Washington Public Power Supply System ; Federal Reserve District, 12th ; Electric utilities ; Municipal bonds ; Bonneville Power Administration

Yvonne Levy

English

Research Papers in Economics

April 22, 1983
Default for Washington Power?
Last week, government and electric utility
officials in the Pacific Northwest reached
tentative agreement on a plan that might
prevent the Washington Public Power
Supply System (WPPSS) from defaulting on
$2.25 billion in bonds issued to finance two
now-cancelled nuclear power plants. The
likelihood that the numerous parties in-
volved will give final approval to the plan
appears dim however.
WPPSS officials have warned of an im-
minenttechnical default in meeting the
monthly payment to its interest account on
debt borrowed to finance the two plants.
Failure to make that payment could be the
first in aseries ofsteps leadingtofinal default
in meeting its interest paymentto bond-
holders due January 1, 1984. The implica-
tions would be enormous forthe Pacific
Northwestelectric utility industry, its
customers, the regional economy and the
municipal bond market.
Reviewing the situation
On July 1, WPPSS needs to make a $94-
million semi-annual interest payment to
holders ofthe $2.5 billion ofmunicipal
bonds issued to finance two cancelled
projects, known as plants 4 and 5. As oflate
March, the agency had $38 million in its
interest account and another $42 million in
its construction fund. By drawing down the
latter accbunt, the agency probably could
make the required monthly payments to its
interest account through May. But in doing
so, it would be in technical default to its
contractors. The deficitarises because many
ofthe 88 Pacific Northwest utilities which
were to have received power from those
plants-the so-called "participants"-are
challenging their legal liability in the courts
and have refused to make their necessary
contributionsdirectlyto WPPSS. Some have
made payments to an escrow account, but
WPPSS probably wiII not have access to
those funds until their liabilityisestablished.
The agency can probably still meet its inter-
est payment to bondholders on July 1 by
drawing down iis Reserve Fund at Chemical
Bank-trusteeto the bondholders. But
unless that fund is replenished in accor-
dance with the bond indenture, WPPSS will
be in final defaulttobondholdersbyJantiary
1, 1984, when its subsequent semi-annual
interest payment comes due.
Institutional framework
The Washington Public Power Supply
System is a municipal corporation and a
jointoperating agency ofthe'State of Wash-
ington. Its 23 members include 19 operating
publicutilitydistricts and the citiesofEllens-
burg, Richland, Seattle and Tacoma, all
located in Washington. In the late 1960s, the
agency agreed to become part of a ten-year
Hydro-Thermal PowerProgram entered into
by the Bonneville Power Administration
(BPA) and over 100 Pacific Northwestutili-
ties to meet the region's projected electrical
demands over the 1970-90period. As part
ofthis effort, WPPSS by 1974 had embarked
on an ambitious mission to build five
nuclearelectricgeneratingplants-threeon
the Hanford Reservation and two near
Satsop, Washington.
WPPSS has sold shares ofthe outputofthese
plants to its members and other Pacific
Northwestutilities.Theseownersare known
as "participants." The agency, acting on
behalfofthe participants, has sold tax-
exempt revenue bonds to finance the nu-
clear projects. Each participant has entered
into agreements with WPPSS with a "take-
or-pay" clause that binds them to pay the
agency its share ofthe annual costofthe
projects, includingdebt service on the
bonds, whetheror notthe projects are ever
completed or operational.
In the case ofplants 1, 2 and 70 percent of
plant 3, the participants have assigned their
shares to the Bonneville Power Administra-
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Opinions expressed in this newsletter do not
necessarilv reilE.~ct the views of the management
of the Federal Reserve' Bank of San Francisco,
or of the Board of Covernors of the- Federal
Reserve System.
tion under "net-billing" agreements. Under
these agreements, BPA is required by lawto
meet the obiigations to creditors ofthese
plants even ifthe plants never produce
power. Moreover, Bonneville must meet
these obligations before makingany cash
payments tothe U.s. Treasury forrepayment
of Federal investment in the Columbia River
Power System.
The purpose ofthe net-billing arrangement
has been to provide security to bondholders
ofplants 1,2 and 3. It also has enabled BPA
to average the high cost ofthese projects
with other lower-cost BPA hydro-power. In
