Debt by Any Other (Utility) Name

Delving into investor-owned utilities? debt-to-equity ratio and rates of return ( Circuit , May 28, 2004) has got me wondering about the role rating agencies and lenders play among public power agencies post-crisis. Public and private utilities are different beasts and serve different masters, but one they both share is Wall Street. Although rating agencies set the rules of the game in both utility worlds because the business is capital-intensive, they have less sway at the muni table. Pacific Gas & Electric, Southern California Edison, and San Diego Gas & Electric continue to strive to boost their rating grades to Wall Street?s liking while their more staid public counterparts keep plugging along, getting high marks for the most part. California IOUs play for high stakes. When they win, they win big. When they stumble, they?or their ratepayers and shareholders?can lose their shirts. Just consider PG&E?s bankruptcy gamble. Being less conservative, private utilities also borrow to finance capital improvements. Public utilities are more risk-averse and are not subject to such stringent rating and lending rules. They not only weathered the energy crisis far better overall than state IOUs, but munis also fund more projects out of rates instead of via loans. And they don?t have shareholders. ?Lately, rating agencies tend to favor munis,? said Tom Habashi, Roseville?s utility director. The difference between private and public utilities is highlighted by muni debt levels and corresponding ratings. Debt-to-equity ratios in the IOU world?hovering around 50 percent?have got a lot of attention the past few years, being one of the factors used to determine credit grades and the cost of borrowing. The level of debt on the munis? books, on the other hand, is not center stage, and debt levels vary. ?We don?t pay attention to debt-equity ratios,? said Mark Mazak, Anaheim assistant general manager of finance and administration. For some agencies, total debt is in excess of 90 percent; for others, the figure is much lower. In contrast to their private counterparts, munis? steep debt tends not to drive up borrowing costs. Generally, rating agencies are comfortable with munis? high debt ratio,? said Jim Tracy, the Sacramento Municipal Utility District?s chief financial officer. SMUD?s debt-to-asset ratio is about 92 percent to 8 percent. Shutting down the Rancho Seco nuclear power project boondoggle wiped out all of the district?s equity (its retained earnings). It finished writing off the $700 million cost last year and hopes to boost its equity to 20 percent in four years, Tracy said. In spite of the high debt, the district?s rating on $100 million in general revenue bonds recently issued was boosted from A2 to A1 . Anaheim?s overall debt-to-asset ratio is 71 percent to 29 percent. It received an A+ rating on its $128 million in revenue bonds. When looking at debt levels tied to distribution and generation separately, the contrast with debt ratios for IOUs is even more stark. Investment in power plants and associated transmission is a big-ticket item, and trying to cover the cost with rates would force a rate increase, so munis, like private utilities, often go to the market for loans. Generation and associated transmission for the Los Angeles Department of Water & Power and Roseville Electric are 100 percent debt-financed. LADWP received the highest short-term ratings of AA and a long-term rating of A+ , according to Robert Rozanski, L.A.?s assistant chief financial officer. Having a net $4.2 billion in generation, transmission, and distribution assets helps, and more so given that the figure is book value, not market value. Roseville, which has an AAA rating, has a 25 percent debt cap on its distribution. Anaheim?s debt ratio for generation is 76 percent. The card in munis? deck that financiers focus on is the ability to comfortably pay off utility expenses after paying operations and maintenance costs. A debt-servicing floor is set out in the agreement with borrowers. SMUD debt coverage is set at 135 percent, so for every dollar loaned, it must have at least $1.35 on hand. Anaheim?s is 130 percent. When setting the amount of debt coverage, rating agencies give a lot of weight to munis? competitiveness, their ability to cover through rates the cost of a loan?s principal and interest, and their potential for growth. Part and parcel of this assessment is how much lower a muni rate is compared to its competitors?, whether it can raise rates without losing customers, whether management will raise?and has raised in the past?rates to cover increased costs, and munis? exposure to the spot market. ?To have success in a competitive environment, management must be focused on establishing a strong competitive position, which can be achieved through a variety of means, including rate advantage, customer contracts, fuel procurement policies, and superior customer service,? states Standard & Poor?s November 2002 public finance criteria. Not being subjected to California Public Utilities Commission authority is also considered a plus because it removes another layer of politics and bureaucracy. Besides the tie to Wall Street, public munis?like IOUs?have off-balance-sheet debt, which help keep ratings from dropping and borrowing costs from rising. Liabilities that result in no equity ownership are difficult to characterize, said Anaheim?s Mazak. These would include long-term contracts and financial liability for a project unaccompanied by an ownership interest, such as the interest held by some Southern California munis in the Southern California Public Power Authority?s Magnolia project. Given the constrained lending market for investments in private generation, munis? debt circumstances help put public agencies in a better position to fund power projects, evidenced by a string of recently proposed ventures, with munis projected to produce more than 1,700 new megawatts. Consequently, their cash flow and favorable debt situation make it easier to expand their service territories, notwithstanding the particulars of new law SB 772, requiring a nonbypassable PG&E debt-financing fee to be paid by certain customers. Debt scenarios should also keep munis in good stead to fit their renewable power portfolios to the state?s RPS rules. You might say this underscores the more modest maxim by which most munis operate: Rather than win big and lose big, it?s win moderately and lose moderately. It?s a defining distinction, and one that?s not lost on ratepayers.

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Debt by Any Other (Utility) Name

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