Public Finance Update - May 2009

On February 27, 2009, Assemblywoman Audra Strickland introduced Assembly Bill No. 1192 ("AB 1192") in an effort to stop California cities from utilizing the lease-leaseback structure to finance public infrastructure. In a typical lease-leaseback financing, a city leases or sells an asset to a joint powers authority ("JPA") formed by the city, and then re-leases or repurchases the asset from the JPA under a long-term lease or installment purchase agreement. The JPA then pledges the resulting lease or installment payments to pay debt service on certificates of participation, which are sold to investors to generate the funds to pay for the required infrastructure. AB 1192 would prohibit cities from leasing or selling any existing public improvement to a public or private entity, and then re-leasing or repurchasing that improvement. According to a fact sheet released by Assemblywoman Strickland’s office, she believes that the lease-leaseback financing structure should constitute an indebtedness that requires two-thirds voter approval under the California Constitution, despite a series of California Supreme Court cases that have definitively ruled otherwise. (See, for example, the 1998 case Rider v. City of San Diego.) California cities have used lease-leaseback vehicles to finance vital infrastructure, including schools, courts, administrative buildings, utilities, airport facilities, light rail, correctional facilities, and asbestos removal. If adopted, especially during the current credit dislocations, AB 1192 could severely hamstring a city’s ability to meet its infrastructure obligations.

Local agencies often impose impact fees as a precondition to project approval. The fees are used to finance roads, schools, affordable housing, transit systems, and other infrastructure and services related to private development. Municipalities argue that impact fees are both a necessary and a fair method of mitigating the costs that befall them as a result of development. Developers argue that impact fees cause a disproportionate increase in construction costs. In the current economic slump, impact fees can make the difference between a project’s completion and its abandonment. Consequently, some municipalities are softening their historically hard stance regarding these fees. In Riverside County, for instance, the Western Riverside Council of Governments will lower its Transportation Uniform Mitigation Fund fee as of July 1, 2009. The City of Menifee is also considering cutting its impact fees by 20% to attract development and spur construction jobs.

Investors have long relied on the yield ratio between AAA-rated municipal bonds and U.S. Treasury bonds to measure the respective appeal of each investment. For the past 20 years, the yield on 10-year, AAA-rated municipal bonds hovered between 75% and 90% of the yield on 10-year Treasury notes. When the ratio dipped below 80%, investors tended to buy munis; when the ratio moved above 80%, U.S. Treasuries were purchased. Since 2007, however, the credit crunch and subsequent economic downturn have thrown investors an unexpected yield curve. In 2008, Treasury yields plunged and municipal yields rose as investors sought the safest sanctuary for their investment dollars. Consequently, the muni-treasury yield ratio has been flipped on its ear, rising as high as 186% during 2008. Although the ratio has flattened in recent months to approximately 100%, investors are revisiting their bargain hunting criteria. Historically, a 100% ratio would have prompted investors to purchase Treasury notes with abandon. In today’s cautious climate, however, 100% is the new 80%, as investors wait for the turmoil to subside.

The yield on AAA-rated municipal bonds dropped during the last 30 days from 4.91% to 4.71% on 30-year bonds and from 3.45% to 3.21% on 10-year bonds, while the yield on Treasuries rose from 3.68% to 4.08% on 30-year bonds and from 2.86% to 3.19% on 10-year notes, bringing the municipal-treasury yield ratio for 10-year maturities close to 100%.

Source:
Bloomberg (www.bloomberg.com)

Most indicators relevant to the bond market worsened in March 2009. However, certain positive economic signs in April, including an increase in pending home sales and construction spending, prompted Federal Reserve Chairman Ben Bernanke recently to suggest that recovery may begin as early as the end of 2009. Here are the official numbers:

Sources:
Unemployment Rate and Consumer Price Index: U.S. Bureau of Labor Statistics (www.bls.gov)
Existing Home Sales, New Homes Sales, and Housing Starts: National Association of Realtors (www.realtor.org)