California’s budget troubles have added to the financial challenges faced by the state’s school districts and local governments, Moody’s Investors Service said in a special comment this week.

“California local governments face major challenges in the current and coming fiscal years,” Moody’s said in a nine-page report authored by senior credit officer Dari Barzel. “The dramatic decline in home prices, falling sales tax revenues, and the state’s difficult budget position can affect their revenue streams and dictate hard budget choices.”

California, which enjoyed one of the nation’s most ebullient housing markets during the boom, has fallen into a deep recession now that housing has crashed. The state’s jobless rate surged to a 14-year high of 9.3% in December from 5.9% a year ago.

The deepening economic crisis opened a $41.6 billion hole in the state’s $103 billion general fund, with lawmakers unable to agree to a solution until yesterday. The months-long budget crisis forced Controller John Chiang to delay some payments, including county aid payments.

“California local governments are depending almost exclusively upon cyclical revenues and state funding, with the amount of each varying most significantly by type of government,” Barzel wrote.

Counties and schools are facing the brunt of the pain because they’re most dependent on state budget aid. California schools get the bulk of their funding from the state, while counties share responsibility with the state for some welfare programs that are seeing a surge in demand from newly jobless Californians.

“California school districts are the most vulnerable to credit and rating pressures,” Barzel wrote. “They have very little near-term expenditure flexibility, are most depending on the state for funding, and as a rule have reserves that are much narrower than those of cities or counties.”

Local governments have also exacerbated the risks caused by perennial state budget crises and sharp cyclical swings by using riskier debt-management strategies.

“California local governments have access to a large number of financial advisers and bankers who offer a wide variety of sophisticated financing tools,” the Moody’s analyst wrote. “In recent years cities, counties and school districts large and small have availed themselves of various types of variable-rate financings, and of interest-rate swaps hedging that debt to provide 'synthetic’ fixed rates.”

That’s not to say California local governments don’t have credit strengths. Most are solidly investment-grade credits, and they can and do cut spending to keep their budgets balanced amid the web of revenue-raising constraints the state’s voters have imposed upon them.

“Most local governments will undoubtedly need to cut spending and/or use accumulated fund balances to balance their budgets during the current recession,” Barzel wrote. “Moody’s believes that most California local governments whose obligations we rate are well-positioned to take the necessary steps to maintain their credit strength.”

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.