BILL ANALYSIS Ó SENATE GOVERNANCE & FINANCE COMMITTEE Senator Lois Wolk, Chair BILL NO: AB 850 HEARING: 7/3/13 AUTHOR: Nazarian FISCAL: No VERSION: 6/19/13 TAX LEVY: No CONSULTANT: Weinberger RATE REDUCTION BONDS FOR LOCAL UTILITIES Allows joint powers authorities to finance projects for public retail water utilities using asset-backed securities called "rate reduction bonds." Background and Existing Law Rate reduction bonds are asset-backed securities that are structured to minimize borrowing costs by qualifying for AAA credit ratings. AAA ratings allow a utility to borrow funds at an interest rate that is well below the rate that would otherwise apply to a utility's long-term debt. To qualify for the AAA rating, rate reduction bond financing typically includes: Statutory authority to impose a dedicated charge on utility customers to repay the bonds. A requirement that the bonds must be issued, and the dedicated charge must be imposed, by a "bankruptcy remote special purpose entity." A "true-up" mechanism by which charges collected to pay debt service are regularly adjusted to ensure that bonds are paid off at the final maturity date. A pledge made by the state not to impair the right to collect charges until bonds are paid in full. The rate reduction bond securitization structure was introduced in response to electricity market deregulation in the 1990s to allow investor-owned-utilities in deregulated markets to recover so-called "stranded" costs of investments the utilities made before deregulation. For example, California's investor-owned electric utilities used rate reduction bonds when the state restructured its energy industry. In that instance, the California Infrastructure and Development Bank (I-Bank) formed a trust that issued the bonds on behalf of the utilities. More recently, other states have adopted statutes allowing AB 850 -- 6/19/13 -- Page 2 investor owned utilities to us rate reduction bond financing for other purposes. The Joint Exercise of Powers Act allows two or more public agencies to use their powers in common if they sign a joint powers agreement. Sometimes an agreement creates a new, separate government called a joint powers authority (JPA). The Marks-Roos Local Bond Pooling Act allows public agencies to use JPAs to finance infrastructure. These JPAs issue Marks-Roos Act bonds and loan the capital to local agencies for public works, working capital, and insurance programs (SB 17, Marks, 1985). In response to substantial demands for investments in projects to enhance water quality, conservation, and supplies, officials from the Los Angeles Department of Water and Power (LADWP) and other public water agencies want to decrease their agencies' borrowing costs by forming JPAs that can issue rate reduction bonds to finance water utility projects. Proposed Law Assembly Bill 850 allows a joint powers authority (JPA) that limits its financing activities to financing utility projects and projects for the use or benefit of public water agencies to finance specified utility projects by issuing rate reduction bonds and imposing utility project charges. Specifically, AB 850: I. Details how local agencies must apply to JPAs to finance utility projects. II. Specifies how JPAs must impose utility project charges. III. Specifies how JPAs must issue rate reduction bonds. IV. Creates a statutory lien on property related to rate reduction bonds. V. Shields JPAs that issue rate reduction bonds from bankruptcy cases. VI. Allows JPAs to finance utility projects through limited liability companies. VII. Defines terms used in the bill. VIII.Makes other declarations and conforming changes to state law. I. Financing local agencies' utility projects . Assembly AB 850 -- 6/19/13 -- Page 3 Bill 850 allows a local agency that owns and operates a utility that provides retail water service to apply to a JPA to finance costs of a utility project with the proceeds of rate reduction bonds. The bill defines a "utility project" as acquiring, constructing, installing, retrofitting, rebuilding, adding to, or improving, any equipment, device, structure, improvement, process, facility, technology, rights or property, located either within, or outside of, the State of California, that is used in connection with the a utility's operations for conservation or reclamation purposes or in response to a requirement imposed by a federal or state entity. Assembly Bill 850 allows a local agency to apply for financing only if, at the time of application, the utility's revenue bonds are, or upon issuance would be, rated investment grade by a nationally recognized rating agency. Assembly Bill 850 requires that a local agency's application to a JPA for financing must specify the utility project to be financed by the rate reduction bonds, the maximum principal amount, the maximum interest rate, and the maximum stated terms of the rate reduction bonds. Assembly Bill 850 prohibits a local agency from applying to a JPA to finance a utility project unless the agency's legislative body has determined that: The project to be financed is a utility project. The local agency is electing to finance costs of the utility project pursuant to the bill's provisions and the financing costs associated with the financing are to be paid from utility project property, including the utility project charge for the rate reduction bonds issued for the utility project in accordance with the bill's provisions. The financing is expected, based on available information and projections, to result in lower total charges to the customers of the local agency's publicly owned utility compared with financing the utility project through bonds payable from the publicly owned