fact, the BPA backing given to plants 1, 2
and 3 obligations has enabled WPPSS to
finance those plants to the level ofnearly $6
billion and to maintain a Standard and Poor
bond rating ofAA. In contrastto plants 1,2
and 3, bonds issued for plants 4 and 5 are
secured only by the power sales agreements
between WPPSS and the 88 participants.
What went wrong?
WPPSS's financial problems can be traced
to cost overruns on its five nuclear plants
and the effectthesecosts have had in raising
electricity prices and thereby slowing the
growthofelectric powerconsumption in the
Pacific Northwest. Higher costs associated
with project delays had boosted the total
cost ofthe five plants from $7 billion in the
mid-1970s to $24 billion in 1982. As BPA
averaged the costs ofplants 1,2 and 3 with
its hydroelectric power costs, the average
wholesale priceofpower to its utility and
direct industrial customers rose four-fold
over the 1979-83 period alone, from 0.3
cents per kilowatt-hourfo 1.2 cents per kilo-
watt-hour. Because Pacific Northwestutili-
ties have passed theircosts (includingplants
4 and 5) on to final users, the average retail
price for electricity in the region has risen
overthe period from 1.7 cents/kilowatt-hour
to 3.2 cents/kilowatt-hour (see chart).
When Northwest utilities developed the
Hydro-Thermal plan, they expected re-
gional electrical consumption to continueto
2
growat an historical average annual rate of7
percent overthe 1970-80period. Higher
prices have since slowed growth to an
annual average of4 percent and forecasts
are for 2 percent annual growth for the
1980-2000period.
When it became evident that the output
from plants 4 and 5 wouId not be needed,
WPPSS cancelled further constructionofthe
plants in January 1982. The same circum-
stances led officials in the spring of 1982 to
suspend work on plant 1 (about two-thirds
complete) for upto five years, and, in
February, to slow construction on plant 3.
legal challenges
Given the take-or-pay clause in their con-
tracts, cancelling plants 4 and 5 means that
the sponsoring utilities will have to pay $7
billion in principal and interestto bond-
holders over30 years with no prospectof
future income from those facilities. In reac-
tion, numerous utilities have filed lawsuits
to challenge the provision, while Chemical
Bank-representingthe bondholders-is
seeking judgment that the 88 utilities are
liableforthe plantdebt. The Chemical Bank
case been postponed, but several prelimin-
ary decisions already rendered in other
lawsuits increase the likelihood ofdefault.
In a possibly precedent-setting case, rate-
payers ofthe Springfield Utility Board in
Oregon challenged the authority oftheir
utilityto sign the Participants' Agreement. In
late October 1982, an Oregon judge ruled in
favor ofthe ratepayers, indicating thatthe
Springfield utility had exceeded its legal
authority in entering into the agreement. If
upheld, this decision as well as an Idaho
ruling could mean that Oregon and Idaho
utilities, which accountfor 10percentofthe
ownership ofplants 4 and 5, may have no
legal obligation to meet debt service on
those plants. Moreover, in a pre-trial ruling
in mid-December, aSuperiorCourtjudge in
Washington ruled that participants in that
-State cannot be forced to "step up" their
payments to cover the unpaid shares of
non-Washington utilities.A keyquestion is whetherthe participants in
plants 1 and 3wiII agreetothis plan, as some
ofthem were not among the 88 utilities
sponsoring plants 4 and 5 and do not have
any legal financial liability. in addition,
Congress would have to pass Federal legis-
lation to enable BPA to incorporate plant 4
and 5 debt into its rate structure.
A second part ofthe plan, which would also
involve regionalizing part ofthe debt,
would limitthe debt obligation ofanyone
utility participating in plants 4 and 5 to an
amount that would boost its rates no more
than .7 cents per kilowatt-hour. The excess
would be distributed to other utilities and
uItimately to electric users throughout the
Northwest. Bonnevillewould act as thecon-
duitfor the regionalization aspects ofthis
plan by raising its rates to its wholesale
customers.
Unlike some earlier proposals, one benefit
of the regionalization approach is that it
would not require the taxpayers throughout
the nation to subsidize the Northwest by
providing low-cost loans. instead, responsi-
bilityforthedebtwould be contained within
the region. Also, the costs incurred by the
region's utilities and their retail customers
in payingoffprojects 4 and 5 might be less
than the costs they would incurthrough
