Posted on 09/27/2002 9:48:00 AM PDT by Robert357
CALIFORNIA DWR WILL ISSUE $11.9 BILLION TO FUND PAST ENERGY PURCHASES
Moody's has assigned the credit rating of A3 to the California Department of Water Resources (DWR) Power Supply Revenue Bonds. The state DWR expects to issue in October 2002 approximately $11.9 billion of revenue bonds including $5.9 billion of fixed rate bonds and an expected $6 billion of floating rate bonds.
The bonds are secured by charges to be paid by customers of the state's three investor-owned utilities. The charges are paid as part of the customers' regular electric bill based on electricity usage and the revenue is passed on to the DWR by the utilities. The California Public Utilities Commission (CPUC) has covenanted that it will set rates sufficient to meet DWR's revenue requirements under terms of the authorizing statute and the Rate Agreement between the DWR and CPUC.
The credit rating takes into consideration the strong security features provided for in the state authorizing statute and bond indenture, the bond counsel and state attorney general's opinions regarding enforceability of the Rate Agreement, the CPUC covenant to set rates sufficient to meet DWR's revenue requirements, and the legal strength of the servicing order in the context of the PG&E bankruptcy. Also, the expectation is that, in the near term, likely more stable power market conditions will not entail a retail rate increase to meet DWR's power and debt service costs.
Key to the credit rating are the substantial cash reserves funded from funds on hand and bond proceeds, including a minimum operating expense account balance of $1 billion, an operating reserve of $777 million which includes one month of projected power contract costs in the Priority Contract Account. The approximately $1.8 billion of reserves, equal to about 39% of the 2003 revenue requirement, are available to protect DWR cash flow for an extended period from delays in the revenue requirement process due to regulatory board or legal challenges and to protect against a variety of power market stress scenarios. The indenture also includes a maximum annual debt service reserve, which provides additional cushion. The reserves are fully funded at closing, and the operating reserve is required to be adjusted over the life of the transaction, based on future potential power market volatility forecasts and with a minimum floor of a percentage of the prior year's annual operating expenses. If DWR projects the operating reserve will be utilized in the following four months, it must begin the revenue requirement process to revise its charges to replenish the reserve.
The reserves remain at the maximum levels during the most problematic period for DWR, while it pursues the approval of its 2003 revenue requirement and continues to purchase the residual net short of the IOUs. -snip-
The obligation of the CPUC to set adequate rates is well defined in the Rate Agreement. This represents a key credit factor. The CPUC has covenanted to adjust rates in a specified timeframe on customers of the state's investor-owned utilities if needed to meet the DWR revenue requirement. -snip-
· There are lingering questions posed in litigation about whether costs of DWR's power contracts are "just and reasonable" under Section 451 of the state Public Utilities Code. However, the CPUC's General Counsel has opined that "the CPUC has no authority to determine whether DWR's costs submitted in its revenue requirement are just and reasonable." -snip-
RISKS/WEAKNESSES
LEGAL
· Rate setting process is untested and complex. (Plus a bunch of other stuff)
POWER MARKET
· California industrial and commercial power prices are very high compared to regional and the U.S. average.
· DWR is likely to remain in the power procurement business beyond year-end and remain responsible for the net short position of the state's IOUs, and thus vulnerable to supply-demand factors. It is likely that some of the IOU's will be responsible for power procurement in 2003. Existence of operating reserves also mitigates some of this risk.
· Gap between likely market price and price of long-term DWR contracts may widen over time, creating political pressure for rate reductions or retail choice.
· Uncertainty regarding the future power market structure and changes in marketplace rules in California present political risk as well as potential for higher spot market prices and gas price pressure on long-term contracts. This pressure may be translated into legal challenges to the DWR rate-making process.
· Electric industry restructuring will continue to present complicated policy issues.
