L.A. County Bond Rating Lowered : Budget: The credit downgrade by Moody’s could mean higher interest on some future borrowing. Officials say the “wake-up call” might have been worse.

In another blow to Los Angeles County’s finances, a major credit-rating agency Wednesday downgraded the county’s bonds for the third time in 2 1/2 years and warned that the ratings could drop further if the county’s budget woes worsen.

Moody’s Investors Service, one of the two major Wall Street rating firms, reduced its credit grade on the largest portion of the county’s $4.4 billion in long-term debt from A to Baa1, a designation that places the county’s credit-worthiness just slightly ahead of such troubled municipalities as the city of Philadelphia and Wayne County, Mich., which includes Detroit.

Moody’s said its decision reflects “both the severe fiscal pressures facing the county and the adoption of a workable, but still vulnerable, [budget] plan for addressing these pressures in the current fiscal year.”

The lowered bond ratings, which were expected in the wake of the county’s unprecedented struggle to patch together the $12-billion budget adopted by the Board of Supervisors last week, won’t have an immediate effect on the county’s finances. But the rating cut could mean the county will pay significantly higher interest rates if it attempts to borrow to fund capital projects or refinance existing bonds later this year.

Higher interest expenses, in turn, would mean fewer dollars for other pressing county needs, such as health care services.

Indeed, Supervisor Yvonne Brathwaite Burke said the county already had included in its new budget as much as $14.4 million in interest savings from the proposed refinancing of up to $2 billion in pension bonds.

The credit downgrade will probably force the county to pay higher-than-expected rates if it refinances those bonds, which means “we’ll still make money, but we’ll make less, and that was money already in the budget,” Burke said.

She said the continuing deterioration of the county’s financial situation--and its bond ratings--makes it more likely than ever that a hospital will have to be closed.

Still, many county officials on Wednesday greeted the Moody’s announcement with a sense of relief that the firm did not go further in downgrading the county’s ratings, given that the current budget was balanced using at least $300 million in speculative state and federal funding that may never materialize.

Moody’s and rival credit-rating firm Standard & Poor’s Corp., both of whose opinions can carry great weight with Wall Street investors, have previously chastised the county for using accounting tricks and other questionable practices to close budget gaps.

Standard & Poor’s also is expected to announce a ratings cut for the county, probably by Friday.

Chief Administrative Officer Sally Reed called the Moody’s action “very sobering and . . . very sad” but added that she had feared a deeper ratings cut.

“Actually, [the downgrade] is pretty much in between,” Reed said.

Supervisor Zev Yaroslavsky, who described the ratings downgrade as “another wake-up call for L.A. County government,” nonetheless said that he viewed it as “relatively mild. . . . I think they [Moody’s] have given us room to rehabilitate ourselves.”

In San Francisco, Moody’s analyst Ken Kurtz agreed that the firm meant its decision to be viewed at least in part as “reassuring” to investors who own county bonds.

In reducing the county’s rating for each class of debt just one notch instead of two--and in keeping the rating for the county’s general-obligation debt at A, down from A1--Kurtz said Moody’s is indicating that “we don’t see bankruptcy or insolvency on the horizon.”

Even so, in its official announcement Moody’s warned that it “retains significant concerns about the county’s future financial position and its ability to work within the tight parameters of the [budget] plan.”

“In the near term, maintenance of the current rating levels will depend upon the county meeting the self-imposed deadlines contained in the plan and responding quickly to any new threats to financial balance.”

In other developments Wednesday:

* The county’s largest employee union, Service Employees International Union Local 660, rejected the county’s proposal that 42,000 union employees take four days off a year without pay as a way of saving $28 million. The union rejected the offer during negotiations over members’ new two-year labor contract, spokesman Dan Savage said, because the county publicized the proposal--and even included the money in its annual budget adopted last week--before notifying union leaders. “We just didn’t like the fact they unilaterally proposed something, wrote it into their budget and then came to us and asked us if it was OK,” Savage said. “Considering we have been negotiating with them for a month, they could have brought this to the table much earlier.”

* The 258 students at the County-USC Medical Center School of Nursing were notified that the school’s fall semester may start late due to budget problems. In a letter from Director and Dean Sharon A. Hilton, students also were told there was a “strong possibility the school may be closed due to the County of Los Angeles budget crisis.” “Certainly everything is being looked at,” Hilton said. “Our students are very afraid that that is going to happen, but we don’t know yet. . . . Final decisions have not been made.”

