Prop. 218 Spurs Downgrade of Anaheim’s Credit

Citing concerns that the recently approved Proposition 218 will hamstring the ability of local government to raise tax revenues, Moody’s Investors Service Thursday downgraded Anaheim’s municipal bond rating.

Anaheim now becomes the fifth California city hit with a lower rating from Moody’s since voters approved the anti-tax measure last November. Los Angeles, San Diego, Sacramento and Fresno also have seen their credit ratings decline.

Thursday’s action comes just as Anaheim is preparing to sell approximately $500 million in bonds for street improvements to accommodate the upcoming Disneyland expansion.

But analysts Thursday said Moody’s downgrade of Anaheim’s general obligation bonds from Aa1 to Aa2 won’t result in higher interest payments for the city in the sale early next month. The bonds are slated to carry the highest possible credit rating because they are fully insured, partially backed by the Walt Disney Co. and--unlike general obligation bonds--won’t rely on property taxes for repayment.

“It will have no impact on our deal,” said Jon Schotz, a financial advisor to Disney on the bond sale. “The city is not on the hook at all here.”

Still, the downgrade is a sign of Wall Street’s uneasiness with Prop 218, which limits the authority of local governments to raise taxes.

And it highlights a potentially costlier future awaiting California cities in the debt markets. Typically, a lower debt rating means a municipality must pay higher interest rates to compensate investors for assuming additional risk.

Moody’s isn’t the only rating firm adjusting credit rankings downward in response to the anti-tax measure. Standard & Poor’s, another major bond rating agency, lowered San Diego’s credit rating in November, citing the city’s hampered ability to raise revenue under Proposition 218 as the reason.

Thus far, the downgrades have caused barely a ripple in the bond markets. But critics of the initiative say lowered credit ratings will ultimately lead to higher interest payments for cities and a cutback in essential services for their residents.

“This is just the beginning,” said Deborah Thornton, spokeswoman for the League of California Cities in Sacramento. “The downgrades will eventually affect the cities’ finances.”

Moody’s downgrading of Anaheim is part of a wholesale review of all state municipalities undertaken by the agency in the wake of Proposition 218.

Moody’s Vice President David Brodsly described Anaheim’s demotion as a “minor adjustment” that shouldn’t have much effect on the city’s ability to raise funds in the bond market.

“Anaheim is still a strong credit,” Brodsly said. “But like other cities, its power to raise revenue has been impacted by Prop. 218 . . . and we’ve adjusted the rating to reflect that.”

At present, Anaheim has about $9 million of general obligation bonds outstanding that were used to finance a storm sewer project, but the downgrade won’t raise the city’s cost to repay them, according to Anaheim Finance Director William G. Sweeney.

Sweeney said Anaheim’s upcoming municipal bond sale also will not be affected because it involves “lease revenue” bonds that are repaid through hotel bed taxes and incremental sales taxes and property taxes generated from Disney’s new California Adventure theme park, scheduled to open in 2001.

Sweeney lamented the timing of Moody’s announcement, coming on the eve of Anaheim’s largest-ever bond sale. Still, he said he was confident that the downgrade won’t sour potential investors on the upcoming deal.

“This won’t have an adverse affect on the Anaheim resort financing,” Sweeney said. “It’s an insured deal with a different revenue stream” than that of general obligation bonds.

Anaheim has purchased private insurance for the entire bond issue, meaning that if the city can’t make the payments, the insurance company will step in to pay bondholders.

Additionally, Disney has agreed to guarantee about $250 million of the bonds. Bond expert Joe Piraro says the Disney name should go a long way to ease the fears of potential investors.

“Disney has an impeccable reputation in the financial markets,” said Piraro, who manages a $2.5-billion municipal bond portfolio for Van Kampen American Capital in Oakbrook Terrace, Ill. “The perception is very positive.”

That deal aside, Piraro said that Proposition 218 “has created a gray cloud” over the California municipal bond market that could make it tougher for cities to issue new debt.

Although critics of the proposition point to the credit downgrades as harbinger of hard times ahead for municipal financing, proponents predict the downgrades won’t last long.

The rating agencies “are just being overly cautious,” said Jon Coupal, one of the principal authors of Proposition 218. “They did the same thing following Prop. 13. It’s temporary and insignificant.”