The Bond Buyer

SAN FRANCISCO: The long-awaited approval last week by the California Public Utilities Commission of a rate agreement with the state’s Department of Water Resources is only the first in a chain of events that must occur before the agency can issue up to $11.1 billion in power purchase revenue bonds.

Rating analysts and potential investors will now look closely at what security the agreement affords bondholders and also will have a high level of interest in any legal challenges to the plan that arise in coming weeks.

“We are pleased by the actions taken by the PUC,” said Nathan Brostrom, vice president at J.P. Morgan Securities Inc. and senior manager for the deal. “They represent critical first steps in getting the bonds structured and sold.”

The commission approved a rate agreement last Thursday under which utility ratepayers would provide two separate revenue streams, one to meet the DWR’s costs associated with the bonds, and the other for its operating expenses, including the cost of buying electricity under long-term power contracts negotiated by California.

But until legal challenges to the PUC‘s orders are aired and resolved, the state will not be able to say when the bonds may be sold, according to state Treasurer Phil Angelides. Parties have until March 7 to appeal the agreement with the PUC.

Already, the Foundation for Taxpayer and Consumer Rights has said it may appeal. Doug Heller, a consumer advocate with the group, said the rate agreement removes public review of rate requests because the PUC agrees to comply with the DWR’s revenue needs. It also makes no guarantees that the state will be reimbursed in full for what it has spent buying power since California’s deregulated energy market went haywire in 2000.

All appeals need to be resolved before necessary legal opinions on the validity of the bond structure can be issued. A financing structure proposed last week is preliminary and may change based on market conditions and further analysis, J.P. Morgan said in a news release last week.

The current agreement entails a complicated flow of funds from customer utility bills to pay for the DWR’s operational costs, bond-related costs, costs of the long-term energy contracts, past loans, debt service payments, and various reserves. Under certain circumstances, revenue can cross between operational funds and bond funds.

Crossovers between funds for the power charge and bond charge had to be available to satisfy companies with contracts and legal concerns, Brostrom said. But they should not be necessary financially because of reserves and pre-paid accounts, both for power costs and debt service.

Once the bonds are sold, most likely during the second half of 2002, proceeds are expected to reimburse the state general fund for the approximately $6 billion it spent for power early last year and for $4.3 billion in bridge loans made to California from private banks.

However, financiers had to establish a flow of funds in case of the “remote possibility” that the bridge and general fund loans can’t be paid immediately, according to Brostrom.

The majority of the bonds are expected to be exempt from taxes, he said. The breakdown will depend on tax analyses, following any challenges to the structure, and what credit enhancement is available. Fixed- and variable-rate portions will also depend on credit enhancement.

Separately, the DWR should stop having to pay an extra 2% in interest being charged on the bridge loans if the rate agreement is confirmed after appeals to the satisfaction of the interim lenders.

The penalty was added after the loans weren’t paid off in October. The state must continue making quarterly payments on that loan — starting with roughly $400 million due in April — until bonds are issued.

Ratings on the bonds will be issued prior to the sale date, analysts said. By law, the bonds must obtain investment-grade ratings.

Fitch Ratings analysts are focusing on the legislative and regulatory framework and the ability of the PUC to raise rates as needed, said Donna DiDonato, a director with the agency. The current structure is similar to a net revenue bond because priority is given to paying power contracts, and the rating will depend on what type of protections are afforded to bondholders, she said.

Legal challenges also must be resolved.

“We’re actually looking forward to seeing what issues are raised and having the structure confirmed,” DiDonato said.

The timeline for PUC action is of particular importance, said Dan Aschenbach, a senior vice president at Moody’s Investors Service.

“That’s because of the regulatory uncertainty in the past year,” he said. “It argues for additional reserves to be available to insure that whatever disagreements come up have time to be worked out prior to bond repayment.”

There’s always a trade-off between the level of reserves built in and the amount of time it takes to increase rates, said Dave Hitchcock, a director at Standard & Poor’s.

“They’re stuffing it with a lot of reserves right now, but there will probably be some kind of give-and-take for different ratings,” he said.

Copyright c 2002 Thomson Media. All Rights Reserved. http://www.bondbuyer.com