utility's revenues. II. Utility project charges . Assembly Bill 850 defines a "utility project charge" as a charge imposed and adjusted pursuant to specified provisions of state law which is paid by a retail water utility's customers to pay financing AB 850 -- 6/19/13 -- Page 4 costs of rate reduction bonds issued to finance a utility project. Assembly Bill 850 allows and directs a JPA financing a utility project with rate reduction bonds to impose and collect a utility project charge with respect to the rate reduction bonds, subject to Article XIIID of the California Constitution. To impose a utility project charge, the JPA's governing body must adopt a financing resolution, which must include: The addition of a separate charge to the bill of each customer of the publicly owned utility in the class or classes of customers specified in the financing resolution. A description of the financial calculation, formula, or other method that the authority is to use to determine the utility project charge. A requirement that the authority enter into a servicing agreement for collecting the utility project charge with the local agency for which the financing is undertaken or its publicly owned utility. Assembly Bill 850 requires that the method for determining the project utility charge must include a periodic adjustment method to the then current utility project charge, to be applied at least annually, that the JPA must use to correct for any overcollection or undercollection of financing costs from the utility project charge or any other adjustment needed to ensure timely payment of rate reduction bonds' financing costs, including debt service coverage requirements. Assembly Bill 850 requires that the method for determining the project utility charge and the allocation of utility project charges to, and among, the publicly owned utility's customers must be decided solely by the JPA's governing body. The bill declares the JPA's decision to be final and conclusive. Assembly Bill 850 prohibits any changes to the method for determining the utility project charge, and the periodic adjustment method, after they have been established in the financing resolution and have become final and conclusive. Assembly Bill 850 prohibits the periodic adjustment method established in the financing resolution from being applied less frequently than required by the financing resolution and the documents relating to the applicable rate reduction bonds. AB 850 -- 6/19/13 -- Page 5 Assembly Bill 850 requires that the servicing agreement for collecting the utility project charge must require the local agency or its publicly owned utility to act as a servicing agent for purposes of collecting the utility project charge as long as the servicing agreement remains in effect. Funds collected as a utility project charge by the local agency or its publicly owned utility, acting as a servicing agent on behalf of the JPA, must be held in trust for the exclusive benefit of the persons entitled to the financing costs to be paid, directly or indirectly, from the utility project charge and must not lose their character as revenues of the JPA by virtue of possession by the local agency or its publicly owned utility. The local agency or its publicly owned utility must provide the JPA with the information about estimated water sales and any other information concerning the publicly owned utility required by the JPA in connection with the utility project charge. Assembly Bill 850 contains provisions that: Define the utility project charge as a non-bypassable charge. Establish a customer's obligation to pay a utility project charge regardless of whether or not the customer has an agreement to purchase water from a person or entity other than the publicly owned utility. Require timely and complete payment of all utility project charges, specify collection procedures, and prohibit withholding payment of the utility project charge. Detail the manner in which a JPA must determine whether adjustments to the utility project charge are required and the manner in which a JPA must make such adjustments. Specify how revenues must be applied to the payment of the financing costs of the rate reduction bonds. Require a JPA to impose and collect utility project charges sufficient to pay, on a timely basis, rate reduction bonds' financing costs. Declare the pledge of a utility project charge to secure the payment of rate reduction bonds to be irrevocable. Prohibit the reduction, impairment, or adjustment of the utility project charge, with specified exceptions. AB 850 -- 6/19/13 -- Page 6 Deem revenue from a utility project charge as special revenue of the JPA, not revenue of a local agency or its publicly owned utility. Define the conditions under which a utility project charge constitutes a utility project property. Apply the bill's provisions to any entity providing water distribution service in lieu of a local agency for which rate reduction bonds have been issued and remain outstanding. III. Rate reduction bonds . Assembly Bill 850 defines "rate reduction bonds" as bonds issued by a JPA, the proceeds of which are used directly or indirectly to pay or reimburse a local agency or its publicly owned utility for the payment of the costs of a utility project, and that are secured by a pledge of, and are payable from, utility project property as specified in state law. Assembly Bill 850 requires that: Rate reduction bonds must be within the parameters set forth by a local agency. Rate reduction bonds' proceeds must be used for the utility project identified in the local agency's application for financing. A JPA's governing body must, by resolution, authorize the issuance of rate reduction