S&P - Public Finance Criteria (2007). - The Global Clearinghouse

Tax-Secured DebtSpecial-Purpose DistrictsTax Increment BondsTax increment financing, sometimes called taxallocation bonds, has been issued in a majorityof states, although California redevelopment agenciescontinue to account for the bulk of nationalvolume. Tax increment financing is secured by taxesgenerated from the increase in property value in adistrict after a redevelopment project has begun. Assuch, it does not raise the tax rate on district taxpayers,but merely reallocates tax revenues thatwould otherwise flow to pre-existing taxing entitiesin favor of a redevelopment agency that issues debt.Tax revenues produced from pre-existing propertybefore the tax increment district was formed continueto flow through to the underlying taxing entitiesas before; only the taxes attributable to theincrease in property values flow to the redevelopmentagency and are pledged to bondholders.Tax increment bonds benefit from several favorablestructural elements compared to other specialdistrict debt. Unlike special assessment and Mello-Roos bonds, no additional tax burden is created fortaxpayers, and tax collection rates are generally lessof a concern, unless project area tax payments areconcentrated in a few taxpayers. In addition, whileundeveloped land in a special assessment or Mello-Roos district can lead to high debt burdens, undevelopedland in a tax increment district is generallya favorable factor, since tax revenue will increase tothe extent new development occurs and taxableproperty values grow. In contrast, revenues do notincrease for special assessment or Mello-Roos debtwhen property values rise because those taxes arenot based on land value, although developmentmay lead to more favorable value to debt ratios.The main credit risk for tax increment districts isthat tax rates and the pace of private developmentin a project area lie outside the control of the redevelopmentagency issuing the debt. Actual tax ratesgenerating the tax are set by the underlying taxingentities—cities, counties, school, park districts, andothers—that set their tax rates without considerationof the needs of the redevelopment agency.Changes in state tax law, or assessment practices,can dramatically influence tax increment revenue.Tax increment district bond pitfallsA typical investment-grade tax increment districtalready generates sufficient revenues to cover futuremaximum annual debt service (MADS) at the timeof the sale of bonds, a feature sometimes called“coverage in the ground”. However, the experienceof southern California during the 1990s shows thatmany different factors can subsequently reduce taxincrement revenues. Some of the common pitfalls ofthese bonds include volatility in commercial realestate values during an economic downturn, particularlyfor warehouses and hotel properties, widespreadtax appeals that can overwhelm countyassessment offices, a residential real estate bust,construction risk on projected projects, state taxlaw changes, plant closures, concentration in a fewtaxpayers, purchase or foreclosure of land by taxexempt entities, and a high tax increment volatilityratio for recently formed project areas.Project area analysisStandard & Poor’s Ratings Services analysis focusesfirst on general economic factors that may affectthe economic growth of the project area, such as amunicipality’s population, employment, and incomelevel. Building permits may indicate overall cityconstruction trends. Nonetheless, the general characterof a city is not necessarily a barometer of theconditions within a localized project area. In thisrespect, a site visit may help give credence to rapidlyimproving economic conditions that are notreflected in assessed valuation numbers. One wayto get a description of a new project area is to readthe redevelopment agency’s plan, which outlinesprior economic conditions and project objectives.Taxpayer concentrationOne weakness of many project areas is their smallsize, leading to taxpayer concentration. Standard &Poor’s has no size limit on investment-grade ratedproject areas. Generally, smaller districts will haveweaker credit characteristics and, thus, lower ratings.A larger project area, generally one of over150 acres, is usually more diverse and more creditworthy.Standard & Poor’s analyzes taxpayer concentrationby comparing assessed valuation of the78 Standard & Poor’s Public Finance Criteria 2007