Our thoughts are with our clients, business partners, and all individuals whom the Los Angeles area wildfires have impacted. Please note that this commentary is written strictly from a credit perspective and is not intended to minimize the devastating impact of this natural disaster on people and property.
The Scope of the Southern California Wildfires
Natural disasters and other tragic events are, first and foremost, extremely painful at a human level, yet they also introduce challenges that we, as an investment advisor, must evaluate. The ongoing California wildfires have already at least temporarily displaced nearly 200,000 residents and destroyed thousands of homes and buildings. While it is still too early to calculate the ultimate economic cost, these wildfires are expected to be the costliest in US history.
Our Exposure to Local Bond Issuers
Given the size of our client base in California and the State’s prominence in the tax-exempt markets, Appleton has significant bond holdings issued by Los Angeles area-domiciled state and municipal entities.
Appleton Holdings By Issuer
The list below is comprised of municipal issuers owned on behalf of clients that we believe have revenue or service area exposure to the wildfires. This exposure is subject to change.1
Initial Thoughts Concerning Credit Implications
Greater Los Angeles is an enormous, economically vibrant metropolitan area that encapsulates many large and financially strong tax-exempt bond issuers. While it is too early to draw definitive credit conclusions, municipalities in the region will certainly face short-term financial and management challenges, some more severe than others. At this stage, the authorities’ focus appropriately remains on evacuation, containment, the provision of essential utilities, and then rebuilding of infrastructure.
Despite the loss of life and devastating property damage, we feel that most public finance credits will not incur long-term credit deterioration. Appleton’s Municipal Research team is not recommending selling any CA-based bond holdings for credit reasons at this time.
While there may be a need to draw on reserves to address significant operational disruptions, federal reimbursements, state grants, and private insurance will likely cover a large portion of the rebuilding costs. Funding of this nature has historically quickly materialized and, in time, provided an economic boost as rebuilding commences.
Furthermore, our investment process emphasizes large, well-established issuers, most of which have diverse revenue streams, sizeable financial reserves, and ready access to financial liquidity. Areas that have historically attracted wealth and businesses have done so for a reason – they are typically supported by healthy economies. These characteristics better enable bond issuers to manage the costs and operational disruption created by unfortunate events of this nature.
Local General Obligation credits support essential governmental services, which in turn attract fiscal support during times of stress. In California, the State has historically backfilled property taxes lost by municipalities in areas devastated by fire and provided resources to ensure that per pupil state funding for school districts remains at the pre-disaster level for years after a natural disaster. Although our credit analysis is not dependent on this, we expect there to be similar extraordinary support in this situation.
Appleton’s impacted revenue bond exposure is limited to utilities, higher education, and healthcare. Although we also invest in revenue bond sectors such as airports, toll roads, and ports, our holdings in these sectors to date have not been impacted by the wildfires.
In analyzing revenue bond credits, we look for revenue and geographic diversity. While a given local operation may be forced to close, an entity with a larger footprint can rely on the revenue generation of its other operations to weather short-term disruption. Our focus on larger operations helps to reduce the risks to which smaller entities are subject. Balance sheet strength is also critical as it helps manage operational challenges while facilitating a rebuilding process.
Utilities face the risk of wildfire liabilities, specifically due to California’s “inverse condemnation” laws. We are not currently aware of any evidence that points blame at a specific municipal electric utility for the fires, but it is a possibility that has our attention. Even if such liability were to be incurred, the municipal utilities in which we invest have the ability to increase rates without regulatory approval, as well as significant balance sheet and external liquidity sources. Due in part to the essential nature of their services, State support and/or authorization to issue securitization bonds could materialize if there was severe financial strain.
California General Obligation Bonds1
We are changing our outlook on California’s GO Bonds to “stable” from “positive.” Due to the impact of the Los Angeles area wildfires, the IRS has extended the tax filing and payment date of federal personal and commercial income taxes to October 15th for those affected. We expect the State of California to follow suit. The extension disrupts the State’s ability to accurately track tax revenues and to budget accordingly, and this change also extends payment from one fiscal year to the next (FY24 ends June 30th, FY25 begins on July 1st), introducing additional complexities.
Our “AA-“ rating reflects the State’s healthy fiscal profile, substantial reserves ($22.1 billion projected as of 6/30/25), and manageable long-term liabilities.
From a purely economic standpoint, despite the tragic nature of the Los Angeles area wildfires, we anticipate short-term economic disruption to be followed by growth from a robust rebuilding effort. Metro Los Angeles is California’s largest economic region and, as a going concern, will be able to manage through the economic slowdown. Our change in credit outlook to “stable” is a function of the tax filing and payment extension and should not be seen as a negative reflection of our long-term credit confidence in California’s GO bonds.
More Vulnerable Sectors
Inevitably, certain issuers will be more acutely impacted by events such as the L.A. wildfires, often due to reliance on a narrow tax base, single-site facility operations, and modest financial resources. Issuers with such characteristics include redevelopment agencies, charter schools, senior living, and student housing. Appleton has long avoided exposure to these sectors due to perceived business risks, and the current situation only reinforces our reluctance to take on natural disaster-related tail risks.
