BILL ANALYSIS
SENATE COMMITTEE ON BANKING, FINANCE,
AND INSURANCE
Senator Ronald Calderon, Chair
AB 1550 (Committee on Banking and Finance) Hearing Date: June
17, 2009
As Amended: April 15, 2009
Fiscal: Yes
Urgency: No
SUMMARY Would authorize the Department of Water Resources
(DWR) to restructure a portion of its power supply revenue
bonds, with the aim of reducing its long-term borrowing costs.
DIGEST
Existing law
1. Provides that the purchase or other acquisition of bonds
by or on behalf of the state or a local government that
issued the bonds does not cancel, extinguish, or otherwise
affect the bonds (Government Code Section 5925);
2. Requires DWR to recover costs associated with the
2000-2001 energy crisis through the issuance of up to $13.4
billion in bonds, which are to be repaid by ratepayers
(Water Code Section 80130);
3. Authorizes DWR to refund (i.e., buy back and restructure)
those bonds, if the refunding is done to obtain a lower
interest rate, but further specifies that any refunding done
for any other purpose counts toward the aggregate amount of
bonds authorized to be issued (Water Code Section 80130).
This bill
1. Would add to the number of circumstances in which DWR is
authorized to refund its power bonds, by authorizing
refunding in any of the following additional circumstances:
a. Refunding variable rate bonds with fixed rate bonds;
b. Refunding bonds, if any nationally recognized rating
AB
1550 (Comm. On B. and F.), Page 2
agency reduces or withdraws, or proposes to reduce or
withdraw, the rating assigned to securities secured by
bond insurance policies, credit or liquidity facilities
issued by the provider of a bond insurance policy, or a
credit or liquidity facility securing the bonds being
refunded;
2. Would provide that all refunding bonds issued by DWR before
January 1, 2010 are deemed to have been issued for one or
more purposes authorized under existing law or under this
bill, and that these refunding bonds shall not be included
in calculating the aggregate amount of bonds that DWR may
issue under its existing power supply revenue bond cap.
COMMENTS
1. Purpose of the bill To reduce DWR's exposure to unforeseen,
unfavorable bond market conditions, by increasing the
department's flexibility to refund its existing bond debt.
2. Background In late 2000 and early 2001, California's energy
market failed, and the state was forced to step in and
purchase power to stabilize the market and prevent
continued statewide power outages. DWR was given the
authority to purchase power and sell it, both directly and
indirectly, to consumers, through a division within DWR (the
California Energy Resources Scheduling Dvision; CERS)
expressly created for those purposes (AB 1X, Keeley, Chapter
4, Statutes of 2001).
AB 1X directed that the cost of that power be covered through
the issuance of up to $13.423 billion in Power Supply
Revenue bonds, which were to be paid back over time by the
ratepayers of California's investor-owned utilities (Pacific
Gas & Electric, Southern California Edison, and San Diego
Gas & Electric). CERS manages the long-term contracts
entered into by DWR in 2001, with funding for the contracts
provided by the ratepayer-supported Power Supply Revenue
bonds. California's investor-owned utilities manage the
receipt and delivery of the energy procured by through
contracts.
Due to recent turmoil in the capital markets, and the high
interest rates demanded by some investors, DWR has found it
necessary to restructure more than $2 billion of its
AB
1550 (Comm. On B. and F.), Page 3
variable rate Power Supply Revenue bonds, to address
investor concerns with bond insurers and/or banks providing
credit enhancement for the bonds. Some of these bonds have
been refinanced as fixed rate bonds, and others have been
restructured as variable rate bonds, with credit enhancement
provided by stronger banks.
Unfortunately, as DWR and the State Treasurer's Office (STO)
have worked to restructure DWR's debt, to lower DWR's cost
of borrowing, they have encountered an obstacle created by
the wording of AB 1X. According to the Attorney General's
office, any bond debt that is restructured must be counted
against DWR's $13.4 billion cap, unless the restructuring
can be shown, with certainty, to produce debt servicing
savings. Because most of the bonds being restructured are
variable rate bonds, and because future rates cannot be
known with certainty, DWR has been unable to conclusively
demonstrate that its restructurings meet the savings test.
Because it lacks the ability to conclusively demonstrate
savings, the STO has been unable to refinance the variable
rate bonds, and has instead issued new fixed rate debt,
which it has used to pay off the variable rate debt. To
date, DWR has expended $1.76 billion of its bond
authorization to restructure debt. After the last bond sale
in mid-January, only $45 million is left under the original
$13.4 billion bond cap. The STO believes that it is highly
likely there will be a need to restructure far more than $45
million in additional variable rate bonds, by changing them
to fixed rate bonds. Such a restructuring cannot occur,
without a change in law.
Neither the STO nor DWR wants to increase the $13.4 billion bond
cap. Instead, they would like to amend Water Code Section
80130 to include conditions, other than debt servicing
savings, which would allow the remaining variable rate power
bonds to be restructured. According to the STO, the
flexibility being sought through this bill is similar to
flexibility allowed in other state bond programs
administered by STO.
