Officials Still Need to Work Out Bond Details

As state legislators attempt to wrestle California’s electricity crisis to the ground, a different kind of exercise has begun at the Department of Water Resources: how to craft a multibillion-dollar revenue bond issue that will keep the electrons flowing and bond buyers happy.

The legislation signed Thursday by Gov. Gray Davis is mute on the details of how the bond issue will be structured, but staff estimates have placed the value as high as $10 billion and the term at perhaps 10 years. The bonds will be repaid with a charge on the bills of customers of Southern California Edison and Pacific Gas & Electric, which are at the brink of bankruptcy.

Whether investors will be interested in buying these bonds hinges on such pesky details as how secure the revenue backing the bonds will be and what kind of credit rating they will receive from the major debt-rating agencies.

“It’s like driving a car,” said Michael Dow, senior vice president of Pacific Investment Management Co., or Pimco, a large Newport Beach-based bond fund manager. “You want to take a look under the hood. If you open it up and it’s empty, as the electricity bonds are now . . . you’re going to have a hard time selling it.”

Orrick, Herrington & Sutcliffe, longtime bond counsel to the Department of Water Resources and other state agencies, already is consulting on the design of the electricity bond issue, Orrick spokeswoman Deanna Hodgin said.

“It’s really kind of an art form to structure an instrument that not only solves your problem but will also be attractive in the marketplace,” she said.

To many, the lucrative world of bond financing is complicated and arcane, employing such eye-glazing terms as “yields,” “calls,” “puts” and “zero coupons.” But it all boils down to an age-old tool of commerce: the IOU.

A bond is a debt security, a kind of fancy IOU, issued by a corporation or a government entity, including cities, counties and the federal government. When you buy a bond, you are lending money to the issuer, who promises to repay that loan by a specific date and usually will pay you a set amount of interest each year in the meantime.

The electricity bonds authorized Thursday will be municipal bonds, even though they will be repaid with money from corporate customers. They also are revenue bonds, which means they will be repaid with revenue from a specific project or source--in this case, electricity bills. Another, more secure variety, the general obligation bond, is backed by the full faith and credit of the government entity and usually requires voters’ approval.

Here’s how bonds are born:

One group of professionals, called the bond counsel, writes up the terms of the bond deal. Underwriters, such as large banks and investment firms, sell the bonds.

Then investors, both individual and institutional, buy the bonds after reading about them a prospectus filed with the Securities and Exchange Commission.

Bonds are also traded, like stocks, but generally between investors, with brokerages acting as middlemen.

Bonds usually pay interest, which make them attractive to investors looking for a stable source of income.

Interest on bonds issued by corporations is usually taxable as ordinary income. Interest on municipal bonds generally is exempt from federal tax and from state tax in the state in which the bonds are issued.

But it is not yet clear whether the new electricity bonds, which are authorized by the state but backed with non-state revenue, will be subject to tax, bond experts said Thursday.

In any case, because these bonds will be repaid by charges to electricity ratepayers, not the state, the interest rate paid on the securities could be fairly attractive--reflecting the higher risk that such bonds carry.

“The most important thing to bondholders is security. Because of all the bad press,” Dow said, referring to the state’s power woes and the headlines they have generated around the world, “iron-clad guarantees are going to be required.”