3. Summary of Request
By the time reply briefs were filed, Alco and DRA had reached an agreement on all issues except whether Alco should be required to file a GRC application. The following is a summary of Alco's request as it stood after the submittal of reply briefs.
3.1. Use of Proceeds
Alco requests authority under Pub. Util. Code § 816 et seq., and § 851 to issue $6 million of long-term secured debt, $2 million of preferred stock, and $0.33 million of common equity for the following purposes:
Table 1 | |
Purpose |
Amount |
Repay capital leases executed in 2005 and 2006 for water plant |
$ 1,118,260 |
Repay short-term notes executed in 2006 and 2007 to finance new water plant |
$ 936,000 |
Reimburse treasury funds expended in 2005 and 2006 to finance new plant and equipment |
$ 2,565,740 |
Install water mains pursuant to a federal court order |
$ 1,200,000 |
Install pumping equipment, pump houses, & ancillary plant and equipment for three new wells |
855,000 |
Install automatic meter reading system, including radios, antennas, software, and meters |
$ 700,000 |
Debt issuance costs and contingency reserve for the above projects |
$ 625,000 |
Total |
$8,000,000 |
Although Alco requests authority to issue $8.33 million of debt and equity, Table 1 shows that Alco has plans to use only $8.0 million of the proceeds.
Alco represents that all of the requested debt and equity will be used to finance or refinance plant and equipment needed to serve customers in Alco's service territory as it existed prior to Resolution W-4630.2 Additional details regarding Alco's proposed uses of the debt and equity are set forth below.
In 2005 and 2006, Alco acquired a truck, an excavator, and a trailer at a cost of $1,118,260. The equipment was financed with capital leases and is included in Alco's rate base. The average interest rate of the capital leases is 9.47%.
Alco represents that it used $2,565,740 of "treasury funds" in 2005 and 2006 and $936,000 of short-term debt in 2007 to finance the acquisition of utility plant and equipment. All of the treasury funds and short-term debt were borrowed from Alco's President, Thomas Adcock. Alco requests authority to repay the treasury funds and short-term debt from the proceeds of the debt and equity requested in this proceeding.
A federal court order issued in April 2002 required Alco to install the improvements listed in the Black and Veatch Report that is referenced in the court order.3 The court-required improvements include water mains. Commission Resolution W-4577, dated December 15, 2005, authorized Alco to install the water mains at a cost of $1.2 million and to include them in rate base.
Commission Resolution W-4577 authorized Alco to install three new water wells, which Alco intends to finance with the proceeds of the long-term debt authorized by D.06-01-039. In this proceeding, Alco requests authority to issue $855,000 of debt and equity to pay for pumps, pump houses, back-up generators, and other plant and equipment associated with the three new wells.
Alco intends to install an automatic meter reading (AMR) system at a cost of $700,000. There is currently no Commission Decision or Resolution that authorizes Alco to install an AMR system or to recover the costs of an AMR system. Alco intends to use the proceeds of the debt and equity requested in this proceeding to pay for the AMR system.
3.2. Requested Debt and Equity
Alco requests Commission authority to issue $6 million of long-term debt secured by utility assets. Alco has received a letter from Wulff, Hansen & Co., Investment Bankers (Wulff) that provides the basic terms under which Wulff and Redwood Securities Group, Inc., would offer private placement services for the proposed debt. The letter states, among other things, that the anticipated term of the debt is 20 years, the interest rate will not exceed 9%, and that the debt may be secured by Alco's utility assets. A copy of the letter is attached to A.07-10-012.
Alco anticipates the interest rate will be in the range of 7.5% to 9.0% based on Wulff having sold $8.5 million of Alco's 20-year secured bonds in May 2007 at an interest rate of 7.85%. The final interest rate will be determined based on market conditions at the time the debt is issued. Copies of the executed debt documents will be provided to the Commission when they are completed.
Alco's debt-to-equity ratio is currently more than 10-to-1. Alco and DRA agree that Alco should reduce its debt-to-equity ratio to 3-to-1 over a three-year period. To help achieve this objective, Alco now requests authority to issue $6 million of long-term debt, $2 million of preferred stock, and $0.33 million of common equity. The preferred stock will be issued to Thomas Adcock, the President of Alco. The common stock will be issued to Patricia Adcock, the mother of Thomas Adcock. Alco proposes to issue the preferred stock within 180 days from the date that Alco's $6 million loan closes. The common equity would be issued, as necessary, to achieve a debt-to-equity ratio of 3-to-1 over a three-year period.
