Moody’s Investors Service has downgraded all California tax allocation bonds that were rated Baa3 or higher. All of our California tax allocation bond ratings remain on review for possible withdrawal.
This continued review reflects the likelihood that insufficient information will be available to evaluate the relative probability of default due to the new cash flow pattern established in the redevelopment dissolution law (AB 1x 26). The new cash distribution procedure effectively eliminates bond indentures’ flow of funds, and it is clearly subject to differing procedural interpretations. These differing interpretations can, without warning, give rise to the potential for debt service defaults that did not exist prior to the passage of this law.
Absent administrative or legislative correction of this weakness in the law’s terms, Moody’s will likely withdraw its ratings on California tax allocation bonds.
The downgrades for the bonds rated Baa3 and higher primarily reflect the heightened cash flow risks arising from the implementation of state legislation dissolving all redevelopment agencies. This legislation effectively altered the flow of funds to be used to pay bondholders.
Even with strong credit fundamentals and intact legal security, timely debt service payments on California tax allocation bonds cannot currently be assured. This uncertainty primarily arises from the potential for legal and political disputes on the correct procedure for distributing cash according to the redevelopment agency dissolution law, AB 1x 26. This risk was recently highlighted by a dispute (discussed below) between the City of San Jose’s Successor Agency and Santa Clara County that, according to a public notice filed by the City of San Jose, threatens timely payment of debt service in August despite sufficient tax increment revenues derived from the legal pledge to bondholders.
The downgrade also reflects the absence of a robust mechanism within the dissolution law itself to resolve such disputes and the evolution of the California Department of Finance’s guidelines on distributing tax increment revenues. While the law has a reallocation procedure in the event of a shortfall that results solely from the new cash distribution procedure, the process for resolving disputed calculations and varying legal interpretations is not sufficiently detailed or prescribed so as to provide assurances of full or timely bond payments. The resolution of such issues may be left up to the courts if the state does not pass additional “cleanup” legislation. The current state guidance to county auditor-controllers to withhold property tax distributions in the absence of a state approved payment schedule also injects an element of payment timing uncertainty that did not exist prior to the dissolution law’s adoption.
While the implementation of the law has given rise to new cash flow risks, Moody’s believes the law is clear that fundamental legal security for tax allocation bonds is intended to be preserved. Therefore, we would expect that any defaults stemming solely from the new law’s cash distribution procedure would likely over time be corrected. We believe that after a default, recovery would likely be at or close to 100%.
All ratings remain on review for possible withdrawal due to the potential that insufficient information will be available on a continuing, long-term basis with which to determine the relative probability of cash flow disputes leading to defaults.
– Successor agencies, which replaced the dissolved redevelopment agencies, remain explicitly obligated to honor existing bond contracts, with recognition of legally pledged revenue streams, debt service reserve funding requirements, and other performance requirements in existing bond documents.
– County auditor-controllers have generally indicated a very strong willingness and ability to comply with the new revenue allocation requirements on a sufficiently timely basis to allow successor agencies to meet existing debt service payment obligations.
– In the long-run, existing contract law should protect bondholder’s interests, minimizing losses that might result solely from new procedural requirements in the redevelopment dissolution law.
– While the legislature’s intent to honor existing obligations is clearly stated in the law, the mechanics of the new law do not provide sufficient clarity on process to realize this intent.
– The law creates significant uncertainty with respect to timing and mechanics of cash flows, which in our view effectively trumps the strength of the legal security and debt service coverage of bonds.
– The law establishes an initial allocation of property tax revenues that conflicts with existing bond documents, and the effectiveness of the resolution process on a timely basis is uncertain.
– The timeframe for property tax disbursements is more restricted than it had been previously, potentially resulting in mismatched receipt and disbursement schedules over the course of a year.
– The new law’s audit requirements and sheer complexity have resulted in unexpected payment delays. These will require legal and/or administrative clarification.
WHAT COULD MAKE THE RATINGS GO UP
– Implementation of the legislation in a manner that clearly preserves timely debt service payment and enables compliance with bond documents
– Legislative or judicial clarification that compliance with bond documents takes precedence over other, apparently conflicting aspects of the legislation
WHAT COULD MAKE THE RATINGS GO DOWN
– Continued implementation of the legislation in a way that does not clearly preserve timely debt service payment
– Continued legal uncertainty and conflict between the law’s requirements and strict compliance with existing bond documents
– Judicial determination that compliance with bond documents is subordinate to, or to be balanced against, other objectives of the legislation