BILL ANALYSIS SENATE LOCAL GOVERNMENT COMMITTEE Senator Patricia Wiggins, Chair BILL NO: SB 613 HEARING: 1/6/10 AUTHOR: Harman FISCAL: No VERSION: 12/15/09 CONSULTANT: Weinberger IRVINE RANCH WATER DISTRICT'S BONDS Background and Existing Law The Irvine Ranch Water District (IRWD) and the Santa Margarita Water District (SMWD) are special districts, formed under the California Water District Act, which together provide water and sewer service to approximately 480,000 residents within a service area of over 177,000 acres in Orange County. IRWD and SMWD can form improvement districts, which are geographical subdivisions through which each district can fund capital improvements that benefit those specific geographic areas. With a 2/3-vote of the property owners in an improvement district, IRWD and SMWD can finance capital projects by issuing general obligation bonds, which are secured by property tax revenues outside of the standard 1% rate. When issuing general obligation bonds for improvement districts, IRWD and SMWD typically purchase credit enhancement, like bond insurance or a letter of credit, to provide additional security for the bonds. Credit enhancement improves the bonds' credit rating and lowers the districts' borrowing costs. Investors rely on the higher rating of a third-party credit enhancement provider rather than the issuer's rating, so that the investors will demand a lower interest rate, more than paying for the cost of the credit enhancement. Recent turmoil in the credit markets is making it more difficult for IRWD and SMWD to purchase affordable third-party credit enhancement for their improvement districts' general obligation bonds. District officials want greater flexibility to provide their own direct credit enhancement for their bonds. SB 613 -- 12/15/09 -- Page 2 Proposed Law Senate Bill 613 authorizes the Irvine Ranch Water District and the Santa Margarita Water District to provide credit enhancement, liquidity support, or both, by pledging and applying all or any part of the districts' revenues to the payment or security of the principal, redemption price, purchase price, and interest of any general obligation bonds for improvement districts or consolidated general obligation bonds for improvement districts issued or carried by the districts. The bill allows the districts to make that pledge in the manner and upon terms that the districts' boards deem advisable. In connection with the pledge, SB 613 authorizes the board of each district to provide, in the document in which the pledge is provided for or created, any covenants, promises, restrictions, and provisions that the district may deem necessary or desirable, including, but not limited to, covenants, promises, restrictions, and provisions relating to: The use of bond proceeds, The maintenance, operation, and preservation of the district's facilities, Any rates and charges to be established and collected by the district, including rates and charges for the services or products furnished or provided by the district's facilities, The incurring of additional indebtedness payable from the revenues, and The establishment, maintenance, and use of reserve funds, sinking funds, interest and redemption funds, maintenance and operation funds, and other special funds for the payment or security of any or all of the principal, redemption price, purchase price, and interest. SB 613 allows the board of each district to exercise the powers specified in the Revenue Bond Law of 1941 to carry out the bill's provisions. SB 613 specifies that pledges authorized by the bill are governed by specified statutes relating to pledges of collateral to secure bonds. SB 613 -- 12/15/09 -- Page 3 SB 613 requires the board of each district to adopt criteria to govern its determinations to use the general revenue pledge. The criteria may include evaluating the use of a pledge in lieu of, or in combination with, other available credit enhancement and liquidity options. SB 613 states that the authority granted by the bill is in addition to any authority granted by other provisions of law relating to the payment of the districts' general obligation bonds from the proceeds of assessments to be levied upon and collected from lands of any improvement district or relating to the levy and collection of the assessments. The bill states that it does not affect any other law authorizing or providing for the issuance or carrying of bonds by the districts. SB 613 declares that it shall be deemed to provide a complete and supplemental method for exercising the powers authorized by the bill, and shall be deemed supplemental to the powers conferred by other applicable laws. Comments 1. Making credit more affordable . Recent volatility in the credit markets and the financial industry has increased bond issuers' costs of borrowing by dramatically increasing the cost of purchasing third-party credit enhancements for bonds. Credit enhancement costs can be particularly high for the issuance of consolidated improvement district bonds because the bond market tends to perceive the strength of the consolidated bonds in terms of the weakest improvement districts included in those bonds. Rather than relying entirely on third-party credit enhancements, IRWD and SMWD can use SB 613 to pledge their general revenues towards the payment and security of their improvement districts' general obligation bonds. By allowing IRWD and SMWD to use their strong overall credit to support general obligation bonds issued by their improvement districts, SB 613 will significantly lower the districts' cost of borrowing and, as a result, will save money for taxpayers and ratepayers. 2. Oversight . SB 613 responds to the unprecedented scarcity and expense of credit enhancement for bonds over the last two years. However, it is possible that improved credit market conditions, within a few years of the bill's SB 613 -- 12/15/09 -- Page 4 January 1, 2011 effective date, could eliminate these credit enhancement cost and availability problems. Because SB 613 authorizes IRWD and SMWD to use a new form of bond credit enhancement, and because future credit market conditions could change dramatically, legislators may wish to ensure oversight of the use of the revenue pledges that the bill authorizes. The Committee may wish to consider amending SB 613 to require the districts to report back to the Legislature and State Treasurer's Office on their use of the bill's provisions by January 1, 2014. 3. Cut out the middle-man . As part of a credit enhancement transaction, issuers and third-party credit enhancement providers enter into a reimbursement agreement, which specifies the issuer's obligations to repay the third party if there are draws upon the credit or surety extended to the issuer by the third party. IRWD asserts that it is currently able to make a pledge of district revenues as a part of a reimbursement agreement for its improvement districts' general obligation bonds. As a result, IRWD argues that SB 613 allows it to effectively "cut out the middle-man" by pledging district revenues directly to bondholders as a form of credit enhancement, rather than pledging them to a third-party. 4. Not a hybrid . Ad valorem property taxes outside the standard 1% rate pay for general obligation bonds. By specifying that the use of a revenue pledge would function only as credit enhancement or liquidity support for IRWD and SMWD's general obligation bonds, the December 15 amendments clarify that SB 613 does not allow IRWD and SMWD to issue a new type of hybrid general obligation/revenue bond. 5. Special legislation . The California Constitution prohibits special legislation when a general law can apply (Article IV, 16). SB 613 contains findings and declarations explaining the need for legislation that applies only to IRWD and SMWD. Support and Opposition (12/22/09) SB 613 -- 12/15/09 -- Page 5 Support : Irvine Ranch Water District, California Special Districts Association, Orange County Business Council, Santa Margarita Water District. Opposition : Unknown.