California Muni Credits Sell Off but Remain Resilient Amid Catastrophic Wildfires; Market Ponders Potential Impacts on Tax Base 

Relevant Documents:
PLOM – Department of Water and Power of the City of Los Angeles (Jan. 7)
Issuer EMMA Pages:
Los Angeles Department of Water and Power: Series 2024 E, Series 2024 B
Los Angeles Unified School District: 2024 Series A
The J. Paul Getty Trust: Series 2021B

Spreads have widened over the past week for large issuers in the Los Angeles metropolitan area, but sources say L.A.-based credits have remained resilient as the market stays laser-focused on utility bond trades and local rescue efforts amid the catastrophic wildfires.

Broader credit issues such as outmigration and potential tax-base erosion have become increasingly important for issuers, investors and analysts alike as they look to reassess the credit risk in regions coping with more regular – and more existential – disasters. Litigation against municipal issuers could compound any financial fallout from the loss of property value and taxpayers.

Bids Wanted for Los Angeles

The Los Angeles Department of Water and Power, or LADWP, the largest municipal utility in the country and one of the largest municipal issuers in California, has recorded a series of trades across its water and power revenue bonds, according to secondary trading data on EMMA.

Its 5% 2024 Series B water system revenue bonds maturing July 1, 2043, last traded yesterday, Jan. 14, at roughly 107 to yield 4.1%, which was about 71 bps lower than its issuance price of 113.6 to yield 3.39% in May 2024. Similarly, LADWP’s 5% 2024 Series E power system revenue bonds maturing July 1, 2048, last traded Jan. 14 at roughly 108 to yield 4.4%, which was a slight discount from its premium issuance price of 110.4 to yield 3.69% in December.

Earlier this week, spreads on the power bonds widened up to 100 bps and were more concentrated on longer maturities, with the bulk of the trades going past 15 years, according to one source. Other market participants offered similar observations, cautioning that the situation is still unfolding in real time and that it is still too early to tell what the full impact will look like for local credits since rescue efforts are a top priority.

For a large issuer with a strong balance sheet like LAWDP, “you’re not looking at cents-on-the-dollar type story but a more technical type of more sellers than there are buyers right now,” said John Miller, head and chief investment officer of First Eagle’s municipal high-yield credit team.

Miller noted that as of Jan. 14, spreads have also widened up to 75 bps for the Los Angeles Unified School District and widened slightly for the state of California’s general obligation longer-dated bonds.

Although it is too early to say for certain, there might be recovery bonds down the road that are issued at a cheaper price, Miller added. Bonds funding the Getty Museum, which were issued via the California Infrastructure and Economic Development Bank on behalf of the J. Paul Getty Trust, have also traded down to the mid-90s from their premium issuance price of 111, another source highlighted.

In the immediate term, LADWP pulled a $371.05 million issue of Series 2025 water system revenue bonds, which was originally slated to price Jan. 13, according to market sources. The deal, which was announced on Jan. 7 and underwritten by BofA Securities, is now on a day-to-day basis.

Earlier on Jan. 14, S&P Global Ratings downgraded LADWP by two notches, to A from AA-, for its power system revenue bonds, and to AA- from AA+ for its water system revenue bonds. The ratings agency cited the utility’s potential vulnerability to financial liability and litigation claims as rationale for this rating action.

“Market response to the LADWP bonds continues to evolve; follow-through trading in the power bonds [since the downgrade] has widened around 50 bps,” said Kim Olsan, senior fixed income portfolio manager at NewSquare Capital.

Litigation Looms

Potential litigation claims are highlighted by a complaint filed in California superior court by a group of Los Angeles County residents and businesses against the city and LAWPD. The complaint, which asserts a cause of action for inverse condemnation, alleges that “the water supply system servicing areas in and around Pacific Palisades on the date of the Palisades Fire failed,” causing the plaintiffs to suffer “real and personal property damage, personal injuries, loss of use of their homes, loss of income, business interruption, and emotional distress.”

The complaint states that “[a]mong other failures, the Santa Ynez Reservoir, a 117-million-gallon water storage complex that is part of the Los Angeles water supply system, was empty, leaving fire crews little to no water to fight the Palisades Fire.”