With the flexibility given to it through this bill, the STO
indicates it would seek to utilize a restructuring
transaction known as a "current refunding," which the STO
characterizes as the most cost-effective option within
today's marketplace. Under a current refunding, the old
AB
1550 (Comm. On B. and F.), Page 4
variable rate bonds could be replaced with new fixed rate
bonds, which could be structured to meet specific investor
demands on the day of the sale.
If DWR is unable to utilize a current refunding or is unable to
gain more room under the authorization cap, it will be
limited to a "conversion" of the existing bonds from a
variable to a fixed interest rate mode. Because the
mechanics of a conversion are much more restrictive than
those of a refunding, DWR will be forced to sell bonds under
terms that are less desirable to investors. Investors will
demand a premium to accept these terms, and DWR will not be
able to obtain interest rates as favorable as those that
could be obtained with a current refunding issue.
In background material provided to this Committee, the STO
provided the following example to document some of the
problems it faces under existing Water Code Section 80130:
On November 20, 2008, DWR and the STO entered the market to
convert $523 million of variable rate bonds to fixed rate
bonds. Because investors wanted a bond structure that
required features which could not be fully accommodated with
a conversion, DWR was only able to obtain acceptable
interest rates for $173 million of the $523 million.
The underwriter of the bonds, J.P. Morgan Securities, while not
confident that there were buyers for the bonds at any price,
estimated that the minimum rates which would have been
required to place the $350 million balance of bonds using
the conversion mechanics would have been at least 0.45-0.50%
higher than what could have been achieved with a more
flexible bond structure. These higher rates would have
equated to an additional interest cost of $17.6 million over
the 14-year remaining life of the bonds.
Another complicating factor is that variable rate bonds which
cannot be remarketed, and which are surrendered by
bondholders, must be purchased by the banks originally
contracted to provide credit enhancement for the bonds. The
$350 million of bonds DWR was unable to convert to fixed
rate bonds became "bank bonds". The banks were obligated to
hold these bonds until DWR could successfully remarket the
bonds in fixed rate mode (something it was able to do in
January 2009). While the bonds were "bank bonds", the
interest rate on the bonds was set at the prime rate (4.00%
at the time) plus 2.00%, for a total of 6.00%. If the bonds
AB
1550 (Comm. On B. and F.), Page 5
had been successfully remarketed, DWR would only have paid a
fixed rate of 5.30%. The difference between the 5.3% rate
the state was unable to get (because we lacked the necessary
flexibility) and the 6.0% rate the state paid on the bank
bonds would have equated to an additional $2.4 million per
year in additional interest. All of that interest would
have been paid by ratepayers, pursuant to the original terms
of AB 1X.
Finally, and perhaps most onerous, if bank bonds are not
remarketed within six months, DWR is required to begin
repaying the principal of the bonds, ahead of their
scheduled amortization. If this situation occurred, it could
increase annual debt service costs by more than $90 million
in 2009, and by more than $120 million annually for each of
the next two years, until the bonds are fully amortized.
The language proposed by the STO is intended to give DWR maximum
flexibility to restructure the remaining Power Supply
Revenue bonds, with the aim of obtaining the lowest possible
interest rates for ratepayers.
3. Support Writing in support of the bill, the STO, its
sponsor states that "the revision required is minor and will
merely provide DWR with the flexibility that already exists
in most, if not all of the state's other bond-related
programs. The proposed change to the Water Code Section
80130 will, in addition to the existing provision allowing
for refundings for interest savings, allow the Department to
refund bonds to restructure bonds bearing a variable
interest rate with bonds bearing interest at a fixed
interest rate or to restructure bonds secured by bond
insurance policies or other credit or liquidity facilities
which have adversely affected the marketability or interest
rates on such bonds. This change will give the Department
the flexibility to refund its bonds in situations such as
the current one in which action is required to avoid having
variable rate bonds converted to very high fixed interest
rates or held by credit banks at high interest rates and
with accelerated amortization."
4. Opposition None received.
5. Questions
a. Are there any other state departments or
AB
1550 (Comm. On B. and F.), Page 6
agencies with bonds outstanding that require similar
flexibility as the flexibility authorized under AB
1550?
b. Should the authority provided to DWR by this
bill be made more generally to all state and local
governments with outstanding bonds, to reduce or
eliminate the need for similar legislation in the
future?
AB
1550 (Comm. On B. and F.), Page 7
6. Prior Legislation
a. SB 344 (Machado), Chapter 3, Statutes of 2008:
Provided that the purchase or other acquisition of
bonds by or on behalf of the state or a local
government that issued the bonds does not cancel,
extinguish, or otherwise affect the bonds.
b. AB 1X (Keeley) Chapter 4, Statutes of 2001:
Authorized DWR to sell $13.4 billion in Power Supply
Revenue Bonds, and created the California Energy
Resources Scheduling Division within DWR to manage
billions of dollars of long-term electricity contracts
entered into by the state curing the 2000-2001 energy
crisis.
POSITIONS
Support
State Treasurer Bill Lockyer (sponsor)
Oppose
None received
Consultant: Eileen Newhall (916) 651-4102