bonds. Rate reduction bonds must be nonrecourse to the credit or any assets of the local agency and the publicly owned utility for which the utility project is financed. Rate reduction bonds must be payable from, and secured by a pledge of, the utility project property relating to the rate reduction bonds and any additional security or credit enhancement specified in the documents relating to the rate reduction bonds. Assembly Bill 850 defines "utility project property" as the property right created pursuant to state law, including a JPA's right, title, and interest: In and to the financing resolution and the utility charge established with respect to the rate reduction bonds, as adjusted from time to time in accordance with state law. To be paid the financing costs of the rate reduction bonds and to all revenues, collections, claims, payments, moneys, or proceeds for, or arising AB 850 -- 6/19/13 -- Page 7 from, the utility project charge relating to the rate reduction bonds. In and to all rights to obtain adjustments to the utility project charge relating to the rate reduction bonds pursuant to state law. Assembly Bill 850 requires a JPA issuing rate reduction bonds to pledge the utility project property relating to the rate reduction bonds as security for payment. The pledge must be made pursuant to, and with the effect set forth in, a specified statute governing a public body's pledge of collateral to secure bonds. The bill declares that all of a JPA's rights with respect to utility project property pledged as security for the payment of rate reduction bonds must be for the benefit of, and enforceable by, the beneficiaries of the pledge to the extent provided in the documents relating to the rate reduction bonds. Assembly Bill 850 declares that utility project property constitutes property for all purposes, including for contracts securing rate reduction bonds, whether or not specified revenues and proceeds have accrued. To the extent that any interest in utility project property is pledged as security for the payment of rate reduction bonds, Assembly Bill 850 requires a local agency or its publicly owned utility to contract with the JPA that the local agency or its publicly owned utility will: Continue to operate its publicly owned utility system that includes the financed utility project to provide service to its customers, Collect amounts in respect of the utility project charge for the benefit and account of the authority and the beneficiaries of the pledge of the utility project charge, and Account for and remit these amounts to, or for the account of, the authority. Assembly Bill 850 specifies that such a contract is part of the utility project property. Assembly Bill 850 states that any requirements that a JPA must take action with respect to utility project property are binding upon the JPA. The bill prohibits the JPA from rescinding, altering, or amending any resolution or document containing the requirement. AB 850 -- 6/19/13 -- Page 8 Assembly Bill 850 declares that the recovery of the financing costs for the rate reduction bonds from the utility project charge is irrevocable. The bill prohibits a JPA from: Revaluing or revising for ratemaking purposes the financing costs of rate reduction bonds, Determining that the financing costs for the related rate reduction bonds or the utility project charge is unjust or unreasonable, or Reducing or impairing the value of utility project property that includes the utility project charge, either directly or indirectly. Assembly Bill 850 prohibits any reduction, impairment, postponement, or termination of the amount of revenues arising with respect to the financing costs for rate reduction bonds or the utility project charge until all financing costs to be paid from the utility project charge are fully met and discharged. Assembly Bill 850 contains a pledge and agreement made by the State of California that the State of California will neither limit nor alter the financing costs or the utility project property, including the utility project charge, relating to the rate reduction bonds, or any rights in, to or under, the utility project property until all financing costs with respect to the rate reduction bonds are fully met and discharged, with specified exceptions. The bill allows a JPA to include this pledge in the governing documents for rate reduction bonds. Assembly Bill 850 requires a JPA to adjust the utility project charge relating to rate reduction bonds and the documents related to those rate reduction bonds as may be necessary to ensure timely payment of all financing costs with respect to the rate reduction bonds. The adjustments must not impose the utility project charge upon classes of customers which were not subject to the utility project charge pursuant to the financing resolution imposing the utility project charge. Assembly Bill 850 declares that financing costs in connection with rate reduction bonds do not constitute a debt or liability of the State of California or of any political subdivision thereof, other than the special AB 850 -- 6/19/13 -- Page 9 obligation of the JPA, and do not constitute a pledge of the full faith and credit of the State of California or any of its political subdivisions, including the JPA. The bill specifies that this provision does not preclude guarantees or credit enhancements in connection with rate reduction bonds. Assembly Bill 850 states that the issuance of rate reduction bonds does not obligate the State of California or any political subdivision to levy or to pledge any form of taxation to pay the rate reduction bonds or to make any appropriation for their payment. Assembly Bill 850 requires all rate