The California Supreme Court is considering the constitutionality of Assembly Bill AB 1X26 (AB 1X26, which eliminates redevelopment agencies (RDAs)) and Assembly Bill AB 1X27 (AB 1X27, which permits their existence but requires large annual payments to the state). A ruling by the court is expected in January 2012. The court could uphold neither bill, AB 1X26 only, or both. Recently, another lawsuit was filed in the state's superior court, which could further delay the legislation's implementation.
If upheld, the legislation could have a significant impact on the future of redevelopment in California, but Fitch Ratings does not believe it will affect most of its ratings on tax allocation bonds (TABs) issued by RDAs. Pressures on RDA ratings have increased in recent years due to economic and management factors such as increased leverage, and Fitch expects continued negative rating action due to such pressures.
The legislation presents some ambiguity about the flow of funds from county auditor-controllers to bondholders. However, Fitch does not believe it was the state legislature's intent to interfere with the flow of pledged revenue to bondholders. Therefore Fitch believes there is strong incentive for the state legislature to clarify the language to assure that payments flow as specified by the bond indentures created when the debt was offered. Furthermore, based on conversations with the state finance department and controller's office, several county auditor-controllers, and a number of bond attorneys, Fitch believes that there is a general awareness that enhanced administrative procedures at the state and county level may be required.
Fitch will monitor events and actions by the appropriate parties should AB 1X26 be upheld (whether or not AB 1X27 is also upheld), and Fitch will review any legislative and administrative actions to insure they are adequate to protect bondholder payments. Fitch will then discuss with the appropriate county auditor-controllers their procedures for tracking pledged tax increment revenues, including plans to adhere to state procedures.
Fitch will also assess whether the successor agencies and the boards appointed to oversee them are aware of the issues and are prepared to apply procedures correctly to project areas. These boards would represent various interested parties (i.e. from overlapping taxing entities benefiting from RDA's dissolution), although they would also have a clearly stated fiduciary responsibility to protect bondholder payments.
The legislation creates successor agencies to insure that debt service is paid from tax increment revenue, among other duties. The legislation specifically states that '...pledges of revenues associated with enforceable obligations [whose definition includes bonds] of the former redevelopment agencies are to be honored. It is intended that the cessation of any redevelopment agency shall not affect either the pledge, the legal existence of that pledge, or the stream of revenues available to meet the requirements of the pledge.'
Another section of the legislation instructs county auditors to create a fund for the tax increment revenues related to each 'former redevelopment agency' but does not actively segregate increment among multiple project areas within an agency. While Fitch has some concerns that, without clarifying instructions to the county auditor-controllers, pledged revenue for TABs may not be accounted for appropriately among project areas (enhancing debt service coverage in some and diluting it in others), Fitch believes the above noted section in AB 1X26, among others, clearly indicate the state's intent with regard to bondholders.
In addition, the legislation instructs auditor-controllers to allocate funds from a dissolved RDA first for pass-through payments to overlapping entities, prior to debt service. However, the section also clearly provides for these pass-through amounts to be reduced, if necessary, in order for sufficient funds to be available for debt service.
In the event that both bills are upheld and an agency elects to stay in existence, Fitch will look at the effect on cash flows and unencumbered balances of making the required payments to the state. For cases in which coverage is weak for a given rating level and unpledged assets were considered as an offset to other credit weaknesses, Fitch will re-evaluate the rating. Fitch expects this to be uncommon as its TAB ratings rarely are affected by the balance sheet.
Additional information is available at 'www.fitchratings.com'.
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