1 BEFORE THE CALIFORNIA STATE BOARD OF EQUALIZATION 2 450 N STREET 3 SACRAMENTO, CALIFORNIA 4 5 6 7 REPORTER'S TRANSCRIPT 8 FEBRUARY 3, 2009 9 PUBLIC HEARING 10 ITEM F1 11 PROPERT TAXES 12 STATE ASSESSEES' PRESENTATIONS ON 13 CAPITALIZATION RATES AND OTHER FACTORS 14 AFFECTING VALUES 15 16 17 18 19 20 21 22 Reported by: Juli Price Jackson 23 No. CSR 5214 24 25 26 27 28 1 1 2 P R E S E N T 3 4 For the Board Betty T. Yee of Equalization: Chair 5 6 Judy Chu Vice-Chair 7 Bill Leonard 8 Member 9 Michelle Steel Member 10 Marcy Jo Mandel 11 Appearing for John Chiang, State Controller 12 (per Government Code Section 7.9) 13 Diane G. Olson 14 Chief, Board Proceedings Division 15 16 Ken Thompson Appraiser 17 Don Jackson 18 Appraiser 19 Lou Ambrose Counsel 20 21 22 ---oOo--- 23 24 25 26 27 28 2 1 INDEX OF SPEAKERS 2 NAME PAGE 3 4 Justin Hyland 6 5 Peter Hladek 10 6 Peter Michaels 12 7 Fred Vance 13 8 9 ---o0o--- 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 3 1 450 NSTREET 2 SACRAMENTO, CALIFORNIA 3 FEBRUARY 3, 2009 4 ---oOo--- 5 MS. OLSON: Our next item on the agenda is F1, 6 Property Taxes -- State Assessees' Presentations on 7 Capitalization Rates and Other Factors Affecting Values. 8 We have four speakers. 9 MS. YEE: As the States is coming up, let me 10 ask the speakers who wish to comment to come forward as 11 well. 12 We have Mr. Michaels, Mr. Hladek, and, I 13 believe, Mr. Vance and Mr. Hyland. 14 All right, good morning. 15 Please introduce yourselves for the record. 16 MR. THOMPSON: I'm Ken Thompson, Principal 17 Property Appraiser in the State-assessed Properties 18 Division. 19 MS. YEE: Okay. 20 MR. THOMPSON: To my left is Don Jackson, also 21 Principal Properties Appraiser. 22 MS. YEE: Okay. 23 MR. THOMPSON: Good morning, Members of the 24 Board. As prescribed by the Rules of practice, today is 25 the first of two opportunities for you State assessees 26 to provide input to the Board in a public forum on 27 issues related to the cost of capital and other factors 28 relating to the assessment of unitary property or 4 1 private railroad cars. 2 Another opportunity for public comment will be 3 available in April. 4 Although there is not sufficient available data 5 at this early date for presentation of an assessee's 6 cost of capital study, the staff encourages input from 7 assessees and will consider any timely information 8 that's provided to the staff by assessees before 9 finalizing the capitalization rate study. 10 In order to meet the March deadline for the 11 study to be published, such information should be 12 applied -- should e provided to the staff prior to 13 February 20th. 14 Property Tax Rule 8 prescribes that the 15 appraiser shall weight the rates for debt and equity 16 capital by the respective amounts of such capital he or 17 she deems most likely to be employed by prospective 18 purchasers. 19 Determining the cost of capital for the 2009 20 lien date will be challenging because the market 21 conditions at the lien date reflect the volatile and 22 somewhat anomalous environment for the financing of both 23 debt and equity required by a prospective purchaser or 24 the purchase of the assets used in unitary operation of 25 our assessees. 26 Staff is available to respond to any questions 27 from the Board or the assessee. 28 Thank you. 5 1 MS. YEE: Thank you very much. 2 Good morning, speakers. If you will introduce 3 yourself for the record, you have three minutes each. 4 ---o0o--- 5 JUSTIN HYLAND 6 ---o0o--- 7 MR. HYLAND: Justin Hyland, Director of 8 Property Taxes for Calpine Corporation. 9 MS. YEE: Okay. 10 MR. HYLAND: Good morning, Madam Chair and 11 Members of the Board. Thanks for your time here this 12 morning. 13 We're here on behalf of Calpine Corporation o 14 address the Board regarding the annual cap rate study 15 that the Board staff puts together. In prior years 16 Calpine's financial information was not included in the 17 capitalization rate study because the company was in 18 bankruptcy. 19 Calpine emerged from bankruptcy in January of 20 2008. Calpine owns six out of the seventeen merchant 21 plants the State Board values in part by the use of the 22 capitalized earnings approach. And our financial 23 position should be considering the development of the 24 proper capitalization rate to be used in that approach. 25 A large portion of the information needed for 26 our input into the cap rate base is currently 27 unavailable since much of the year-end financial 28 information has not been compiled. 6 1 The information will be available in the coming 2 weeks and we will provide it to the Board staff for 3 their review and consideration. 4 When the information is available, we will 5 address it, along with the country's unique financial 6 time, which is going to test some of the underlying 7 financial theory and calculations behind the formulas 8 that are used derive the appropriate cost of equity and 9 the cap rate study. 