LOS ANGELES -- In a report released on Wednesday, Fitch Ratings suggested the recent bankruptcies of three California cities could lead the way for more Golden State cities to declare bankruptcy.
The report also criticizes the state government’s role in local finance, which it described as “neutral to negative,” for actions like the dissolution of redevelopment agencies earlier this year, which made it harder for local governments to achieve fiscal stability.
“Even as the broader economy shows signs of stabilization, California cities face state specific uncertainties based on their diverse economic profiles, and revenue raising environment,” Karen Ribble, senior director in Fitch’s Public Finance group. said in a statement. “California cities facing the most distress are those with limited options to address budget imbalance, reinforcing the divide between the strong and the weak.”
Proposition 13, adopted in 1978, limits the base property tax rate to 1% of assessed valuation and caps assessed valuation growth on properties that don’t change ownership, creating a restrictive revenue raising environment for California cities, according to the report.
The recent bankruptcies of Stockton, San Bernardino and Mammoth Lakes prompted Fitch to review the basic credit characteristics of the cities it rates in the state.
Fitch rates 40 of the 482 cities in California, maintaining an average unlimited tax general obligation, ULTGO, rating of AA, which is consistent with Fitch’s average ULTGO rating for municipalities nationwide.
Fitch downgraded nine California cities in 2011 and another three in 2012 for a total of 30% of its portfolio of California cities over the last 21 months, compared to 12% of general government ratings nationally.
While the financial and reputational costs of bankruptcy remain high, analysts said in the report that some cities may see bankruptcy as worthwhile depending on how the outcome of current cases affects incentives.
It was of particular concern, Fitch analysts said in the report, that both Stockton and San Bernardino officials suggested bondholders accept delayed, and perhaps reduced payments rather than focusing on reducing labor costs, although San Bernardino does provide for its full debt service payment in its current budget.
Analysts questioned the state’s lack of an effective mechanism to help cities in distress, unlike the one that exists for school districts; and the adoption of Assembly Bill 506, which provides for a bankruptcy mediation process for distressed cities, but which Fitch analysts said may have accelerated the three bankrupt cities’ decline into default and then bankruptcy.
“Fitch believes credit deterioration can be forestalled for an entity in a state with an effective intervention program,” the report said.
California, on the other hand, not only provides limited assistance to cities, but in some ways has made it more challenging for local governments to maintain financial stability, the report said.
“The state has the ability to reallocate property taxes among units of local government and has done so on a number of occasions, often to the benefit of school districts, and ultimately the state, and to the detriment of cities and the redevelopment agencies they sponsored,” the report said.
The state’s most recent redirection was the dissolution of redevelopment. The change was detrimental to many cities that relied on their RDAs to channel excess tax increment funds to basic city infrastructure maintenance needs, according to the report.