The lingering effects of the Great Recession and other economic issues are still having an impact on municipal governments in California. This has prompted Moody’s Investors Service to place 32 municipalities in California under review for possible reductions in the credit rating on their debt obligations.
The city of Oceanside is one of the local government entities being reviewed by Moody’s to calculate the impact of property market downturns, limitations on the ability to raise property taxes, rising fixed costs and other issues.
“California cities operate under more rigid revenue raising constraints than cities in other parts of the country," said Eric Hoffmann, head of Moody’s California local government ratings team. "Combined with steeply rising costs, these constraints mean that these cities will likely recover more slowly than their peers nationally, even if the state’s economic recovery tracks the nation’s.”
Despite the concerns raised by the rating service, defaults by municipal agencies are rare. The number of issuers missing a payment for the first time fell in the third quarter of 2012 to 17, down from 23 in the second quarter, according to Municipal Market Advisors.
Of course, much attention has been directed toward the Chapter 9 bankruptcy filings this year by three California cities: Stockton, Mammoth Lakes and San Bernardino. They represent a small portion of the state’s 478 incorporated cities.
“The reported seriousness of the default picture became the focus of media coverage, but few stories mentioned what we see as the salient facts — namely, that muni default rates across the credit spectrum have historically been miniscule in comparison to the corporate default rate,” according to a report from the investment firm Oppenheimer.
The mere specter of a municipal bankruptcy raises the level of fear from individual investors who own 75 percent of the $3.7 trillion muni bond market, either directly or through mutual funds. The attraction is the tax-free status of the interest paid to investors — a benefit likely to become more important as federal and state governments increase income taxes to deal with budget shortfalls.
“The limited sample set of municipalities facing severe problems underscores that although isolated problems may arise with small, local issuers of municipal debt, the bankruptcy process available to these entities is fraught with uncertainty, drawn-out negotiations, exorbitant costs and bureaucratic hurdles," said Dan Solender, director of municipal bonds at Lord Abbett. "Except in extremely rare circumstances, therefore, the combination of these factors makes a Chapter 9 scenario an unlikely threat to municipal bondholders.”
Many cities, like Oceanside, are attempting to refinance their outstanding debt to take advantage of significantly lower interest rates, allowing them to reduce the amount of debt service on the bonds. But another issue is likely to get more attention to help cities raise revenues.
“Many cities’ assessed valuations for the property taxes that support their general obligation bonds have declined only modestly in recent years, but their general funds have come under more pressure," Hoffmann said. "Since the adoption of Proposition 13 in the late 1970s, the cities' inability to access their local property tax bases for increased operating funds led to diversification into even more economically sensitive revenue sources, such as sales, business and hotel taxes.”
Solender at Abbett suggested that raising the 2 percent cap on property tax increases, as mandated by Proposition 13, “could further assist many cities and towns.”
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