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California Redevelopment Bonds Take Ratings Hit

LOS ANGELES — Analysts at Moody's Investors Service were not persuaded by repeated reassurances from California Department of Finance officials that debt service payments take precedence in the state's redevelopment agency wind down.

More than a year after Moody's analysts announced in June 2012 that it was lowering the ratings on $11.6 billion in RDA credits it rated Baa3 or higher to Ba1, and putting the ratings on watch for possible withdrawal, it has more bad news regarding the bonds' ratings.

In a report released Tuesday tallying the results of its redevelopment reviews, Moody's analysts deemed most of the 94 California tax allocation bond credits it currently rates to be junk, affirming average Ba1 ratings on the bonds and withdrawing the ratings on 31. Only 12 of the 63 credits still rated by Moody's are at investment grade Baa3 or higher.

"Given the uncertainty of the statute, we wanted to see coverage done on a semi-annual basis — and we wanted to see two times debt service coverage in order for the bonds to receive investment grade ratings," said Gregory Lipitz, a Moody's vice president and senior analyst.

Moody's warned in a report released in February that it might withdraw the ratings on all credits it rates for debt issued by the state's 427 shuttered redevelopment agencies.

Since the state Supreme Court in December 2011 upheld the law dissolving California's redevelopment agencies, the so-called successor agencies — in most cases, the municipalities that created the RDAs — have had to tally their debts and assets, get them approved first by a county-level committee and then by the state, so they could make the required payments to the state and debt service.

The idea behind the original legislation was that any tax-increment money left after paying off the bonds of the dissolved redevelopment agencies would be split among the city, school district and other districts, such as water districts, that usually receive a share of property taxes.

Schools therefore receive more money locally, lessening the amount California has to provide through an equalization law ensuring that all school districts receive the same amount of funding.

"I'm not sure that Moody's has a fundamental understanding of the dissolution law and the protections of debt service," said H.D. Palmer, a Department of Finance spokesman. "We do not think there is any ambiguity in the law. And we think our track record of payments as enforceable obligations reflects that."

Lipitz said one of the rating agency's concerns is that the hierarchy of payments — pay the administrative expenses first, then pay the pass-throughs to the local governments — doesn't follow the structure for senior and subordinate debt outlined in bond documents.

"Once the successor agency is done paying all the [enforceable obligations], all the money flows out to the taxing entities," Lipitz said. "The successor agencies don't have any fund balance to deal with cash flow changes from period to period."

The process creates volatility in cash flow and the successor agencies don't have fund balances to deal with it, he said.

"The debt service has always been approved for payment," Palmer said. "The amount of funds flowing to successor agencies is the same amount as when the RDAs were in existence."

He said in some instances there is more money available because the successor agencies don't have to set aside 20% for affordable housing, which the former RDAs were required to do.

Moody's analysts issued the February warning saying they were not receiving sufficient or clear enough information from the successor agencies. They also put out a list of new criteria required for bonds to achieve investment grade ratings.

The criteria are that Moody's wants the successor agencies to provide information on semi-annual debt-service coverage, have data provided by a third party, and be given the cash balance of the debt-service reserves.

To receive an investment-grade rating from Moody's, a redevelopment successor agency must have a project area size of more than 1,000 acres, debt service coverage of more than 2 times including all pass-throughs, and incremental assessed value totaling more than 80%, according to Moody's February report.

After the report was released, Moody's analysts received information from a number of issuers, a dozen of which achieved upgrades as a result, Lipitz said.

The state's semi-annual distribution process raised cash flow concerns, which is why analysts wanted agencies to synch up reserve funds with the state's process.

"It necessitated analysis on a semi-annual cash flow basis, rather than annual," Lipitz said. "We wanted to make sure both periods received sufficient coverage."

The state's so-called recognized obligation payments schedule process functions on a six-month time frame, where successor agencies provide budgets outlining the amount they need to make bond payments and to cover expenses of the streamlined successor agencies.

The issue that has arisen is that typically the first bond payment of the year is less than the second.

If the state only approves the lower amount needed for the first payment, successor agencies are coming up short for the second payment, and then have to return to the state in the appeals process called meet-and-confer so they receive enough money to pay the second payment of the year.

"After we got information from the issuers, we ran the information through the revised criteria," Lipitz said. "Most of the issuers just didn't exceed the coverage threshold to receive investment grade ratings."

Some of the bonds now being repaid by the successor agencies have received downgrades from all three major rating agencies because successor agencies tapped reserves to make bond payments last year while they awaited a decision from the state.

Moody's announcement comes as the deadline on the next phase of the dissolution process approaches.

The successor agencies are now at the point where they are providing the state a property management plan for all the properties owned by the agencies.

Before they can submit the property management plans, they first must have made all their "true-up," payments — the state required any excess money be redistributed to all the municipal entities that benefit from property taxes. Once that is done, they need to have received a finding of completion on the first phase of the dissolution process.

The successor agencies are now providing the state with lists of all the commercial real estate properties owned by the agencies and how they plan to manage the properties.

The state has approved 12 plans of the 280 successor agencies that have received a finding of completion, Palmer said. As part of the approval process, the DOF determines which properties cities and counties, through their successor agencies, are allowed to keep and which ones they need to sell off.

The process could result in the exchange of a significant amount of money.

Kosmont Cos. estimates that 2,000 to 3,000 properties could be sold through the process, said Larry Kosmont, president and chief executive officer of the Los Angeles-based government and development consulting firm.

Those properties represent roughly 326 million square feet of property. If sold for a $7 a square foot, a median of property prices across property types throughout the state, they would net $2.28 billion.

There are three exemptions from selling the property immediately under clean-up legislation passed to prevent former RDA properties from being sold in a fire sale.

Successor agencies can retain properties that have a government purpose such as city hall or a fire station. They can also retain properties to fulfill an enforceable obligation such as a property that has a 20-year lease on it. The third category exempting the sale is if the property was identified in a redevelopment plan approved by the DOF.

The property management plans "are stacking up on the desk of the DOF" and "there really is no direction," Kosmont said.

Kosmont said his firm has filed 100 property management plans for clients and is waiting to hear what policy direction the state is going to take. The small number of plans already approved involved smaller cities with few properties that don't act as good test cases for what's to come, Kosmont said.

For instance, there has been some disagreement about what constitutes "government use," particularly regarding municipal parking lots, he said.

There are also questions about properties that were purchased for redevelopment before the recession hit in 2008 — and have valid redevelopment plans, but whose contracts may have expired.

Other queries are whether the state will allow cities to rezone properties to maximize sale prices, since that is a process that can take two years.

"This is ostensibly liquidation, but what if there is a higher and better use for the property where all the taxing agencies would end up doing better?" Kosmont said. "How do we know if the Department of Finance is going to cooperate with this?"

As for the bonds issued by the former RDAs, Kosmont said one thing resolved "is that for better or worse DOF has come out on the side of getting the bond investors paid and recognizing bonds as an enforceable obligation."

Kosmont said he understands Moody's concerns about the priority pass through payments from a credit underwriter perspective, but it's not a legitimate reason to "smack the bonds around," he said.

"I don't understand why these ratings have been so impaired, because the practice and philosophy has been to get bond investors paid and it's working out," Kosmont said.

The rating downgrades have benefited the market on the retail side, however, because they are getting good deals, he said.

"They aren't viewing the bonds as high risk and they are getting good discounts," he said.

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