· Uncertainty regarding amount of new generation given the credit deterioration of several plant developers and the recent impact of low spot prices on project economics. More than one-half of the new power generation plants to be built pursuant to the DWR power purchase contracts as well as significant other new generation projects in California have not yet been built. Many of the proposed projects have been delayed or suspended. Some of the factors include: a lack of investor confidence in the California electricity market, as further affected by the recent power trading controversies, the continued fallout over Enron, and the low energy clearing prices in California. Also, some new in- state generation projects may not be completed due to air emissions regulations.
· Transmission constraints and difficulty in siting new transmission lines could reduce availability of new generation from outside the state or to northern California.
OTHER
· The State of California's ability to initiate emergency financial measures should a power crisis return is limited given its current financial and economic pressures.
· Highly charged political environment.
*Interest rate risk. While 25% of DWR's debt will be exposed to interest rate risk, DWR has a well-defined interest rate risk management program.
Bond amount: $5.9 billion Power Supply Revenue Bonds, Series 2002 A; DWR expects to issue $6 billion variable rate bonds (Series 2002 B, C, D and E).
Security Pledge. The bonds are being issued under the indenture among DWR and two co-trustees, the State Treasurer and the U.S. Bank N.A. The bonds are payable primarily from charges to be imposed by the California Public Utilities Commission (CPUC) on nearly 10 million retail end use customers in the service areas of the three major investor-owned electric utilities in California.
The CPUC has covenanted in a rate agreement with DWR to calculate, revise, and impose from time to time, bond charges sufficient to provide moneys that are at all times sufficient to pay or provide for the payment of debt service on the bonds. Funds in the bond charge account can be used to pay power expenses of DWR if power charges and operating reserves are insufficient for that purpose.
Once the operating reserve fund is projected to be drawn upon, a new revenue requirement process is required to begin. Once priority lien DWR power purchase contracts are assigned to other parties or expire, only then would charges be used to pay debt service. DWR has entered into servicing agreements with SCE and SDG&E approved by the CPUC, and the CPUC has adopted a servicing order for PG&E.
Rate Covenant: In the rate agreement, CPUC must insure rates are sufficient so bond charge payment account can pay all bond-related costs when due. DWR is required to meet its costs from a revenue requirement that is presented at least annually to the CPUC. The statute AB 1X and rate agreement between DWR and CPUC requires CPUC to include in the rates of the state's investor-owned utilities sufficient funds to meet DWR's revenue requirement.
Operating Reserves: Operating Expense Account Balance minimum while DWR is procuring residual net short is $1 billion and if the floor is reached of $750 million is reached, then DWR must file a new revenue requirement. The operating reserve account is $777 million at closing; a floor for the operating reserve exists at 18% of operating expenses while DWR purchases residual net short if before 2006 and at 12% stops purchasing the residual net short or after 2005 in any case.
Additional Indebtedness: Permitted only with permission of the CPUC.
Debt Service Reserve Requirement: Maximum annual debt service that will be fully funded from bond proceeds.
Use of Proceeds: The amount of $6.56 billion will be used to repay the state's general fund for prior power purchases and another $3.49 billion will retire an interim loan. The balance of proceeds (net of issuance costs) will fund the initial deposits to the operating account, the debt service reserve, the bond charge payment account and the bond charge collection account.
INDENTURE PROVISIONS
· DWR shall cause to be established, fixed, and revised rate or charges sufficient, together with other funds and securities on deposit in the Electric Power Fund, to satisfy all DWR revenue requirements in amounts needed at the time.
· No later than 90 days prior to commencement of each calendar year beginning January 1, 2003, DWR shall file with the trustee an estimate of the DWR revenue requirements for such calendar year.
· Fund Flow: The Electric Power Fund is established in the state treasury by the Act and by Senate Bill No. 7X. All moneys deposited in the Electric Power Fund are deposited in the (1) Operating Account, (2) Priority Contract Account, (3) Bond Charge Collection Account, (4) Bond Charge Payment Account, (5) Debt Service Reserve Account, (6) Operating Reserve Account, and (7) Administrative Account.
· The Bond Charge Payment Account and the Debt Service Reserve Account shall be under the control of the treasurer as trustee.
