Public Finance Update - May 2011 May 26, 2011
In This Issue

Governor's Revised Budget No Help to California's Shrinking Bond Market

California Governor Jerry Brown released his revised State budget earlier this month.  Under the proposal, Governor Brown plans to reduce general obligation bond sales by approximately 60%.  Some municipal finance analysts argue that the Governor’s efforts to mitigate the State’s mounting debt and to raise the State’s credit rating through curtailing California bond sales may further tighten yield spreads for California securities, but also prompt investors to search for alternative investments in an already supply-constrained market.

The Governor’s original budget, delivered in January of this year, projected a $25.4 billion deficit for fiscal year 2011-12, and proposed a combination of spending cuts and tax extensions as a remedy.  Many of the Governor’s proposed spending cuts have been adopted by the California Legislature, and additional tax receipts of $2.5 billion are expected, thus leaving a revised budget deficit of $9.6 billion.  Balancing of the budget, however, still remains dependent on the Governor obtaining legislative and voter approval to extend several expiring taxes. According to the Governor, without the tax extensions, additional cuts to State spending must occur.

Brown Still Hunting Redevelopment Agencies

In his revised State budget released this month, Governor Jerry Brown renewed his call for the elimination of California redevelopment agencies (“RDAs”). The Governor continues to argue that the demise of RDAs will yield approximately $1.7 billion in fiscal year 2011-12 to pay for Medi-Cal and trial court services and, thereafter, the tax increment currently flowing to RDAs will be better utilized by cities, counties, special districts and K-14 schools.

Redevelopment proponents have countered the Governor’s proposal with Senate Bill 286, introduced by Senator Rod Wright (D-Los Angeles). If adopted, SB 286 would reform the current redevelopment law in California, while preserving the RDAs and their basic functions.  Among other things, SB 286 would:

  • Exempt schools from contributing to redevelopment for new and expanded redevelopment project areas adopted after January 1, 2012
  • Limit the total amount of land that can be included in a new or expanded redevelopment project area
  • Prohibit uses of property tax increment revenue for: (a) vacant land of 20 acres or more that has not previously been developed (with an exception for military base conversions); (b) a golf course, race track or racing venue; and (c) a stadium, coliseum, arena or other professional sports facility without voter approval
  • Expand redevelopment authority to include direct assistance for industrial and manufacturing uses and to increase energy efficiency, reduce greenhouse gas emissions and facilitate infill development
  • Heighten blight evidentiary requirements
  • Provide a mechanism for establishment of standard tax increment pass-through methodology
  • Cap interest rates on money borrowed from the local legislative body
  • Require performance audits of RDAs by the State Auditor and provide funds for those reviews
  • Require community input and additional information on implementation plans

SB 286 is still being considered by the Senate Governance and Finance Committee and no hearing is currently scheduled. Click here for a copy of SB 286 or information regarding the status of the bill.

Investors Beware: Special Assessments May Be Larger Than You Think

In 2004, Johnny Ribeiro, a seasoned real estate investor, thought he had found a sweet deal: a plot of commercial property being sold at a tax sale by the County of El Dorado, California, for $834,000, which was appraised for substantially more.  Available documentation showed approximately $560,000 in delinquent taxes and indicated there was a lien against the property for special assessments authorized under the Improvement Bond Act of 1915 (California Streets and Highways Code Section 8500, et seq.). Mr. Ribeiro understood there were delinquent special assessments encumbering the property, but did not know the amount of those delinquencies.  The auctioneer warned that the sale was subject to the principle of caveat emptor – “buyer beware.” Unable to confirm the amount of delinquent special assessments, Mr. Ribeiro assumed such delinquencies must equal the difference between the required opening bid and the amount of delinquent property taxes – approximately $250,000 – and so submitted his winning bid and paid the 10% deposit of $83,400.

Several weeks later, Mr. Ribeiro received a document from the County Auditor-Controller showing delinquent special assessments securing outstanding bonds in the amount of $2.7 million, rendering the property, as he would later state in his lawsuit, “economically unviable.”  Mr. Ribeiro canceled his purchase and sued the County for the return of his deposit.  The trial court ruled in Mr. Ribeiro’s favor, but the California Court of Appeal, Third District, reversed that decision, upholding previous California Supreme Court precedent that “there is no relief for a buyer at a tax sale who has made an unwise bid based on incomplete or incorrect information.”

Ribeiro could not invoke statutory remedies because the tax sale was not fraudulent or improper.  Ribeiro then sought the equitable remedy of rescission due to mistake. The court, however, concluded that caveat emptor “precluded a dissatisfied buyer at a tax sale from recovering, except as explicitly allowed by statute.”

The lesson: A buyer at a tax sale must do its lien homework, and that includes checking all sources, including the county, the issuer of bonds, tax bills and title reports.

Bond Market Snapshot

Municipal bond yields continued their steady decline since February 2011.  Yields dropped from 4.78% to 4.32% for 30-year municipal bonds and from 3.05% to 2.59% for 10-year municipal bonds.  Yields on Treasuries also fell in May, declining from 4.41% to 4.26% for 30-year bonds and from 3.33% to 3.14% for 10-year notes. Importantly, spreads between municipals and Treasuries narrowed.

Source: Bloomberg (www.bloomberg.com)