Public Finance Update - October 2010

Governor Schwarzenegger has finally signed a budget for California, a record 100 days after the deadline. However, according to a report recently released by California’s Legislative Analyst’s Office, most of the solutions for the current $19 billion budget deficit are “one-time or temporary in nature,” which means California will likely face similarly large budget deficits in upcoming fiscal years. In fact, the most favorable projections show the new budget producing a $10 billion revenue shortfall for fiscal year 2011-12.

The new budget provides for approximately $87.5 billion in spending, expunging a previously projected $19 billion deficit, and Governor Schwarzenegger employed his line-item veto to cut an additional $965 million before signing the budget bills. Passage of the budget frees California Treasurer Bill Lockyer to begin issuing $10 billion in short term notes and to continue pursuing a $5 billion bridge loan from Wall Street banks that is hoped to eliminate the need for IOUs to pay upcoming State expenses.

Some of the assumptions and spending provisions in the new budget include the following:

Revenue Projections

• $5.3 billion in federal aid ($2 billion more than Governor Schwarzenegger’s May projection)
• $1.4 billion in additional tax revenue (based on presumption of economic improvement)
• $1.2 billion from sale of 11 state properties – the so-called “Golden State Portfolio”

Budgetary Adjustments

• Deferment of $1.8 billion owed to K-14 schools
• Reduction of budget reserve to $200 million (Governor Schwarzenegger requested $1.2 billion)
• $1.4 billion from the delay of a corporate tax break for two years

Spending Reductions

• $3.1 billion in Proposition 98 school funding
• $1.5 billion in State employee pay and pension benefits
• $1.1 billion in Department of Corrections and Rehabilitation expenses
• $937 million in health and human services programs
• $212 million from higher education (presuming increased federal funding)

The Milken Institute, a public charity and economic think tank, held its 12^th annual State of the State Conference on October 19 at The Beverly Hilton Hotel. Leaders in business and government met to discuss issues and propose solutions to California’s current economic woes.

Panels included:

Advice from Leading CEOs: How to Fix California. Michael Milken led this panel of top level CEOs as they discussed the most important issues California currently faces, the most important of which is education. Panelists included Art Coppola, Chairman and CEO of Macerich, Theodore (Ted) Craver Jr., Chairman, President and CEO of Edison International, Kellie Johnson, President and CEO of Ace Clearwater Enterprises, and Michael Lynton, Chairman and CEO of Sony Pictures Entertainment.

Politics, California Style: Can We Break the Gridlock? Frank Luntz, CEO of The Word Doctors and author of Words That Work and What Americans Really Want...Really, led a panel discussion of the current state of politics in California. Panelists included Bill Carrick, Democratic Strategist and owner of Carrick Consulting, Susan Estrich, the Robert Kingsley Professor of Law & Political Science at USC Gould School of Law and a partner at Quinn Emanuel Urquhart & Sullivan LLP, Steve Schmidt, Vice Chairman of Public Affairs at Edelman and former Senior Advisor to the John McCain Presidential Campaign, and Don Sipple, President of Sipple:Strategic Communications.

Keeping California on the Cutting Edge of Innovation. Nancy McFadden, Senior Vice President and Senior Advisor to the Chairman and CEO of PG&E Corp., led a panel discussion regarding jobs and innovation in California. Panelists included Kevin Czinger, President and CEO of Coda Automotive, Tim Draper, Managing Director of Draper Fisher Jurvetson, Pervaiz Lodhie, President and CEO of LEDtronics Inc., Perry Wong, Director of Regional Economics at the Milken Institute, and Shariq Yosufzai, Vice President of Chevron Corporation.

Public Pensions: How to Protect Workers – and Taxpayers. Emily Chang, Anchor at Bloomberg TV, led a panel discussion regarding solutions for California’s pension woes. Panelists included Jon Hamm, CEO of the California Association of Highway Patrolmen, Jerilyn Harris, Chair of the California State Teachers’ Retirement System, Dennis Hollingsworth, State Senator and Minority Leader, Bill Lockyer, California State Treasurer, and Scott Minerd, Chief Investment Officer of Guggenheim.

Click here for summaries and videos of the various programs.

In an apparent effort to quell growing concerns in the marketplace regarding its enforcement of issuer compliance with respect to the Build America Bond (“BAB”) program, the Internal Revenue Service recently posted a notice on its website clarifying some of its enforcement policies. According to the notice, the IRS “is aware that BABs and other direct-pay bonds present novel interpretive issues and factual scenarios for issuers” and, “[a]s such, compliance programs with respect to direct-pay bonds will reflect both the [IRS’s] responsibility to promote compliance and its recognition of the importance of reasonable efforts to achieve compliance in light of such issues and scenarios.”

The notice indicated that the IRS plans to update its voluntary closing agreement program (“VCAP”) so that issuers may “resolve violations on a basis proportional to the violation.” The VCAP is a program that allows issuers to resolve violations of the Internal Revenue Code by voluntarily entering into closing agreements with the IRS, which usually result in smaller penalties than would otherwise be assessed if the violations were uncovered in an audit.

Among other things, the VCAP updates being considered for BABs are expected to address the standards for violating the “de minimis” limitation on premiums and the requirement that 100% of the available proceeds must be used for capital expenditure, issuance costs, and a reasonable reserve fund. Until such changes are incorporated, the IRS has stated in its notice that issuers may still utilize the current tax-exempt version of the VCAP to resolve issues with their BABs.

You can read the IRS notice here.

The October 2010 yield on AAA-rated municipal bonds increased slightly from 4.08% to 4.19% for 30-year bonds and from 2.30% to 2.59% for 10-year bonds. Yields on 30-year treasury bonds also increased slightly from 3.74% to 3.91%, but decreased on 10-year treasury notes from 2.67% to 2.56%, dipping below munis once again.

 

Source: Bloomberg (www.bloomberg.com)