10 One of the items we wanted to address is the 11 riskfree rate of return that is used in the capital 12 asset pricing model, or Cap M approach, to calculate in 13 the cost of equity. 14 Many of the inputs into the capitalization rate 15 models are derived from year -- end of year point in 16 time figures, as well as some annual averages. 17 With the turmoil in the financial markets in 18 the second half of 2008, as well as the unprecedented 19 government intervention in the markets, the yield on the 20 riskfree rate standard US Treasury bills has plummeted 21 to historically low levels. 22 As potentially applied to the Cap M model, this 23 end of year riskfree rate may imply a lower cost of 24 equity than is realistic and rational in the current 25 financial marketplace. 26 The concern that we have at this point is that 27 given the tightening in the capital markets and the 28 increase in the cost of debt available to borrowers, the 7 1 indicated cost of capital, which includes the cost of 2 equity, is not actually declining, despite the reduction 3 of the riskfree rate, which the Cap M model would read 4 as a potential reduction in the overall cost of equity. 5 We would like the Board staff to consider other 6 methods in determining the cost of equity. One 7 alternate method for determining the cost of equity is 8 to examine the historical spreads between a company's 9 cost of debt and their cost of equity, with equity 10 requiring a higher rate of return than debt. 11 A reasonable spread can be determined from this 12 data and applied to the indicated cost of debt of the 13 industry. 14 There also exists some unique elements to the 15 industry's current cost of debt. In the second half of 16 2008, more pointedly in the fourth quarter, Calpine's 17 publicly traded debt was trading at a significant 18 discount to its face value, which implies a 19 significantly higher current cost of debt. 20 Since most of the companies in the merchant 21 electric generating industry are in the same range of 22 noninvestment grade bond ratings, we expect that the 23 year-end cost of debt will be significantly higher for 24 merchant generators than historically seen in prior 25 years. 26 Another item we'd like for the Board staff to 27 address is the selection of the peer group of companies 28 for the electric generating -- generation facilities 8 1 grouping. 2 To proper assess the appropriate cap rate to be 3 used on electric generation facilities, we believe that 4 the peer group should be limited to companies that have 5 a profile that's -- 6 MS. OLSON: Time has expired. 7 MS. YEE: Please finish your thought. 8 MR. HYLAND: Okay. 9 That is comprised primarily of nonregulated 10 merchant power -- merchant plant owners that require the 11 similar rate of return on equity from investors, as does 12 Calpine. 13 Very quickly, the current group includes 14 merchant or unregulated power providers, as well as 15 utilities such as Duke, Semper and Excel Energy. And we 16 would like the company profile to reflect companies that 17 derive the majority of their revenues from nonregulated 18 operations. 19 Thank you. 20 MS. YEE: Thank you. 21 Next, Mr. Hladek? 22 ---o0o--- 23 24 25 26 27 28 9 1 PETERHLADEK. 2 ---o0o--- 3 MR. HLADEK: I'm Peter Hladek with Thomson 4 Reuters Property Tax Services in Scottsdale, Arizona. 5 I'm not going to be talking about the cap rates 6 today, but rather the other part of this, which is the 7 procedures and other factors that come into play when 8 valuing property in the State of California. 9 What I'd like to do is concentrate on a couple 10 of recommendations for the Appeals conference summaries 11 that are distributed to the Board Members. 12 As I understand it, that's a very key piece of 13 information for the Board Members so that they can make 14 an appropriate decision. 15 And what I'd like to recommend -- and I think 16 it's a good process -- but I'd like to recommend to make 17 sure that we have the -- all of the information that's 18 necessary, that all of the issues that are presented by 19 both parties are articulated and that all of the 20 discussions on those particular items are also included 21 in that summary. 22 Any new issues or ideas that are presented at 23 the hearing conference, I think, should be articulated 24 and noted as such and the reason for them. For example, 25 if the Board asks a client to -- or a taxpayer to 26 provide additional information, we should have that 27 information and make sure that we know why that was 28 presented. 10 1 Also I'd like the make sure that all of the 2 submissions, exhibits and supporting documents that are 3 discussed in the hearing summary be furnished with that 4 summary. 