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Moody’s Downgrades LA’s Bond Rating

From Moody’s via iStockAnalyst:

Moody’s Downgrades Los Angeles From Aa2 To Aa3

NEW YORK, Apr 7, 2010 — Moody’s Investors Service has downgraded to Aa3, from Aa2, our rating on the City of Los Angeles’ general obligation bonds. At this time we have also downgraded each of our ratings on the city’s general fund obligations by one notch, resulting in ratings ranging from A1 to A3 depending on the specific security pledge. The downgrade primarily reflects the continued erosion of the city’s historically better-than-average willingness and ability to quickly rebalance its budget mid-year.

This is a particularly important rating factor for Los Angeles since its balance sheet has typically been relatively weak for the rating level. The downgrade also partly reflects the likelihood that the city’s general fund reserves at the end of the current fiscal year could be materially weaker than we had previously expected, now that an expected transfer from the Department of Water & Power may be reduced.

The loss of these DWP funds would, at a minimum, make the city’s planned rebuilding of its budgetary reserves over the next few years more difficult, if only because it would likely be starting from a weaker position. Given the likely difficulty in rebuilding reserves according to the city’s three-year plan–particularly in the current economic environment–our rating outlook for the city’s general obligation and general fund ratings remains negative.

The current long-term ratings and outlook also reflect our expectation that the city’s near-term, general fund liquidity challenges will be addressed in a timely fashion, most likely with a transfer from the city’s general fund budget reserve, currently estimated at $199 million. While we believe it highly unlikely that the city would fail to take the necessary steps to shore up its general fund liquidity, failure to do so would put significant downward pressure on the rating.

These negative developments continue to be balanced by, and our rating continues to reflect, the city’s very modest and rapidly retired direct debt burden, as well as an extremely diverse economic base that has likely reached the low point of the current economic cycle.

The inherent stability of the city’s property tax base relative to market values and the above average strength of the general obligation security pledge and administration are additional positive considerations.

Los Angeles underestimated the full effect of the recession on its revenues and was slow in implementing planned cost savings for the current fiscal year. As a result, in January its fiscal 2010 general fund budget was estimated to be about $212 million out of balance, or approximately 5.0% of projected revenues. In February and March the city did implement a range of budget adjustments to partially close this gap, but the full fiscal effect of these steps is still being evaluated at this time. The city expects to release an updated fiscal status report later this week, which Moody’s believes will show some improvement in the budget gap but not a complete on-going solution. Substantial additional draws from the city’s budget reserve fund are likely to be necessary to achieve a balanced budget for the current year, leaving the city with diminished financial flexibility going forward.

The fiscal challenge the city’s general fund faces would be compounded by a reduction in the annual transfer from its power enterprise. The Department of Water & Power has recently indicated that it will be able to make only a $147 million transfer rather than the $220 million previously budgeted. This $73 million reduction would pose a material, though not unmanageable, challenge for the city’s general fund. We understand that the final figure for this formerly reliable transfer is still being discussed by the city’s leadership, but given its significance to the general fund, the increased political contention around it is a negative credit development.

What Could Change the Rating–Up

Our negative outlook on the city’s ratings largely precludes a rating upgrade over the rating-outlook horizon, particularly in the current, still sluggish economic environment. However, were the city to successfully implement its three-year budget plan, structurally balancing its general fund budget while materially rebuilding reserves, an upgrade could be warranted.

What Could Change the Rating–Down

The city’s liquidity position is further strained, and/or its budget reserve position is further depleted and not replenished on a timely basis. Downward pressure would also likely result if the long-term budget solutions the city adopts are largely one-time measures rather than on-going.

The last rating action with respect to the City of Los Angeles was on February 17, 2010, when a negative rating outlook was assigned to the city’s general obligation and general fund obligation ratings.

The ratings assigned to Los Angeles’ general obligation and general fund obligations were issued on Moody’s municipal rating scale. Moody’s has announced its plans to recalibrate all U.S. municipal ratings to its global scale and therefore, upon implementation of the methodology published in conjunction with this initiative, the ratings will be recalibrated to a global scale ratings comparable to other credits with a similar risk profile. Market participants should not view the recalibration of municipal ratings as rating upgrades, but rather as a recalibration of the ratings to a different rating scale. This recalibration does not reflect an improvement in credit quality or a change in our credit opinion for rated municipal debt issuers. For further details regarding the recalibration please visit www.moodys.com/gsr.

The principal methodology used in this rating review was General Obligation Bonds Issued By U.S. Local Governments, published in October 2009 and available on www.moodys.com in the Rating Methodologies sub-directory under the Research & Ratings tab. Other methodologies and factors that may have been considered in the process of rating this issuer can also be found in the Rating Methodologies sub-directory on Moody’s website.

And Los Angeles is surely just the first of a long line of cities facing a downgrade in their credit rating.

And of course this could happen to the US, as well.

This article was posted by Steve on Thursday, April 8th, 2010. Comments are currently closed.

2 Responses to “Moody’s Downgrades LA’s Bond Rating”

  1. GetBackJack says:

    Having done some work in Statistics, I’d hazard a rather informed guess that just as ratings agencies were screwing the pooch in order to apply an AAA rating to the hideously packaged securities flushed out of our last Bubble …


    … in the same manner Los Angeles in no way deserves an Aa3.

    Their credit-worthiness is most likely (following accepted industry calculations) Caa1 Caa2 or just C.

    From a guy who’s done some math in the past.

  2. proreason says:

    How fitting.

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