Public Finance Update - January 2011

In his proposed budget, released on January 10, 2011, California Governor Jerry Brown recommended the elimination of the State’s redevelopment agencies and the redirection of the tax increment currently controlled by those agencies to pay for certain local services, primarily education. California has repeatedly tapped the pool of tax increment received by redevelopment agencies to help shore up budget deficits. As recently as 2009, Assembly Bill X4 26 authorized the redirection of $2.05 billion from redevelopment agencies to the Supplemental Educational Revenue Augmentation Fund. Brown’s suggestion to wholly eliminate all redevelopment agencies, however, is an unexpectedly dramatic solution to the State’s current budgetary woes.

The Governor’s proposed budget recommends the following steps in the elimination of the redevelopment agencies:

• Enact urgency legislation to prohibit existing redevelopment agencies from undertaking new contracts or obligations.
• “Disestablish” existing redevelopment agencies as of July 1, 2011.
• Create successor agencies to gradually retire the debt of former redevelopment agencies.
• Transfer all redevelopment agency monies designated for low- and moderate-income housing to local housing authorities.
• Beginning in fiscal year 2012-13, distribute tax increment (other than increment needed for pre-existing debts and contractual obligations) to cities, counties, and school districts in the amount of each such entity’s proportionate share of property taxes. Such amount is expected to total approximately $3 billion annually.

In his proposed budget, Brown argues that “the state’s investment in local economic development and redevelopment agencies is less critical than other activities.”  He suggests that, in lieu of the redevelopment agency system, a constitutional amendment should be passed that would provide for limited tax increases and bonding against local revenues for such purposes, subject to 55% voter approval.

Some industry participants are concerned that the demise of redevelopment agencies, which were first authorized in 1945, will cause economic hardship and will not yield the expected budgetary benefit. For instance, Los Angeles Mayor Antonio Villaraigosa has said that “eliminating redevelopment projects and enterprise zones will kill jobs and shift the entire burden of the budget on cities.” John Shirey, Executive Director of the California Redevelopment Association, calls the recommendation “another gimmick that will likely result in extensive litigation.” Other local agencies, including some school districts, fear that, in anticipation of the new local revenue stream, the State will prematurely cut their existing budgets.

Governor Brown has implored the State Legislature to adopt a 2011-12 budget package by March 2011, so that he can put certain of his suggested tax measures on the June ballot. Many legislators expressed doubts, however, as to whether his fast-track schedule can be met, given the magnitude of the spending cuts and tax increases currently on the table.

Governor Brown’s proposed budget is available here.

The Government Accountability Office (“GAO”), in response to a mandate contained in the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”), recently released a report concerning the funding and relevance of the Government Accounting Standards Board (“GASB”). According to the report, GASB’s funding is historically sporadic and increasingly insufficient.

GASB was formed in 1984 to establish generally accepted accounting principles for U.S. state and local governments. Funding for GASB derives from two sources: voluntary contributions from states and local governments and the sale of GASB publications. Since its formation, GASB has struggled to meet its annual operating budget. Moreover, according to the GAO’s report, voluntary contributions to GASB have declined significantly in recent years.

GASB funding has dropped so significantly, in fact, pressure may be mounting on the Securities and Exchange Commission (“SEC”) to quickly enact another provision of Dodd-Frank related to GASB funding. Such provision requires the SEC to direct the Financial Industry Regulatory Authority (“FINRA”) to collect fees from securities dealers to partially fund GASB. Drafters of Dodd-Frank intended this fee provision to mitigate the conflict of interest inherent in GASB’s reliance on funding from the entities it is required to monitor. Before it can levy the GASB fees, however, FINRA is required to announce the proposed fees and invite public comment.

The GAO report is available here.

A recent decision by the California Court of Appeal, Second Appellate District, has expanded the application of prevailing wage laws to the construction of public improvements that are privately financed. In Azusa Land Partners v. Department of Industrial Relations (Dec. 21, 2010, No. B218275), the appellate court affirmed a lower court’s ruling that the acceptance by a developer of Mello-Roos bond proceeds to pay for a portion of public improvements in a mixed-use project rendered the entire project a “public work” under the California Labor Code (the “Code”). The consequence: All public improvements required to be constructed as a condition of regulatory approval for the project – including those financed privately – are subject to prevailing wage laws.

The project in question is a master-planned community called “Rosedale” located on approximately 517 acres in the City of Azusa, which was originally planned to include over 1,200 dwelling units, commercial uses, parks and open space, a school, a fire station, and a light rail transit center. In 2005, the City formed a Mello-Roos district, which included two improvement areas, for the purpose of issuing bonds to help pay for certain public infrastructure required for the project. Bonds to finance improvements in the first improvement area were issued in February 2007.

Prior to the issuance of the bonds, the Department of Industrial Relations (the “Department”) had launched an investigation as to whether, due to the proposed funding of a portion of the public improvements with the Mello-Roos bonds, the entire project constituted a “public work” under Section 1720 of the Code, which would subject the project to the prevailing wage laws.  In October 2007, the Department issued a letter ruling (confirmed in July 2008), concluding:

1. proceeds from the Mello-Roos Bonds constitute “public funds” for purposes of Section 1720(b)(1) of the Code;
2. because it is to be partially funded with public funds, the Project constitutes a “public work” for purposes of Section 1720(a)(1) of the Code; and
3. pursuant to an exemption provided under Section 1720(c)(2) of the Code, the private development portion of the project is not subject to prevailing wage requirements, but all of the public improvements required as a condition of regulatory approval are subject to the prevailing wage requirements, regardless of whether publicly or privately funded.

The developer filed suit challenging the Department’s determinations. The trial court decided in favor of the Department, and its ruling was affirmed by the California Court of Appeal.

The appellate court’s decision, which is available, clearly favors a broad application of prevailing wage laws in connection with any type of financial assistance from governmental entities. Questions remain, however, as to exactly how the decision will affect projects currently in development, projects in the planning stages, unfinished projects that have one or more completed phases, and projects that have been completed.

This month, municipal bond yields continue to outpace treasuries. The January 2011 yield on AAA-rated municipal bonds increased from 4.86% to 5.20% for 30-year bonds and from 3.38% to 3.56% for 10-year bonds. Yields on treasuries also increased modestly from 4.44% to 4.56% for 30-year bonds and from 3.34% to 3.37% for 10-year notes. Despite the continued increases in yields, both demand and prices for municipal bonds continue to decline, with the exception of Build America Bonds, which investors continue to snap up. The authorization to issue new Build America Bonds expired on December 31, 2010.

Source: Bloomberg (www.bloomberg.com)