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California RDAs Ready to Cope

JUL 21, 2011 10:05pm ET
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SAN FRANCISCO — The majority of California redevelopment agencies will likely survive new laws aimed at shrinking or eliminating them, but some worry about outstanding bonds issued by the agencies and what market access they will have in the future.

Facing new laws that force them to either pony up an estimated $2.1 billion over the next two years to schools and special districts or be axed, roughly 80% of redevelopment agencies will make every effort to come up with the cash, according to a recent survey by the California Redevelopment Association.

But with the legislation likely to stamp out at least 20% of RDAs, there is unease about the impact of changes to bond covenants that the laws will bring about.

John Shirey, executive director of the CRA, claimed in a sworn declaration in a lawsuit filed against the new laws that the legislation “materially” weakens protections for bondholders and other creditors.

The League of California Cities and the CRA, along with San Jose and Union City, filed a suit Monday in state Supreme Court, calling the new laws unconstitutional.

According to the declaration, the new law replaces pledges by the redevelopment agencies and prioritized liens with a statutory commitment to pay from a commingled pool of property tax revenues.

Shirey said it creates a redevelopment property tax trust fund that does not actually establish a trust relationship to protect bondholders, which may violate bond covenants.

“They are clearly uneasy about this legislation,” Shirey said.

The 399 active RDAs have $20.6 billion of tax-allocation bonds outstanding, while total indebtedness is $87.5 billion, according to the CRA.

Some in the business say bondholders are protected.

Jim Cervantes, a managing director in Stone & Youngberg’s San Francisco office, said the state has been very clear it is not jeopardizing bonds issued by the redevelopment agencies, even though the payment structures may get modified.

“We are quite confident the bonds will get paid,” Cervantes said. “We are not agnostic on this point.”

Lewis Feldman, a partner at the law firm Goodwin Procter in Los Angeles and head of their public-private development practice, said bondholders should be protected regardless of the new laws because the government cannot void public third-party contracts.

The $2.2 billion in debt service for bonds and other payments will be set aside for creditors from the $5 billion in annual RDA tax increment revenue, according to H.D. Palmer, a spokesman for the state Department of Finance.

“Before anything else happens, that gets taken right off the top,” Palmer said.

Rating agency analysts have said the laws could actually benefit owners of existing bonds because some agencies unable to issue any new debt would see their debt load stabilize.

The two-part legislation eliminates all California RDAs on Oct. 1 unless the cities and counties operating them pass an ordinance to remit revenues to schools and special districts. The agencies would be forced to collectively give up an estimated $1.7 billion this year and $400 million next year.

The agencies collect an incremental property tax in designated areas and use it to back bonds that fund economic development and affordable housing in areas declared to be “blighted.”

In California, a redevelopment agency must use 20% of its revenue for affordable housing development. The remaining 80% is normally used for economic development. This usually creates two different revenue streams backing bonds: housing and non-housing.

RDAs have come under fire because other local agencies do not share the incremental tax revenue, which is the amount of taxes generated by development after a redevelopment zone has been established. Some critics say the agencies sometimes fund development that has little to do with improving rundown areas.

The share of total statewide property taxes collected by RDAs has risen to 12%, according to a report this year from the nonpartisan Legislative Analyst’s Office.

The effort to do away with RDAs has prompted those agencies to step up issuance while they can. As of the end of June, California redevelopment agencies had already sold $1.33 billion of tax-allocation bonds, after issuing only $1.8 billion in all of 2010, according to Thomson Reuters.

Passage of the new laws in June brought new RDA issuance to a standstill and it is unclear that even if a majority of agencies survive, they will be able to issue new debt anytime soon.

Feldman said while the legal questions remain unsettled, bond counsel would likely be unable to issue a clean opinion to support debt issuance. He said if one part of the law is upheld and not the other, it would legally preclude agencies from being able to issue bonds.

The dissolution law is also written in a way that would penalize any agency opposing it by barring it from being able to issue debt, according to Feldman.

“Until the Supreme Court decides this lawsuit,” he said, “it is going to freeze out the agencies from being able to issue any new debt.”

In the 126-page suit, the plaintiffs point to Proposition 22, a ballot measure passed in 2010 they say prohibits state politicians from taking or interfering with revenue dedicated to local governments.

The suit asks the court to grant a temporary stay by Aug. 15 to prevent the implementation of the new laws while the case is ongoing.

The defendants in the suit include state finance director Ana Matosantos, Controller John Chiang, and Patrick O’Connell, auditor-controller of Alameda County and a representative of county auditor-controllers.

Palmer said Proposition 22 does not apply to the new law because the ballot measure dealt specifically with tax increment and the legislation does not limit RDAs’ required payments to tax increment.

“Redevelopment agencies were created by an act of the Legislature back in 1945, and similarly they can be dissolved by an act of the Legislature,” Palmer said.

The spokesman added that even if the court grants the stay, the agencies would still be prevented from issuing debt in the meantime.

“I think there won’t be any bonds issued between now and the end of the year,” Shirey said. “And if we are successful in our lawsuit, we will see agencies try to get back into business.”

Several cities filed declarations in support of the petition, including Oakland, Modesto and Brentwood, because they claim the new law and the attack on RDAs have serious negative implications for them.

They assert that major redevelopment projects will be stalled and left unfinished. Others also worry about the impact on affordable housing.

“We are taking the position that the state’s actions are illegal and that is irreparable harm,” said San Jose finance director Scott Johnson. “It is a big concern of ours.”

Johnson said the city already has to use $10 million from its general fund for RDA debt service because property values have decreased, reducing tax-increment revenue. Additionally, he said the city has a parking revenue fund that is a backstop for the San Jose Redevelopment Agency that is set to pay debt service over the next two years.

The city is at risk for about $63 million due to other loans it has made to the redevelopment agency that are unenforceable under the new laws, Johnson said.

He said San Jose would also have to pay about $50 million this fiscal year to the state under the new law and $10 million to $11 million on an ongoing annual basis.

The first payment represents 220% of the San Jose RDA’s funds available for capital projects that year, according to the petition.

“It has just got to stop, we don’t think it is legal,” Johnson said.

San Jose has a $156.4 million payment due this fiscal year on agency-issued bonds and a $25 million payment due on debt secured by the city.

In the petition, San Jose said the agency could not make the payments to the state while at the same time continue to pay its obligations.

In April, Moody’s Investors Service downgraded $1.7 billion of San Jose RDA non-housing tax-allocation bonds to either Baa1 or Baa2, depending on their debt service reserve provisions, from A2, after falling property values cut into debt service coverage.

The surviving RDAs could eventually access the bond market again.

Feldman said those agencies — likely the larger ones — that have the ability to create enough cash flow will have an advantage.

Paul Rosenstiel, a principal at the investment bank De La Rosa & Co., said if the court upholds the laws there could be a mechanism for issuance, though likely based on much less revenue.

“I think it is on a case-by-case basis,” he said. “But certainly there would be the opportunity in fast-growing agencies for increment to be generated in the future that could support new debt.”

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A recent phenomenon is the emergence of bonds with shorter call protection as funding alternatives for municipalities. However, the shorter call protection also dampens the potential upside for investors, which in turn reduces the price they are willing to pay.

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