Oct. 26 (Bloomberg) -- Los Gatos, California, where Apple Inc. co-founder Steve Wozniak can be seen riding the sidewalks on his Segway, isn’t often mentioned in the same breath as Fresno, an agricultural hub seeking to stave off insolvency.
Yet both are on a list of more than two dozen California cities, including some of the most affluent, with securities facing possible credit downgrades by Moody’s Investors Service.
Rating companies and investors are scrutinizing the willingness of California localities to budget for bond payments after three of the state’s municipalities filed for bankruptcy since June. One of the failures, Stockton, has said it may try to force investors to take a loss. Another, San Bernardino, is $1 million in default on pension bonds.
“It’s a wakeup call,” said David Kotok, chief investment officer at Sarasota, Florida-based Cumberland Advisors, who helps manage about $2.1 billion. “You don’t see it in Florida, in Palm Beach or Sarasota. You don’t see it in other places where you have wealth in cities. You do see it in California.”
Los Gatos, a Silicon Valley town of 30,000 at the foot of the Santa Cruz Mountains, hosts the headquarters of Netflix Inc., the world’s largest online video service. It had a median home price of $1 million last month, compared with $287,000 statewide and $155,000 in Fresno, according to DataQuick, a San Diego-based provider of property information.
Home to at least six wineries and the two-star Michelin-rated restaurant Manresa, Los Gatos is about 50 miles (80 kilometers) south of San Francisco. Wozniak was first in line at the Apple store there when the iPhone 4S was released last year, according to his website. He didn’t respond to an e-mail seeking comment.
The town, with a $122,000 median household income that is double the state level, has an Aa1 issuer rating, Moody’s second-highest mark. That rating is under review for downgrade, as are the grades for a combined $26 million of certificates of participation, Moody’s said Oct. 9.
The certificates, backed by lease payments, are rated one step lower at Aa2. They were issued to finance projects such as library construction and renovation of a downtown plaza.
The community has added to its reserves annually for the last five years, improved its pension system and reduced salaries, said Greg Larson, the town manager.
“We think our sound financial practices will keep us as one of the top-rated smaller cities in the state,” he said.
Investors are showing confidence in the town’s fiscal outlook. The extra yield bondholders demand to own some Los Gatos debt has shrunk by almost a third in the past two years.
Securities sold for the library project and due in August 2028 traded Oct. 24 at an average yield of 2.73 percent, about 0.43 percentage point above top-rated debt, data compiled by Bloomberg show. The so-called spread is down from 0.62 percentage point at the time of issue in 2010.
Moody’s is concerned that cities might skip debt payments in a cash crunch to preserve services and meet payroll. San Bernardino withheld a $1 million payment on 2005 pension-obligation bonds, according to a Municipal Securities Rulemaking Board filing Oct. 16. Stockton, the largest U.S. city to enter bankruptcy, missed a $4.3 million bond payment in September, Standard & Poor’s said last month.
The decisions to seek bankruptcy “provide some indication that willingness to pay debt obligations may be eroding in the U.S. municipal market,” according to the Moody’s report.
“It’s understandable that Moody’s and other agencies are reviewing the finances of many entities in California,” said Larson, the Los Gatos manager. “That they’re finally reviewing the highest-rated entities, I don’t find that surprising.”
California municipalities have limited ability to boost revenue. They can’t impose higher sales taxes without going to voters, and the state caps real-estate levies at 1 percent of a property’s most-recent sales price.
“Even with a booming local housing market and a very wealthy community, local governments don’t have as easy access to property taxes as communities across the country,” said Eric Hoffmann, a San Francisco-based Moody’s senior vice president who wrote the report.
Los Gatos isn’t the only affluent locality on the list.
Rancho Mirage, a resort community near Palm Springs where singer Frank Sinatra lived and the median home price was $375,750 last month, also has securities under review. Moody’s selected its Series 2005A lease bonds, rated Aa2, to be studied for a downgrade.
The desert community, about 120 miles east of Los Angeles, has cash reserves of more than $70 million, triple the $21 million operating portion of its general-fund budget, Scott Morgan, the city’s director of administrative services, said in a telephone interview.
“Why they selected Rancho Mirage, in light of our outstanding financial condition -- to me their time would be better spent elsewhere,” Morgan said. “Bondholders have no reason whatsoever to be concerned about whether they’re going to get their money back.”
John Knox, an attorney for Stockton in its bankruptcy case who also represented Vallejo, which filed for court supervision in 2008, said the issue is more cities’ ability to pay their debt rather than willingness.
“If you say there’s a lack of willingness to pay, in my book, you’re saying there’s a realistic choice whether to pay or not,” Knox, a partner at Orrick, Herrington & Sutcliffe LLP in San Francisco, said at a municipal finance conference last week.
In many cases, “you really don’t have the choice as to whether to pay, because you can’t have no police on the street, you can’t have an ineffective firefighting force,” Knox said.
Cumberland’s Kotok said his company is avoiding the debt of California cities.
“We think they are a troubled group,” Kotok said. “It is no longer a one-off, single-town event. It’s a systemic shock.”
Moody’s homed in on obligations such as lease-backed and pension-obligation debt because they’re paid from a city’s general fund, which requires appropriation by the city council, according to the report.
The review doesn’t imply the cities are distressed, Hoffmann said.
“We’ve had an economic downturn that has dragged on for quite a while and longer than might have been expected,” he said by telephone. “It’s certainly having fallout in other communities, and so these highly rated leases were identified as potentially at greater risk.”
In trading yesterday in the $3.7 trillion municipal-debt market, yields on benchmark 10-year bonds were little changed at 1.7 percent, the highest since Oct. 1, a Bloomberg index shows.
Following is a pending sale:
NEW JERSEY plans to sell $2.6 billion of general-obligation tax-and revenue-anticipation notes through competitive bid as soon as Oct. 30, data compiled by Bloomberg show. It’s the state’s largest short-term note deal, the data show. Proceeds will repay a loan from Bank of America Merrill Lynch and boost cash flow. (Updated Oct. 24)
THE TRUST FOR CULTURAL RESOURCES OF THE CITY OF NEW YORK, which sells debt on behalf of museums and non-profits, plans to issue $112.5 million of revenue bonds as soon as Oct. 31, data compiled by Bloomberg show. The Wildlife Conservation Society will use the proceeds to help finance a building holding sharks and other sea creatures at the New York Aquarium in Coney Island. The deal will also fund renovations at the Bronx Zoo and refinance debt, according to offering documents. (Added Oct. 26)
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