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Prop. 9 Anxiety Goes All the Way to Wall Street


With roughly $6 billion in bonds at stake when voters decide Proposition 9 on Nov. 3, anxiety is running high from California to Wall Street over the ballot measure designed to lower electricity rates for most of the state's consumers.

The source of the concern is a provision of Proposition 9 that would halt the flow of money from ratepayers that is paying off nearly $6 billion in bonds. The bonds were sold late last year to finance a 10% rate cut for the nearly 10 million residential and small business customers of Pacific Gas & Electric, Southern California Edison and San Diego Gas & Electric.

At the time they were sold, the bonds received a AAA rating--the highest possible--and were snapped up so quickly by institutional investors that potential buyers were turned away.

But what was once seen as "an airtight cash flow," according to one analyst, could come undone if Proposition 9 is approved. For the first time in memory, voters would effectively be using the initiative process to renounce a financial obligation.

"The state has never backed away from a pledge," said Steve Spears, a former deputy state treasurer and now managing director of Metropolitan West Financial and Strategic Services, an investment and consulting firm in Sacramento. "A proposition has never been on the ballot that attacks a revenue stream on bonds. It is absolutely unprecedented."

Proposition 9 is trailing in polls, but many voters are believed to be undecided. If it does pass, count on the measure to touch off a series of court battles. Both the California and U.S. constitutions also have prohibitions against impairing contracts. In past cases, the courts have held that government agencies could not come back to a bond issue after the fact and change payment pledges.

Bond repayments have been considered so sacrosanct that even during California's financial crisis of the late 1980s, when money for welfare recipients, vendors and state employees was held up, bond payments were always made.

The ratepayer bonds still carry the highest rating. But Moody's Investors Service announced in New York this week that if Proposition 9 passes and California courts fail to grant injunctive relief while the measure is litigated, the bonds' rating could be downgraded, a move that would reduce their value.

"There is a lot of concern," said Bruce Fabrikant, a senior credit officer with Moody's. The worry stems from "the uncertainty--if it passes and a judge doesn't issue a restraining order or preliminary injunction," he said.

"Obviously we are following it very closely," said Ellen Welsher, New York-based director of new assets for Standard & Poor's, which also gave the ratepayer bonds their highest rating. "We aren't making any comments until we see what happens [in the election]."

The bonds were issued by the three utilities through an obscure state agency as part of the 1996 law that began California's program of deregulating electric utility service. The bonds allowed utilities to cut residential and small business customer rates by 10%; consumers are paying them off via a surcharge that appears on their monthly bills. The initiative promises a 20% electric rate reduction.

Peter Bianchini, western regional public finance director of Standard & Poor's in San Francisco, tracks municipal bonds used by cities, counties and other government agencies to raise capital. He said that even though ratepayer bonds were privately issued, they could affect the municipal bond market.

"If you disrupt a debt service for any bond in California, it tends to have a broad effect," Bianchini said, noting that when Orange County defaulted on bond payments, borrowing costs for cities and counties throughout the state went up.

No Risk for Bondholders

At this point, both sides in the Proposition 9 contest agree that the bonds will be paid off. The argument is over who will be responsible for doing so.

"It's going to be a cold day in Hades before the bondholders are going to lose a penny," said Michael Florio, an attorney for the Utility Reform Network, one of the sponsors of Proposition 9.

Utility executives and others who have studied the issue say the state and its taxpayers are ultimately responsible to pay off the bonds.

Some state officials disagree, but concede that there is a possibility, however remote, that California taxpayers could end up paying the bill.

The bonds carried a disclaimer that they were not backed by "the full faith and credit" of the state. But the Legislature, anticipating a problem, wrote into the bond prospectus a caveat that the state would do nothing to impair repayment of the borrowed money.

"At the heart of this is whether the state, through the initiative process, can walk away from financial obligations," said attorney Dean Criddle, who advises PG & E for the national law firm Orrick, Herrington & Sutcliffe.

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