* Board Chairwoman Gloria Molina joined state lawmakers and others to protest welfare reform legislation under consideration in Washington. If passed, she said, it would have catastrophic effects on the already beleaguered county. In Medicaid payments alone, Molina said, the county would lose more than $5 billion over the next seven years, as the proposals call for the federal government to relinquish much of its responsibility for welfare programs to state and local governments. “Coupled with other legislative proposals being considered, the price tag is staggering,” Molina said at a news conference at The Angelus Plaza Senior Activity Center.

As county officials worried about additional shortfalls in the budget, Yaroslavsky said supervisors must immediately patch the hole created when Gov. Pete Wilson vetoed a bill that would have allowed supervisors to siphon $75 million a year in transit funds for five years.

He said the county also must rigorously adhere to the Oct. 1 deadline the supervisors set for cuts in health services in the event that hoped-for state and federal funding does not come through.

“If we make these tough decisions by October, the county can begin turning the corner on its fiscal problems and even restore the bond rating it lost today,” Yaroslavsky said.

Supervisor Deane Dana agreed that quickly identifying as much as $75 million in additional health-care cuts would send a strong signal to Wall Street that the county is committed to getting its financial house in order.

“We have changed,” Dana said. “We are moving forward faster now. We are starting to cut almost immediately. Health centers have been named, and they are already informing patients. We are moving in the right direction. After that confusing week last week, I think the board is more together and they realize we have to get on with it.”

But echoing Burke, Dana said closure of a hospital, possibly County-USC Medical Center, must now be reconsidered by the board because of the $300 million in non-guaranteed revenues.

On Wall Street, many institutional investors upon whom the county relies to buy its bonds said Moody’s credit downgrade was expected, and that many of the county’s bonds already are priced in the marketplace to reflect the higher level of credit risk.

“This has already been reflected in the way the bonds are trading,” meaning that the yields on the bonds are above those of safer securities, said Joseph Deane, manager of the Smith Barney California Municipal bond fund in New York.

Still, some Wall Street money managers said Moody’s action carried a great deal of symbolism in that the rating on the largest portion of the county’s debt fell below A-level for the first time.

Moody’s reduced its rating on the county’s $2.5 billion in pension obligation bonds and on $1.8 billion in fixed-asset leases (also called certificates of participation, or COPs) to Baa1 from A.

Although a Baa1 rating is still considered “investment grade”--an important distinction for many big investors--it is just two notches above “junk” bond status. Junk bonds are considered speculative investments and are off-limits to many institutional investors.

“Psychologically, from A to Baa1 is the biggest leap you make as an investor,” said one municipal bond trader who asked not to be named.

Moody’s rating on the county’s general obligation bonds, reduced from A1 to A, affects only about $70 million in securities.

Meanwhile, about $50 million in county equipment leases (another form of COP) were downgraded from Baa1 to Baa by Moody’s.

If the county’s debt is downgraded again, the rating on the equipment leases would presumably fall to the Ba level, which would make them “junk” securities in Wall Street terms.

Moody’s Kurtz said the firm realizes that many of Los Angeles County’s financial woes stem from structural problems in state finance, and are shared to varying degrees by all counties in California.

“The state has a limited view of its obligations” to municipal jurisdictions, Kurtz said.

Board Chairwoman Molina said Moody’s action was a recognition of the county’s financial predicament and the fact that the state needs to do more to help Los Angeles and the other 57 counties in California.

“This action by Moody’s should be taken as a call to action on the part of the California legislative delegation” to help the county with financial assistance and by giving it the legislative authority it seeks to raise revenues “to allow Los Angeles County the stream of revenue income it so desperately needs,” Molina said in a statement.

Noting that Moody’s specifically commended the county supervisors’ “willingness to take difficult actions to maintain financial stability and meet its obligations,” Molina said “the statement by Moody’s should also put to rest any questions of fiscal mismanagement or resolve on the part of the Board of Supervisors to maintain a balanced budget that addresses both fiscal prudence and the need to balance prudent actions against constituent service delivery.”

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What the Ratings Mean

Bond credit ratings are designed to give investors a general sense of the bond issuer’s ability and willingness to repay its debts. Here are thumbnail descriptions of ratings used by Moody’s Investors Service:

Moody’s rating: General description of bonds

Aaa: Highest quality

A: Upper medium grade

Baa: Medium grade

Ba: Predominantly speculative

B: Speculative

Caa: Poor quality

Ca: Highest speculation

C: Lowest quality, no interest payments

Source: Barron’s Financial Guide