LOS ANGELES — Facing a $16.6 million deficit just four months into fiscal 2013, Los Angeles officials are contemplating axing 259 city jobs.

The recommendation comes after the city received both good news and bad news from Moody’s Investors Service in early October when the agency completed a review of local ratings throughout California.

The good news was that Moody’s put Los Angeles’ Aa3 general obligation bond rating on review for upgrade. It was one of only two positive outcomes from the agency’s review of 56 California credits.

At the same time, however, Moody’s downgraded Los Angeles’ $70 million in judgment obligation bonds from A1 with a stable outlook to A2 and stable, and its lease revenue bonds are on review for downgrade.

That’s because Moody’s is drawing more of a distinction between local California GO debt, which is backed by voter-approved property taxes, and obligations that are paid from general fund revenues.

Los Angeles chief administrative officer Miguel Santana recommended the cuts on Tuesday.

The CAO cited Moody’s review in his report, saying that in light of the “rating agency warnings, it is even more critical that the city take decisive actions to build up its tax base, mitigate expenditure growth and grow its reserve.

Only by pursuing all three goals can the city address its structural deficit in a permanent and sustainable manner.”

Los Angeles had a debt portfolio of $6.2 billion as of March 1 that included $1.2 billion of GO bonds and $1.4 billion in Municipal Improvement Corporation of Los Angeles lease revenue bonds, according an investor presentation prepared by the city.

The City Council whittled the 669 job cuts recommended in the mayor’s budget down to 209 proposed layoffs, and postponed action until January. The CAO’s recent report recommended an additional 50 workers from the city attorney’s office be added to the 209 layoffs already planned.

The layoffs that would take effect on Jan. 3, 2013, would only reduce the city’s projected budget deficit for 2013-14 to $216 million. Without the layoffs, the shortfall would increase to $232 million.

Most of the bonds Moody’s placed on downgrade review are pension obligation bonds or lease revenue bonds backed by general funds and do not benefit from a pledged single-revenue source, according to its report.

“California cities’ cost-cutting fatigue may be weakening their willingness to use general fund resources to make [pension obligation bonds] and lease payments,” the report said. “A GO default is unlikely to provide any fiscal relief for a city, unlike a POB or lease payment default, owing to the legal restrictions on the use of the GO debt-service levy.”

Moody’s may no longer adhere to the industry standard of automatically rating lease revenue bonds two notches below general obligation bonds, Eric Hoffmann, who heads Moody’s California local government rating team, said during a panel at The Bond Buyer’s California Public Finance Conference last week in San Francisco.

The rating agency will look more closely at how essential the leased property is to the city when reviewing ratings, according to Hoffmann.

“We determined we were seeing a more stark difference between California’s GO bonds and those backed by the general fund,” he said.

The credit quality of local GO debt in California is linked to the property tax roll, as opposed to lease-revenue and other debt repaid from a city’s general fund, such as many pension obligation bonds.

Los Angeles and San Francisco general obligation bonds were the only credits placed on review for upgrade after Moody’s study because L.A.’s assessed values have grown by 2% over the past two years, and San Francisco’s assessed values never declined during the recession, Hoffmann said in an interview.

San Francisco’s assessed-value growth slowed considerably, but it never declined, and it grew by another 3.9% for fiscal 2013, Hoffmann said.

Los Angeles has a 90% collection rate on property taxes, said Natalie Brill, the city’s debt manager.

“We can’t ignore that two cities [Stockton and San Bernardino] have defaulted on their pension obligation bonds,” Hoffmann said in justifying the continuing review.

Moody’s has a policy of not taking longer than 90 days to conduct its review, but the agency could come back sooner with its revamped ratings, he said.

Hoffmann confirmed during a question-and-answer period that bonds backed by the general fund that are under review could be downgraded by two or up to five notches.

In Los Angeles, judgment obligation bonds, lease revenue bonds and MICLA bonds are backed by the city’s general fund, Brill said.

The city issued bonds to pay for adverse court judgments because it was cheaper to go to the municipal market, she said.

Moody’s rates MICLA bonds backed by real property at A2 and the MICLA bonds backed by equipment at A3. While Brill agreed that the city’s general fund is “still not out of the woods,” she questioned Moody’s decision to lump all of the cities together.

The review for downgrade also included $117 million in lease revenue bonds issued by Santa Monica, a city that has maintained a triple-A rating from the big three rating agencies since 1995, according to finance director Gigi Decavalles-Hughes. Its lease-revenue bonds are double-A-plus across the board.

Moody’s placed Santa Monica’s GOs and lease-revs on review for possible downgrade.

“We were very puzzled by the report,” Decavalles-Hughes said. “I think this is something they are looking at across the board with California cities that have unusually high ratings.”

Typically, a city’s lease revenue bonds are rated two notches below general obligation bonds, but that is not the case for Santa Monica, where it’s just one notch. But Santa Monica is doing the three things mentioned in Moody’s report for cities on steady fiscal ground, Devalles-Hughes said.

“We have tax-based growth, we are balancing our revenues with our expenditures, and we have a strong reserve-fund balance,” she said.

That is not the case for Los Angeles although Santana says the city is in much better shape than it was two years ago when a $1 billion deficit was projected. But the city still has work to do, he said in his report.

Los Angeles Mayor Antonio Villaraigosa in a memo to the City Council Monday asked it to cut positions and approve his pension reform measure in order to rebalance this year’s budget and address the structural deficit.

The council already approved pension reform on a first reading vote last month, but must confirm the measure with a second vote on Friday.

Revenues are at or above expected levels, but the city faces a current-year deficit due to overspending and unanticipated expenditures, according to Villaraigosa. Los Angeles’ reserve fund is $224.7 million — the highest it has been in 10 years, but the city still has a structural deficit, he said.

Revenues are growing at 3% a year, but expenditures are growing at 5% a year, Santana noted.

The pension reform plan creates a new tier for future city employees that would increase the retirement age from 55 to 65, cap the maximum retirement allowance at 75% of an employees’ final compensation instead of up to 100%, and reduce pension spiking by basing the pension on a three-year final salary average as opposed to one year.

It also requires employees to share the cost of investment losses so that employees would contribute a portion of their salary at 75% of normal costs plus 50% of any future unfunded liabilities.

The pension reform plan is projected to save the city $50 million to $70 million over the next five years and up to $4.3 billion over the next 30 years.

Former Mayor Richard Riordan, however, does not think the pension reforms go far enough. He filed papers last week to launch a signature-gathering campaign that would place a more severe pension reform initiative on the May ballot.

Under Riordan’s “Fair Share Pension Reform Act of 2013” current employees would contribute more to their pension benefits and new workers would be enrolled in a 401(k)-style system with a maximum 10% contribution from the city.

Despite actions already taken, future austerity is necessary, Santana said.“Rating agencies for one are appraising the financial strength of California cities based on their assessment that more municipal bankruptcies and bond defaults will occur in the future,” he said in his recommendation. “Every decision the city makes will be examined and analyzed in the context of the city’s overall fiscal health and sustainability.”

Subscribe Now

Independent and authoritative analysis and perspective for the bond buying industry.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.