LA's Regional Economy Will Recover, But The Higher Risk Of Future Events Complicates The Picture For Some Local Governments

Given the strength and resilience of the L.A. regional economy, S&P Global Ratings believes that the direct impact of the L.A. wildfires on local government credit quality will be limited, even as the area experiences significant damage and loss. Going forward, the increasing frequency and severity of wildfires in urbanized areas in California will require local governments and utilities to meet a higher standard of risk resilience for infrastructure and services. It also exposes them to greater liability compared with entities in other states with wildfire exposure. Beyond the horizon of this event, increased costs will likely push debt burdens higher and exacerbate tax and rate-setting pressures in a region already facing affordability constraints.

What's Happening

Wildfires that spread throughout Los Angeles County have caused widespread damage and destruction of homes and businesses, as well as significant loss of life. Conditions were exacerbated by high winds, low humidity, vegetation density, and lack of rainfall, which allowed the fires to spread rapidly into urbanized areas and resist containment. S&P Global Ratings rates 31 local government entities, including cities, counties, and school districts, as well as 16 special purpose district financings, within or near the areas affected by the fires. We also rate three charter and independent schools and seven higher education and cultural institutions in the area.

In addition to the tremendous loss of life and property, the increasing frequency and cost of wildfires in urban areas and elevated liability risk for property damage could subject local governments and public utilities to significant damage claims and higher operating costs over time.

What We Think And Why

Overall, the Los Angeles region's extremely strong economy and tax base will, in our opinion, remain resilient through this disaster, supporting the credit quality of local government entities affected by the fires. We expect that state and federal funds will cover a significant share of the cleanup and recovery costs, which will alleviate short term expenditure pressure. However, we see several potential credit risks to local government entities stemming from the wildfires:

Permanent loss of property tax revenue.   The risk of lower property tax valuations resulting from fire damage is at least partially mitigated by the effect of California's Proposition 13, which could hedge valuation losses to the extent properties change hands. Still, lower valuations could dent revenue because of the limitations on general property tax rates, particularly for smaller entities that experienced significant damage.

Tighter liquidity constraints.  Limited reserves, or an inability to adjust tax rates to offset a temporary decrease in revenue or rising delinquent property tax payments, could increase liquidity risk when revenues fall. This risk is likely most acute for Mello-Roos and tax increment financing (TIF) districts with closed financing structures.

Increasing costs of resilience and liability for damages could pressure balance sheets.  In addition to liability for damages caused by the fires, urban utilities and governments will likely face higher operating and infrastructure repair costs and increasing management complexity associated with wildfires, potentially impairing credit quality and stability.

Mounting challenges to affordability dynamics.  This could accelerate pre-existing demographic trends, including outmigration, pressuring city revenues and school enrollment.

What Comes Next

On Jan. 15, 2025, we placed the ratings on the City of Los Angeles (AA/Watch Neg) and Altadena Public Library District (AA-/Watch Neg) on CreditWatch with negative implications, reflecting our view of the increased risks of financial impact resulting from the fire. In the case of the city, the rating action also reflects exposure to heightened risk of credit deterioration at Los Angeles Department of Water and Power, for which we lowered the ratings on water and sewer revenue (AA-/Watch Neg) and electric utility revenue (A/Watch Neg) bonds on Jan. 13, 2025.

Tables 1-3 include a list of government entities rated by S&P Global Ratings that are in or near the area of the fires that we are actively monitoring for potential credit impact. The list is subject to change, and inclusion on the list does not indicate the likelihood of a rating action. We believe these issuers could experience lower property values that dampen their tax-base trends and revenue-raising flexibility, or could be exposed to elevated liability claims against the local government or related utilities. As the situation evolves and the extent of the damage is better understood, we will monitor potential credit impacts.

We could take negative rating actions on these or other entities to reflect our opinion of increased credit risk resulting from the fires or their aftermath.

Table 1

S&P Global Ratings analyzes the potential rating effect from acute events on a case-by-case basis. Our approach includes asking questions of management teams to help us evaluate the breadth and depth of any potential operational, financial, and economic impacts. The severity of an event could influence our ability to reach an issuer and it might take several weeks or months for management teams to fully evaluate damage or property loss, or determine what federal or state support is available to help absorb recovery costs.

Special-purpose districts face unique risks compared with cities and school districts

We believe special assessment (Mello-Roos) and TIF tax increment financing bonds are more exposed to acute financial risks from the wildfires due to their revenue and structural characteristics. Pledged revenue is often generated by a narrower tax base, and there is limited flexibility to raise rates or adjust expenditures within the transaction. The potential for disproportionate changes in revenue arising from relatively small fluctuations in assessed valuations exacerbates fiscal vulnerability, particularly in the case of Mello-Roos debt structured with low debt service coverage. Where reserves are not funded with cash or an investment-grade surety provider, or are nonexistent, the risk of default is greater.

Our ratings on community facilities districts (CFDs) and TIFs incorporate the ability of a district to withstand multiyear delinquencies of its largest taxpayers. We believe cases of default, if any, will be rare, and would be primarily a function of the level of devastation, coverage and reserves, and years to maturity. To date, we have taken one rating action on a CFD in the path of the Eaton Fire (Altadena Library District).

Table 2

Table 3

Public K-14 education providers affected by fires could see decreased enrollments

• K-12 school districts most affected by the fires, including LA Unified, Pasadena Unified, La Canada Unified, and Malibu-Santa Monica Unified, will benefit from state and federal assistance to clean up and rebuild damaged schools. However, the loss of buildings and displacement of students and staff will disrupt operations, and could increase near-term costs.
• For community college districts located near the fires, such as Santa Monica, Pasadena Area, Glendale, and Santa Clarita, near-term enrollment volatility could occur as students tend to more immediate issues in the aftermath of the fires, or due to heighted price sensitivity if tuition and fees are adjusted to offset recovery costs. While these districts benefit from revenue diversity, effective management of expenses to align with potential declines in property tax revenue and student generated revenues will be important for credit stability.
• Decreases in taxable valuation from fire damage to structures and property will reduce property tax revenue but will be offset by state funds to ensure schools stay funded at the level determined under the state's enrollment-based funding formula.
• Charter schools could face similar challenges to local school districts including draws on liquidity, damage to facilities, and higher than expected expenses. As charter schools do not have the ability to levy taxes this emphasizes the need for charter school management teams to focus on liquidity management and maintenance of budgetary flexibility to prepare for hazards.
• Permanent displacement of families in the aftermath, particularly if rents and taxes rise sharply, could accelerate declining enrollment. Managing budgetary pressure will remain an important determinant of schools' credit quality in the wake of the wildfires.

Related Research

• Altadena Library District Community Facilities District No. 2020-1, CA Bond Rating Placed On CreditWatch Negative, Jan. 16, 2025
• Los Angeles, CA General Obligation Bond Rating Placed On CreditWatch Negative Due To Risks Associated With Wildfires, Jan. 15, 2025
• Los Angeles Department of Water & Power Ratings Lowered Two Notches To ‘A’ (Power) And ‘AA-‘ (Water) On Increased Risks, Jan. 14, 2025
• As Los Angeles Wildfires Burn, Credit Implications For U.S. Public Finance Issuers Are Unclear, Jan. 9, 2025
• Insurers Can Absorb Losses Amid Escalating Los Angeles Wildfires, Jan. 9, 2025

Jillian Morley contributed research to this report.