Trading Environment
Trading has been active in some of the impacted bond issues since the onset of the wildfires, although spreads have, for the most part, only widened modestly. Secondary market trading volume in Los Angeles area credits was significantly higher on Monday, January 13th, up to 10 times a typical business day. Los Angeles Department of Water and Power bonds alone had ~$226 million in attempted sales via Bids Wanted listings compared to early last week. The pricing of most other Los Angeles area credits is generally trading about 10-15 bps cheaper than pre-fire levels. A notable outlier is the Los Angeles Department of Water & Power System, where we have seen trades nearly 70 bps wider than pre-fire levels.
We are monitoring developments closely and will adjust client portfolios if we believe it would be in the interests of clients to do so. We are hopeful that the Los Angeles area wildfires are contained as soon as possible and are keeping all those impacted in our thoughts. We encourage financial advisors to reach out to discuss specific questions or concerns.
1.As of January 10, 2025. Bond holdings are subject to change at any time.
This commentary reflects the opinions of Appleton Partners based on information that we believe to be reliable. It is intended for informational purposes only, and not to suggest any specific performance or results, nor should it be considered investment, financial, tax or other professional advice. It is not an offer or solicitation. Views regarding the economy, securities markets or other specialized areas, like all predictors of future events, cannot be guaranteed to be accurate and may result in economic loss to the investor. While the Adviser believes the outside data sources cited to be credible, it has not independently verified the correctness of any of their inputs or calculations and, therefore, does not warranty the accuracy of any third-party sources or information. Specific securities identified and described may or may not be held in portfolios managed by the Adviser and do not represent all of the securities purchased, sold, or recommended for advisory clients. The reader should not assume that investments in the securities identified and discussed are, were or will be profitable. Any securities identified were selected for illustrative purposes only, as a vehicle for demonstrating investment analysis and decision making. Investment process, strategies, philosophies, allocations, performance composition, target characteristics and other parameters are current as of the date indicated and are subject to change without prior notice. Registration with the SEC should not be construed as an endorsement or an indicator of investment skill acumen or experience.
"Bank of America provides monthly updates on state tax revenue trends. In the Bank’s latest publication it noted that median sales tax collections in July are pointing to a 0.4% decline, which would be the second consecutive drop .."
"It is often said that predicting market direction correctly is much easier than timing. We concur with that sentiment, and one only needs to point to the fact that a year ago Appleton highlighted the risk of holding short-term bonds despite attractive front-end yields. Those yields are still appealing, although with Fed Funds rate cuts likely on the near-term horizon it’s time to revisit the case for adding duration..."
"A common refrain when discussing the Federal Reserve’s ongoing fight to quell inflation is “the last mile is the hardest.” On one hand, progress so far has come faster than many had anticipated, with both headline and core inflation falling below 4% before the end of 2023. This was largely due to volatile non-core food and energy prices, however, and core goods, where supply chain normalization has allowed transitory-after-all price pressures to quickly fade..."
Economic & Market Commentary
01.14.2025
Los Angeles Wildfires
Our thoughts are with our clients, business partners, and all individuals whom the Los Angeles area wildfires have impacted. Please note that this commentary is written strictly from a credit perspective and is not intended to minimize the devastating impact of this natural disaster on people and property.
The Scope of the Southern California Wildfires
Natural disasters and other tragic events are, first and foremost, extremely painful at a human level, yet they also introduce challenges that we, as an investment advisor, must evaluate. The ongoing California wildfires have already at least temporarily displaced nearly 200,000 residents and destroyed thousands of homes and buildings. While it is still too early to calculate the ultimate economic cost, these wildfires are expected to be the costliest in US history.
Our Exposure to Local Bond Issuers
Given the size of our client base in California and the State’s prominence in the tax-exempt markets, Appleton has significant bond holdings issued by Los Angeles area-domiciled state and municipal entities.
Appleton Holdings By Issuer
The list below is comprised of municipal issuers owned on behalf of clients that we believe have revenue or service area exposure to the wildfires. This exposure is subject to change.1
Initial Thoughts Concerning Credit Implications
Greater Los Angeles is an enormous, economically vibrant metropolitan area that encapsulates many large and financially strong tax-exempt bond issuers. While it is too early to draw definitive credit conclusions, municipalities in the region will certainly face short-term financial and management challenges, some more severe than others. At this stage, the authorities’ focus appropriately remains on evacuation, containment, the provision of essential utilities, and then rebuilding of infrastructure.
Despite the loss of life and devastating property damage, we feel that most public finance credits will not incur long-term credit deterioration. Appleton’s Municipal Research team is not recommending selling any CA-based bond holdings for credit reasons at this time.
While there may be a need to draw on reserves to address significant operational disruptions, federal reimbursements, state grants, and private insurance will likely cover a large portion of the rebuilding costs. Funding of this nature has historically quickly materialized and, in time, provided an economic boost as rebuilding commences.
Furthermore, our investment process emphasizes large, well-established issuers, most of which have diverse revenue streams, sizeable financial reserves, and ready access to financial liquidity. Areas that have historically attracted wealth and businesses have done so for a reason – they are typically supported by healthy economies. These characteristics better enable bond issuers to manage the costs and operational disruption created by unfortunate events of this nature.
