Quake rebuilding to unleash flood of muni bonds.

Local agencies' credit ratings could be hurt by temblor

Predicting the aftershocks a natural disaster will have on various economic markets can be as impossible as predicting the disaster itself. But it hasn't taken long for the Northridge quake to trigger predictions of a wave of new activity for the Los Angeles municipal bond market.

On the state level, Gov. Pete Wilson wants to sell $1.6 billion worth of bonds for post-quake rebuilding. But municipal bonds may be the source of greatest activity -- at least in the short run.

Muni bonds can help a city raise a lot of money fast. And government agencies such as the Los Angeles Unified School District, which faces $42 million in earthquake-recovery costs on top of a proposed state budget that provides no new money for public schools, can certainly use that kind of quick influx of cash. Arguably, an even likelier immediate candidate for muni-bond funding is Los Angeles City Hall, which sustained quake damages estimated in excess of $100 million.

Los Angeles city officials confirm that muni bonds are being considered as a central part of their rebuild effort.

"Municipal bonds are among the options we've discussed, especially for work on city facilities that were hardest hit," said Jerry Miller of the city's Chief Administrative Office. "A bond issuance can be very helpful for our immediate cash flow, giving us money to work with now, for which we'll be reimbursed by FEMA later. How heavily we go with bonds will depend on how much federal and state money we end up getting. So this'll be an evolving kind of decision-making process."

Grigsby Brandford & Co., a San Francisco-based financial services firm, was chosen by the Los Angeles City Council last July to manage the largest bond sale in the city's history -- $500 million to refinance the expansion of the L.A. Convention Center.

Mark Hughes, a vice president at Grigsby's Los Angeles office, said the quake clean-up offers opportunities for investors and fund managers, albeit opportunities predicated on tragedy. But, Hughes cautioned, that the quake fallout may also jeopardize local municipal bond credit ratings.

"A lot of potential exists for issuance of debt to reconstruct buildings and public improvements, as well as for new seismic reinforcement and retrofitting," said Hughes. "It's obviously unfortunate that this potential has come about by disaster -- there are definitely better ways to get business. And at first we'll have to deal with ratings agencies and insurers who tend to go earthquake-crazy, thinking that the quake destroyed everything and no one will be able to make payments and their bonds have gone to hell. But I'd be surprised if they can show one case where a quake has led to a default. We'll have to work a little harder to convince them that things are stable, but we will." Other industry insiders said new muni bond offerings were expected to be floated by cash-starved L.A. municipalities anyway, given the dwindling amount of funding coming from Washington, D.C. and Sacramento.

"Cities are having to completely re-evaluate the way they pay for their needs, at a time when those needs have never been greater," said Jack Dilday, a senior vice president in the Long Beach office of investment banking firm Smith Barney Shearson. "There's an ongoing need to fix bridges, roads, school districts and the rest of an infrastructure that was built at the turn of the century and has simply been wearing out fast lately. The desire to take care of problems like toxic-waste clean-ups also have taken on more urgency. But money from a lot of former sources just isn't there anymore and 'pay as you go' is difficult to do. So we expect people to turn to municipal bonds to close the financing gap." Of course, new bonds mean more debt. Executives at some financial services firms expressed concern that relying on bonds to hurriedly get L.A. back on its feet could hurt if new debt brings down bond ratings and drags on the local and state economies.

"What with Moody's seeming lack of confidence in California and Standard & Poor's changing its rating outlook from stable to negative after the quake, I think both the bond market and the people of L.A. and California would be better served by a sales tax rather than a billion-plus-dollars more in bonds," said an analyst at Goldman, Sachs & Co., who spoke on condition of anonymity. "California's position had improved 10 to 15 basis points (prior to the quake), and the drain of new debt would pose a threat to recovery that isn't worth the risk."

This has been a roller-coaster couple of years for governments trying to finance public works projects and investors looking to buy in to muni bonds. Optimism was raised at the beginning of last year when state Treasurer Kathleen Brown called on the Legislature to replace a constitutional provision that requires voters to agree by a two-thirds margin to issue general obligation bonds with a measure that would allow a simple majority vote to prevail. Just one week later, though, Brown sent a negative signal to the market when she said she was curtailing sale of state bonds because too much of the general fund was going to pay off debt.

As the recession lingered and unemployment rates in Los Angeles remained at greater than 10 percent, a study released by the California Municipal Bond Advisor newsletter put a total of 41 California bond issues worth $740 million on its "Watchlist" of issuers who were in danger of defaulting on payments. The Standard & Poor's outlook downgrade was the latest disappointment.

Jeremy Ragus is lead portfolio manager for the $315-million Scudder California Tax-Free Fund. Back in June he said, "There's a pretty strong perception in this market that things are going to get worse before they get better."

In a recent interview, however, Ragus said there are reasons to be positive about the California economy and, particularly, post-quake L.A.

"Los Angeles has certainly shown the world that it has resiliency, and that's got to inspire economic confidence," said Ragus. "With any earthquake you're going to have some net loss, and people will be poorer than they were before. But the bottom-line this time is that the quake will turn out to be just a little setback, muni credits didn't sustain much damage, and you'll see a little pickup in muni activity, especially when it comes to health care systems with solid backups and to assorted high-quality papers."

Jerry Miller of L.A. city's Chief Administrative Office also said he remains confident. "Our general obligation bond rating is 'AA' with Standard & Poor's and 'AA1' with Moody's," he said. "We had a strong year in '93 with 12 bond issues, and the city's credit will remain solid."

The AA and AA1 credit ratings are the second-best possible ratings granted by Standard & Poor's and Moody's, respectively -- just a shade below both agencies' top AAA rating.

But Steven Permut, manager of municipal bond research for the Benham Group, stressed that only time will tell how much damage the quake will do to L.A.'s credit ratings.

"The real importance of the quake on the market will come in its extended effect on the economy of the macro L.A. area, and that effect is very difficult to anticipate right now," he said. "Los Angeles was already economically stressed. If that condition worsens because of the quake, L.A. will become less economically desirable. That would definitely hurt its longer-term credit quality and reduce its ability to participate in a lot of financial options that L.A. would like to keep."