reduction bonds to contain a statement to the following effect: "Neither the full faith and credit nor the taxing power of the State of California or any political subdivision thereof is pledged to the payment of the principal of, or interest on, this bond." IV. Statutory lien . Assembly Bill 850 declares that upon the effective date of the financing resolution relating to rate reduction bonds, a first priority statutory lien exists on all utility project property to secure the payment of the rate reduction bonds. The lien arises pursuant to state law automatically, without any action on the part of the authority, the local agency or its publicly owned utility, or any other person. Assembly Bill 850 contains additional provisions relating to property secured by the lien and the lien's validity and enforceability. Assembly Bill 850 allows a JPA's financing resolution to require the JPA, upon application by the beneficiaries of the statutory lien, and without limiting any other remedies available, to order the sequestration and payment to the beneficiaries of revenues arising with respect to utility project property in the event of default by the local agency or its publicly owned utility. V. Applicability of federal bankruptcy law . Assembly Bill 850 states that, notwithstanding any other law, a JPA that has financed a utility project through the issuance of rate reduction bonds is not authorized, and no governmental officer or organization shall be empowered to authorize the JPA, to become a debtor in a case under the United States Bankruptcy Code or to become the subject of any similar AB 850 -- 6/19/13 -- Page 10 case or proceeding under any other law as long as any payment obligation from utility project property remains with respect to rate reduction bonds. VI. Limited liability company financing . Assembly Bill 850 allows a JPA to elect to effect a financing of a utility project through a single member limited liability company formed by the authority by authorizing the company to adopt the financing resolution and the JPA's issuing rate reduction bonds payable from, and secured by a pledge of, amounts paid by the company to the JPA from the applicable utility project property pursuant to an agreement. The bill specifies statutory provisions that must apply to and be the exclusive method of perfecting a pledge of utility project property by the company securing the payment of financing costs under any agreement of the company in connection with the issuance of rate reduction bonds. The bill provides that specified statutory references to the JPA mean or include the company as necessary to implement the bill's provisions. VII. Definitions . Assembly Bill 850 defines the following terms: "Conservation or reclamation purposes" means a utility project designed to reduce the amount of potable water to be supplied by a publicly owned utility or reduce the amount of water imported by the publicly owned utility, including without limitation, storm water capture and treatment, water recycling, development of local groundwater resources, groundwater recharging, and water reclamation. "Customer" means a person or entity receiving water through facilities of a publicly owned utility. "Financing costs" means any of the following: Interest and redemption premiums that are payable on rate reduction bonds. The cost of retiring the principal of rate reduction bonds, whether at maturity, including acceleration of maturity upon an event of default, or upon redemption, including sinking fund redemption. A cost related to issuing or servicing rate reduction bonds, including, but not limited to, servicing fees, trustee fees, legal fees, AB 850 -- 6/19/13 -- Page 11 administrative fees, bond counsel fees, bond placement or underwriting fees, remarketing fees, broker dealer fees, independent manager fees, payment under an interest rate swap agreement, financial advisor fees, accounting report fees, engineering report fees, and rating agency fees. A payment or expense associated with a bond insurance policy, financial guaranty or a contract, agreement, or other credit enhancement for rate reduction bonds or a contract, agreement, or other financial agreement entered into in connection with rate reduction bonds. The funding of one or more reserve accounts related to rate reduction bonds. "Financing resolution" means a resolution adopted by the governing body of an authority financing a utility project with rate reduction bonds that establishes and imposes a utility project charge in connection with the rate reduction bonds in accordance with a specified statute. A financing resolution may be separate from a resolution authorizing the issuance of the rate reduction bonds. "Mandate" means a requirement, imposed by a mandating entity by any means, including a statute, rule, regulation, an administrative or judicial order, a building, operating, or licensing requirement or condition, or an agreement with, or license or permit from, the mandating entity, on a facility of a publicly owned utility or a facility operated in whole or in part for the benefit of a publicly owned utility, or on the operations of the publicly owned utility, or on the water pumped, acquired, or supplied by the publicly owned utility. "Mandating entity" means the United States; a state of the United States; an agency, department, commission, or other subdivision of the United States or a state of the United States; a court of the United States or a state of the United States; or any other body or organization, that has jurisdiction over the operations of a publicly owned utility; the facility of a publicly owned utility, or a facility operated in whole or in part for