Local General Obligation credits support essential governmental services, which in turn attract fiscal support during times of stress. In California, the State has historically backfilled property taxes lost by municipalities in areas devastated by fire and provided resources to ensure that per pupil state funding for school districts remains at the pre-disaster level for years after a natural disaster. Although our credit analysis is not dependent on this, we expect there to be similar extraordinary support in this situation.
Appleton’s impacted revenue bond exposure is limited to utilities, higher education, and healthcare. Although we also invest in revenue bond sectors such as airports, toll roads, and ports, our holdings in these sectors to date have not been impacted by the wildfires.
In analyzing revenue bond credits, we look for revenue and geographic diversity. While a given local operation may be forced to close, an entity with a larger footprint can rely on the revenue generation of its other operations to weather short-term disruption. Our focus on larger operations helps to reduce the risks to which smaller entities are subject. Balance sheet strength is also critical as it helps manage operational challenges while facilitating a rebuilding process.
Utilities face the risk of wildfire liabilities, specifically due to California’s “inverse condemnation” laws. We are not currently aware of any evidence that points blame at a specific municipal electric utility for the fires, but it is a possibility that has our attention. Even if such liability were to be incurred, the municipal utilities in which we invest have the ability to increase rates without regulatory approval, as well as significant balance sheet and external liquidity sources. Due in part to the essential nature of their services, State support and/or authorization to issue securitization bonds could materialize if there was severe financial strain.
California General Obligation Bonds1
We are changing our outlook on California’s GO Bonds to “stable” from “positive.” Due to the impact of the Los Angeles area wildfires, the IRS has extended the tax filing and payment date of federal personal and commercial income taxes to October 15th for those affected. We expect the State of California to follow suit. The extension disrupts the State’s ability to accurately track tax revenues and to budget accordingly, and this change also extends payment from one fiscal year to the next (FY24 ends June 30th, FY25 begins on July 1st), introducing additional complexities.
Our “AA-“ rating reflects the State’s healthy fiscal profile, substantial reserves ($22.1 billion projected as of 6/30/25), and manageable long-term liabilities.
From a purely economic standpoint, despite the tragic nature of the Los Angeles area wildfires, we anticipate short-term economic disruption to be followed by growth from a robust rebuilding effort. Metro Los Angeles is California’s largest economic region and, as a going concern, will be able to manage through the economic slowdown. Our change in credit outlook to “stable” is a function of the tax filing and payment extension and should not be seen as a negative reflection of our long-term credit confidence in California’s GO bonds.
More Vulnerable Sectors
Inevitably, certain issuers will be more acutely impacted by events such as the L.A. wildfires, often due to reliance on a narrow tax base, single-site facility operations, and modest financial resources. Issuers with such characteristics include redevelopment agencies, charter schools, senior living, and student housing. Appleton has long avoided exposure to these sectors due to perceived business risks, and the current situation only reinforces our reluctance to take on natural disaster-related tail risks.
Trading Environment
Trading has been active in some of the impacted bond issues since the onset of the wildfires, although spreads have, for the most part, only widened modestly. Secondary market trading volume in Los Angeles area credits was significantly higher on Monday, January 13th, up to 10 times a typical business day. Los Angeles Department of Water and Power bonds alone had ~$226 million in attempted sales via Bids Wanted listings compared to early last week. The pricing of most other Los Angeles area credits is generally trading about 10-15 bps cheaper than pre-fire levels. A notable outlier is the Los Angeles Department of Water & Power System, where we have seen trades nearly 70 bps wider than pre-fire levels.
We are monitoring developments closely and will adjust client portfolios if we believe it would be in the interests of clients to do so. We are hopeful that the Los Angeles area wildfires are contained as soon as possible and are keeping all those impacted in our thoughts. We encourage financial advisors to reach out to discuss specific questions or concerns.
1.As of January 10, 2025. Bond holdings are subject to change at any time.
This commentary reflects the opinions of Appleton Partners based on information that we believe to be reliable. It is intended for informational purposes only, and not to suggest any specific performance or results, nor should it be considered investment, financial, tax or other professional advice. It is not an offer or solicitation. Views regarding the economy, securities markets or other specialized areas, like all predictors of future events, cannot be guaranteed to be accurate and may result in economic loss to the investor. While the Adviser believes the outside data sources cited to be credible, it has not independently verified the correctness of any of their inputs or calculations and, therefore, does not warranty the accuracy of any third-party sources or information. Specific securities identified and described may or may not be held in portfolios managed by the Adviser and do not represent all of the securities purchased, sold, or recommended for advisory clients. The reader should not assume that investments in the securities identified and discussed are, were or will be profitable. Any securities identified were selected for illustrative purposes only, as a vehicle for demonstrating investment analysis and decision making. Investment process, strategies, philosophies, allocations, performance composition, target characteristics and other parameters are current as of the date indicated and are subject to change without prior notice. Registration with the SEC should not be construed as an endorsement or an indicator of investment skill acumen or experience.
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