3. Details of DWR's Proposed Bond Sale
DWR, the State Treasurer's Office, and their combined financing team of underwriters, financial and legal advisors began in early 2001 the process of structuring a power supply revenue bond credit that would comply with the provisions of AB1X and also receive investment-grade ratings. This group faced a formidable task. The proposed sale of bonds at close to $12 billion will be "the largest municipal bond sale in history."14 In addition, there are several aspects of this financing, as well as of AB 1X and DWR's power supply program, that make this bond deal complex and unusual:
· DWR entered into certain contracts for power (called priority contracts) that have a higher priority for payment than bond costs.
· As several contracts include terms that pass through the costs of natural gas, fluctuations in gas prices will lead to fluctuations in the price paid by DWR for power.
· Unlike a typical municipal bond offering, where the borrowing entity has the power to provide a dedicated stream of revenues, in this particular situation, the Commission must impose bond and power charges on IOU customers.
These characteristics serve to complicate the credit structure of DWR's indenture. DWR, working with rating agencies, has developed an elaborate credit structure that is described in Exhibit 1, pp. 6-13. We will not describe the detailed features of the credit structure or the elaborate flow of funds between the multiple reserve accounts, but will focus on the key features of the financing that drive the costs of the funds.
The most unusual element of the credit structure is the large number of reserve accounts that are funded at a total of more than $3.6 billion.15 Because the projected borrowing is $11.95 billion, the balances deposited in accounts will total 30% or more of total borrowing. The purposes of these reserves, however, are readily described:
· The reserves provide bondholders with additional security in covering the contingency that the revenues designated for repayment of bonds are needed to pay "priority contracts;"
· The reserves help maintain a quality investment-grade credit rating for DWR's bonds, as required by the Act;
· As a result of the additional security and higher credit rating the reserves produce, the reserves can help to lower overall costs of the bonds.
The exact annual revenue requirement needed to support the bonds will not be known until the bond placement is complete. To support this Commission's development of a bond charge methodology, DWR's Exhibit 1 does provide the best estimates of the credit structure and costs as of July 9, 2002. At that date, DWR estimated that a bond issuance of $11.1 billion (with reserve accounts funded at more than $3.0 billion16) would, after adding in miscellaneous bonding costs, lead to a 2003 revenue requirement of $841,965,794, which will rise to $971,256,477 and remain at that level through the repayment period.
In Exhibit 1, DWR's estimate anticipates an "A-level" rating, which will then lead to an "all-in average" interest rate of 5.24% for the 20 year bonds.17
DWR's Supplemental Testimony contains substantial revisions to Exhibit 1. The Supplemental Testimony increases the size of the bond offering from $11.1 billion to $11.95 billion. It increases the amount of funds deposited to the reserve and operating accounts from $3.0 billion (27% of the $11.1 billion in bonds to be issued) to $3.6 billion18 (30% of the $11.95 billion in bonds to be issued). DWR states that "The rating agencies are concerned that the Department may be obligated to purchase the Residual Net Short beyond the December 31, 2002 deadline for such purchases contained in Assembly Bill 1X."19 In addition, DWR proposes a different schedule of debt service payments, resulting in a bond charge revenue requirement of $1.140 billion in 2003, but decreasing to $784 million in the "years 2005 through 2022."20 DWR notes that its estimate anticipates an "A-level" rating, which will lead to an "all-in average" interest rate of 5.38%.21
A. Discussion: Major Changes in DWR's Testimony Illustrate
Need for Explanations of New Revenue Requirement
and Suggest Mathematical Errors
DWR's proposed 2003 revenue requirement in its Supplemental Testimony is almost $300 million higher than that contained in its initial testimony (Exhibit 1). Since the major difference between the Supplemental Testimony and Exhibit 1 is the $850 million increase in the amount borrowed, we are puzzled as to how the revenue requirement for 2003 grew by such a large amount. DWR's testimony in this proceeding indicates that the carrying costs (or "negative spread") of reserves will be 2%-3% per year.22 Thus, even if we use the high end of this range, an increase in reserve accounts of $850 million will add only $25.5 million to the annual revenue requirement, far less than the $300 million increase requested.
Moreover, the Supplemental Testimony surprisingly projects a dramatic decrease in revenue requirements from 2003 to 2004. Since DWR anticipates that payment of bond principal will not begin until 2004, we would have expected that the revenue requirement would increase slightly from 2003 to 2004, similar to DWR's projected revenue requirement in Exhibit 1. Instead, DWR's Supplemental Testimony projects a $356 million decrease in revenue requirement between 2003 and 2004. DWR's Supplemental Testimony fails to explain this anomaly.
Furthermore, we note that in Exhibit 1, the revenue requirement is $841 million in 2003 and $971 million for years 2004 through 2022. This leads to total payments on the $11.1 billion loan of $19.3 billion over 20 years. In the Supplemental Testimony, the revenue requirement is $1,140 million in 2003, and $784 million for years 2004 through 2022. This leads to total payments on the $11.9 billion loan of $16 billion over 20 years. Once again, this makes no sense - how can the total repayment amount decrease by $3.3 billion when the amount of borrowing goes up by $850 million and interest rates remain unchanged?
The record established by DWR's Supplemental Testimony does not explain these discrepancies to all parties. Therefore, DWR, in its comments on this proposed decision, should fully explain the following: 1) why does increasing the bond offering by $850 million result in a $300 million increase in the 2003 revenue requirement; 2) in the Supplemental Testimony, why is the revenue requirement in 2004, which includes repayment of principal, $356 million less than the revenue requirement in 2003, which includes no principal payments? and 3) why does increasing the bond offering by $850 million lead to a $3.3 billion drop in the cost of loan repayment? In addition, DWR should indicate whether it is possible to establish revenue requirements for the bond-related costs that are more stable over the initial twenty years.
Absent a detailed explanation of these important matters, this Commission can only conclude that DWR's calculations in its Supplemental Testimony contain numerical errors. We see comments on this proposed decision as providing an opportunity for a full explanation to effected parties and the Commission. Parties will have an opportunity to respond to this explanation in their reply comments. The comments and reply comments will provide additional record on this issue.
In summary, DWR plans to borrow approximately $12 billion to repay the $6.6 billion to California's General Fund and $3.5 billion to retire an Interim Loan. The exact costs of retiring these bonds, the establishment of annual revenue requirements, and the determination of its reasonableness are, under the provisions of AB1X, the responsibility of DWR. Nevertheless, DWR's filings show such anomalous outcomes may be the product of calculation errors. We cannot tell from the testimony DWR provided.
We note that the Supplemental Testimony was also filed in DWR's own administrative process; DWR has the statutory authority to determine the reasonableness of the bond's revenue requirement and must created a separate opportunity for parties to file comments. Moreover, we note that DWR will present this Commission with its final 2003 revenue requirements for bond-related costs following its placement of the bonds according to the implementation procedures described in Section 8 below. Because DWR's Supplemental Testimony does not constitute a final 2003 revenue requirement, we consider it only as illustrative of DWR's ongoing work in placing the bonds and estimating their costs. In light of this ongoing effort, we find it reasonable to identify and accept the Supplemental Testimony as Exhibit 1-a. We stress that we do not use this exhibit as probative evidence to set the bond charge, but instead we will use these figures to help illustrate the applicability of our bond charge methodology over a range of financing possibilities and to identify numerical issues that require further explanation. Moreover, identifying the Supplemental Testimony as Exhibit 1-a ensures its incorporation into the official record of this proceeding and facilitates references to it.
