Financial fallout from Washington State's bond blast
Will people buy bonds in large public power projects again? This is the question reverberating around Wall Street now that investors are looking over an abyss at the largest municipal default in the country's history. Unless Congress intervenes, this dubious distinction is almost certain to fall soon to the giant Washington Public Power Supply System (WPPSS).
Default, possibly bankruptcy, was assured when the Washington Supreme Court ruled last week that the utilities, which had borrowed $2.5 billion from investors, did not have the authority to enter into their agreement with the system. Thus WPPSS, which was set up to fund the building of five nuclear power plants in the state, had a significant part of its financial underpinnings destroyed. The decision left Wall Street, which had sold $8 billion of WPPSS bonds, ''in a state of shock,'' says Michael Godwin, vice-president at E.F. Hutton & Co.
Many investors regard the court's decision as political rather than legal. They believe the courts were searching for a way to bail out the utilities. And they reckon the action will hurt the credit rating of all utilities, municipalities, and school districts in the Pacific Northwest.
Once the reaction wears off, investors, underwriters, and municipalities will have to face up to some tough issues.
Robert Adler, a vice-president at Shearson/American Express, says, ''The issue is now bigger than 'Whoops' (as the system is known).'' Another source, who is intimately involved in analyzing the project, adds, ''I think it has the potential to be bigger than Whoops.''
One of the biggest issues is whether or not investors will feel comfortable again buying the bonds of large public power projects. Mr. Adler says that unless there is some sign from Washington - either positive or negative - then ''I don't think we can expect large public power projects to be financed in the marketplace.''
Another aspect is whether or not utilities, which have signed contracts that said they would ''take or pay'' for electricity produced - whether or not the project was completed - can get out of these contracts. One analyst says the Washington Supreme Court ruling that they could was based on a very narrow interpretation of the law.
David Goodrich, a partner in the national accounting firm of Coopers & Lybrand, says, ''If such contracts are ignored it would create a real problem, since so many projects are based on take-or-pay contracts as a backup to the debt.''
Already there is considerable fallout from the Washington court decision. Standard & Poor's, the rating agency, says it is reviewing the decision and evaluating what the effect might be on other municipalities in the state of Washington and on other large power projects. The rating agency won't publicly state what it thinks until its evaluation is complete.
In an initial action Friday, however, S&P placed four utilities that have a 30 percent stake in WPPSS's No. 3 nuclear power plant on its ''credit watch'' list. For the utilities, this has negative implications. A spokesman for S&P said they could see their credit ratings downgraded if the power plant is not completely funded. Those placed on the list are Pacific Power & Light, Portland General Electric, Puget Sound Power & Light, and Washington Water Power.
Large institutional buyers of municipal bonds are talking - with their money. Some have decided to move out of buying such bonds issued in the Northwest. One source, who wished to remain anonymous, commented, ''The mess is not just going to be in lower Manhattan, but also in the Pacific Northwest.''
This is the case at IDS, the large mutual fund complex based in Minneapolis. Kurt Larson, portfolio manager of the IDS High Yield Tax Exempt Bond Fund, says his fund sold its Whoops bonds a year ago at the same time it lightened up on other bonds issued in the Pacific Northwest. He says that ''people will be very reluctant to loan money to municipalities which allowed contracts not to be honored.''
Peter Schmidt, director of fixed-income research at Prescott, Ball & Turben, a Cleveland-based broker, says a lot of customers are going through similar ''serious soul-searching.'' The results could affect school districts and cities in the Pacific Northwest that would normally be considered good credit risks. ''There will be a penalty assigned to their debt,'' he says.
Mr. Schmidt believes that as a result of the Whoops debacle, buyers of tax-exempt bonds issued by utilities will look more carefully at the projects they invest in. Rather than being concerned about the nature of the contracts the buyers of the electricity have signed, he says there will be more emphasis on the nature of the project, who is involved with it, and when it will pay off.
In this regard, investors have been looking closely at some rather large unfinished power projects that are jointly funded - like WPPSS. This includes such ''joint-action agency'' projects as the Massachusetts Municipal Whole Electric Corporation, which is involved in the Seabrook and Millstone Power Plants, and the North Carolina Municipal Power Agency No. 1, which is building a power plant from which Duke Power has contracted for On Thursday the North Carolina agency postponed a $350 million bond offering until investors had more time to digest the WPPSS news. An agency official said he hoped investors would differentiate between regions and agencies such as the one in North Carolina.
In some ways, the collapse of Whoops is still part of the fallout from the Three Mile Island nuclear mishap. For example, a fair amount of the cost overruns and quite a few of the delays were attributable to changes that have taken place since the TMI incident. The Whoops project has fallen four years behind schedule and is costing 95 percent more than expected.
Mr. Schmidt comments, ''I guess investors have learned you just can't hope a power project will come on line and the contracts signed by the participants will be abided by.''
In the meantime, those contracts will be the subject of intense scrutiny by packs of lawyers. Chemical Bank, trustee for the WPPSS bondholders, has said it will sue nearly everyone involved in the affair.
''This is the Lawyers Relief Act of 1983,'' says Mr. Adler of Shearson.
* Wall Street was euphoric last week as investors began to sense that the Federal Reserve Board would not tighten up on interest rates in the near future. During the week the Dow Jones industrial average broke its record high, closing at 1,242.19, up 46.08 points. Volume soared in the surge.