5 The other thing is that -- and the last point 6 on this -- is that in the supporting decision, in the 7 summary, when the decision is made by the Appeals group, 8 that most of the time it talks about the Petitioner not 9 meeting the burden of proof or to meet the burden of 10 proof to do something. 11 I'd like that articulated a little bit further 12 in terms of appraisal theory that does go into the idea 13 of valuing property. 14 And the last point I'd like to make is that I 15 think it would be a great idea to have these hearing 16 summary decisions e-mailed to the taxpayers rather than 17 waiting for the mail. We've had some problems in the 18 last couple of years where we don't get things in time 19 and then when we try to put a rebuttal together or a 20 resubmission, that it's too late for the Board to take a 21 look at it. 22 Thank you. 23 MS. YEE: Thank you very much. 24 ---o0o--- 25 26 27 28 11 1 FREDVANCE. 2 ---o0o--- 3 MR. VANCE: My name is Fred Vance. I'm with 4 Fred Vance & Associates, LLC and I'm an agent for 5 Calpine. 6 Since you were gracious enough to let 7 Mr. Hyland finish his remarks, I have nothing else to 8 add to that. 9 I will turn it over. 10 MS. YEE: Thank you, Mr. Vance. 11 Mr. Michaels? 12 ---o0o--- 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 12 1 PETERMICHAELS. 2 ---o0o--- 3 MR. MICHAELS: Thank you very much. 4 For the record, my name is Peter Michaels. And 5 I'm here today on behalf of 33 State assessees, 6 including local exchange telephone companies, which are 7 becoming extinct, interexchange telephone companies, 8 likewise, wireless telephone companies, intercounty 9 pipeline companies, gas and electric utility companies 10 and railroads. 11 And it's great that we've had four speakers 12 today, unlike past years where it's just usually been 13 one speaker. And, fortunately, they've touched on the 14 dynamics that we confront, both with uncertainty about 15 risk rates, costs of capital and earnings projections 16 and earnings abilities. 17 And I think my overarching concern is that you 18 remember at all times that you are an assessor when you 19 have value the State assessees year, when you value 20 these local exchange companies who are losing 10 percent 21 of their customer base every year. You're the 22 assessor -- just as you yourselves have your property 23 locally assessed by your assessor. 24 And you're not a revenue agent. And these 25 values are going down. The cap rates are going to go 26 up. I think that just comes with the territory. 27 Even the rate base regulated companies find 28 that their costs of capital are doubling. So, it's 13 1 grim. 2 And, that aside, there is the more sharply 3 focused continuing attention that the Board has paid an 4 industry to recognizing, quantifying obsolescence in 5 telecommunications equipment, telephone company 6 equipment, that is going to the subject of an interested 7 parties meeting, the second interested parties meeting. 8 We've had LTAs. I'm not sure -- well, we have an 9 interested parties meeting later this week. 10 It wasn't clear to us that the Board paid much 11 heed to what transpired so far in that process in 2008. 12 Decisions in -- I guess we hope that there will be some 13 recognition of some these really fundamental widespread 14 concerns when the Board sets its values in May and hears 15 the, hopefully, few appeals -- maybe they won't even 16 need appeals. 17 But I'm sure that there will be some issues 18 unresolved but we really hope that there is 19 institutional recognition through these guidelines for 20 the principles that are -- that we have been pressing 21 and for the widely -- widely publicized downturn in that 22 market. 23 Thank you. 24 MS. YEE: Thank you, Mr. Michaels. 25 Does staff have any reactions? 26 MR. THOMPSON: We're looking forward to working 27 with Mr. Hyland and anticipating using the information 28 that he presents in developing the cost of capital. 14 1 We acknowledge that this -- it's a roiled 2 market and somewhat anomalous. The old ways of 3 producing the cap rate study, where we used the 4 operating ratios and the rates of equity and debt and 5 the capital structure at the lien date may not be 6 appropriate for this -- this trying time. 7 MS. YEE: Okay, very good. 8 Mr. Leonard? 9 Then I have a comment. 10 MR. LEONARD: Thank you, Madam Chair. 11 A couple of comments on cap rates. I know that 12 your preference is to pick a number. It does seem to me 13 that in this in unsettled market a range or a band might 14 be useful to give us choices that you could argue for 15 one side or the center of that band, but to kind give us 16 the range of what's out there. 