The plaintiffs say that the reservoir “had been out of commission since February of 2024, awaiting repairs to its cover,” when the LAWDP “made the conscious decision not to timely repair … as a ‘cost-saving’ measure.” With the reservoir empty, “hydrants in Pacific Palisades failed after three … tanks each holding one million gallons of water went dry within a span of 12 hours,” according to the filing.

The complaint was filed the same day several other lawsuits were brought against Southern California Edison concerning the Eaton Fire, signaling a potential wave of litigation that could affect municipal and nonmunicipal credits alike.

Taking the Long View

The recent downgrade and lawsuits associated with LADWP depict another story of how utilities come under high scrutiny in times of devastating fires. While the circumstances of the LA fires might be different, PG&E Corp. filed for bankruptcy in 2019, citing potential liability relating to multiple wildfires in Northern California in 2017 and 2018, and Hawaiian Electric and other parties agreed to pay $4 billion to settle tort claims related to the 2023 wildfires in Maui – stories of a not-so-distant past that still reverberate today, market sources tell Octus, formerly Reorg.

Regardless of the scope of the Los Angeles fire damages, it is important to keep in mind that the two major entities involved are Los Angeles County and the city of Los Angeles, both of which “have a massive tax base,” said Alice Cheng, muni credit analyst at Janney Montgomery Scott.

The average annual property tax bill of the heavily affected Pacific Palisades, where the median home value is $1.58 million, is roughly $17,241 per each of the reported 5,300 homes destroyed by the fires so far. This would result in about 5% property tax loss to the affected areas, and property tax is only one of the many types of tax revenue that Los Angeles collects, Cheng explained.

“Not saying this is not significant, but I don’t believe this would be a time to panic about the credit quality of the city of Los Angeles or even the county of Los Angeles,” she said.

Smaller cities such as Pasadena and Altadena are more susceptible to severe impacts to their budgets and balance sheets. Even then, however, given that they are not highly leveraged, any recovery and rebuilding costs will likely get absorbed by Los Angeles County, Cheng added.

“There will be resources going toward rebuild and rescue efforts … and there will be expenditures incurred to put things back to somewhat of a normalcy.”

The recurring nature of natural disasters of such enormous scale is something that issuers and the larger market will have to come to terms with, potentially changing how municipal finance is handled in those regions, sources tell Octus. Rising insurance costs might drive outmigration trends in the area, which would contribute to tax base erosion in the long run, sources said.

Last March, State Farm announced that it would not renew approximately 30,000 homeowners and rental dwellings insurance policies as well as about 42,000 commercial apartment policies, in addition to withdrawing from offering new commercial apartment policies entirely. The company attributed its decision to “inflation, catastrophe exposure, reinsurance costs, and limitations of working within decades-old insurance regulations.”

Regional Credit Watch

Looking ahead to upcoming ripple effects on the primary pipeline in the region, Goldman Sachs is still expecting to price the $121 million issue for Sunrise of Manhattan Beach tomorrow, Thursday, Jan. 16, according to two market sources. The deal, which is for a senior living project just south of the Palisades Fire, was originally scheduled to price last week but was delayed because of the federal holiday on Jan. 9, according to one source.

Workforce housing projects in California tracked by Octus might also be affected by the California wildfires. Westgate Phase 1-Pasadena, Pasadena Portfolio, Theo-Pasadena and MODA at Monrovia Station are all housing developments south of the Eaton Fire.

Westgate missed its mezzanine debt service covenant for fiscal year 2024, and only just started to implement consultant recommendations to bring its coverage reserve back in line. Now the housing development needs to grapple with wildfire recovery as well as regional threats of outmigration.

The properties at MODA at Monrovia Station avoided physical damage, and its residents did not have to evacuate, according to site management.

While none of the workforce housing projects are in active evacuation warning zones as of publication, regional recovery could slow rental revenue. That happened in the case of Annadel Apartments, a distressed workforce housing development in Santa Rosa, Sonoma County, that experienced both the Tubbs Fire in 2017 and the Kincaid Fire in 2019. Rent increase limitations imposed by the state to multifamily operators was a contributing factor to the property’s current financial distress, according to a consultant report.