Bloomberg News

Believing Default-Averse Fresno Returns 5.41% Love: Muni Credit

August 03, 2012

Believing Default-Averse Fresno Returns 5.41% Love

Pedestrians walk along the street in Stockton, California. Photographer: David Paul Morris/Bloomberg

Fresno, California, leaders insist that the state’s fifth-largest city isn’t going to go bankrupt. That’s cheering investors who bought its debt at a record low.

Like Stockton and San Bernardino, California cities that sought court protection from creditors in the past six weeks, Fresno’s budget has buckled as labor costs rose while tax revenue succumbed to the longest recession since the 1930s. The city north of Los Angeles had its credit downgraded last month as cash ran dry and talks to win wage concessions stalled.

The fiscal resemblance to its insolvent neighbors has put Fresno “in the crosshairs,” Citigroup Inc. analysts said in a report last month. As speculation built that the city of 500,000 would become the nation’s biggest to go bankrupt, the extra yield on some Fresno bonds over AAAs soared to a record 2.71 percentage points last month. The debt has appeal at these levels, given officials’ vows while municipal interest rates are at 45-year lows, said Bud Byrnes at RH Investment Corp.

“In a market where there is no yield, I would think that there are buyers who would look at this,” said Byrnes, president and chief executive officer of RH, a muni-bond trading company in Encino, California.

Fresno, in the middle of the state about 200 miles (322 kilometers) from Los Angeles, is the hub of a farming county that produced $6 billion of agricultural commodities in 2010, including almonds, raisins and oranges.

Budget Challenge

Nonetheless, the recession helped open $100 million of cumulative deficits in the city budget since February 2009 even as Fresno cut a third of its worker positions. The metropolitan area’s jobless rate was 15.3 percent in June, compared with 10.7 percent statewide. Fresno, Stockton and San Bernardino were among the 20 metropolitan areas with the nation’s highest foreclosure rates in the first half of 2012, according to RealtyTrac Inc.

San Bernardino filed for bankruptcy Aug. 1, becoming the third municipality in the most-populous state to do so since June. The mountain resort of Mammoth Lakes sought protection last month. Stockton, with 292,000 people south of Sacramento, in June became the biggest U.S. city to go bankrupt, amid rising labor, pension and retiree health costs.

Fresno officials say they don’t intend to follow that path and are developing plans to reduce expenses and borrow internally to stave off insolvency.

‘Very Thin’

“We are making ends meet,” Mark Scott, the city manager, said in an interview. “We don’t even talk about filing bankruptcy. It’s not even on our radar screen to do that. We just know that we are going to have to operate very thin for a while.”

The City Council adopted a budget in June that eliminated a $16 million deficit with one-time fixes, in part because it hasn’t been able to secure concessions through negotiations with its police union.

After the failure of those talks, Fitch Ratings July 2 cut the city’s credit rating one step to A-, the seventh-highest mark, from A. Moody’s Investors Service on July 23 dropped the ratings on $462 million of debt. The city’s rating fell one level to A3, seventh-highest. Its pension-obligation bonds were cut to Baa1, one grade lower, and its lease-revenue bonds to Baa2, the company said in a statement.

Extra Yield

The city, through a joint powers authority, sold $53 million of lease-revenue debt in 2004 for capital projects. Tax- exempt bonds from that sale that mature in 2034 traded July 30 at an average yield of 5.41 percent, according to trade disclosure data. That was about 2.71 percentage points more than top-rated general obligations, the most since Bloomberg Valuation data began in 2009.

Setting Fresno apart from Stockton and San Bernardino, its two public pensions had at least 110 percent of the funds needed to cover benefits as of June 30, 2010, annual reports show. The funds of Stockton and San Bernardino were less than 70 percent funded, according to data from the California Public Employees’ Retirement System.

“There are some bright spots on the city’s ledger,” Vikram Rai, a municipal strategist at Citigroup in New York, said in an interview. “One of the most important things is that it has a fully funded pension system.”

The bank in a July 13 research note stressed the importance to the city’s finances that it trim public-worker compensation.

Cost-Cutting Dependence

“The city is very dependent upon cost-cutting to stave off any more financial distress,” Rai said yesterday. “It’s very important that negotiations with public-employee unions go through. If there is a standoff, that won’t bode well.”

For some investors, the debt still carries too much risk.

“Fresno is not a credit that we would buy,” said Michael E. Johnson, a managing director in Solana Beach, California, at Gurtin Fixed Income Management LLC, which manages $4 billion in munis. “Looking at their deteriorating financial position is why we have continued to stay away from that credit.”

Scott, the city manager, said the city will solve its fiscal affairs.

“We are adamant we are not going to be bankrupt,’ he said. “We have a short-term cash flow problem, but we do not have long-term liabilities like those other cities do.”

Following are pending sales:

NEW JERSEY ECONOMIC DEVELOPMENT AUTHORITY is set to issue on behalf of Continental Airlines $734 million of revenue debt subject to the alternative minimum tax as soon as next week, according to sale documents. Moody’s rates the bonds B3, six levels below investment grade. (Added Aug. 3)

CHICAGO plans to issue about $1.2 billion of revenue bonds for O’Hare International Airport to refinance debt, according to bond documents. About $729 million of the offer will consist of general airport senior-lien revenue debt, set to price as soon as Aug. 8, data compiled by Bloomberg show. Moody’s last month downgraded O’Hare general-revenue bonds one level to A2, its sixth-highest grade. In another segment of the deal, the city will issue $443.3 million of passenger-facility charge revenue bonds. Moody’s rates that sale A2. (Added Aug. 2)

To contact the reporter on this story: Michael B. Marois in Sacramento at mmarois@bloomberg.net

To contact the editor responsible for this story: Stephen Merelman at smerelman@bloomberg.net


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