· The flow of funds separates power charges from bond charges: revenues in the bond charge collection account can be used to pay long-term priority contract costs as needed, and these draws can only occur if priority contract account, operating account, and the operating reserve accounts have been depleted.
· Once revenues are deposited in the bond charge payment account, they are no longer available to pay long-term priority contract costs.
· The operating reserve account requirement is the largest aggregate amount projected by DWR by which operating expenses exceed power charge revenues during any consecutive seven calendar months. Such projections shall be based on such assumptions as DWR deems to be appropriate after consultation with the CPUC. The operating reserve account level is subject to a floor of 18% of projected operating expenses while DWR is procuring the net short position and 12% of operating expenses once it is no longer is procuring the net short position.
· The debt service reserve account, which is required to be funded at maximum annual debt service, can be funded by an irrevocable surety bond, insurance policy, letter of credit, or any other similar obligation provided to the trustee as a substitute for cash.
· The State of California pledges and undertakes that, while any obligations of DWR incurred under the Division 27 of the State Water Code remain outstanding, the rights, powers, duties, and existence of the DWR and the CPUC shall not be diminished or impaired such that they will affect adversely the interests and rights of the holders to such obligations.
Outlook
Given the substantial reserves at closing, the credit outlook is stable. Over time, the credit outlook could improve as DWR exits the power procurement business and its role diminishes to one of paying debt service from the bond charge. Similarly, while the PG&E bankruptcy reorganization presents continuing risks, once settled, litigation risk will recede and the credit outlook could improve.
(Excerpt) Read more at moodys.com ...
I am amazed that this got a three A rating, but some of the interesting things are the variable bond interest rate, the huge DWR exposure to interest rate changes in the future (and hence the pressure on DWR and the CPUC to anything that Alan Greenspan does). It will be interesting to watch democrats suck up to Greenspan to keep interest rates low!
The amount of fixed reserves and the promise made by the state are real interesting!
I expect other rating agencies to announce ratings as well. Should be interesting to see how Davis trys to spin this!
I am surprised that it is tripple A, but Moody's is clearly relying upon promises made to them by the Cal Attroney General, by the Cal CPUC attorney, and by the Treasurer and Controller. If there is a problem, Moodys and investors will be able to sue the State and its officials for fraud.
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Good luck catching up with Davis!
Looks like we have a rate increase (imposed taxes ) coming for the next X years!
When the next power crunch hits California (which it will, given their policy of discouraging new plants but increasing their population), it will come down to a choice of raising electricity rates to pay off the bondholders, or to default on them.
Since California isn't personally on the hook to repay the bondholders, the temptation will be great, especially if it's an election year.
I wouldn't risk a penny buying these bonds.
Actually, what I read said that the Attorney General and the Chief attorney for the CPUC have submitted legal opinions that the CPUC and/or DWR must pay funds into a special bond fund that goes for repaying the lenders and that the State Treasurer must act on behalf of the lenders in his/her making payments from that fund.
What I read said that California is deeply on the hook and that legal opinions have been rendered by various representatives of the state as saying that the State will pay when called upon. That means if the state doesn't pay those branches of government and hence the state provided false and misleading legal information, upon which the rating agencies and lenders relied upon.
Ahhhh, but there's the rub. You might get your money put at risk for you.
A favorite trick of the muni's is to have state funds (generally those controlled by Democrats) invest their temporary surpluses in bonds that look good on paper but that everyone really knows are junk.
Hence, the state of Tennessee has Billions in California bonds. Democrats in one state can easily cover for Democrats in other states by channeling state investments (every state has temporary surplus funds)...
Fitch Ratings-New York-September 27, 2002: Fitch Ratings assigns an underlying 'A-' rating to the California Department of Water Resources (DWR) power supply revenue bonds. The underlying rating represents an assessment of the non-enhanced, long-term, credit quality of the bonds. The Rating Outlook is Stable. A total of $11.9 billion of bonds are expected to be issued, of which $5.9 billion are expected to be fixed-rate, with the remainder variable-rate, including daily, flexible, commercial paper, weekly and auction modes. There will be several forms of credit enhancement, leading to the assignment of several ratings on specific sub-series of bonds reflecting the enhancement provided.
