WASHINGTON -- California's struggle to pay its lease revenue bonds on time during its budget impasse illustrated an inherent risk with lease securities that the rating agencies say is prompting them to take a new look at the way they rate such securities.
The two-month-long standoff forced many lease investors to focus for the first time on the risk that a state might not appropriate lease payments -- not because it did not want to, but because it was not legally authorized to do so -- noted Sally Rutherford, a Standard & Poor's Corp. senior vice president, in a Creditweek Municipal article yesterday.
Earlier incidents, including the Richmond, Calif., Unified School District's lease default and Brevard County, Fla.'s debate over suspending payment on its lease securities, highlighted the risk an issuer might simply decide not to appropriate. But the link between lease payments and the sometimes volatile appropriations cycle was never so much in the spotlight as it was during the California crisis that ended earlier this month.
According to the rating agencies, which have been mulling their policies in the wake of the California incident, payment disruptions for budgetary reasons are possible in other states and municipalities.
Ms. Rutherford noted in her article that "most other states" besides California have no clear statutory authority enabling them to make payment on a lease security in the absence of a budget or legislated appropriation.
George Leung, managing director for state ratings at Moody's Investors Service, said his agency also has been "wrestling" with the possibility that there might be a repeat in some other state of the kind of internal political struggles that led to California's budget impasse and lease crisis.
Both Mr. Leung and Ms. Rutherford said their agencies, in rating lease securities, have already taken into account to some extent the possibility that budget delays could endanger a lease's payment.
"The appropriation risk is embodied in the traditional rating distinction between the general obligation credit, which does not have an appropriation risk, and lease debt," Mr. Leung said.
But in light of the California experience, Moody's "will need to incorporate into current and future evaluations" the possibility of payment disruptions caused by political disputes totally unrelated to the lease issue, he said.
Ms. Rutherford said in an interview that budget-induced disruptions in lease payments have been anticipated for the most part in Standard & Poor's lease ratings and are among the reasons the agency requires issuers to establish debt service reserves.
But Standard & Poor's continues to list California's lease securities on Credit Watch with negative implications as it contemplates the implications of the incident, she said. "I have not seen late budgets threaten lease appropriations in this way before," she commented.
Some issuers may be able to call upon continuing appropriations authorities, as California did, to make lease payments during a budget hiatus, Ms. Rutherford said, noting that she has witnessed other states and municipalities doing so during previous budget delays.
But the availability of such ad hoc authorities is uncertain and cannot be depended on by investors or the rating agency, she said.
As a result, Standard & Poor's and Moody's in recent statements served notice that they are sharpening their requirements for issuers seeking ratings on lease securities tied closely to the budget cycle.
In Ms. Rutherford's article, Standard & Poor's laid out its debt service reserve requirements for issues with payments coming due close to an issuer's budget adoption date. The agency said it now defines "close" as having payment due within four months of a budget deadline.
Jeffrey Thiemann, a vice president at Standard & Poor's, said even though the agency requires debt service reserves to cover possibly late payments, it frowns upon the use of such reserves.
The ratings agency, for example, threatened California with a downgrade when state Treasurer Kathleen Brown said she might have to use the lease bonds' reserves to get through the budget crisis.
Mr. Thiemann said the agency discourage the use of reserves in place of regular appropriations because the reserves may be needed in the event of other more pressing emergencies, such as an earth-quake-induced abatement of the lease.
Robert Tucker, a vice president with Moody's, also advised state debt managers recently that they should "push debt service payments further away from the budget adoption period" to avoid political problems and obtain better ratings.
The agencies' officials all said they would prefer issuers to enact clear statutory authority allowing them to make payments on all their lease securities in the absence of a budget. Rating agencies had repeatedly pressed California to do so throughout the state's crisis.