The California Debt Advisory Commission at the end of the month is expected to publish its first leasing guidelines, laying out some strong advice for the state's hundreds of municipal issuers and its multibillion dollar lease industry on how to avoid public controversies.
Judging by the response to the commission's draft guidelines, which have been circulating for weeks, the publication could be a best seller in the municipal market, according to Steve Shea of the commission.
Dealers and bond lawyers from around the state and the country have been poring over the nearly 100 draft copies distributed by the commission and have been voicing their opinions and concerns, Shea said.
Shea said the final report will try to address the top complaint voiced by dealers - that the draft report goes too far in pushing the state's municipalities to consider holding advisory public referendums on controversial lease issues, he said.
The commission is revising the report's language on the referendums to emphasize that the decision to hold a vote rests with the municipality and is not a state requirement being imposed with publication of the report, Shea said.
"These are just advisory guidelines from the get-go. If we thought a stronger approach was needed, we would have done that," he said.
Shea said the commission has received no comments thus far from public citizen groups or individuals outside the bond industry.
The guidelines try to strike a balance, Shea said. Citizens have become alarmed over the huge volume of leasing seen in California during the past 10 years, he said, but issuers need the leasing option because of the state's two-thirds voter approval requirement for general obligation bonds.
"You have to look at the niche tax-exempt leasing is filling in public finance," Shea said. "If you looked at it in a vacuum, it might seem that it should be more controlled. But it evolved into the current state because of the GO requirement. You would see a lot less leasing if there was a majority requirement for GO bonds."
Shea said the final report will simply recommend that issuers solicit public opinion in one of three ways: scheduling public hearings on major capital lease financings as part of their regular capital budgeting processes, establishing a citizens oversight commission to review leasing decisions, and scheduling public referendums on controversial financings.
The idea of setting up a citizens oversight commission, which would help public activists develop expertise on leasing issues, came from a report issued earlier this year by a grand jury in Santa Cruz County, which, like two other grand juries in the state, recently investigated local leasing practices.
The Santa Cruz panel and grand juries in Santa Barbara County and Nevada County found that the growing use of certificates of participation represents a potential abuse of power by county authorities. The Santa Barbara panel recommended banning certificates issued for capital projects.
The draft report warns that the public hostility reflected in the grand jury reports could grow if issuers do not take preemptive action. Shea said that, for the most pa;,t, the cautionary language will not be softened in the final version.
"Public agencies voluntarily need to exercise control over their leasing practices, or face increased pressure for additional regulation," the draft report says.
But Shea said the final report, like the draft guidelines, will also conclude that because the actual number of troubled financings has been small, and the industry for the most part has conducted business professionally, public officials should continue to have broad discretionary leasing powers.
Behind Closed Doors
Leasing has attracted public criticism because it is done largely outside the public eye, Shea said. But elected officials often make even more far-reaching financial decisions behind closed doors when they negotiate labor contracts or pension benefits packages, he said.
Labor deals, which often absorb a majority of an issuer's operating funds, usually have "greater financial implications" than lease financings, which typically take up no more than 2% to 3% of an issuer's operating budget, Shea said.
In addition to tackling some of the sticky public issues that have dogged leasing in recent years, the report provides oodles of practical advice for municipalities on managing, structuring, and marketing lease financings.
One such guideline in the draft report recommends that issuers establish a maximum general fund lease burden no higher than 6% to 8%. Other guidelines suggest informally earmarking repayment sources for lease obligations and caution against using long-term leases to finance operating deficits.
The management guidelines, including a special section on school district COPs, aim to establish good credit practices and help issuers decide when to use leasing rather than cash payment or other forms of debt, Shea said.
The report also contains the most extensive discussion of vendor leasing practices to date by any state agency. Vendor or third-party leases are the relatively small leases used to finance equipment purchases such as computers, school buses, and police cars.
Concern about abusive and misleading practices by some lease dealers in connection with third-party transactions have bubbled to the surface over the past two years. That prompted the commission to include an investigation of vendor leasing practices in its report.
The commission concluded that issuers need to take strong preemptive sessment refunding in Pleasanton. Calif. Brodsly said the investment grade rating was possible because of a "structural innovation" in which coverage was provided to senior lien debt by excluding the junior lien from consideration.
But as public finance professionals contemplate a window of opportunity for broadened use of assessment financings, the tax watchdog groups also see their chance to shut the window.
Both sides know the public is restless about paying more taxes and levies. A statewide uproar last year over perceived abuses of Mello-Roos special taxes. for example, led to reform legislation to provide better disclosure to home owners moving into the districts.
Knox of Orrick Herrington said he was leafing through a Contra Costa County, Calif., Sunday newspaper last month when an advertisement for a new housing tract stopped him cold.
The advertising line designed to lure home buyers promised "No Mello-Roos and No Assessments." Knox said it marked "the first time I've seen assessments in these kinds of ads."
Knox said there is "resistance on the part of home buyers to taking property subject to assessments and Mello-Roos taxes."
Nevertheless, market participants do not anticipate seeing an assessment financings backlash similar to the one that engulfed Mello-Roos taxes last year.
"I don't want to overstate our concern" regarding special assessments, said Steve Juarez, executive director of the debt advisory commission. "Problems are not at the same level as they were for Mello-Roos in past years.