March 25 (Bloomberg) -- Placentia, a Los Angeles suburb with median home prices 34 percent above the state level, is struggling for fiscal survival amid a California renaissance led by Governor Jerry Brown.
While California’s economy is surging to a record, the plight of Placentia shows how a financial misstep can imperil municipalities facing rising costs for retirees and infrastructure. The community of 52,000 exhausted most of its reserves on a failed railroad project. Southern California’s Adelanto and Upland are also fighting to avert insolvency.
Even with the lowest jobless rate since 2008 and Brown predicting the biggest budget surplus in more than a decade, California is at risk of logging its first local-government bankruptcies in almost two years. The disparity highlights the hit-or-miss nature of the recovery, said Michael Coleman, fiscal adviser to the League of California Cities.
“For higher-quality issuers, things are stable or improving,” said Michael Johnson, who helps oversee $8 billion as managing director of Gurtin Fixed Income Management LLC in Solana Beach, California. “For those that are lower quality or were on the brink during the recession, they’re still on the brink or worse. We’re really seeing a bifurcation.”
No California city has sought court protection from creditors since Stockton, San Bernardino and Mammoth Lakes filed in 2012. Those cities and Vallejo, which filed four years earlier, represent one-third of U.S. municipal bankruptcy cases since 2007, according to research by Matt Fabian, managing director of Concord, Massachusetts-based Municipal Market Advisors.
Additional municipal failures are likely in California in the next few years as cities confront higher costs for retiree expenses and upgrades to streets and sewers, Fabian said.
Suburbs such as Placentia, Upland and Adelanto reap none of the income-tax bounty that provides two-thirds of revenue at the state level. The communities rely on real-estate levies, capped at 1 percent of the most recent sale price under limits known as Proposition 13, and sales taxes -- if they have the businesses to generate them.
In Placentia, which bills itself as a “pleasant place to live,” two-thirds of its 52,000 residents own their homes, with a median value of $515,400, compared with about $384,000 statewide.
Yet the community 30 miles (50 kilometers) southeast of Los Angeles faces deficits for at least the next five years, a consultant concluded in December.
Upland’s city manager warned of bankruptcy in October, and Adelanto declared a fiscal emergency in June. Such a declaration is a prerequisite under state law before seeking court protection.
While coastal California communities generally are faring better than inland areas, there are many exceptions, said Gurtin’s Johnson. Economically challenged inland cities that prudently managed budgets during the recession that ended in 2009 are stable, while some wealthier towns face bankruptcy because of mismanagement, he said.
“We find pockets of strength and weakness all across the state,” Johnson said.
Placentia, with $14.7 million in debt as of July 2013, suffers from “significant organizational stress and fatigue” in part because of its fiscal struggles, according to a December report from Cathy Standiford of Management Partners Inc., a consulting firm with offices in Cincinnati, San Jose and Orange County.
“There are no easy options available,” she said in the report.
Placentia certificates of participation maturing in January 2028 traded Dec. 19 at an average yield of 6.05 percent, or about 2.6 percentage points above benchmark municipal bonds, data compiled by Bloomberg show. The securities, which have bond insurance, have had a junk grade from Standard & Poor’s since 2010.
Incorporated in 1926 on former citrus and avocado groves, the city boasts on its website of “beautiful suburban homes, good schools, stately churches and wholesome recreation.”
Its median household income of $75,693 exceeds the California median by 23 percent, according to the U.S. Census Bureau.
Yet Placentia has been dogged by deficits since at least 2008, according to the Management Partners report.
Placentia was developed as a residential community, so it receives less sales-tax revenue than other cities, said City Administrator Troy Butzlaff. About 20 percent of revenue for the year through June 2013 came from sales and use taxes, compared with 35 percent for neighboring Brea, which has a mall, according to documents.
Like other California cities, Placentia has been squeezed by rising costs for retiree health care and pensions, Butzlaff said. The city’s contribution to the California Public Employees’ Retirement System may rise to about $3.8 million, from $2.8 million, in the next three years, Butzlaff said.
While other cities carry reserves against higher costs, Placentia exhausted its budget in the mid-2000s on a since-canceled $650 million project to rebuild Berkshire Hathaway Inc.’s Burlington Northern Santa Fe LLC railroad corridor through its historic downtown, Butzlaff said.
“We’re looking at revenue enhancements, employee compensation and alternative service delivery,” he said. “Our goal is to not declare bankruptcy and we’re taking every step we can to avoid that.”
Upland, a city of 75,000 at the base of the San Gabriel Mountains about 35 miles east of Los Angeles, is considering leasing its water system to a private operator, asking voters to approve higher sales taxes and turning over library management to a private company, City Manager Stephen Dunn said.
The city’s budget crumbled as pension costs climbed to $6 million this year from zero in 2003, while property values declined during the housing crisis and the city defended against a lawsuit by San Bernardino County’s flood-control district over a development, Dunn said.
“We’ve flattened out as far as the decline, but we’re not making any progress,” he said of the city’s financial condition. “We talked about bankruptcy because we can’t go on deferring maintenance and not paying the obligations we have.”
Adelanto, a city of 31,000 in the High Desert region about 60 miles northeast of Los Angeles, could run out of money this year and may have to file for bankruptcy, according to the city’s June 2013 fiscal emergency declaration. The city lost out on major stores to nearby communities, while home foreclosures hit in the late 2000s, Mayor Cari Thomas said.
City officials are pushing for a November ballot measure to raise utility user rates by a range of 5.9 percent to 7.9 percent, Thomas said.
“If we get to November and nothing changes, bankruptcy is going to be a big word in our city,” she said. “We’re down to bare bones.”
California is one of 28 states with no tools to help cities in fiscal distress, Moody’s Investors Service said in a September report.
“The serious issue is that people in communities and organized labor think the problem has passed and it has not,” said Coleman from the League of California Cities, referring to trends that may push cities into bankruptcy. “It’s actually getting worse.”
Brown, a 75-year-old Democrat, has freed up $651 million in property-tax revenue for cities since the state eliminated redevelopment agencies in 2012, said H.D. Palmer, a spokesman for the state Finance Department.
State Controller John Chiang, a 51-year-old Democrat, worries that local bankruptcies could taint California’s credit, said Jacob Roper, a spokesman. Standard & Poor’s raised California’s grade last year for the first time since 2006, to A, sixth-highest, and issued a positive outlook after Brown released his proposed budget in January.
The comptroller is “concerned not only for the local governments but also for the impact on other cities and the state as a whole,” Roper said.
Chiang wants the state to have more tools to curb municipal fiscal abuses, such as stronger auditing powers and fiscal “strike teams” to advise distressed localities, Roper said. A Chiang-backed bill to accomplish those steps died in the state legislature last year.
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