July 20, 2002
State Is Set for Record Bond Issue
Financing: At $11.1 billion, sale is largest in U.S. history. Cash could start coming in within weeks to fill budget hole left by power purchases. By NANCY VOGEL, TIMES STAFF WRITER
SACRAMENTO — To fill the financial hole gouged by the electricity crisis of 2000 and 2001, California is at long last putting the final touches on an $11.1-billion bond sale—the biggest one-time borrowing by a government agency in U.S. history.
If the bonds are sold as planned, the first infusion of cash could reach California this fall. Ê Within weeks, Wall Street rating agencies expect to grade the riskiness of buying the bonds. Then, in the sort of road show the state hasn’t performed since 1997, the treasurer will visit cities across the country to drum up investor interest. The money is intended to replace $6.5 billion that the state spent buying electricity in the winter and spring of 2001 and to retire a $4.3-billion loan also used to purchase power. Lawmakers wrestling with the current $23.6-billion shortfall in the overdue 2002-03 budget have been counting on the bond sale. Without it, the state would have to take out short-term loans to keep cash flowing.
“This is a very unique situation,” said Dan Aschenbach, senior vice president for Moody’s Investors Service, one of three major Wall Street rating agencies. “I don’t think there’s any other type of bond issue that’s had to be put in place to resolve an issue as significant as a $6-billion deficit to the state.”
The cost of retiring the new bonds is built into utility rates, so the debt will be paid off dollar by dollar, month by month as customers of Southern California Edison, Pacific Gas & Electric and San Diego Gas & Electric get their bills over the next 20 years. State officials say they do not expect to have to raise rates to cover the cost of the bonds. But bond payments make those rates, now among the highest in the country, less likely to be reduced anytime soon.
The bond sale is designed to spread the financial pain of an extraordinary year of threatened blackouts and astronomical power prices. State Treasurer Phil Angelides had sought to sell the bonds 14 months ago, but a deal was delayed by concerns over possible lawsuits and a dispute between the California Public Utilities Commission and Gov. Gray Davis’ administration. The slowdown could bring unintentional savings because interest rates have dropped.
Wall Street rating agency analysts say they have grown more confident in recent months that California officials have taken steps to protect investors, such as reaching an agreement with utilities on how to divvy the money they collect from ratepayers.
“A lot of the things that have been a concern have been addressed in various ways,” said Claire Cohen, a vice chairman at Fitch, a Wall Street rating agency.
But the power bond sale is unusual not just for its size. It is also exceptionally complex.
The agency backing it—the California Department of Water Resources—was thrust into the business of serving 27 million electricity consumers practically overnight. To keep electricity flowing to the customers of nearly bankrupt utilities, DWR spent billions of general tax dollars in 2001, when the state enjoyed a substantial budget surplus.
DWR is expected to bow out of that business by the end of this year and turn operations back to the utilities, long before the bonds are repaid.
Besides being a temporary utility, DWR is a hybrid utility. It is governed by rules rushed through the Legislature in January 2001 as the state veered toward collapse of its electrical system.
DWR depends upon the California Public Utilities Commission to adjust rates to cover its expenses. The two agencies are naturally at odds. DWR, to guarantee bond buyers that they’ll get their money back, wants the PUC to adjust rates quickly, with no fuss, as DWR sees necessary. But the PUC, charged with protecting ratepayers, would prefer to first make certain DWR’s costs are legitimate and reasonable.
Power Market Murky
An uncertain electricity landscape lies in the backdrop. Prices of wholesale power in California plummeted a year ago. But supplies got dangerously low in a heat wave earlier this month. Many companies have shelved their plans to build power plants, and federal regulators have lifted price caps to a level that California officials say could allow gouging. Another spike in prices could crimp DWR’s ability to cover its costs and force the agency to request higher utility rates from the PUC.
Rating agency analysts note, however, that today’s power market is vastly changed from a year and a half ago. At times 90% of the power DWR needs to supply utility customers comes from contracts arranged months ago.
“They’re not buying everything off the spot market any longer,” said Aschenbach. “There’s been a fair amount of new generation built, which has helped the supply-demand balance and helped keep prices moderate.”
“It takes the pressure off having to ask for additional revenue,” he said. “Those types of factors argue for a more stable rating.”
DWR officials say they seek an “A” credit rating on the bonds, which is not the highest and therefore an implicit acknowledgment of some risk.
The ratings given by Fitch, Moody’s and Standard & Poor’s will have a huge effect on how much California ratepayers will be charged in interest on the bonds. Experts estimate, for example, that the difference between an “A” and a “B” rating can amount to $1 billion in interest paid over the life of the bonds.
One risk factor the rating agencies analyze is whether utilities or other outside parties can go to court to slow down or prevent the PUC from adjusting rates as DWR dictates.
Under the law that pushed DWR into the power-buying business, the department must at least once a year submit its revenue requirement to the PUC. The PUC is supposed to then adjust the amount of money flowing from ratepayer bills to DWR to cover its costs.
PG&E, driven into bankruptcy by exorbitant energy costs, sued last year to force DWR to publicly explain and justify its costs. To comply with a court ruling, DWR this summer established a 21-day public hearing process under emergency regulations.
PG&E and Edison argue that such a compressed window for public comment violates state law, although they have not challenged it in court. The possibility of a lawsuit lingers, though, and that could discourage investors.
“Fundamentally, a bond is only a promise to pay,” said Joseph S. Fichera, chief executive officer of Saber Partners, an investment banking firm that helped the Davis administration handle energy issues in 2001. “Investors will judge the credibility of the PUC and DWR’s promise, and if they demand huge amounts of cash to be collected from ratepayers and set aside as collateral, it means they’re skeptical at the very least.”
Big Reserves Built In
The treasurer’s office and DWR have built fat reserves into the bond deal. Billions of dollars will be sitting idle in DWR accounts to help guarantee that the state can promptly repay investors.
DWR proposes to have at least $1 billion in operating reserves and $1.1 billion in bond-related reserves. The utilities claim that an additional $1.5 billion in excess collections from ratepayers also will be set aside to support the bond issue.
The cost of keeping such reserves will be worth it, DWR officials say, if it helps the state get a high investment grade rating and thus a lower interest rate.
Even with an “A” rating and interest rates between 5% and 6%, over the next two decades, utility ratepayers will have to pay nearly as much in interest on the bonds as the $11.1-billion in principal borrowed.
Cohen said she expects a keen appetite for the power bonds on Wall Street as investors look for a safer place than stocks to put their money.
“California is a big name,” said Cohen. •