California Wildfires’ Impact on the Municipal Bond Market

For three weeks, California was ravaged by devastating wildfires, leaving a trail of destruction across the state. Thousands have been displaced, homes and businesses reduced to ash, and lives forever changed. Amidst this turmoil, an unexpected beacon of resilience has emerged: municipal bonds. Despite the catastrophic damage, the financial systems underpinning local governments and utilities appear remarkably stable. But how long can this stability hold?

The Exposure of Municipal Debt

Approximately $70 billion of municipal debt is currently exposed to the wildfires. Half of that is concentrated in the Los Angeles Department of Water and Power (LA DWP), which holds $20 billion of debt; the LA Unified School District, with $12 billion; and the LA County Metropolitan Transportation Authority, with $5 billion. Smaller borrowers, such as the Altadena Library District, which has $20 million of municipal debt outstanding, are also affected.

Despite these substantial amounts, the inherent resilience of municipal bonds reduces the likelihood of long-term defaults.

The Resilience of Municipal Bonds

Broad revenue streams secure the majority of affected municipal debt, shielding bonds from default. Southern California's diverse and robust tax base allows borrowers reliant on sales, income, and ad valorem property taxes to maintain debt service payments. Similarly, due to the scale and diversity of local transportation systems—including toll roads, highways, public transportation, and airports—local transportation bonds are not expected to suffer long-term credit quality reductions.

Even municipal utilities are insulated. For example, LA DWP is the nation’s largest public utility, of its kind, serving 700,000 water connections and 1.6 million electric connections in the City of Los Angeles. Currently, only 0.5%, or 8,000 accounts, are out of service—a minor revenue disruption. The city-owned power company also transfers approximately $250 million annually to Los Angeles. The probability of repaying municipal bonds remains strong even if a utility incurs wildfire-related liabilities.

Spotlight: Altadena Library District

The Altadena Library District is one of the smallest bond issuers impacted by the fires, with $20 million of debt issued in 2022. These bonds are secured by a “special tax” collected and general property taxes. The special tax applies to over 13,000 parcels within an eight-square-mile area, 95% of which are residential properties.

Unlike traditional property taxes, the special tax is a fixed fee unaffected by property value fluctuations. Non-payment leads to a lien on the property and eventual foreclosure, creating strong incentives for property owners and banks to ensure taxes are paid. Banks holding mortgaged properties typically pay delinquent taxes to maintain control over the foreclosure process, yielding higher recovery amounts than a county auction. In foreclosure scenarios, delinquent taxes are prioritized for repayment over mortgage repayment to the banks.

This illustrates the fundamental strengths of property-tax-backed municipal bonds: a diverse tax base, strong payment incentives for stakeholders, and a predictable billing process. While many issuers maintain reserves for such scenarios, the Altadena Library District does not. We will monitor this situation closely to see if payments are disrupted.

Natural Disasters and Federal Aid

Despite the inherent strength of municipal bonds, financial humanitarian aid plays a vital role in stabilizing affected areas. On a federal level, former President Biden declared the wildfires a disaster eligible for FEMA relief funding, pledging to cover 100% of cleanup and firefighting costs for six months. Negotiations regarding additional federal assistance are ongoing.

On January 23rd, the California Legislature passed a set of bills allocating $2.5 billion in bridge funding to support state and local agencies’ relief efforts. This funding represents the first of many steps required to aid recovery and rebuild communities devastated by the fires.

A Testament to Resilience

Although the California wildfires have wreaked havoc on communities and infrastructure, the financial systems supporting municipal bonds remain steadfast. With diverse tax bases, strong payment incentives, and federal and state aid, the likelihood of long-term bond defaults is low. However, smaller issuers like the Altadena Library District highlight the need for vigilant monitoring and preparedness. As California navigates the path to recovery, its municipal bonds continue to reflect the resilience of its communities.

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