Alco agrees to cap the dividend on the preferred stock at 8.5%. Alco believes this rate is consistent with the current market rate for preferred stocks issued by comparable water utilities. For example, the preferred stock of Valencia Water Company has a dividend of 9.5%. In addition, by investing in the preferred stock, Thomas Adcock will forgo other investment opportunities for a period of 20 years or more with no ability to redeem the preferred stock once it is issued. And because Alco's stock is not publicly traded, there will be little or no opportunity to sell the preferred stock if that were to become necessary. Alco believes that these factors together demonstrate that it is reasonable and necessary to pay a dividend of 8.5% to attract investment.
Alco recognizes that preferred stock can be considered as either debt or equity, depending on its characteristics. In order to reach a debt-to-equity ratio of 3-to-1, Alco's preferred stock would have to be classified as equity.
Standard & Poor's (S&P) identifies four characteristics of equity capital. These characteristics are: (1) there are no ongoing payments that could lead to default; (2) there is no maturity or repayment requirement; (3) it provides a cushion for creditors in the case of a bankruptcy; and (4) it is expected to remain a permanent part of the capital structure. Alco represents that its preferred stock will satisfy these four criteria. First, the preferred stock will not have any ongoing payments that could lead to default because the preferred stock will include provisions that (i) prohibit preferred shareholders from foreclosing upon the utility if dividends are not paid, and (ii) prohibit Alco's Board of Directors from declaring a preferred dividend that would cause the utility to default on any of its obligations. The dividends on the preferred stock will be non-cumulative (unlike interest on debt), and the preferred stock will not have any voting rights at shareholder meetings.
Second, the preferred stock will not have any maturity date or repayment schedule, and there will not be a sinking fund established to accumulate funds to buy back the preferred stock. Alco states that it will be the only entity that has authority to call and retire the preferred stock. Thus, there will be no right to sell the preferred stock back to Alco (i.e., a put option). Alco also agrees to not retire the preferred stock unless it has a debt-to-equity ratio of 3-to-1, and only to the extent that it maintains that equity ratio after the retirement.
Third, the preferred stock will provide a cushion for creditors in the case of a bankruptcy because, in the event of liquidation or reorganization, creditors will have priority over the preferred shareholder(s). Any remaining assets will go first to the preferred shareholder(s) and then to the common shareholders. Alco also agrees that no dividends will be paid on the preferred stock if doing so would threaten Alco's ability to pay its operating expenses.
Finally, Alco expects the preferred stock to be a permanent feature of its capital structure. The purpose of the preferred stock is to help achieve a debt-to-equity ratio of 3-to-1 by the year 2012. The preferred stock will remain in Alco's capital structure until such time that its retirement would not cause the debt-to-equity ratio to exceed 3-to-1.
3.3. Sources of Revenue to Pay for Requested Debt and Equity
Alco plans to pay for the debt and equity requested in this proceeding (i.e., debt principal, interest, and preferred stock dividends) with the cash received in rates for the depreciation expense and rate of return on the rate base that is financed with the requested debt and equity.
To demonstrate that it can pay for the requested debt and equity, Alco provided a forecast of rate base, revenues, expenses, net income, and debt principal and interest payments for the years 2008 through 2011. The forecast includes (1) additions to rate base that are financed with the debt and equity requested in this proceeding, (2) increased revenue from rate base additions (i.e., reimbursement of deprecation expense and rate of return), and (3) interest on the $6 million of requested debt. Forecasted interest was calculated assuming that new debt of $6 million was in place on January 1, 2009, at a rate of 8.5%.
2 Resolution W-4630, dated April 12, 2007, authorized Alco to expand its service territory to include a proposed subdivision. Alco represents that all of the facilities needed to serve the new territory will be paid by developers requesting water service and that the financing of such facilities will occur in accordance with Tariff Rule 15 that governs main extensions. (Alco's Response to DRA's protest, p. 10.)
3 United States v. Alisal Water Corp. (9th Cir. 2002) 326 F. Supp. 2d 1010.
