Muni Update: Important Development in California Local Finance Law

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Monthly Muni Market Update Sept 2015

Jeffrey Burger, CFA

Jeffrey Burger, CFA - Senior Portfolio Manager for Tax Sensitive Strategies

California State Senate Bill 222 has been signed into law and strengthens the security pledge of California local general obligation bonds, though we have not seen yield spread tightening of local general obligation bonds tied to this recent passage. Yield spreads in California are already at their tightest levels. The law’s most direct impact is a benefit to holders of local California general obligation bonds, and:

  • Significantly strengthens California local general obligation bondholders relative to pensioners.
  • Reduces, but does not eliminate, the incentive for severely distressed California municipalities to pursue bankruptcy.
  • Further establishes the superiority of the general obligation pledge relative to other common security pledges such as appropriation backed bonds.

Governor Brown has signed Senate Bill 222 into law, which will become effective on January 1, 2016. The law explicitly establishes that local California general obligation bonds are secured by a statutory lien, consistent with the meaning under the federal bankruptcy code. The law codifies that California local general obligation bondholders are protected in the event of a local government’s bankruptcy filing as the law explicitly establishes bondholders’ secured status. The law imposes a lien on future property taxes that are the source of repayment of general obligation bonds. In the event that a California local government were to declare bankruptcy, the revenue stream (ad valorem property taxes) should continue to be paid to service the general obligation debt service. Creditors are unlikely to challenge the lien, and general obligation bondholders should receive full and uninterrupted payment.

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