Water Bonds Shrivel as California Sees Driest YearJames Nash
The driest year on record for Los Angeles and San Francisco is threatening water supplies to the world’s most productive agricultural region and almost doubling borrowing costs on some bonds issued by California water agencies.
Los Angeles, which normally gets almost 15 inches (38 centimeters) of rain a year, got less than 4 inches in 2013, according to the National Weather Service. San Francisco, where 22 inches is typical, got 6. Severe or extreme drought grips 85 percent of California, a federal monitor reported Dec. 24.
The scarcity is depleting California’s reservoirs and jeopardizing the credit of at least 30 water agencies that had been considered safe bets because their debt is backed by user fees rather than general taxes. Concern grew in November when the California Water Resources Department, the state’s largest supplier, said it was filling just 5 percent of orders from local water agencies, the lowest in five years. Less supply means lower sales and revenue.
“Supply is always at the center of our analysis of California water agencies,” said Michael E. Johnson, managing director of Gurtin Fixed Income Management LLC in Solana Beach, California.
“If you don’t have water, you just don’t have water,” said Johnson, whose firm oversees $7.5 billion. “There’s not going to be much that mitigates not having water.”
About two-thirds of Californians get at least part of their flow from northern mountain rains and snow through a network of reservoirs and aqueducts known as the State Water Project, according to a Dec. 16 report by the Water Resources Department. The water content of the snowpack is about 20 percent of normal for this time of year, the department said Dec. 30 in a statement.
The system supplies households and businesses from the San Francisco Bay area to Southern California and irrigates crops in the San Joaquin Valley near the center of the state -- the world’s most productive agricultural region.
With reservoirs at 66 percent of average, and a third dry year predicted, revenue is likely to fall short for the Water Resources Department and the local agencies that depend on it, Moody’s Investors Service said in a Dec. 5 note. That may harm the credit of such authorities as the Metropolitan Water District of Southern California, rated Aa1, second-highest, the company said.
The district, based in Los Angeles, is the largest supplier of treated water in the U.S., serving 19 million people -- half of California’s population -- along the coast from Ventura to San Diego. It had $4.4 billion in long-term debt as of June 30, according to data compiled by Bloomberg.
Since July 10, investors have demanded an average of 2.85 percentage points of extra yield to own tax-exempt Metropolitan Water District bonds maturing in July 2037, up from an average of about 1.5 percentage points in the previous six months, Bloomberg data show.
Still, households in Los Angeles and other urban areas should be spared the effects of the shortage because the district has enough water and cash to cushion it against a few dry years, said General Manager Jeffrey Kightlinger.
The district connects to the State Water Project in northern Los Angeles County at Castaic Lake, which was at 89 percent of capacity as of Dec. 30. The MWD’s biggest reservoir, Diamond Valley Lake, was 72 percent full.
“We build our whole system around three- or four-year drought cycles,” Kightlinger said by telephone. “We don’t see any downgrades from one or two dry years.”
California agencies are still among the safest for municipal investors, said Craig Brothers, a senior portfolio manager at Bel Air Investment Advisors LLC in Los Angeles, which manages $2.8 billion. Metropolitan Water District and the state Water Resources Department, which has $2.6 billion in long-term debt, are “two of the premier trading credits in the state,” Brothers said by telephone.
Agencies can raise fees to compensate for shortages and are thus more insulated from politics than cities and states, Brothers said.
“I don’t think there’s a reason for people to shy away from these really strong water credits,” Brothers said. “If the market prices in a penalty, I’d definitely be a buyer. These are safe.”
The Water Resources Department plans to sell from $200 million to $250 million in bonds in March, said Perla Netto-Brown, its head of fiscal services. She said she doesn’t expect investors to penalize it because local agencies such as the Metropolitan Water District pay the same to the state regardless of how much water the state furnishes.
The shortage will be felt most in the San Joaquin Valley, where farmers who depend on irrigation will be forced to leave some fields out of production, or fallow, said Kightlinger of the Metropolitan Water District.
“You’ll likely see widespread fallowing throughout the Central Valley with major economic consequences for the state,” he said.
With $16 billion in net farm income in 2012, California ranked first among states, according to the U.S. Agriculture Department. The drought could cost more than $1 billion in the western San Joaquin Valley alone, according to the Westlands Water District, which supplies the area.
“Some farmers are pumping water from the ground to compensate for the lack of water in reservoirs, but that’s not sustainable in the long term,” said Dave Kranz, a spokesman for the California Farm Bureau Federation. “If we see this for the remainder of the rainy season, there’s going to be some serious dislocation.”
On Dec. 11, a group of San Joaquin Valley lawmakers sent a letter to Governor Jerry Brown urging him to declare a drought emergency and increase supplies from the State Water Project.
While Brown, a 75-year-old Democrat, didn’t issue an emergency declaration, he established a task force to monitor the situation, said Richard Stapler, a spokesman for the Natural Resources Agency.
The Kern County Water Agency, which serves farms in the southern San Joaquin Valley and is the second-largest State Water Project user behind the Metropolitan Water District, was identified by Moody’s as being at risk from the state shortfall. The agency gets about a quarter of its water from the State Water Project, said Brent Walthall, its assistant general manager.
“A 5 percent initial allocation rings all kinds of alarm bells,” he said by phone. “We and our farmers will need to very aggressively manage our supplies for the next year.”
The drought may influence voters’ willingness to pay for water projects. Brown is considering whether to submit a bond measure to voters to pay for tunnels and other infrastructure to increase supplies from the Delta region. In July 2012, Brown withdrew an $11 billion borrowing proposal from the November 2012 ballot, citing concerns that it would have jeopardized his plan for higher sales and income taxes.
Renewed concern about water shortages may tilt public opinion in favor of a water-bond measure, said Ellen Hanak, a water specialist at the nonpartisan Public Policy Institute of California in San Francisco.
“It makes it more salient for people,” she said by telephone. “There’s still the question about the shift in public opinion in general about state borrowing, compared to before the recession.”
The $3.7 trillion municipal market greets 2014 today after closing out its worst year since 2008, according to Standard & Poor’s index data. Local debt fell about 2.6 percent in 2013 after rising 7.4 percent in 2012.
The ratio of the yield of 10-year munis to U.S. Treasuries of comparable maturity, a measure of relative value, was 96.8 percent, the lowest since May and down from 2013’s peak of 115.4 percent in April, according to Bloomberg data. The smaller the number, the more expensive munis are compared with U.S. securities.
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