the benefit of a publicly owned utility; or the water pumped, acquired or sold by a publicly owned utility. "Mandating entity" does not include a local agency that owns the publicly owned utility. AB 850 -- 6/19/13 -- Page 12 "Publicly owned utility" means a utility furnishing water service to retail customers that is owned and operated by a local agency or a department or other subdivision of a local agency and includes any successor to the powers and functions of the department or other subdivision. VIII. Other changes and declarations . Assembly Bill 850 makes additional conforming and clarifying changes to state law. Assembly Bill 850 declares that its provisions must be liberally construed to effectuate their purposes, and that all incidental powers necessary to carry into effect its provisions are expressly granted to, and conferred upon, public entities. Assembly Bill 850 declares that its provisions are severable. State Revenue Impact No estimate. Comments 1. Purpose of the bill . To comply with federal and state clean drinking water standards, remediate groundwater contamination, and address the constant challenge of water scarcity, public water utility operators anticipate investing billions of dollars in vital water infrastructure projects over the coming years. For example, just to comply with two primary drinking water standards under the Safe Drinking Water Act, the Los Angeles Department of Water and Power expects to spend $1.4 billion between 2011-12 and 2015-16 to complete its water quality improvement program. Financing water infrastructure projects with rate reduction bonds will produce lower borrowing costs for public agencies. These cost savings reduce the rates that water customers will pay compared to the rates they would pay if the water infrastructure had been financed using more traditional financing mechanisms, like revenue bonds. LADWP estimates that ratepayers would save as much as $3 million per year for each $100 million of financing under this bill's provisions. Given its planned spending for water quality and local water supply projects, LADWP projects that rate reduction bond financing would lower rates by 2-4% during the course of the next AB 850 -- 6/19/13 -- Page 13 five years. In addition to lower borrowing costs, rate reduction bonds also can, under certain conditions, qualify for off balance-sheet accounting treatment that benefits the public utility. AB 850 will allow communities throughout California to realize the benefits of making critical water project investments at lower costs. 2. Shifting risk . AB 850's use of a bankruptcy-remote special purpose entity to issue rate reduction bonds insulates bondholders from potential insolvency of the public agency that receives the bond proceeds. This structure allows for higher bond ratings and lower costs of debt issuance. However, by protecting rate reduction bondholders from becoming creditors if a public agency files for bankruptcy protection, the bill may increase the risks borne by vendors, employees, investors holding other forms of debt, and other potential creditors in a municipal bankruptcy proceeding. Municipal bankruptcies are rare events and it is unlikely that AB 850's bankruptcy-remoteness provisions will ever be necessary to shield rate reduction bondholders from a bankruptcy case. However, in the event that a publicly owned utility does become insolvent, it is unclear whether state law should shield some potential creditors, leaving a smaller pool of remaining creditors to bear the costs of restructuring. 3. Don't overlook oversight . Government programs start with the best intentions but, if no one pays attention, they can sometimes go awry. Recent experiences in the financial markets demonstrate that complex structured-financing mechanisms that receive AAA ratings don't always work as expected and can harbor unanticipated risks. The type of securitization financing AB 850 authorizes has never been used by public agencies to finance the types projects described in the bill. Fundamental assumptions underlying an JPA's decision to issue rate reduction bonds may prove to be flawed. A projection that ratepayers will pay lower overall rates as a result of rate reduction bond financing is no guarantee that ratepayers will actually realize those savings. Allowing local utilities to use off balance-sheet accounting for assets involved in rate reduction bond financing may distort measures of a public utilities fiscal condition. Legislators sometimes use sunset clauses, evaluations, reports, and oversight hearings to make sure that new programs stay on track and function properly. AB 850 -- 6/19/13 -- Page 14 However, imposing a sunset clause on provisions authorizing long-term financing can be counter-productive, sometimes creating uncertainty among investors about the long-term security of the debt. As an alternative approach to oversight, the Committee may wish to consider amending AB 850 to: Authorize rate reduction bonds to be used to finance a fixed number of projects statewide. Require a state entity, such as the I-Bank or the State Treasurer's Office, to review and approve the use of rate reduction bond financing for each project. Require the California Debt and Advisory Commission to evaluate the results of the financing used for the authorized projects. Assembly Actions Assembly Local Government Committee: 9-0 Assembly Banking and Finance Committee:12-0 Assembly Floor: 72-0 Support and Opposition (6/27/13) Support : City of Los Angeles Department of Water and Power; Association of California Water Agencies; California Municipal Utilities Association; California Special Districts Association. Opposition : Unknown.