Public Finance Update - April 2010

Moody’s Investors Service recently raised the credit ratings of 34 states and Puerto Rico, marking the first stage in a massive ratings adjustment expected to affect tens of thousands of outstanding municipal securities.  Earlier this month, Fitch Ratings implemented similar changes in its rating methodology, resulting in a ratings increase for over 38,000 municipal securities.  Both agencies have been careful not to characterize the higher ratings as upgrades, but instead refer to them as “recalibrations.”

The diagnostic changes implemented by the two rating agencies were designed to more closely emulate the criteria used in the private sector, which focus more on payment histories and default probability than on “distance to distress” models.  California and Puerto Rico were the most notable beneficiaries of Moody’s recalibrations, each rising three rating grades – from Baa1 to A1 for California and from Baa3 to A3 for Puerto Rico.

Market observers expect the Fitch and Moody’s recalibrations to stimulate the municipal securities market, especially the market for short-term securities, by attracting additional investors looking for more secure investments.   An increase in the volume of long-term tax-exempt securities may still take time, however, if issuers use their higher credit ratings to access the Build America Bonds (“BABs”) market instead.  BABs are taxable bonds that have been available to municipal issues since 2009.  An increase in the issuance of BABs tends to depress the market for long-term tax-exempt municipal bonds.

Moody’s Investors Service and Fitch Ratings recently downgraded the City of Los Angeles’s general obligation debt to Aa3 and A+, respectively.  Standard & Poor’s has not reduced its AA- rating on L.A.’s G.O. debt, but recently put the debt on a negative credit watch.  Fitch also downgraded certain of the City’s certificates of participation and lease revenue bonds.

The rating downgrades are thought to stem from L.A.’s budget woes and the recent standoff between Mayor Villaraigosa and the City Council over job cuts and utility rates.  Los Angeles has projected a $148.9 million budget deficit for fiscal year 2009-10, and the Mayor’s budget proposal for fiscal year 2010-11, released April 20, 2010, paints an even bleaker picture.  In his State of the City address, presented in conjunction with the release of his new budget proposal, the Mayor warned that “painful” layoffs and service cuts would be required to bridge the $485 million budget deficit for the coming fiscal year.

Home builders are expressing renewed confidence in their industry, prompted in part by home buyers scrambling to utilize tax credits that expire at the end of April.  In fact, the Housing Market Index – the gauge published by the National Association of Home Builders that measures builder confidence in home sales – rose from 15 in March to 19 in April, a score that has not been seen since September 2009.  Although new home construction actually fell slightly in March, housing construction as a whole rose to its highest level in nearly 16 months, bolstered by better-than-expected multifamily construction numbers.

According to Fannie Mae’s April 2010 Economic Outlook, however, the housing recovery may be hindered in the coming months by excess inventory and pending foreclosures.  Persistent unemployment may also delay the recovery, although most economists believe that the 10.1% unemployment figure in October 2009 will stand as this recession’s peak.

Nevertheless, the median home price in California rose 14% during the past 12 months – the highest annual increase in more than four years – and the state’s median home price rose from $223,000 to $255,000 for the same period, representing the fifth consecutive month of year-to-year increases following two years of decreases.

In 1990, the Securities and Exchange Commission added Rule 15c2-12 to the rules and regulations promulgated under the Securities and Exchange Act of 1934.  In its current form, Rule 15c2-12 prohibits underwriters from purchasing municipal securities unless the issuer and, if applicable, the conduit borrower have agreed in writing to provide periodic financial information and notices of certain specified events, such as defaults and bankruptcies.  Failure to comply with a continuing disclosure obligation constitutes the breach of the underlying contract, for which the damaged party or beneficiary (in this case, the investors) may file an action to compel performance.  In addition, while Rule 15c2-12 does not provide specific consequences for a failure to provide continuing disclosure information, such a failure must be disclosed in connection with any future municipal financing, which could affect the price at which such future securities can be marketed.

Goodwin Procter provides compliance services and expert counsel with respect to continuing disclosure obligations relating to government securities.  We represent all entities with disclosure obligations, including government issuers and private obligated parties.

The April 2010 yield on AAA-rated municipal bonds has stayed level for 30-year bonds at 4.44% and has increased slightly for 10-year bonds from 3.04% to 3.22%.  Treasury yields decreased slightly from 4.73% to 4.62% on 30-year Treasury bonds and from 3.85% to 3.74% on 10-year Treasury notes.

 

Source: Bloomberg (www.bloomberg.com)