default. It mightbe in their mutual interest
for the various groups to reach aconsensus
outsidethecourts thatpreserves the region's
creditworthiness.
Permitting WPPSS to declare bankruptcy
mightnotbeabad solution, however, in that
the courts would then be required to deter-
minewhich parties really are responsible for
the debt. Like all investors, plant4 and 5
bondholders musthave realized there were
risks in purchasing those bonds.
Yvonne levy
owned utjjities, whether or not they were
sponsors. Specifically, itcalls for plants 1
and 3 to assume the full $400 million of
shared costs for projects 4 and 5.
3
3.06
2.36
2,72
2.04
Centsr4ci'Wlllf
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Retail )l>-
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11
10
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13
12
15
The WPPSS jointoperating agency might
also be forced into bankruptcy or receiver-
ship. Bankruptcy mightbe limited toplants4
and 5, ifState law were changed to permit
"selective" bankruptcy. Otherwise,
the claim that holders ofplants 4 and 5 debt
would have on WPPSS' other assets and in-
come could bankrupt the entire WPPSS
corporation. (As is, WPPSS has sold $8.5
billion in bonds-more than any other
tax-exempt issueL) In any case, the agency
would find itextremely difficultto continue
financing plants 1,2 and 3.
Financial analysts contend that a WPPSS
default would make itmore costly for other
state and local government agencies in the
Pacific Northwest to float future debt
because the financial market would view
the region as beingfinancially irresponsible.
A default would have some negative
impacts on the municipal bond market gen-
erally. in addition, several banks in the
Pacific Northwest, heavily invested in plants
4 and 5 and otherutilitybonds, would stand
to lose from defauIt.
Rescue plans
Consultants, brokerage houses and utility
associations have put forth a number of
proposals to avoid default, or at least to
minimize investor losses, The plan utility
negotiators tentatively agreed upon seeks to
prevent default by relieving the 88 utilities
which sponsored plants 4 and 5 from some
oftheir obligation. it calls for "regionaliz-
ing" some ofthe debt by spreading its cost
among all Northwestpublic and investor-
PACIFiC NORTHWEST
ELECTRICITY CONSUMPTION AND PRICE
8 1970 1972 1974 1976 1978 1980 1982 198~70
*Consumption is estimated for 1983; price represents current level.
Impacts of defaulH
Should WPPSS default, the public utilities
sponsoring the projects would find itdiffi-
cult to obtain future financing. Those least
affected would face atemporary exclusion
from the municipal bond market and subse-
quently pay high penalty interest rates
which would declineover time. Those most
heavily involved would be precluded from
most types offinancing, and some might
choose bankruptcy.U01~U!4st?M· 4l?ln • UO~<uO • I?pf'lIaN • 04l?PI
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BANKING DATA-TWELFTH FEDERAL RESERVE DISTRICT
(Dollar amounts in millions)
Selected Assetsand Liabilities
largeCommercial Banks
Amount
Outstanding
4/6/83
Change
from
3/30/83
Change from
year ago
Dollar Percent
Loans (gross, adjusted) and investments'" 163,684 487 5,072 3.2
Loans (gross, adjusted) - total# 142,640 538 5,286 3.8
Commercial and industrial 45,211 30 2,159 5.0
Real estate 57,098 - 48 142 0.2
Loans to individuals 23,456 0 265 1.1
Securities loans 1,993 - 28 4 0.2
U.s. Treasury securities'" 8,180 43 1,890 30.1
Other securities'" 12,864 - 94 - 2,104 - 14.1
Demand deposits - total# 43,007 2,975 1,538 3.7
Demand deposits - adjusted 29,552 1,329 484 1.7
Savings deposits - total 66,584 1,318 34,645 108.5
Timedeposits - total# 66,791 -1,102 - 23,607 - 26.1
Individuals, part. & corp. 59,608 - 899 - 21,505 - 26.5
(large negotiable CD's) 20,459 - 776 - 12,640 - 38.2
Weekly Averages
of Daily Figures
Member Bank Reserve Position
Excess Reserves (+)/Deficiency(-)
Borrowings
Net free reserves (+)/Netborrowed(-)
Weekended
4/6/83
1J1
14
97
Weekended
3/30/83
88
67
21
Comparable
year-ago period
40
95
56
* Excludes trading account securities.
# Includes items not shown separately.
Editorial commentsmay be addressed tothe editor(GregoryTong) ortotheauthor....Freecopies of
thisandotherFederal Reserve publicationscanbeobtained by callingorwritingthePublic Information
Section, Federal Reserve Bank of San Francisco, P.O. Box 7702, San Francisco 94120. Phone (415)
974-2246.

Default for Washington Power?

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Default for Washington Power?

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