The bonds will be secured by DWR's bond charge revenues, imposed by the California Public Utilities Commission (CPUC) on all customers served by the three investor owned utilities (IOUs) in California, Pacific Gas & Electric Company (PG&E), San Diego Gas & Electric Company (SDG&E) and Southern California Edison Company (SCE). The underlying 'A-' rating reflects Fitch's assessment of the statutory and regulatory framework that establishes the bond charges, the adequacy of the reserves and transaction cash flows to withstand significant stress, the ability of the IOUs to service the power and bond charges, and the relative economic stability of the service territory. The bonds are separately secured from any other obligations of DWR. The bonds will not be obligations of the state of California and no state credit is involved.
The bond charge is a part of DWR's revenue requirement, which also includes a separate power charge for operations and maintenance expenses. Such charges are authorized under a rate agreement between the CPUC and the DWR that was entered into pursuant to the authorizing legislation. Under the legislation, DWR has sole authority to determine and present to the CPUC for recovery its revenue requirements, although they must be just and reasonable. The revenue requirements include the amounts necessary for operations and maintenance (primarily purchased power) and debt service. While the CPUC does not have the authority to determine that the DWR's revenue requirements are not 'just and reasonable', it will continue to be responsible for setting rates among classes of customers. The CPUC has covenanted in the rate agreement to calculate, revise and impose bond charges that are sufficient to provide for the payment of all bond-related costs at all times. The rate agreement has the force and effect of a financing order, meaning that it is irrevocable and enforceable in accordance with its terms. DWR will rely on the IOUs, pursuant to agreement and/or order, to collect the charges but legislation has delineated clearly that DWR owns the revenues derived from the sale of its power. The IOUs have significant experience with the functions required to service the charges.
While DWR has the ability to set the revenue requirement to cover its costs, the rating also considers risks to transaction cash flows associated with the volatility of power prices in California, variances from expected demand for electricity, and potential delays both in DWR arriving at the revenue requirement and the CPUC adopting customer rates. Additionally, about half of the bonds will be in variable-rate modes; after hedging, the ratio drops to a lower 25% but the various arrangements will require oversight. Of some, but lesser, concern is the ability of priority contract counterparties to access the bond charge collection account.
While the bond and power charges are separate and distinct, a first lien on revenues was granted under certain power purchase contracts, designated priority long term power contract costs. Consequently, the priority holders can access the bond charge collection account if power charge revenues are insufficient. However, once amounts in the collection account have been deposited into the bond charge payment account, which is to occur on a monthly basis, the funds will no longer be available to priority contract holders. Fitch's cash flow analysis considers the impact of the unlikely need for the bond charge collection account to be tapped for priority long-term contract costs.
Bondholders benefit from significant reserves to be maintained to support both debt service and the power purchase program. A debt service reserve account equal to maximum annual debt service is initially expected to be just under $1 billion. On the operating side, additional protection is provided by an operating reserve account and a required minimum balance in the operating account of $1 billion for so long as DWR continues to procure the additional power needed beyond the amount supplied by the long term contracts (residual net short position). Looking ahead, risk will diminish when DWR is no longer responsible for fulfilling the residual net short position, but only for collecting the bond charge for debt service. Positive security factors also include the wealth and diversity of the service area and the essentiality of electric power. California has a population of about 34 million, 60% larger than Texas, the second largest state.
California entered the electric power business in January 2001 when soaring energy prices outpaced the capped rates charged by the IOU's, rendering PG&E and SCE uncreditworthy and compromising the ability of all three investor owned utilities to deliver power. DWR is responsible for purchase of the 'net short', or the power necessary to be purchased to supplement that provided by the IOU's themselves. Through June 2001 DWR borrowed $6.1 billion from the state's general fund for power purchases. DWR at that time obtained interim financing of $4.3 billion, ending general fund involvement. Bond proceeds will be used first to repay the remaining $3.5 billion of the interim loan, second to repay the general fund with interest and to fund reserves.
