SAN FRANCISCO -- Recent concerns about lease financings in California reinforce the need for a disciplined approach by bond professionals toward credit analysis, speakers said Friday at a public finance conference.
At a session focusing on the certificate of participation market in California, the speakers generally agreed that last year's $9.8-million default by the Richmond Unified School District represented an isolated occurrence.
But the school district's problems did serve "as a wake-up call to the industry" on the need for refined credit analysis, said Blake E. Anderson, a vice president of the Putnam Cos., at the California public finance conference sponsored by The Bond Buyer. That default "should not be an index," however, for determining the fate of COP financing in the state, he added.
In particular, Mr. Anderson noted that local and state issuers in California benefited over the last decade from strong investor demand that has occasionally "blurred" overall credit-quality distinctions.
At one point, some COP deals traded at spreads of only about 10 basis points above general obligation bond issues, he said. Even at more recent spreads of 20 to 25 basis points, he added, "GOs are enormously cheap, or COPs are enormously rich, if you look at [COPs] as unsecured financings."
Mr. Anderson said it is the "obligation of the market to appropriately analyze price risk," and called for a "credit discipline on the buy side" that closely examines credit fundamentals.
Suzanne M. Finnegan, a managing director of Financial Security Assurance, agreed that the Richmond district's problems caused a "refocus" on the underlying credit quality of COPs and the willingness of issuers to make good on their obligations.
Pending state legislation would permit a restructuring of the Richmond district's obligations and allow existing COP holders to be paid back. The state also has challenged the legality of the district's COP issue, and a lawsuit is pending on that matter.
"Significant concerns remain" because the state launched such a broad-based assault on the transaction, Ms. Finnegan said.
A lengthy court history in California helps support many COP deals, she noted, but she warned that some bond insurers will not touch asset-transfer transactions for now because of problems raised in the Richmond school case.
The Richmond school district helped fund an operating deficit with an asset transfer, a financing secured by the sale and leaseback of an existing real estate asset. That use of proceeds represented "a unique situation" because virtually all similar deals fund capital projects, Ms. Finnegan said.
David Brodsly, vice president and manager of the Western regional office for Moddy's Investors Service, stressed his agency was "not spooked" by the legal wrangling over the Richmond district. As comfort, he cited the "long legal history" in California that supports lease financings.
"Leasing remains in good shape" in the absence of an adverse ruling in the Richmond school case, Mr. Brodsly said. He pointed to strong and seasoned state law, established market structures, and a "strong willingness by California governments to live up to their commitments."
Anthony J. Taddey, a managing director of Morgan Stanley & Co., observed that the three COP defaults in California in recent years all involved small, nonrated issues. Aside from those rare exceptions, the COP market in California remains extremely active, he said.
"The market, though, is going to make some judgments" that differentiate credits and also affect interest rate spreads, Mr. Taddey said, adding that investors can be "extremely selective" because issuance volume is so high.
Mr. Taddey also said it is likely that state law requiring two-thirds voter support at the local level for GOs financing highly essential projects "will be looked at very hard." A 1994 statewide ballot measure will propose lowering this threshold to a simple majority for local school GOs.
During a question-and-answer session, an official from the city of Richmond asked how the underwriting community will police itself to avoid future COP problems. He complained particularly that the Richmond school district's problems hurt his city's standing in the market, even though the issuers are entirely separate credits.
"We in the industry bear a lot of responsibility" for structuring deals properly, Mr. Taddey said, noting that school board members and other local officials cannot assume that burden.
It is "easy to point fingers" in the wake of the Richmond school problems, Mr. Taddey said. But he cautioned that "we should be somewhat prudent when talking about irresponsibility" because the entire municipal industry, including buyers and salespeople, has a responsibility akin to fiduciary duty to screen out marginal issues.
Sharon N. Yonashiro, director of public finance for Los Angeles County, said "we welcome the closer look" at credit fundamentals because not all COP issuers share the same characteristics. Less responsible issuers can hurt all government borrowers, she said, stressing the importance of the marketplace in making distinctions.
