Bloomberg News

Whoever Wins Los Angeles Higher Debt Price Signaled: Muni Credit

March 04, 2013

Los Angeles bonds are beating the $3.7 trillion municipal market even as leading mayoral candidates oppose a measure to raise the sales tax while also vowing to eliminate a $450 million-a-year business levy.

As residents of the second-most populous U.S. city vote today on a successor to Mayor Antonio Villaraigosa, they also face a ballot measure to boost the sales tax to 9.5 percent from 9 percent. That would tie Los Angeles with Chicago for the highest rate among the 10 largest American cities.

Less than two months ago, Los Angeles got its first credit upgrade in more than 20 years from Moody’s Investors Service, which cited property-tax growth. Investors such as Daniel Genter at RNC Genter Capital Management in Los Angeles say the election outcome won’t be enough to derail the city’s debt. Los Angeles is benefiting from demand for California munis after tax increases championed by Governor Jerry Brown.

“California paper is pretty attractive and we don’t see this election changing that right away,” said Genter, who manages about $2 billion of munis, including Los Angeles bonds.

Mayor’s Endorsement

Villaraigosa, a 60-year-old Democrat who cannot run again because of term limits, has endorsed the sales-tax increase. The higher tax would yield from $208 million to $215 million a year, according to an estimate from City Administrative Officer Miguel Santana, comparable with the deficits he projected for each of the next three years.

Yet city Controller Wendy Greuel and Councilman Eric Garcetti, who have raised the most money in the race, have spoken against the higher sales tax and also advocated for scrapping the tax on business receipts. At $450 million a year it’s the fourth-largest revenue source. They said at a Feb. 7 debate that phasing out the business tax would encourage companies to move to and grow in Los Angeles, lifting property and other taxes.

Moody’s upgraded the city of 3.8 million to Aa2 in January, the third-highest level, citing growth in property levies, its largest revenue source. Standard & Poor’s rates Los Angeles AA-, its fourth-highest mark. Sussan Corson, a director in public finance at S&P, said by telephone that passage of the sales-tax measure could accelerate progress in reducing recurring budget deficits.

Rising Demand

Investor demand for L.A. debt has risen. The difference in the yield spread between city general obligations maturing in September 2020 and top-rated debt was about 0.4 percentage point last month, according to Bloomberg Valuation pricing. That gap was down from an average of about 0.6 percentage point for most of last year.

If voters reject the tax boost, Los Angeles would have to reduce its 10,000-officer police force by as much as 500, Villaraigosa said Feb. 11. At a press conference backing the tax measure, Villaraigosa declined to respond to mayoral candidates’ claims that the city could maintain or even expand its police force without higher taxes.

“When you’ve made the kinds of cuts we’ve made, you have to look for new revenue,” said the mayor.

Los Angeles has already faced $1.6 billion in deficits over the past four years. The city has reduced its workforce by 5,300 positions, or more than 14 percent, since 2007, according to Santana’s February report.

Cost Analysis

Scrapping the business tax would equate to losing more than 40 swimming programs, firing more than 2,200 police officers or firefighters, or neglecting to fill more than 21 million potential potholes, according to figures compiled by Santana in a September presentation.

For Marilyn Cohen, president of Envision Capital Management Inc., the candidates’ pledges to reduce taxes without affecting city services add to concern that the city is failing to address its fiscal challenges. The firm has no Los Angeles debt among its $325 million of holdings.

“They’ve dug such a hole that they’re going to have to show me that they’re being fiscally prudent,” said Cohen, who’s based in Los Angeles.

Cohen said none of the leading candidates has offered a sufficient proposal to curb the city’s pension liabilities or other employee benefit costs.

Pension Bill

Los Angeles’ pension contributions are projected to reach $999 million this year, more than double the level for the year ended June 30, 2006, according to a report by Santana. The city has a $7.2 billion general fund. In October, the City Council voted to raise the retirement age for non-safety employees to 65 from 55 and limit pension payments to 75 percent of final salary.

In the February debate, City Councilwoman Jan Perry and lawyer Kevin James, the only Republican in the race, stopped short of calling for eliminating the business tax. Perry said the city would need to find an alternative revenue source. James suggested a flat fee rather than a tax on business income.

In a USC Price/Los Angeles Times poll of 500 likely voters taken Feb. 24-27, Garcetti led with 27 percent, Greuel had 25 percent, James had 15 percent and Perry 14 percent. If no candidate receives a majority, the top two finishers advance to a runoff May 21. The survey, with a 4.4 percentage point margin of error, found 53 percent support the tax boost, with 41 percent opposing it and 6 percent undecided.

Candidates’ Approach

Austin Beutner, a co-founder of New York investment bank Evercore Partners Inc. and former Los Angeles deputy mayor, moderated the February debate.

In an interview March 1, he said none of the candidates has a realistic approach to the city’s budget dilemma.

“I was singularly unsuccessful in drawing out of any of the candidates anything other than the notion that ‘We’ll grow the pie,’” Beutner said. “They haven’t identified where new revenue would come from, they’ve sworn off new taxes, and they’re not making any specific proposals regarding employee compensation and benefits.”

Beutner said investors probably won’t punish Los Angeles for the vagueness of its prospective leaders’ proposals or even for the possible failure of the sales-tax increase.

That’s because most debt is issued by the city’s self- funding airport and port authorities and its public water and power utility, which rely on user fees rather than taxes, he said. Also, most debt pledged against the city general fund is short-term revenue anticipation notes rather than general obligations, he said.

In trading yesterday, yields on tax-exempt benchmark debt due in 30 years were little changed at about 2.98 percent, close to the highest since September, data compiled by Bloomberg show.

To contact the reporter on this story: James Nash in Los Angeles at jnash24@bloomberg.net

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


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