Fitch weighs in on California’s plan to step in on bonds for damaged lab

A decision by the California State Treasurer’s Office to cover bond payments for a flood-damaged agriculture lab supports Fitch Ratings’ view that issuers “will repay abatement lease debt, even if they technically have the option not to do so,” according to the rating agency.

The California State Public Works Board filed an event notice March 30 saying flood damage to the Alex Ardans Branch Laboratory in Tulare had rendered the animal health and food safety lab inoperable after a series of storms soaked California’s Central Valley .

The lab was financed with a portion of the proceeds of a $630 million lease revenue bond deal in 2013.

In the event filing, the Public Works Board said the state Department of Food and Agriculture won’t make lease payments while the building is out of commission, as allowed in the bond indenture; but it asked the treasurer’s office, as trustee, to step in and cover the bond payments, and the treasurer’s office agreed.

Fitch rates the lease revenue bonds AA-minus, one notch below its AA rating on the state’s general obligation debt. The outlook is stable.

Fitch put out an advisory Wednesday clarifying its methodology in rating the bonds, but took no rating action.

Fitch said in the advisory that it doesn’t consider abatement lease risk heightened enough to take the rating down an additional notch below the issuer default rating. It rates lease revenue bonds one notch below general obligation bonds and the issuer default rating, “reflecting the slightly higher degree of optionality associated with lease/appropriation payments,” Fitch analysts wrote.

“Fitch believes the incentive and propensity to repay lease/appropriation debt is closely linked to an obligor’s incentive and propensity to repay all debt,” Fitch analysts wrote. “This reasoning applies to abatement leases which give obligors the right to withhold payments for abatement.”

Fitch doesn’t go down another notch on abatement risk, which is the risk that the lease won’t be paid if a building is damaged, said Karen Krop, a Fitch senior director. Fitch takes the view that even if lease payments aren’t made, the issuer will cover the bond payments, she said.

“We always notch once for appropriations risk, but we don’t further notch for abatement risk,” Krop said.

The treasurer’s office will pay the missing $165,000 of the $13.3 million May 1 payment on the board’s 2013 Series I lease revenue bonds “using Build America Bond subsidies and future payments will be made from lawfully available sources as directed by the State Public Works Board,” said Joe DeAnda, a spokesman for the California treasurer’s office.

The remainder of the payment is backed by lease payments made for a San Diego courthouse, which received a much larger portion of the bond proceeds.

S&P Global Ratings took similar action on Monday, opining on the disclosure, but not taking rating action.

David Hitchcock, an S&P director, said the rating agency will be monitoring the situation to see what occurs if the facility doesn’t come back on line.

It is too soon for the state, let alone the rating agency, to know if the facility will ever come back on line, Krop said. Even if it does not, Fitch expects that the state will cover payments for the bond debt, she said.