Restrictions that limit issuers' financial flexibility are forcing more and more states to find alternatives to general obligation bonds, according to a survey scheduled for release today by Moody's Investors Service.

The need for voter approval on general obligation debt, voter initiatives limiting property tax increases, and regulations restricting overall debt issuance have combined to hamper new bond sales in over 80% of states with such restrictions, according to the survey.

The impact on credit quality due to legislation requiring voter approval for bonds is mixed and takes its toll gradually, according to the Moody's survey, "General Obligation Debt Limits: Their Effects on Local Governments' Credit Ratings."

Diana Roswick, vice president and assistant director in the public finance group at Moody's, said debt restrictions "have imposed limits that otherwise wouldn't have been there in selected instances, [but] have not had as big of an impact as market conditions themselves" on overall issuance.

However, the laws have spawned a variety of alternatives to GO debt, most notably revenue bonds.

The rating agency noted that many states are prohibited from selling revenue bonds and that they are not appropriate for all projects, fostering the use of other financing techniques.

Certificates of participation and other lease financings "are the most widely used alternatives to voter-approved GO debt," Moody's said.

The use of COPs has become so prolific that Moody's treats them as debt for purposes of analysis, even though they are not legally regarded as such in most states. The popularity of lease financings can be attributed to the fact that they have no taxing pledge and allow municipalities to circumvent voter approval.

But problems can arise.

Last March, citizens in Brevard County, Fla., voted on a referendum to suspend payments on $23.9 million of outstanding COPs. After an intense lobbying campaign from both sides and pressure from the municipal industry, Brevard County voters decided to maintain the payments in a narrow vote.

Even though payments on the COPs were maintained, the Brevard County controversy and a default on a Richmond, Calif., Unified Schools District COP issue sent shock waves through the industry and cast a pall over all remaining lease-backed financings that has not fully subsided, according to Roswick.

"We noticed increased credit concern after Brevard and Richmond," she said. "Some investors were less comfortable with purchasing COPs or wanted a higher yield."

The Moody's report cites several other "loopholes" that state employ, including limited and special tax debt, lease rental bonds, and the use of financing authorities.

Debt restrictions can either weaken or improve a municipality's credit quality, the report concluded.

When issuers rely on alternative financing tools, Moody's said, weakened ratings can result from: reliance on forms of debt that draw on general operating revenues, affecting the financial position; altered debt structures, such as balloon maturities, which add risk; and deferred maintenance, which can make a community less attractive to business.

On the position side, voter approval for a debt issue ensures popular support for the project, Moody's said. Also, voter approval and debt limits can force municipalities to be more disciplined.

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