California law restricts the types of instruments in which California cities, districts and other local agencies can invest public funds. Previously, among other requirements, Section 53601 of the California Government Code provided that these municipalities could only invest public funds in asset-backed securities and mortgage-backed securities when (i) issued by an issuer rated at least “A” or its equivalent for its debts by a nationally recognized statistical rating organization (an “NRSRO”) and (ii) such securities had a maximum maturity of five years or less. As described in the Local Agency Investment Guidelines issued by the California Debt and Investment Advisory Commission (available here), Section 53601 has been amended to both (i) eliminate the requirement that a securities issuer be rated at least “A” or its equivalent and (ii) revise the maximum maturity provision to require that asset-backed securities and mortgage-backed securities have a maximum remaining maturity of five years or less, as determined when the municipality acquires the investment.
The removal of the rating requirement expands the scope of potential investors for issuers of asset-backed securities and mortgage-backed securities that did not previously meet the rating requirement. This change also provides increased investment opportunities for California cities, districts and other local agencies that would have previously been precluded from buying securities from issuers that did not meet the rating requirement. However, the five year maximum remaining maturity requirement may still prevent a number of issuers from selling asset-backed securities and mortgage-backed securities to California agencies. It should be noted that the “maximum remaining maturity” requirement is measured by reference to the legal final maturity date of the securities, rather than the expected or scheduled final payment date. Therefore, one way issuers could structure more securities offerings to be within the five year limitation is to shorten the time period between the expected final and the legal final maturity date. In particular, credit card issuers that typically issue bonds with a bullet maturity have shown recent interest in shortening the time period between the bullet maturity, i.e. the expected final, and the legal final maturity date. Ratings by NRSROs typically address the likelihood of repayment by the legal final maturity date (rather than expected final), so any shortening of the time period between the expected final and legal maturity dates will require approval from the relevant NRSROs for a transaction.