The Los Angeles County Museum of Art's bond rating has been downgraded a notch, with Moody's Investors Service warning that a default could ensue if another market collapse causes the museum's investment portfolio to lose a third of its value.
"That is an extremely unlikely situation," museum Director Michael Govan said Friday.
But the downgrade from A2 to A3 means LACMA could see the interest on its $383 million in construction bonds rise somewhat from the 3.5% or so it's currently paying, Govan acknowledged. LACMA paid $14.7 million in bond interest during the fiscal year that ended June 30, Govan said.
The downgrade doesn't mean LACMA's financial position has worsened, Govan said — in fact, he said it has improved since the bonds were last rated in November. Instead, he said, the downgrade simply reflects growing pressures on financial ratings services such as Moody's and Standard & Poor's to be tougher in assigning grades.
The services have come in for sharp criticism since the 2008 financial meltdown for failing to detect underlying weaknesses in risky securities whose collapse triggered the crisis. Investors were lulled by high ratings that, as it turned out, were undeserved.
"Our position is getting better, the museum is getting stronger, but the world is recalculating its metrics on things like this," Govan said. As for Moody's assertion that a 33% investment loss would trigger a default, Govan said it would require a far more devastating market meltdown than the one in 2008-09 because LACMA now has a much more conservative investment strategy than it did then.
LACMA's portfolio lost 23.4% of its value in 2008-09; Moody's report, issued Wednesday, said the museum's investments had bounced back in the ensuing two years with gains of 12.6% and 13.4%.
Barring such a crisis, Moody's rating pegs LACMA's bonds as having a "low risk" of default; it cited a number of fiscal strengths for the museum, including "good governance and management" and "good operating performance" in recent years. Govan said auditors are working on the books for the 2010-11 fiscal year that ended June 30, but it appears that LACMA will register an operating surplus in the six figures.
The museum's bonds have paid for its ongoing expansion and renovation, which has yielded the new Broad Contemporary Art Museum and the Resnick Exhibition Pavilion as well as other improvements. LACMA has raised $335 million –- meaning it still has $48 million to go to establish a big enough sinking fund to retire the bonds when they come due starting in 2030. The museum is $115 million short of the $450-million campaign goal set when it began in 2005. The $335-million total reflects progress since last November, when the campaign stood at $320 million.
Govan said some seven-figure gifts have come in since then, although the recent spasms in the financial markets aren't helpful. "In the last week, there haven't been any big alarms" about prospective donors pulling back, he said. "Nothing yet has been a negative."
The rating downgrade leaves the museum's bonds in the A category, which Moody's defines as an "upper-medium grade" investment "subject to low credit risk." But instead of being on the middle rung of that category, LACMA's bonds have now been moved to its lowest rung.
In November, Moody's had changed the LACMA bonds' investment outlook from "stable" to "negative" but didn't lower the A2 rating. Now the "negative" outlook remains, and another one-step downgrade would drop LACMA's bond rating to Baa — a "medium grade" investment that "may possess certain speculative characteristics."
One risk Moody's cited is that LACMA's bonds are "variable rate," with the interest rate reset weekly and therefore vulnerable to market fluctuations. The worst-case scenario that the analysts outlined — heavy investment losses throwing LACMA into sudden default on its bonds — stems from the complex financial arrangements the museum has made to reassure investors they will be paid in full even if there is a default.
A group of banks led by Union Bank is providing a letter of credit, which guarantees that the banks will make bondholders whole if that should happen (LACMA pays the banks for providing the guarantee). As a result, interest rates stay lower than they would be without the guarantee.
In exchange for the banks taking on that risk, LACMA has promised to maintain a certain amount of liquidity –- an "unrestricted net assets ratio" that reflects the financial headroom between how much the museum owes and how much ready money it has. Moody's said LACMA's liquid assets stood at $344 million, $57 million above the threshold that would trigger a default.
According to Moody's, LACMA's board "is considering ways other than fundraising" to boost that cushion to $100 million. Govan, however, said that's the one thing in the Moody's report he found puzzling. "I'm not 100% sure what they're referring to."
"We don't have any plans for layoffs or reductions," he said, nor does the museum intend to sell real estate it owns near its Wilshire Boulevard campus that, according to Moody's, has been appraised at $50 million and could be sold to boost the assets cushion — although the report said the property is "not immediately marketable."
Apart from its debt situation, Moody's gave LACMA high marks for its regular operations. Strengths include revenues exceeding expenses, a "high-profile" board that has grown from 42 to 50 members, annual attendance of more than 900,000, and a strong financial commitment from Los Angeles County, which provides $28.2 million a year, covering more than a third of the museum's operating expenses.