Overview

California counties and municipalities (or local governments [LGs]) have maintained or improved credit quality during the past year through a combination of conservative budgeting practices, better-than-expected local revenue performance, and the receipt of stimulus funds to aid recovery from the COVID-19 pandemic. However, macroeconomic conditions--including high inflation and the rising risk of recession--are headwinds for rated issuers, and S&P Global Ratings is focused on labor negotiations as employees face the prospect of negative wage growth in real terms absent larger-than-typical compensation increases. We expect growing tax bases and very strong budgetary flexibility stemming from recent positive operating results to partly mitigate these challenges.

S&P Global Ratings maintains ratings on 259 LGs within the state. Overall, LG credit quality remained stable, with 5% experiencing rating actions since October 2021. During this period, we took seven positive rating actions and revised six outlooks to positive on general obligation or general-fund-secured bonds with no negative rating actions. In addition, almost 99% of the ratings have a stable outlook. We have negative outlooks on our ratings for one county (Madera County) and two municipalities (Anaheim and Torrance), and a positive outlook on the ratings for one municipality (Vallejo). Although we revised the outlook to negative on 3% of our ratings on California LGs in 2021, we revised most of those outlooks to stable in 2022 based on the LGs' resilience through the pandemic and the credit pressures that we anticipated at the outset either not materializing or being mitigated by the receipt and use of stimulus funds.

What We're Watching In 2022 And Beyond

One-time federal stimulus may offset overall expenditure growth this fiscal year, but it poses a challenge for future years

LGs continued to perform well last year through a combination of conservative budgeting practices, better-than-expected local revenue performance, and the receipt of stimulus funds to aid recovery from the COVID-19 pandemic. This is evident in improvements in the median available fund balances at almost every rating level. California LGs have received the second round of federal stimulus provided under the American Rescue Plan Act, and these funds will be deployed to backfill revenue losses or cover other eligible expenditures. For the year ahead, we believe that credit quality will remain stable because LGs have demonstrated a willingness and ability to constrain expenditures in the face of budgetary stress.

However, we expected personnel costs to be the primary source of budgetary pressure in fiscal years 2023 and 2024. They represent the majority of LG general fund budgets and LGs will face pressure to increase compensation beyond the typical 2%-3% annual raises that we have observed in the past. High inflation is eroding purchasing power, and employees face the prospect of negative wage growth in real terms absent more substantial compensation increases. These pressures may also be heightened given tight labor markets and the ability of employees to find comparable--but better compensated--positions with neighboring LGs. We believe that wage pressures will be particularly high for LGs that reduced expenditures during the past two years by negotiating with bargaining units to defer scheduled wage increases, or for those LGs that consummated short-term agreements with wage increases that were in line with previous low rates of inflation but that have subsequently lagged the high inflation of this period. We anticipate that LGs may use a combination of one-time payments in conjunction with moderate wage increases to smooth the budgetary effects.

AV growth remains strong in fiscal 2023 but may slow

Tax base growth has remained strong, and we expect this will continue into at least fiscal 2023 given the lag between property assessments and the collection of property tax revenue. Median single-family home prices in California increased by 21% for new housing and 19% for existing housing in calendar 2021, and are projected to rise by 14.3% and 19.1%, respectively, in calendar 2022, according to S&P Global Market Intelligence forecasts. The stored value inherent within the Proposition 13 system, which tends to be a substantial cushion for tax base growth even when real estate market conditions weaken, also tends to result in tax base growth even as property values stagnate or decline. However, we monitor for real estate market effects tied to less favorable borrowing terms and demographic shifts.

Spotlight On Environment, Social, Governance Factors

The state is broadly exposed to a wide range of environmental risks. Acute physical risks stemming from wildfires and droughts, as well as chronic issues resulting from hydrological volatility and sea level rise; energy transition risk; other hazards such as seismic events and mudslides; and natural capital stress related to water scarcity are heightened risks for some entities absent adaptation measures.

Housing affordability has resulted in demographic shifts and elevated social risks. In addition, we expect the cost of municipal services to rise significantly given infrastructure investment required to meet demand and asset deficiencies such as grid reliability associated with ambitious energy transition requirements.

The state has a long history of policymaking aimed at preserving natural capital that mitigates or reduces climate risks and addresses socioeconomic inequities. While these policies advance environmental, social, and governance (ESG) principles, limitations on key revenue streams have hindered infrastructure investment, creating meaningful challenges to adaptation efforts. Furthermore, the state provides limited oversight for distressed municipalities as represented in our LG institutional framework.

For more information on California LG ESG factors, see "ESG U.S. Public Finance Report Card: California Governments And Not-For-Profit Enterprises," published June 16, 2021, on RatingsDirect.

Table 1

Chart 1

Table 2

Table 3

Chart 2

Table 4