Public Finance Update - March 2011

As April 2011 draws near, Governor Jerry Brown continues to pressure California lawmakers to adopt his proposals to cure the State’s budgetary woes. Among the Governor’s more controversial ideas is his proposal to eliminate redevelopment agencies State-wide.  Taxes currently captured by those agencies but not pledged to existing debt would be used for education and public safety, among other purposes, in an effort to reduce the current State budget deficit.

Assuming unanimous Democratic support, the Governor needs two Republican legislators from each of the Assembly and the Senate to secure passage. A few Republican lawmakers have indicated they might support the bill in exchange for serious reform in the areas of public pensions, spending limits and environmental regulations.

The California Redevelopment Association (“CRA”) and other proponents of continuing redevelopment activities have been lobbying to defeat the bill.  Redevelopment advocates proposed a compromise whereby a portion of the State’s annual redevelopment funding would be diverted to local school districts in exchange for the agencies’ survival.  In a recent joint statement, the CRA and the League of California Cities stated that adopting the compromise “would mean the State avoids contentious and costly legal battles that will surely follow if the Governor’s unconstitutional proposal is enacted.”

Redevelopment advocates have raised the specter of litigation frequently throughout this debate. 

The U.S. Congressional Budget Office recently released a report that suggested the federal government could save as much as $143 million over 10 years by eliminating the tax-exempt bond market. As an alternative to tax-exempt municipal securities, the report proposed that state and local governments sell taxable bonds and then receive a federal subsidy of 15% of the related issuance costs.

The report admitted that “[a] disadvantage of the option is that it could raise borrowing costs for issuers of tax-preferred debt and thereby deter some investment that might have national benefits or place greater burdens on already strained state and local budgets.”

Industry observers do not expect the tax-exempt market to disappear any time soon.  However, taxable municipal debt supported by federal subsidies is not a new concept.  Build America Bonds, a recent and unexpectedly popular program authorized by the American Recovery and Reinvestment Act, provided a 35% federal subsidy for taxable state and local debt.  The Build America Bond program expired in December 2010. However, Congress recently introduced a bill – H.R. 992 – that, if passed, would reinstate the Build America Bond program until December 2012, albeit at reduced subsidy rates.

In 2008, voters in the California counties of Sonoma and Marin approved a one-quarter percent sales tax increase to build a transportation network connecting those two counties. The project is being coordinated by the Sonoma Marin Area Rail Transit District (“SMART” District), and was originally planned to feature a 70-mile passenger railroad along an existing Northern Pacific Railroad right-of-way, with parallel pedestrian and bike paths, stretching from the northern end of Sonoma County to the ferry terminal at Larkspur in Marin County, where commuters catch the Golden Gate Ferry into San Francisco.

California sales tax revenues have fallen short of original projections, however, and the SMART project now faces a shortfall in required financing. SMART officials have elected nonetheless to go ahead with their initial bond offering in June 2011, and focus on an abridged, 37-mile version of the railway. The initial phase of the project is scheduled to open in 2014, and will connect the county seats of Sonoma and Marin Counties.

The District announced that it will seek to sell approximately $161 million in sales tax revenue bonds in June 2011, which will provide less than the entirety of the proceeds needed for an abridged version of the railway. The District is further constrained by the 2029 expiration of the targeted sales tax, which limits the maturity of the bonds to 18 years.

SMART officials met recently to discuss further curtailments to the project to accommodate the reduced revenues, which are expected to include fewer passenger stations and the elimination of a portion of the bike paths.

Yields on municipal securities remained relatively flat in March 2011, despite an increase in supply and continued turmoil in the Middle East and Japan.

This month, the yield on the 10-year U.S. Treasury note continued to outpace 10-year municipal bond yields – 3.44% versus 3.20% – while the yield on 30-year municipal bonds dropped slightly to 4.76%, but remained higher than 30-year Treasuries, which held at 4.50%.

Source: Bloomberg (www.bloomberg.com)