Public Finance Update - August 2011

The California Supreme Court (the “Court”) has agreed to hear a lawsuit challenging the constitutionality of Assembly Bill No. 26 (“ABX1 26”) and Assembly Bill No. 27 (“ABX1 27”) (collectively, the “Redevelopment Bills”). Governor Jerry Brown signed the Redevelopment Bills into law at the end of June 2011 as part of California’s budget package. The California Redevelopment Association and the League of California Cities subsequently filed the lawsuit alleging, among other things, that the Redevelopment Bills violate certain provisions of the California Constitution. The plaintiffs also requested the Court to issue a stay, which would stop the Redevelopment Bills from taking effect while the Court considers the case.

The Court stayed the enforcement of the Redevelopment Bills in many respects, but not completely.  Until the case is decided, certain restrictions on redevelopment agency operations that were imposed by ABX1 26 will remain in effect, including prohibitions against incurring new debt, acquiring or transferring property, modifying existing contracts, and entering into new contracts.

The Court established an expedited schedule for briefs and oral arguments to facilitate its stated goal of rendering a decision by January 15, 2012. 

For a more detailed description of the Redevelopment Bills and the legal issues addressed in the lawsuit, click here.

As we reported in Goodwin Procter’s August 11, 2011 Client Alert, “S&P Downgrades U.S. Credit – Muni Bonds Hang Tough,” Standard & Poor’s Ratings Services (“S&P”) downgraded the rating on the United States’ sovereign debt from AAA to AA+, and subsequently downgraded over 11,000 state and local bond issues, including thousands of pre-refunded bonds that were defeased by U.S. Treasuries.  Many issuers of pre-refunded bonds have expressed concern as to whether a rating downgrade on defeased bonds requires the filing of an event notice under Securities and Exchange Commission (“SEC”) Rule 15c2-12.

According to an alert recently released by the National Association of Bond Lawyers (“NABL”), unless the controlling documents provide otherwise, the SEC has indicated that the legal defeasance of bonds generally terminates an issuer’s continuing disclosure agreement.  Therefore, most issuers do not have to disclose a rating downgrade on pre-refunded bonds.

Notwithstanding the foregoing, NABL encourages issuers to consult their bond counsel as to the disclosure requirements relating to a specific issuance.  Should it be deemed advisable to do so, a notice regarding a rating downgrade may easily be filed using the EMMA system maintained by the Municipal Securities Rulemaking Board.

Michael Bartolotta, chair of the Municipal Securities Rulemaking Board (“MSRB”), recently sent a letter to Elisse Walter, commissioner of the Securities and Exchange Commission (“SEC”), recommending more stringent enforcement of continuing disclosure obligations.  Mr. Bartolotta noted in his letter that “there is limited accountability” of bond issuers and borrowers who choose not to comply with their disclosure obligations and recommended that the SEC “consider issuing more interpretive guidance in this area and amending Rule 15c2-12, as necessary to impose consequences for noncompliance with continuing disclosure undertakings.”

In his letter, Mr. Bartolotta recommended several specific actions the SEC should consider, including:

• Requiring more “robust” disclosure in official statements regarding previous failures to provide continuing disclosure.
• Requiring disclosure agreements to include enforceable remedies for noncompliance, such as enforcement rights for investors or the engagement of professionals to assist with compliance.

Mr. Bartolotta also addressed specific areas of disclosure in his letter, recommending that the SEC provide guidance in the following areas:

• Enhanced disclosure for variable rate instruments.
• Disclosure regarding underlying obligors in transactions with liquidity providers or credit enhancers.
• Uniform disclosure regarding risk factors.
• Disclosure regarding conflicts of interest, particularly with respect to payments made and received by third parties, such as swap or guaranteed investment contract providers.

Industry reaction to Mr. Bartolotta’s letter has been mixed. Most market participants favor transparency and complete information for investors.  Some observers have noted, however, that the SEC’s jurisdiction is limited to municipal securities brokers and dealers, making it difficult for the agency to impose sanctions on issuers and borrowers for disclosure noncompliance.

Judge Michael McManus of the United States Bankruptcy Court, Eastern District of California, has approved the restructuring plan for the City of Vallejo (the “City”), clearing the way for the City to emerge from Chapter 9 bankruptcy.  The City filed for bankruptcy protection in May 2008, claiming it could no longer maintain normal operations under its crushing budget deficits and dwindling revenues.  The case represented the largest municipal bankruptcy filing since Orange County’s bankruptcy in 1994.

Under the approved restructuring plan, Union Bank, who owns $45 million of the City’s certificates of participation (“COPs”), will receive approximately 53% of the principal and interest payments otherwise due to the bank.  In addition, payments to National Public Finance Guarantee, Corp., the insurer of a portion of the COPs, will be deferred for a year and paid at a lower interest rate. Bonds backed by specific revenue streams will remain unaffected under the restructuring plan.

Unsecured creditors, whose claims total approximately $262 million, will receive only a small percentage of the amounts claimed, which moneys will be paid over a two-year period from a fund of $5.9 million.  The restructuring plan includes cuts to retiree health care, reduced pension benefits for new employees, and increased contributions from current municipal employees.

In August, yields on both Treasuries and municipal securities dropped precipitously, despite the SEC’s rating downgrade of U.S. sovereign debt.  Yields on 10-year Treasury notes dropped from 2.95% to 2.19%, dipping as low as 2.07% during the month.  Yields on 30-year Treasuries fell from 4.26% to 3.60%.  Yields on municipal bonds fell from 2.74% to 2.20% on 10-year bonds and from 4.37% to 3.85% on 30-year bonds.

Source: Bloomberg (www.bloomberg.com)