LOS ANGELES -- California's bond community is analyzing ways to use a new tax-exempt bond law that may help clean up the state's toxic waste sites.

Under a law enacted in May, public agencies can now use tax-exempt bond proceeds to pay for hazardous waste cleanup on both public and private property. The law expands the Mello-Roos Community Facilities Act of 1982, which allows an agency to create special districts and then use levies from property owners to back bonds.

Before the new law was passed, Mello-Roos bonds were limited to funding local infrastructure improvements, such as sewers, streets, lighting, and schools. California's local governments view the expanded Mello-Roos law with hope, but noen have tried to create such districts for waste cleanup, partly because of concerns about liability, complexity, and cost.

Some public finance experts are worried that a city could be left responsible if bonds are issued for waste removal and it is later discovered that the toxic site cannot be fully cleaned. Others caution that liability concerns may prompt construction lenders to shy away from approving loans for housing on a site where cleanup has occurred.

Although lawmakers approved initial legislation last year that would extend Mello-Roos authority into the hazardous waste area, a legislative snag required passage of a special bill in May before the authority could be used.

In Response to Concerns...

Lawyers at Orrick, Herrington & Sutcliffe, meanwhile, are expected to meet soon to discuss implications of the new tool for public finance. It remains uncertain, however, whether the authority will ever gain widespread use.

In response to different concerns, hazardous waste experts have joined to create a nonprofit firm called the Institute of Environmental Solutions, which developed a program to try to provide a negotiating structure to pave the way for the issuance of tax-exempt bonds.

"One of the objectives of the Institute of Environmental Solutions is the design of finance structures that shift the credit risk as much as possible away from the bondholders and other permanent lenders," said Rebekah Buckles, president of the institute.

Under the institute's program -- called the Cooperative Solution -- a site owners with waste removal needs would pay for an evaluation to provide clear estimates of clean-up costs. A bank then would guarantee a loan for the amount of the projected waste removal costs. The mainpart of this process entails deferring payment to the contractor for cleanup until the site is certified as clean by a state agency. Only then does the bank release funds.

The expanded Mello-Roos law provides another option, allowing bond proceeds instead of a bank loan to pay the contractor after cleanup is complete.

"The most disconcerting thing for lenders is that they will end up holding the bag," said Larry Kurmel, executive director of the California Bankers Association, which represents more then 400 commercial lending institutions. The association recently adopted the Cooperative Solution as a pilot program.

Credit risk is a key issue because owners and operators are liable for cleanup under current federal Superfund rules. A lender can be targeted as an owner following a loan foreclosure, or as an operatorl where the lender is involved in the borrower's business activities. These principles apply to both commercial lending and public finance. Several court cases regarding this issue are pending.

The creators of the program expect insurance to be required by all lenders to alleviate some of the liability concerns. This insurance product is still in the design stages, Ms. Buckles noted.

"I see an opportunity with this program to get some sites cleaned up that otherwise would not be," said William Leonard, executive officer of the state Regional Water Quality Control Board in San Luis Obispo and a member of the Cooperative Solution's advisory board. "It's a lot better than sitting here wringing my hands saying, 'Boy, I wish we had some money to clean up this mess.'"

Ms. Buckles lobbied hard for the expanded Mello-Roos authority, but she advises local governments not to use the financing tool unless they adopt protective mechanisms -- such as not releasing bond proceeds until after site cleanup -- because of liability and default pitfalls.

She cautioned, for example, that a public agency could issue Mello-Roos bonds for toxic waste cleanup and then find a commercial lender will not fund future construction because of perceived liability, even if a regulatory agency has certified the property as clean.

Mello-Roos financing districts in California have funded more than $2 billion of development. But an analyst at Standard & Poor's Corp. recently cautioned that land-backed financings may encounter problems because of a softening California real estate market and continuing economic recession.

Some bond underwriters also say the prospect of using of Mello-Roos financing for hazardous waste cleanup generates public policy issues for local governments.

"This is a public policy question that will be battled in city halls of California: Is it appropriate to tax home owners for hazardous waste cleanup?" said Mark T. Young, vice president of Donaldson, Lufkin & Jenrette Securities in Los Angeles. "We, as the bond community, have to be responsible about how we use this tool."

Laying the Groundwork

Mr. Young said market participants need to work carefully on laying the groundwork for such transactions before diving into issuance of Mello-Roos bonds "to clean up all the hazardous waste sites in California."

The author of the original Mello-Roos legislation said he is familiar with the expanded toxic waste authority but seemed skeptical about its ability to be used.

"It never sruck me as especially likely that they could get the two-thirds approval required for toxic waste cleanup when creating the districts on developed property," said Dean Misczynski, principal consultant of the Senate Office of Research.

Despite all the difficulties with the new law, beleaguered city officials view the tool as a needed option.

"This is just an additional tool," said Yvonne Hunter, legislative representative for the League of California Cities. "At least we have it. I don't think it will be the cure-all."

Union City, in Northern California, may be the first beneficiary of the new law. It is close to reaching an agreement with lenders, Ms. Buckles said.

A 440-acre development is being thwarted by a small contaminated piece of property owned by Pacific State Steel Corp., which is under the control of a federal bankruptcy court. the city and its redevelopment agency are supporting a plan to issue $10 million of Mello-Roos tax-exempts to clean the site up.

If successful, the Union City financing could be adopted by other cities.

Theodore Sorenson, president of a subsidiary of Bruck Train & Associates, the company managing Pacific State Steel, said he did not think the financing would run into problems. "To say that a billion-dollar development is not going to get done because you can't finance $13 million dollars of cleanup is harsh," he said. "I don't think we'll have any trouble at all."

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