LOS ANGELES -- California's land-backed municipal bonds are inherently risky and local governments should adopt tough guidelines that go beyond existing legal requirements for such bonds, a recent study says.

The 67-page state report, entitled "Mello-Roos Financing in California," offers guidelines designed to "minimize credit risk and to protect taxpayers from excessive or inequitable tax burdens."

Some local issuers hailed the California Debt Advisory Commission's report as sorely needed, but they questioned whether cities and counties would follow the guidelines. At least one market participant said the study could be the first step toward increased state control over what has traditionally been a flexible local financing tool.

Local governments in California have struggled to find revenue sources since Proposition 13 slashed property taxes in 1978. The Mello-Roos Community Facilities Act of 1982 provided local governments with a flexible way to finance infrastructure needs by allowing the creation of special taxing districts. More than $3.2 billion of Mello-Roos bonds have been issued by local governments in California to pay for sewers, schools, roads, and lighting needs.

The commission's report includes a review of conditions that led to the Mello-Roos law, issues involved in district formation, taxation and bond issuance, an analysis of the public policy objectives, a credit analysis, and the project evaluation guidelines.

"The use of Mello-Roos financing. . .should be guided by sound planning and project evaluation guidelines that go beyond the minimum requirements of state law," the report says. "Local governments need to exercise caution in their use of Mello-Roos financing, as land-backed securities are inherently risky and may pose an excessive burden on taxpayers when coupled with other taxes and assessments."

Because local governments are bearing more of the burden for infrastructure finance, they need to be more cautious when structuring debt, the report says. The trend toward local responsibility could be greater in the future due to budget constraints at the state level, the report says.

It notes that the state Department of Finance's "1991 Capital Outlay and Infrastructure Report" calls for local governments to bear all future responsibility for school finance, although such a change would require legislative support. This trend will mean a continuing demand for Mello-Roos bonds, the report finds.

"If local governments at least consider these guidelines as they go forward with Mello-Roos financing, we will feel successful," said Steve Juarez, executive director of the California Debt Advisory Commission.

One analyst pointed to the report as possibly a first move by the state toward imposing more control over Mello-Roos financing, which has been hailed as the most flexible revenue raiser for local governments.

"This is just the first step," said David Hitchcock, vice president of Standard & Poor's Corp. in New York. "The Mello-Roos law was one of the most flexible development financing laws I've seen and I think it's just a matter of time before we see legislation to impose more requirements," he said.

Mr. Juarez disagreed. He said the report does not suggest a need for new legislation affecting Mello-Roos deals.

"By having local governments increase their guidelines, we may avoid new legislation coming down from the state level," he said.

One local issuer said she did not think the state should tell local officials what to do, but added that problems can develop if guidelines are not followed.

"I'm not one to think that the state needs to fall on the heads of local issuers," said Eileen T. Walsh, director of public finance for Orange County. "But if locals don't follow some guidelines they are going to hear a lot of screaming from homeowners."

Orange County will be selling a $9.1 million Mello-Roos bond next week, Ms. Walsh said.

"We have very conservative practices on Mello-Roos debt in Orange County that some other local jurisdictions don't," she said. "Our Mello-Roos debt always goes way beyond the legal requirements of the law."

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.