Fitch Ratings has completed its comprehensive portfolio review of 62 ratings on tax allocation bond securities (TABs) issued by 36 former California redevelopment agencies (RDAs). The rating actions are as follows:
--Affirmed and removed from Rating Watch Negative ratings on 22 TABs and subsequently assigned a Stable Outlook;
--Affirmed and removed from Rating Watch Negative ratings on two TABs and subsequently assigned a Negative Outlook;
--Downgraded and removed from Rating Watch Negative ratings on seven TABs and subsequently assigned a Stable Outlook;
--Downgraded and removed from Rating Watch Negative ratings on two TABs and subsequently assigned a Negative Outlook;
--Removed 13 TABs from Rating Watch Negative without affirmation;
--Maintained Rating Watch Negative on seven TABs, including two downgrades and five without affirmation;
--Withdrew the rating on seven TABs issued by one agency due to insufficient information;
--Assigned Rating Watch Negative on two TABs, including one downgrade and one without affirmation.
Fitch had placed the TABs on Rating Watch Negative on Jan. 24 of this year in response to the implementation of AB 1x26 (the dissolution act). For the majority of ratings, Fitch's analysis incorporated a full credit review. For those that were reviewed shortly before Fitch's January application of the RWN, Fitch considered only the impact of the dissolution act and the subsequently-adopted AB 1484 (the trailer bill). In these cases, when Fitch removed the TABs from Rating Watch Negative of Maintained Rating Watch Negative, it was done so without affirmation.
NEGATIVE RATING ACTIONS LARGELY REFLECT UNDERLYING CREDIT
Most revisions of ratings or Outlooks reflect the characteristics of the project area. These characteristics include economic activity, taxpayer concentration, tax base maturity, pledged revenue performance, level and trend of appeals, and debt service coverage. The dissolution act introduced a number of procedural risks. The trailer bill to the state's fiscal 2013 budget (adopted June 27) partially mitigates two of Fitch's primary concerns. Maintenance of the Rating Watch Negative on seven credits reflects uncertainty regarding successor agencies' (SAs) ability to make retroactive tax distributions (true-up payments) required by the trailer bill without compromising funds available for debt service. Fitch reviewed with each redevelopment agency's SA its exposure to the risks introduced by the dissolution act and not resolved by the trailer bill, and the SA's actions to mitigate such risks.
CUMBERSOME APPROVAL PROCESS EXPECTED TO IMPROVE
The dissolution bill requires SAs to request approval semiannually sufficient tax revenues to pay TAB debt service and other so-called enforceable obligations (EOs) placed on a recognized obligation payments schedule (ROPS). Approval is required from the SA's oversight board created by the dissolution act, as well as by the state's Department of Finance (DOF).
The dissolution process has been cumbersome and seemingly inconsistent. However, there have been only two disputes involving Fitch-rated credits that Fitch believed might have affected TAB debt service repayment. One case was resolved in time to protect bondholders. The other is still pending. The adoption of the trailer bill will provide DOF more time, resources and a standardized process of review and approval. As such, Fitch's rating actions reflect its belief that the ROPS approval process will only improve from the somewhat chaotic experience that took place this spring. Further, Fitch believes that credit quality could improve over time given the effective closure of debt liens.
RATING WATCH REMOVED FROM MOST TABS
Fitch removed the Rating Watch Negative status from TABs where the SAs have been able to overcome the following risks resulting from implementation of the dissolution act:
CASH FLOW TIMING ISSUES
Some agencies have traditionally budgeted April increment for debt service payments earlier in the same fiscal year (ending June 30). They received advances from their sponsor city to pay debt service and repaid the city from the April increment. However, under the dissolution act, April tax revenues are reserved for the next fiscal year ROPS (starting July 1). This has resulted in the need for cash on hand or a cash flow loan from the sponsoring city or the county to cover the debt service payment due in the first ROPS period (January-July 2012). In some cases, cities and counties expressed concern about providing loans because there was not a clear mechanism under the new law for repayment.
Agencies that used cash on hand for the first ROPS debt service payment can now follow the new structure. The trailer bill clarifies that a loan from the sponsor city or county to the SA will be considered an EO eligible to be repaid from tax revenues. The trailer bill removes some risk for the few Fitch-rated SAs that still require cash flow loans.
The trailer bill also addresses Fitch's concern about a potential miss-match of semi-annual tax revenue distributions and debt service payments by allowing for a reserve for the larger (principal and interest) debt service payment.
PROJECT AREA REVENUE SEPARATION
With one exception, Fitch-rated SAs with multiple project areas are tracking revenues on a project area-specific basis. They have indicated their intent and ability to allocate any potential future revenue shortfall to the appropriate TAB in conformance with security requirements under bond indentures. Although DOF instruction on this issue appears to be inconsistent, Fitch views positively SAs' efforts to adhere to these security provisions. In that exceptional case, the rating was withdrawn.
HOUSING REVENUE
The lack of distinction between former housing set-aside revenue and total tax increment under the dissolution act did not affect Fitch's assessment of credit quality. Fitch believes further clarification as to the availability of revenue not pledged under the indenture is needed before factoring any increased coverage into ratings. For Fitch-rated housing bonds, either the aggregation of tax increment results in higher or not materially lower calculated debt service coverage levels, or the SA has stated its intent to track pledged revenue in the manner required under bond indentures.
SOUND INSTITUTIONAL OVERSIGHT
Fitch analyzed the SA's willingness and ability to manage the new processes involved in requesting and distributing tax increment. This includes staffing levels, ability and willingness to track revenues pursuant to bond indentures and the need for, and ability to secure, cash flow loans. Fitch believes that despite limited resources and inconsistent guidance, SAs have shown a strong commitment both to follow procedures and protect bondholder payments.
REPAYMENTS UNDER AB 1484 STILL A CONCERN FOR SOME; RATING WATCH NEGATIVE MAINTAINED
In cases where the SA has either expressed a lack of resources to fund both its true-up payment under the trailer bill and upcoming debt service, or is disputing the amount required, Fitch is maintaining the Rating Watch Negative. True-up payments required by the trailer bill were derived from tax distributions made in December 2011 and January 2012, a period in which the legality and timing of implementation of the dissolution act was unclear. Fitch acknowledges the state's continued commitment to ensuring continued bondholder repayment. Fitch also recognizes its goal of recapturing sufficient revenue to alleviate its own budgetary pressures with regard to distribution of funds to other taxing entities. Fitch does not believe this risk will recur for future tax distributions.
ADDITIONAL ISSUES MAY SURFACE
Fitch believes there will continue to be occasions in which the dissolution act does not clearly outline procedures for distributing property tax revenue among parties. It is also possible that the state will impose additional requirements that SAs consider onerous. This concern is more pronounced in cases with limited revenue available to satisfy debts and other obligations. Fitch will continue to monitor the situation and take rating action when appropriate.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Tax-Supported Rating Criteria' (Aug. 15, 2011);
--'U.S. Local Government Tax-Supported Rating Criteria' (Aug. 15, 2011).
Applicable Criteria and Related Research:
U.S. Local Government Tax-Supported Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=648842
Tax-Supported Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=648898
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