply with a yearend deadline to transfer power-buying to the investor-owned utilities, Douglas Montague, a consultant to the department, said in a regulatory filing.

A failure to meet the deadline may expose the department to future energy cost increases, unless it can negotiate new contracts, Montague said. Rating analysts also cited concern about delays if utility rates must rise to cover costs, he added.

More Questions

“Then the question becomes, how effective will they be in getting those increases approved and implemented in a reasonable amount of time,” said David Blair, a senior analyst for Nuveen Investments.

The utilities commission last week approved letting the water department raise as much as $11.95 billion from the bond sale — up about $900 million — to meet the rating companies’ requests for more reserves.

That means the department will keep a minimum $1 billion in an operating account rather than the $150 million previously planned, as long as it keeps buying power for the private utilities. The operating account functions akin to “your checking account,” said Oscar Hidalgo, a department spokesman.

The department’s latest filing, assuming a final bond closing by Oct. 10, estimates that its overall power fund balance will total about $13.9 billion once the proceeds from the bonds are added to money collected from the utilities.

$3 Billion Reserve

Almost $10.1 billion of that will be used to pay off the state and bank loans. Setting aside reserves of about $3 billion is the next priority.

Part of those reserves, almost $1 billion, would cover a year’s worth of principal and interest payments on the debt. That isn’t unusual. “Debt reserve” accounts typically account for about 10 percent of a municipal bond.

What isn’t typical, investors and analysts said, is the water department’s need to put $1.26 billion aside in the operating account and another $777 million in reserve for power purchase costs.

The underwriters of the bonds, led by J.P. Morgan Chase & Co., have “no historical experience” to gauge whether rate increase requests will be passed “on a timely basis” by regulators or face legal challenges, said Richard Ciccarone, a managing director of McDonnell Investment Management, which oversees $6.5 billion.

After last year’s energy squabbles among state leaders that prompted downgrades of the Pacific Gas and Edison utilities to “junk” status, precluding them from energy purchases, investors in the power bonds will need proof that they “are a priority concern” for the utilities commission, said Fichera, the consultant. The water department “only has an extremely complex rate agreement with the PUC as security for the bondholders.”

The department assumed in its calculations that the bonds will be rated A. The ratings were received on Aug. 9, according to filings, and are being kept confidential during negotiations with insurers and banks that plan to guarantee some of the debt.