LOS ANGELES - Market analysts said yesterday that they will scrutinize local government credits in California, particularly counties, in the aftermath of this week's state budget agreement.
"I'm real concerned about the weaker counties," said Thomas Orphanos, a vice president of municipal research at Kemper Securities Inc.
Specifically, certain rural counties will merit close review because their economies tend to be less diversified, Orphanos said.
Orphanos cautioned that each issuer must be examined on a case-by-case basis. From a broad credit perspective, however, "counties are the ones to watch."
Other market analysts generally echoed that view yesterday, after the state Legislature earlier this week approved a spending plan that with transfer $2.6 billion of local property tax revenues to schools to help balance the state's fiscal 1994 budget, which begins July 1.
The biggest question is "what will happen at the local level" once those cuts sink in, said Joseph Rosenblum, director of municipal credit research at Sanford C. Bernstein & Co.
Analysts said that it is a bit premature to make any definitive comments about the overall budget. Legislators yesterday were still working on many key trailer bills that will actually implement the spending plan.
Those bills are "going to really tell the story," Orphanos said, because they will provide details on how the property tax transfers are allocated among local governments. Accordingly, analysts said they will really dig into the plan once the entire package is forwarded to Gov. Pete Wilson.
But market attention is already focused on counties because they are targeted for about $2 billion of the $2.6 billion property tax shift.
The budget agreement tries to soften the blow by extending a temporary statewide sales tax surcharge through the end of this year. Proceeds from the extension will be funneled to local governments for public safety services, with the bulk of money expected to benefit counties.
Voters statewide will decide in November whether to extend the surcharge indefinitely. Approval of the measure would provide more than $700 million of additional local funds in the second half of fiscal 1994.
But Rosenblum expressed concern over potential taxpayer resistance to the surcharge, especially if Southern California's economy continues to limp along later this year.
As an example of his concern, Rosenblum observed that voters in Los Angeles have turned down many funding measures for additional police protection. Based on that experience, he said passage of the statewide surcharge is by no means guaranteed simply because it targets police and fire protection.
The state budget agreement also frees counties from certain mandated obligations. But municipal analysts said that action and the sales tax surcharge combined will not provide enough money to offset the overall property tax transfer.
Municipal traders and others also stressed the need to monitor local credits.
"We are going to great lengths to make sure we analyze the impact of the state budget on local communities," said W. Peck Ferrin, vice president and manager of municipal bond trading at Bank of America.
It is imperative to conduct "extensive research," both to recognize potential risks and to determine an appropriate level at which to bid on bonds, Ferrin said.
Certain types of financial instruments also are more likely to draw scrutiny. Orphanos and Rosenblum said they would especially monitor tax-supported bonds, such as lease obligations, that depend on payments from an issuer's general fund for security.
The state budget agreement also helped alleviate worry about some categories of issuers.
Rosenblum said he is now generally "less concerned" about school districts because the state agreement will "keep them close to whole" compared with previous funding levels.
Overall, however, he said investors face "a tougher challenge than ever before" in identifying local credits to purchase.
Sanford Bernstein's California tax-exempt portfolio is now heavily weighted toward pre-refunded bonds and insured issues to help remove the budget and economic risks, Rosenblum said.
By contrast, local tax-supported debt - such as leases and general obligation bonds - provide only 10% of the portfolio's weighting, he said. Revenue-backed debt, including water, sewer, and electric bonds, is one area in which the California fund might take on more exposure, he added.
A financial adviser who includes rural counties among his clients agreed yesterday that local issuers face tough adjustments, but he also said that they can take steps to address investor concerns.
"It's going to be a very, very challenging environment," said Jeffrey Leifer, president of Leifer Capital.
Nevertheless, even smaller counties can take steps to reassure the capital markets about their creditworthiness, Leifer said.
He suggested issuers can undertake a debt capacity review to understand "what they're able to do or not to do. "
Other steps, such as obtaining bond insurance, can also calm investor fears, Leifer said. Issuers also can obtain preliminary ratings and then work with credit analysts to tailor a financing that addresses strengths and weaknesses.
It is also essential for issuers to do "a rigorous revenue-source analysis for capital projects" that addresses the predictability of revenues, as well as the anticipated accuracy of projections, he said.
Issuers that can demonstrate contingency plans for dealing with continuing fiscal pressures also stand a better chance of reassuring the capital markets, Leifer said.
He said that the state's leadership also needs to consider how their budgetary policies affect issuers such as rural counties.
A sales tax surcharge "is not a substitute for a property tax" because sales tax collections can be less dependable and more volatile, Leifer said. And rural counties have less of a sales tax base than urban areas, he said.
Rosenblum said a continuing reliance on the sales tax surcharge also raises longer-term policy issues statewide. "It doesn't help for cooperative government" if localities have an incentive to compete against each other for sales-tax producing enterprises, Rosenblum said.
State legislators also have yet to tackle major realignment proposals affecting the state and local fiscal relationship, he said.
"The broader policy questions get lost" in the midst of short-term budget negotiations, Rosenblum said.
As a result, Proposition 13, the 1978 property-tax limitation initiative that shifted many funding responsibilities to the state, is "coming back to haunt them," Rosenblum said. State and local officials at some point have to resolve ongoing policy issues spawned by the initiative's fiscal restrictions, he said.
Separately yesterday, further details were not available on how the state might approach a deficit borrowing envisioned by the budget agreement. The borrowing, which could address an accumulated deficit of as much as $2.7 billion, would be retired by the end of 1994.
California Department of Finance officials have discussed selling warrants to accomplish the borrowing. But the timing and size of a sale is expected to hinge on various factors, including the date on which the state decides to redeem a $2 billion revenue anticipation warrant issue that closed yesterday.