California Thrives as Inland Cities Struggle: Muni CreditJames Nash
California’s highest credit ratings since 2009 and projections of billions of dollars in surpluses mask the struggle of inland communities such as Fresno, whose bonds this month were cut to junk.
More than four years after the national recession ended, interior cities, principally in areas dependent on agriculture and the boom-and-bust cycle of homebuilding, are faring little better: Stockton and San Bernardino are in bankruptcy, while the resort town of Desert Hot Springs has declared a fiscal emergency as it works to stave off insolvency.
The economic recovery that buoyed the world’s 10th-largest economy to forecasts of almost $10 billion surpluses by 2018 has brought coastal urban centers stronger job gains and rising home prices. Compounding the stress on the interior, California’s cities and counties face mounting costs for worker pensions and health care, said Scott Minerd, global chief investment officer of Guggenheim Partners LLC in Santa Monica.
“There are a lot of liabilities piling up here that are going to have to be paid,” said Minerd, whose firm manages $190 billion. “We see a lot of strain at the municipal level in the state.”
The California economy is at a record high, according to a Federal Reserve Bank of Philadelphia index that began in 1979.
The most-populous U.S. state expects to end its fiscal year with a $2.2 billion surplus, largely from higher income- and sales-tax rates passed in 2012, according to the nonpartisan Legislative Analyst’s Office. The analyst projects a surplus of almost $10 billion within five years.
Investors have responded, demanding about 0.35 percentage point of extra yield to buy 10-year California debt instead of top-rated munis, down from a gap of about 0.63 percentage point in January, data compiled by Bloomberg show. The spread is close to the lowest since 2008.
Yet budget-balancing steps at the state level, such as eliminating redevelopment agencies and shifting responsibility for inmates and social services to localities, have burdened cities and counties, said Justin Land, who helps manage $3.5 billion in munis at Wasmer Schroeder & Co. Inc. in Naples, Florida.
“Many of the things that have helped the state of California haven’t helped the municipalities,” Land said. “They don’t have the flexibility that the state does to shift costs.”
Land said he’s avoided bonds of inland California cities, with few exceptions, since the housing market collapsed in the recession that ended in 2009, undermining property-tax revenue.
Guggenheim’s Minerd said that when looking at inland credits, he focuses on bonds for water, sewer and power systems that are repaid by user fees rather than taxes.
Fresno, 160 miles (260 kilometers) southeast of San Francisco, has 506,000 residents, making it California’s largest inland city. Standard & Poor’s on Dec. 7 cut the issuer rating to BBB-, the lowest investment grade. It dropped to junk $418 million in debt, including lease-revenue and pension-obligation bonds.
S&P said it based part of its decision on an auditor’s letter on Fresno that “raises doubts about its ability to continue as a going concern.”
The city has $842 million in bonds, none of them general obligations, according to Phillip Hardcastle, the city’s debt administrator. Fresno is not in danger of defaulting or going bankrupt, he said. For one thing, its pensions are almost 100 percent funded, according to Hardcastle.
“We get roped into the same corral” as Stockton and San Bernardino, he said. “We are struggling. But we should be able to come out of this pretty well.”
Taxable Fresno pension-obligation bonds maturing in June 2029 traded Dec. 17 at an average yield of 6.86 percent, Bloomberg data show. Since the end of June, investors have demanded about 4.6 percentage points of extra yield on average to hold the debt, which is insured, instead of benchmark Treasuries. That’s up from an average of 4.32 percentage points from February through June.
Fresno’s per-capita income ranks at 70 percent of the national average and total assessed property value remains more than 11 percent below the peak four years ago, according to S&P.
Part of the challenge stems from the state’s elimination of local redevelopment agencies and shifting of responsibility for certain prison inmates and social services to localities, Hardcastle said.
“It’s primarily actions in Sacramento that are coming at the expense of cities and counties,” Hardcastle said.
The agencies were set up to reduce blight by financing road, sewer, lighting and affordable housing. They received property-tax revenue increases resulting from new development. Some cities used the funds for expenses such as police, rather than for the redevelopment zones.
Lawmakers and Democratic Governor Jerry Brown eliminated more than 400 of the districts in 2012 to free an estimated $1.4 billion to close a budget deficit.
Since then, cities have received $651.8 million in unrestricted funds from the state to help compensate, said H.D. Palmer, a spokesman for Brown’s Finance Department.
“The state has provided new general-purpose resources to cities and counties that they did not have under redevelopment,” Palmer said.
Officials in San Bernardino, a city of 210,000 east of Los Angeles, blamed the loss of redevelopment funds in part for their July 2012 bankruptcy filing.
Brown, speaking in San Bernardino on Oct. 29, defended the decision as emphasizing the needs of California schoolchildren. Money from the former agencies was earmarked for public education.
S&P raised California’s rating to A, its sixth-highest level, in January, the first increase since 2006. Fitch Ratings followed in August with a boost to the same rank, the state’s highest score from the company since 2009.
Yet much of inland California has a weak, resource-dependent economy, according to a report this month from the University of California at Los Angeles’s Anderson School of Management.
Silicon Valley and San Francisco experienced job growth of more than 2 percent from October 2012 to October 2013, while the San Joaquin Valley, of which Fresno is the largest city, lost jobs, according to the report. Southern California’s coastal areas also outpaced inland counties, though the gap was narrower, UCLA said.
“Inland California has long relied on growth in government, residential construction, manufacturing and logistics to drive the economy and in large parts of inland California these sectors continue to decline five years into a national economic recovery,” the report said.
In the municipal market, benchmark 10-year munis yield 2.96 percent, close to a three-month high and compared with 2.93 percent on similar-maturity Treasuries.
The ratio of the yields, a measure of relative value, is 101 percent, about even with its five-year average. The higher the figure, the cheaper munis are compared with federal securities.