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California COP Issue Opens Eyes

SAN FRANCISCO — A bond issue that allowed Oxnard, Calif., to securitize future state gas tax payments to the city should pave the way for many more such transactions, according to participants in the deal. The $27.7 million in Oxnard gas tax revenue certificates of participation, which closed Tuesday, is believed to be the first of its kind in California, though more are in the pipeline. Proceeds will be applied to the city’s street improvement program. “Generally through the budget process there’s not typically enough funds to allocate annually to do capital improvements for streets,” said Michael More, financial services manager for Oxnard. “We looked for a way to take our gas tax revenues apportioned by the state and monetize that cash flow in the form of a bond issue.” California collects an 18-cent-per-gallon tax on gasoline. Some of the proceeds are distributed to local governments for transportation purposes based on pre-set formulas. Standard & Poor’s assigned the Oxnard transaction an underlying rating of A; the deal is wrapped by XL Capital Assurance Inc. Though Standard & Poor’s rates similar bonds in other states, it was the first such rating in California, according to analyst Rob Williams. “It just came from working with the city,” said John Kim, principal at underwriter De La Rosa & Co. “We were just trying to come up with different ideas.” The firm is also underwriter for other deals that follow the template of the Oxnard transaction: a $60 million deal for Santa Ana, which priced Wednesday, according to Kim, and a planned pool transaction to be assembled through the California Statewide Communities Development Authority. The legal structure of the Oxnard transaction involved the city selling the streets in question to a joint-powers agency, and purchasing them back through an installment purchase agreement, which was securitized through the certificates of participation, said Bruce Graham, partner at Goodwin Proctor LLP, special counsel to Oxnard. The legal structure needed to be strong enough to garner an investment-grade rating without requiring any kind of city general fund pledge, said Lew Feldman, chair of Goodwin Proctor’s Los Angeles office. Oxnard received about $3.4 million annually from state gasoline tax distributions as of 2006. Historically, the state tax revenues have funded street projects on a pay-as-you-go basis, but that was only enough to patch up streets suffering from deferred maintenance, More said, adding that the bond issue allows the city to adopt a more cost-effective approach. “The idea is to put the money into capital improvements and maintain the streets over the life of the improvements so that ultimately you end up spending less money,” he said. “Our engineers tell us that if the streets are reconstructed and you maintain them appropriately, then you’ll get more life out of them than if you just do the annual slurry seals and patching of older streets.” The California fuel tax proceeds are distributed to cities through formulas set in state law. “The relative population of the entity is usually the biggest driver,” Standard & Poor’s analyst Chris Morgan said. The state is permitted to borrow against those gas tax revenues for three years to boost the general fund when the governor declares a fiscal emergency. Gov. Arnold Schwarzenegger has already said he will declare a fiscal emergency in 2008, though the per-gallon gas tax has emerged unscathed from recent state budget crises. California has borrowed against a separate sales tax on gasoline. That uncertainty is incorporated into the single-A rating, according to Standard & Poor’s. Proposition 91, a measure on the state’s February ballot, would bar such multi-year borrowing against gas taxes. The Oxnard deal closed Tuesday after pricing the preceding Tuesday, and the intervening week was not lacking for stress, More said. The pricing was one day before Fitch Ratings put insurer XL’s AAA rating on watch for possible downgrade, and three days before Moody’s Investors Service did the same with its Aaa rating. “As it turns out, from my understanding we didn’t have any buyers back out,” More said Tuesday, after closing. Standard & Poor’s this Wednesday revised its outlook for XL’s AAA rating to negative. The Oxnard deal was priced with yields from 2.97% for Sept. 2008 maturities to 4.87% for 2037 term certificates. The Santa Ana gas tax deal also received an underlying A rating from Standard & Poor’s. Fieldman, Rolapp & Associates was financial adviser for Santa Ana. Orrick, Herrington & Sutcliffe LLP was special counsel and Quint & Thimmig LLP was disclosure counsel. Both the Oxnard transaction and the Santa Ana transaction were validated in court in advance of the respective issuances. That’s a fairly standard procedure when there is a new debt security, according to Goodman Procter’sFeldman. “It was, in the early days of special tax obligations, de rigueur to validate prior to the issuance of any debt, so that there would be no doubt to the market,” he said. “In this case, with an insurer having guaranteed the obligation, validation would be most important to that insurer, as opposed to the market in general.” Though Oxnard’s gas tax deal has closed, it won’t be enough to keep all the city’s streets in good repair, More said. The city’s redevelopment agency recently sold tax-increment bonds to finance street improvements in redevelopment project areas, he said. “We still have a long way to go and the challenge is to find more funds to continue to do street improvements,” More said.

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