Public Finance Update - June 2009

The recent stall in California real estate development has virtually frozen the Mello-Roos bond market. Between 2004 and 2008, over 600 issues of Mello-Roos bonds were sold – an average of over 120 per year. Since the beginning of 2009, only five issues have come to market, and many experts expect no more than a dozen by year end. Despite the Mello-Roos deep freeze, defaults in the payment of special taxes have not increased significantly. Draws on the reserve funds that secure Mello-Roos bonds, however, have been rising since 2008.

"If we don’t act," said Governor Arnold Schwarzenegger on June 2, 2009, to a joint session of the California Legislature, "the state will simply run out of money and go insolvent." Tough words to sell some tough budget cuts. Californians recently rejected several ballot measures designed to minimize the state’s runaway budget deficit, which is now projected at $24 billion. State Controller John Chiang has warned that, without a budget, the state will likely run out of cash by July 31, 2009, a situation that has contributed to the lowest rating of all 50 states on California’s general obligation bonds.

The Governor’s proposed budget contains approximately $21 billion in spending cuts, which target many social services, including Medi-Cal, public education, and prisons. The Governor also proposes to finance $5.5 billion of the deficit with revenue anticipation warrants, a debt instrument that is typically used to cure temporary cash flow problems, rather than large-scale budget deficits. The Governor’s budget does not include an increase in existing tax rates. It does, however, propose several strategies to increase revenue, including a 10% increase in personal income tax withholding, accelerated estimated tax payments, and the sale of parts of the State Compensation Insurance Fund. The Constitutional deadline for passing a budget was June 15, 2009.

On July 1, 2009, the Electronic Municipal Market Access (EMMA) web-based platform will replace the current information repositories (including DisclosureUSA) as the filing service for all secondary market continuing disclosure filings. EMMA was designed and will be administered by the Municipal Securities Rulemaking Board in response to ongoing complaints about the inability of the current system to provide adequate dissemination of and access to disclosure data. EMMA also is expected to offer free access to official statements and trading information relating to municipal securities. On and after July 1, 2009, all issuers and other obligors subject to continuing disclosure obligations with respect to municipal securities issued after July 1, 1995, will be required to file continuing disclosure reports solely through EMMA.

The yield on AAA-rated municipal bonds dropped slightly during the last month from 4.71% to 4.69% on 30-year bonds, but stayed level for 10-year bonds at 3.21%. During the same period, the yield on Treasuries rose from 4.08% to 4.53% on 30-year bonds and from 3.19% to 3.67% on 10-year notes, bringing the 10-year municipal-treasury yield ratio under 100% for the first time this year.

Source:
Bloomberg (www.bloomberg.com)

Some indicators relevant to the bond market improved slightly during the last couple of months. From April to May 2009, the consumer price index increased by 0.3% and existing home sales increased by 2.4%. Housing starts continued to slide, however, decreasing by 12.8% in April. 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)