California Undreamin'

Moody’s Investors Service hit 54 California local credits with either downgrades or by placing them on review for downgrade, citing the economic strains in the state. The rating agency Monday put the general obligation bond or issuer rating of nine cities on review for possible downgrade, placed the lease-backed obligations of 27 cities on review for possible downgrade, and downgraded nine pension obligation bond issues or similar financings, stating: “The actions reflect a combination of fundamental economic pressures in the state, the different way in which various revenue sources have been affected, and the factors that influence a city’s ability and willingness to pay the obligations backed by these revenue sources.”

On October 9, 2012, we announced a number of rating actions and reviews affecting the debt obligations of 32 cities and one pooled financing in California. Most of these actions are negative – downgrades and reviews for downgrade – and the majority affect securities that are solely paid from these cities’ general funds and do not benefit from a specific, pledged revenue source. The actions reflect a combination of fundamental economic pressures in the state, the different way in which various revenue sources have been affected, and the factors that influence a city’s ability and willingness to pay the obligations backed by these revenue sources.

This week’s rating actions come after Moody’s said in August that it would review the credits of 95 California cities. Moody’s said some cities are suffering due to the dramatic impact of the housing market bust on parts of the state and the rigid constraints on how municipalities can raise revenue. Some of the larger cities affected include Fresno, which saw two of its bonds downgraded to Baa2 and 12 of its credits put on review for downgrade. In addition, Sacramento had its issuer rating put on review for downgrade along with five of its other securities. Oakland had five of its credit obligations tagged for downgrade review. But, the agency placed San Francisco and Los Angeles on review for a possible upgrade to “reflect strengths that may not be adequately reflected in their current ratings, including their relative resiliency during the economic and property market downturns.” Some of the most troubled California bonds, according to Moody’s, include debt issued by Inglewood, Petaluma, Santa Ana and Azusa. Lease-backed obligations, unlike GO bonds, are not backed by voter-approved property taxes and are paid out of a city’s general fund.

The agency noted two critical points: 1) Pension obligation bonds are also paid out of a city’s operating budget and thus must compete with essential services, such as libraries and public safety contracts, and 2) The most significant of these constraints fiscal constraints on California cities is the state’s constitutional ban on raising ad-valorem property tax rates to pay for operations, while cities must also seek voter approval to increase any tax, fee or charge to pay for general operations.: “These constraints, combined with some California cities’ relatively steeply rising costs, will likely result in their recovering more slowly than their peers nationally, even if the state’s economic recovery tracks the nation’s.” Moreover, Moody’s noted, that “cost-cutting fatigue” may be weakening the willingness of the state’s cities to use their general funds to pay for pension obligation bonds and make lease payments.

Moody’s also noted in the report that the recent bankruptcy filings in Stockton and San Bernardino may signal some reluctance to pay for debt obligations in the municipal market since they reflect generally tight budgets, as opposed to such failing enterprises as convention centers, arenas or other specific projects that have caused previous municipal bankruptcies or defaults: “Though we do not expect many cities to follow Stockton and San Bernardino into bankruptcy, as long as the economic recovery remains sluggish, the risk has increased that some California cities will make this choice.”