California’s cities will remain fiscally challenged for the next few years due to rising pension costs, continued revenue raising restraints, and the slow economic recovery, according to Moody’s Investors Service.

The agency said it has cut the ratings on 27 cities out of the 95 it rates in California since October, when it began a review following the bankruptcy filings of Stockton and San Bernardino. The downgrades included four general obligation and 23 revenue-backed ratings, Moody’s said in a report released Tuesday.

Pent-up service demands and rising structural costs are likely to absorb the next few years’ of growth within the cities, Moody’s said. Expenditures picked up in 2012, and more than offset modest revenue gains, on average. While the median general fund balance for California cities is higher than the U.S. average, it continued to decrease in 2012.

“Notwithstanding these downgrades and cities’ likely continuing fiscal challenges, our Aa2 median rating for California cities’ GO bonds remains relatively high,” analysts said in the 11-page report. “This reflects their fair success, so far, in adapting to the new fiscal reality: moderate revenue growth compared to pre-recession levels and continuing cost pressures.”

The review of rated California cities found that inland cities are not recovering from the economic downtown as fast as coastal cities, such as Los Angeles, San Francisco, and San Diego. The primary cause of the economic downturn — the collapse of the housing market — was more severe in inland communities because, with their relatively abundant undeveloped land, they had significantly more home building occur than in the more developed coastal areas.

Along the coast, cities have been benefiting more from recovering revenues, enjoying two consecutive years of revenue increase, which Moody’s believes will probably continue in 2013.

Some of Fresno’s pension obligation bonds and lease revenue bonds were downgraded three notches to Ba2. A couple of Sacramento’s revenue-backed ratings were cut to A2. The ratings for Los Angeles and San Francisco were raised one level to Aa2 and Aa1, respectively.

Some California cities will be further stressed by the dissolution of redevelopment agencies in 2012, and the loss in revenues that would have come from them.

“To varying degrees, California cities relied on RDA revenues to fund much of their development projects, as well as some service provision within their project areas,” the report said.

Moody’s does not expect the state’s cities to fully restore their reserves for several years. Prior to the financial crisis, cities had ample reserves, especially when compared to California counties and school districts, Moody’s said.

“Early indications for fiscal 2013, however, indicate most California cities’ budgets remain balanced, if not trending toward a surplus from better than budgeted sales and property tax growth,” analysts wrote.

The report also noted that some cities will be watching the bankruptcy cases in Stockton and San Bernardino, saying a reduction of these cities’ pension obligations could lead other particularly stressed cities to consider a bankruptcy filing.

The report, “Credit Trends: California Cities Will Remain Pressured Despite revenue Growth” was authored by Kevork Khrimian, vice president and senior analyst, and Eric Hoffmann, senior vice president.

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.