John Illyes, lease-backed securities analyst at John Nuveen & Co., was elected to the first team of All-American Municipal Analysts in 1991.

Overall, John Nuveen finished No. 2 in the team rankings and the No. 1 investment banking firm. Illyes is joined by Nuveen's Katherine Bateman, first-team higher education bond analyst, and Peter Fugiel, first team housing bond analyst.

John Hallacy of Merrill Lynch was the second team All-American Municipal Analyst in the category.

Hallacy was nominated to both the lease-backed and generalist categories, but opted to compete in the Leased-Backed category.

The category was added to the ballot to reflect the growing importance of lease-backed bonds in the municipal bond markets by the 1991 Ballot Committee.

Nationally, 10% of all municipal debt issuance now are leases or certificates of participation, Illyes noted.

In California, 20% of all municipal debt are backed by leases or certificates of participation (COPs), he added.

Issuers find lease-backed debt or COP's to be particularly attractive because they typically can be authorized by a resolution and are not subject to voter approval.

In California, lease bonds are subject to voter referendums, therefore most of the debt tends to COPs.

Key Credit Factors

Illyes explained that any credit analysis of COPs and lease-backed transactions begin with a review of the creditworthiness of the lessee.

Next, the essentiality of the project must be considered in the analysis. "The project should be something that is essential to the lessee providing a basic service," Illyes said.

To illustrate the importance of essentiality of purpose, he noted that since 1988 there have been 10 lease defaults.

Seven of the defaults were in California, and these include:

* Lassen Community College;

* Ventury Port District;

* Downy Redevelopment Authority;

* Los Angeles Community Redevelopment Agency (LACRA).

"The Richmond School District appears headed for default on February 1, 1992," Illyes added.

"Typically, all of these defaults were caused because the underlying projects were ill-conceived," Illyes said. "Also, lease-backed transactions default, the defaults never tend to be cured - which is unlike most other municipal securities."

For example, the Lassen Community College default was due to a high-tech waste to energy co-generation plant that never worked, and in the case of Richmond School District, COPs were sold to financing operating expense, i.e. teachers' salaries.

Trouble in Texas and Southwest

Illyes predicts that 30 lease-backed deals sold in Texas and other Southern states by small rural counties to build 200 to 300 bed jails may meantrouble for COP holders.

"These local issuers have no expertise in running prisons of this size," he said. "Prisoners' rights groups are quick to become involved and when the prisons are shut down the COPs default."

He noted that two of these issues in Zevala County and Pecos County, Texas, have already defaulted on debt (par) of about $16 million. "It is likely that several more, if not all of these issues, will default."

"The default of these issues will make lease financings much more controversial nationwide," Illyes said.

California Volume to Increase

California is expected to continue to be the leader in lease financing, with solid waste disposal prompting a flurry of new lease financings.

These deals will be driven by the "Waste Reduction Act of 1989," a California State law that mandates that cities and counties reduce solide waste going into landfills by 25% before 1995. "We are already seeing the first of these deals. Most will be structured as COPS, and recycling and composting facilities are the main projects that are going to be financed."

The first issues sold pursuant to the Waste Reduction Act was a $80 million COPs offering by Los Angeles County to provide separate garbage containers for residences and automated pick-up arms on garbage trucks.

The LA COPs are payable from garbage collection fees, which may double in LA County because of the new way garbage must be handled.

Also, California is home of the largest issuer of lease bonds in the nation: The California State Public Works Board.

The Board has sold over $2 billion in par for COPs outstanding. Last year, the Board sold $302 million in COPs for the trustees of the University of California. "That was the largest lease issued sold in the nation during 1990," Illyes added.

Since 1988, the Board has borrowed heavily for higher education facilities and prisons. California's prison population of 100,000 is at 175% of capacity and the population is expected to grow at a rate of 10,000 per year. "To reach the standards set by the State Board of Prison Review, 125% of capacity, the Board must spend $2.7 billion by 1995," Illyes said.

Pooled Lease Report at Year's End

Illyes' next research report will be pooled lease financings, which should be published by the end of the year.

California has more pooled lease financings than any other state, Illyes said. Often a service or lobby group is established, which then creates a not-for-profit corporation which acts a financing conduit for a group of cities, special districts or a group of governments in a particular region.

Examples are the County Supervisors Association of California (CSAC) and Association of Bay Area Governments.

He stressed that "some of these are revolving loan pools, so we don't know who the members will be, say, in five years."

Illyes added that many of the pool deals are done for unusual reasons, such as the CSAC's excess liability insurance pool financing.

Earlier this year, Illyes produced a research report entitled: "California School COPs and Bonds after Richmond."

Richmond School District's bankruptcy prompted the report, which was highly publicized because President Bush's administration had touted the school district as a model for the nation.

Basically, Richmond initiated as "system of choice" that featured magnet schools and the students could choose among the schools according to their interests.

Unfortunately, Richmond spent $60 million more than it had a over a three year period and had to declare bankruptcy when it could not pay teachers. Subsequently, the Contra Costa County Court ordered the state to lend money to the school district so it would not close down. "Once a school district or other municipal entity enters bankruptcy court," Illyes said, "there is an open question about what happens to its outstanding debt."

Illyes added there are several school districts in California which are fiscally precarious and the report includes a table showing the weakest California districts. "Some could well follow Richmond into bankruptcy," he said.

The California Department of Education keeps a watchlist of troubled school districts and in this way conduct surveillance of weak school districts.

Report on "How Indiana

Lease Bonds Work"

A new report, "How Indiana Lease Bonds Work," is due out in about two weeks. The comprehensive 40-page report covers all municipal lease transactions in Indiana, both state and local issues.

"Nearly all local Indiana lease bonds are payable from unlimited property taxes," Illyes said, "and state lease bonds are payable from general fund approprations."

"But, another group of local Indiana lease bonds are non-ad valorum credits - payable solely from revenues," he said. These are sold by counties and are payable from three types of income taxes.

The report contains profiles of five major Indiana lessors, including the State Office Building Commission, Indiana's largest lessor.

The commission has sold capital complex revenue bonds, whichfirst constructed and then rennovated office buildings, then engaged in parking lot construction, and will soon undertake lease financings for prisons, Illyes said.

Illyes will be speaking at the All-American Municipal Analysts Conference in New York.

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