17 Just picking a hard number for a cap rate this 18 far out just strikes me as dart board methodology. And 19 to the extent that the company's assessment is dependent 20 on a cap rate methodology and not some other system, 21 that should be noted in your analysis for the Board 22 Members so that we're really aware that one minor change 23 in that cap rate number could have large consequences in 24 the evaluation compared to some other methodology. 25 MR. THOMPSON: You know, I think it's 26 appropriate to comment. 27 The range is established in our presentation of 28 the data, although it's not cited or is probably is 15 1 pronounced as it might be. 2 But we will take that recommendation. 3 MR. LEONARD: If you could do that. 4 I know from May we want to come up with a hard 5 number. But to the extent that you get -- that you also 6 note ranges that we could look at and try to update it 7 given the things that -- the data we have uncovered 8 since the lien date to help figure out what the credit 9 market is, what the debt liability -- or how dependent 10 the assessment is on that number -- just to show what -- 11 what a tweak in the number might do. 12 If it's small, then it's kind of irrelevant. 13 If it's large, then we may want to focus on it more. 14 Secondly, I note that Appeals isn't at the 15 table, so, I guess to Ms. Cazadd, the recommendation 16 about hearing summaries reflecting the entire appeals 17 process is most in order. 18 There should be one document that really 19 includes the Department's and the company's position on 20 that -- welcome, Mr. Ambrose. 21 You are here today. 22 MR. AMBROSE: I didn't know that was going to 23 be discussed, that's why I wasn't up here. 24 MR. LEONARD: But you were taking notes in the 25 back? 26 MR. AMBROSE: I was. 27 MR. LEONARD: Wonderful. 28 Then the third item is when we do compare 16 1 companies in this weird environment between regulated 2 and unregulated, that are all still on our jurisdiction, 3 the comparison band should be as much like to like as 4 possible. 5 And if you can't do that because of lack of 6 data or getting down to single companies that we big 7 asterisks on that so that we know. 8 Because I am assuming that there are going to 9 be differences between regulated and unregulated 10 companies as access to the credit market, simply because 11 of their monopoly or regulated status or lack thereof 12 and their ability to access -- access credit. 13 MS. MANDEL: You mean rate regulated? 14 MR. LEONARD: Yes. 15 You're suggesting they're all regulated -- yes, 16 rate regulated versus non PUC controlled. 17 Thank you. 18 MS. YEE: Thank you, Mr. Leonard. 19 Let me just echo some of your comments. 20 I appreciate Mr. Hdlak's@@ suggestions with 21 respect to submissions and hearing summaries. 22 And I think Appeals has been definitely doing a 23 better job of being inclusive of all of the -- certainly 24 the exhibit submissions, along with the hearing summary. 25 I would just say that this is such a compressed 26 time frame, this process that we go through every year, 27 and, so, a lot of what we can expect Appeals to 28 realistically put forth is really based on having early 17 1 engagement, early dialogue. 2 Certainly to the extent that information is 3 shared timely, we would like to be sure that it gets out 4 timely with all of the attendant attachments. 5 Have you not been getting the hearing summaries 6 e-mails? That seems like something that we should be 7 doing on the natural -- 8 MR. LEONARD: Yes. 9 MR. HLADEK: Usually, I -- we get a paper copy. 10 And the problem is that by the time we get it and it 11 funnels through the different systems or whatever gets 12 into the mail, this last year it was really pretty slow. 13 A couple of years ago I got them like a week 14 after the hearing. And it didn't serve its purpose. 15 This last year we were really compressed. We 16 put things together. There was an awful lot of 17 information in both of the cases that was totally 18 omitted. 19 So, by the time we had to resurrect that, put a 20 brief together, put everything together and bring it in, 21 then we were told that we were too late. 22 So, this is -- that's why I made the comments 23 that I did. 24 MS. YEE: Okay. We could do better there. 25 Thank you. 26 Appeals staff, any other comments? 27 Very well, thank you very much. 28 ---o0o--- 18 1 2 REPORTER'S CERTIFICATE 3 4 State of California ) 5 ) ss 6 County of Sacramento ) 7 8 I, JULI PRICE JACKSON Hearing Reporter for the 9 California State Board of Equalization certify that on 10 FEBRUARY 3, 2009 I recorded verbatim, in shorthand, to 11 the best of my ability, the proceedings in the 12 above-entitled hearing; that I transcribed the shorthand 13 writing into typewriting; and that the preceding pages 1 14 through 18 constitute a complete and accurate 15 transcription of the shorthand writing. 16 17 Dated: March 9, 2009 18 19 20 ____________________________ 21 JULI PRICE JACKSON 22 Hearing Reporter 23 24 25 26 27 28 19