III. Proposals to Manage Debt Costs and
Risks
A. Debt Enhancement Features
GSWC requests authorization to include at its discretion one or a combination of certain debt enhancement features, as described in detail on pages 12 to 13 of the Application. GSWC seeks to use these features to improve the terms and conditions of the Debt Securities and to lower the overall cost of money. These features include put and call options and use of a sinking fund.
The put option, under certain circumstances, would give holders of New Debt the right to require GSWC to buy back their securities. By offering the put option, GSWC may be able to reduce the interest rate required for the New Debt securities.
The call option is the reverse of a put option, and would allow GSWC to retire a New Debt Security, fully or partially, before the scheduled maturity date. This feature is beneficial when interest rates are anticipated to be lower over time by allowing for a New Debt Security to be retired and replaced at a lower cost.
The sinking fund feature involves setting aside a sum of money periodically to provide for the availability of cash to redeem all, or a specified portion, of a New Debt Security at its maturity. GSWC seeks to preserve the discretion to make use of a sinking fund should a market preference for such a feature be indicated.
B. Interest Rate Management Techniques
GSWC also requests authorization to utilize at its discretion one or more of certain interest rate management techniques in connection with the issuances of New Debt Securities and/or preferred stock. These techniques are intended to be used to minimize GSWC's exposure to potential interest rate increases. Such techniques do not affect the amount of the underlying securities that would be issued. These techniques include treasury lock, treasury option, forward-starting interest rate swap, spread lock, spread option, interest rate swap, and cap and collar contracts.
The treasury lock may be utilized to lock in the treasury interest rate yield component of GSWC's borrowing cost. The treasury option is an alternative technique, which provides the option holder the right, but not the obligation to sell Treasury securities at a specified yield. The forward-starting interest rate swap allows for a lock-in of a fixed rate prior to the issuance of floating rate New Debt Securities in order to mitigate interest rate risk. The spread lock allows for a lock-in of the "spread" or differential between the interest rate of a Treasury security and a GSWC New Debt security with the same maturity.
The spread option mitigates the risk that the credit spread may increase over a designated level. If the credit spread exceeds the designated level, the option may be exercised as an offset to the cost of the higher spread. With an interest rate swap, GSWC will have the flexibility to convert a security with a floating interest rate to a fixed rate in order to minimize potential interest rate risk. Under a cap contract, GSWC would only pay a cap (i.e., ceiling) rate even if variable interest rates were to rise above the cap. Under a collar contract, the effective interest rate would remain between a cap and a floor rate.
C. Discussion
We agree that the use of the above-described debt enhancement features and interest rate management techniques may be beneficial in minimizing the overall cost of debt while managing associated risks of interest rate movements. Ratepayers benefit as a result through the lowering of interest costs that may be passed through in a rate case proceeding. Accordingly, we approve the request of GSWC for authority to utilize these debt enhancement features and interest rate management techniques.
We place GSWC on notice, however, that the reasonableness of any resulting interest rates and cost of money arising from debt capital are normally subject to review in general rate case proceedings. By granting this application, we make no determination that the construction budget or capital ratios are necessary or reasonable for ratemaking purposes.
