While a law passed in 1978 allowed tax-increment bond sales from redevelopment agencies in California to flourish compared to the rest of the country, in recent years new issuance has collapsed as property values have switched directions from boom to bust, according to a credit sector report issued by bond insurer National Public Finance Guarantee Corp.

Under Proposition 13, the assessed values of properties that don’t change hands during the course of a year cannot increase more than 2% annually. In addition, the property tax rate was limited to 1% of a property’s assessed value.

Before Prop. 13, the average tax rates on a property were closer to 3%, and there were no limitations on increasing the rate. Property values could also be reassessed dramatically higher one year versus the next, causing owners’ tax bills to increase accordingly, the report noted.

Prop. 13 drastically reduced municipalities’ property tax revenue, but it also made revenue more stable and predictable. Moreover, cities and counties had less financial flexibility to back economic development, so they turned to redevelopment agencies to stimulate growth in blighted areas without increasing the tax burden.

With the boom in property development earlier this decade, sales of tax allocation bonds in California rose rapidly, climbing from $828 million in 2000 to an apex of $4.06 billion in 2003, according to Thomson Reuters. When the financial crisis hit, however, new issuance of the bonds then fell for three consecutive years from $3.78 billion in 2006 to just $753 million last year — the lowest volume since 1996.

NPFG backed $7.5 billion of California’s tax allocation bonds as of Nov. 2009. The credit sector report on tax allocation bonds looks at challenges ahead as part of the firm’s effort to be more transparent.

The primary reason issuance has been falling is the decline of property values, said Jason Kissane, co-author of NPFG’s report. He said tax allocation bonds are secured by tax increment generated within a project area, and as property rates fall the municipalities are unable to issue new debt.

“In California, across the board, property values are going down and redevelopment agencies have less assessed value available to leverage through borrowing in the capital markets,” he said.

Another challenge is that, in an attempt to help balance the budget, the state has redirected $2.1 billion in development funds for state purposes. The California Redevelopment Association has called that attempt unconstitutional and brought a lawsuit against the state, but while the case is pending agencies will have to prepare to meet those payments, further limiting access to the market.

Over the long run, clawing back for “excess revenues” and redirecting those funds away from development will only hurt the state, Kissane said.

“A redevelopment agency is created for the purpose of eliminating areas of blight, facilitating economic growth, and trying to bring in the private sector, but if they have fewer dollars at their disposal because those dollars are going to the state, their goals aren’t going to be met as easily,” he said.

Outstanding credits, at least those insured by NPFG, are less impacted by these factors, the report said, because the insurer takes a conservative forecasting approach which doesn’t factor in property value growth or an increase in the tax base.

Instead, revenue estimates are based on stress tests that take into account substantial reductions in property values. Often the assessment value can fall 40% or more and there would still be sufficient tax increment to cover debt costs.

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