WASHINGTON -- Moody's Investors Service announced Friday that it is not rating some California asset transfer leases in light of questions raised about such transactions in the lawsuit over the Richmond Unified School District's defaulted certificates of participation.
Meanwhile, two Richmond school board members said Friday that the district will not attempt to settle the lawsuit before the end of the month, when the Contra Costa County Superior Court is expected to rule on the validity of the lease contract underlying the $9.8 million certificates. The district defaulted on the issue nearly a year ago.
The "uncertainty raised by the Richmond litigation," Moody's said has called into question the viability of lease issues resembling Richmond's, where a government's existing property is mortgaged to generate cash for purposes other than capital projects. Such purposes would include self-insurance, pension funds, workers' compensation funds, and legal settlement funds, it said.
Because of the Richmond situation, Moody's has begun to refuse to rate lease issues that fall into these "gray areas," the agency said. It may decline to rate similar transactions on a case-by-case basis, it said.
Asset transfers have been used frequently in California lease transactions, analysts say, often to give investors security if the project being financed -- such as road improvements -- has little or no security value.
The school district in the 1988 financing at issue in the lawsuit, for example, mortgaged an administration building and several warehouses that had been owned free and clear to buy some multipurpose rooms and computer equipment and generate $6.7 million in cash for its deficit-ridden general fund.
The state education department, in defending the district's default against an investor lawsuit filed in April, questioned the validity of such a lease transaction, arguing that it created debt in violation of the state constitution's requirement that debt be approved by voters.
The state's argument sent tremors through the California leasing market. But as the argument was not explained in detail in the state's initial filings, its impact on other lease financings has been unclear. Attorneys say the argument will be fully developed in briefs scheduled to be filed today.
Moody's noted in its announcement that the legal underpinnings of asset transfer leases have been similar to those supporting most other California lease transactions, and these legal analyses have been solidly upheld by California courts since the 1930s.
Thus, the agency "continues to believe that the threat to general lease financings in California is minimal," it said.
The agency's "high degree of comfort" with the state's long legal history favoring leases enables it to continue rating lease financings for capital projects and equipment, even if secured by an asset transfer, "pending the outcome of the Richmond litigation," it said.
In addition, while the case has "cast a long shadow" over school district certificates, the agency will continue to rate lease financings by schools, as long as they are for capital projects. A law passed by the state Legislature last year makes it clear that such financings are valid, the agency said.
The use of lease transactions to finance operating deficits has never been acceptable to Moody's, it said, noting that it declined to rate the Richmond certificates in 1988.
W.W. Snodgrass, president of Richmond's five-member school board, said Friday that the certificate issue has been "almost an experimental process" from its inception to its default following the district's bankruptcy last year. Now the state is venturing into new territory with its argument that such issues cannot be used for anything but capital purposes, he said.
The district will let the state pursue that argument in court this month, he added, predicting that settlement of the case could take "a long time."
Frank Calton, an 11-year school board member, agreed that no settlement is likely before the court decides the critical question of the issue's validity. "It's in the hands of the lawyers right now," he said.
Any decision by the court to invalidate the issue will be "to our advantage, at least in the short term," he added. "I'm not so sure in the long term it will be good, if we ever hope to go to the debt market again."