I don't know how many years that would be down the road, and what the costs of the litigation would be, but assuming the bondholders prevailed, they might break even.
Might.
This is going to shake up the investment community. Three A (about as good as it gets) to BBB+ which is low investment grade. This is the kind of controversy that has been delaying the bond issue and the kind of stuff that will make for interesting reading.
The conference call just after high noon (12:30) on Oct 2nd should be one heck of a cat-fight!
I hope some reporters in the business press pick this up and ask what the heck is going on. How can three rating agencies come up with totally different opinions on a set of bonds!
NEW YORK (Standard & Poor's) Sept. 27, 2002 -- Standard & Poor's Ratings Services has assigned a triple-'B'-plus rating and a stable outlook to the California Department of Water Resources' (DWR) $11.9 billion of bonds. The rating principally reflects the bondholder protection provided by the financing's legal framework, which mitigates many of the political risks and power market uncertainties associated with DWR's power program.
Bond proceeds will repay $6.2 billion, plus interest, borrowed from the state's general fund, extinguish the remaining portion of a $4.3 billion loan made by a consortium of private banks to DWR to finance 2001 electricity purchases as part of the state's response to the power crisis, and contribute to required operating and debt service reserve accounts. Approximately 25% of the $11.9 billion of bonds to be issued will consist of unhedged variable-rate debt, with various forms of credit enhancement.
The bonds are secured by a charge on retail electric customers regulated by the California Public Utilities Commission (CPUC), subject to the prior lien of payments to electric power providers. Bonds are also secured by various reserve funds which should provide sufficient liquidity during the time needed for a rate adjustment to be implemented to cover increases in projected DWR power costs and fluctuations in variable bond interest costs. Although California advanced large sums of money in 2001 to support DWR's power program, the bonds are not a state obligation. "DWR is expected to take all actions contemplated by the indenture to garner revenues that will enable it to make timely payment of debt service," said credit analyst David Hitchcock. "Lack of such action could call into question the willingness of the state to make payment on its own direct general obligations." The political incentives to avoid power disruptions and impairment of the state's economy should induce DWR and the CPUC to act in a manner that is supportive of credit quality, at the risk of the state's ability to market its own general obligations. These strengths are buttressed by the financing's legal framework.
Nevertheless, considerable risks do remain and the ratings could be lowered if retail electric rates are not adjusted as needed or if DWR substantially reduces reserves in future years when the minimum required level drops, by incorrectly projecting that it foresees lesser potential for market volatility.
Standard & Poor's full report on the DWR bond issue is available on Standard & Poor's RatingsDirect, and will be posted on the Web at www.standardandpoors.com.
Members of the media may contact Christopher Mortell at 212-438-2756 or christopher_mortell@sandp.com for more information. TELECONFERENCE
Standard & Poor's will hold a teleconference on Wednesday, Oct. 2 at 12:30 p.m. (ET) to discuss the DWR bond rating. The discussion will focus on DWR's creation of a legal framework for the financing that mitigates many of the political risks and power market uncertainties of its power program. The speakers will include David Hitchcock and David Bodek, from the state and local governments and public utilities teams, respectively. After prepared remarks, they will be available to answer your questions. The dial-in number is 712-257-2021; the confirmation number is 8462118; and the passcode is "SANDP". Please call at least 15 minutes before the scheduled start of the call to complete the pre-call registration process. Participants will be asked to provide their name, company affiliation, and fax numbers or e-mail address. The entire call will last approximately one hour.
No thanks.
California bonds have already had complete defaults (witness the Orange County bonds from the early 1990's).
Is that what you think makes for a good investment?
"What recourse do the bondholders have if California simply decides to change the terms of the contract after the fact?"
OK, they sue. Meanwhile, the sapsbondholders get no interest payments for the ten or fifteen years that it takes for the courts to decide in their favor. Even then, how can the Courts make California pay?
Buying these bonds is like making a deal with the devil.
We need to be sure that these worthless pieces of paper carry the name:
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