San Francisco’s sluggish recovery from the pandemic may end up costing the city its pristine top-tier credit rating.
(Bloomberg) — San Francisco’s sluggish recovery from the pandemic may end up costing the city its pristine top-tier credit rating.
The outlook on the city-county’s Aaa credit rating was cut to negative from stable this week by Moody’s Investors Service. The ratings company said prolonged weakness in the city’s commercial real estate market and the “stubbornly slow” rebound of office workers were factors that drove the move.
A credit-rating downgrade would be the latest challenge facing Mayor London Breed, who is seeking to close a $780 million deficit as part of the upcoming two-year budget cycle. A top credit rating is often a point of pride for public officials, and losing it could make it more expensive for the city to borrow in the municipal-bond market.
“Of the largest 25 cities in the United States, we remain the highest rated in California, and continue to hold, with 10 others, the highest possible rating in the country,” Breed said in an emailed statement. “But there is also a warning. By shifting our outlook from stable to negative, Moody’s is shining a light on what we know. It doesn’t mean our rating will drop.”
Persistent work-from-home habits, inordinately expensive real estate, homelessness and crime are colliding to threaten the city’s growth and its spot among the world’s top-tier metropolises.
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Office Woes
The city’s slow recovery is reflected in the debt market. San Francisco ranks last among 32 US cities in an index that tracks secondary market prices for general obligation debt and is published by the University of Chicago’s Center for Municipal Finance. As of late June, it had an index value of 56.75, while Chicago, one of the strongest performers among cities, had a value of 101.52, according to Justin Marlowe, a professor at the university.
Real estate property taxes represent nearly 60% of San Francisco’s local tax revenue, according to Barclays, which says that revenues are expected to barely increase over the next five fiscal years.
A 2022 report from the city’s chief economist found that, in a worst case scenario, San Francisco could lose $200 million in property tax revenue by 2028 because of remote workers.
“While we are not overly concerned about San Francisco’s credit quality, it will likely experience credit pressure for the foreseeable future, which could negatively affect the city’s ratings, as well as the ratings of some of its related credits,” Barclays strategists said in a June 21 report.
Low office occupancy rates have already upended the region’s mass transit system, which is eyeing large deficits as pandemic relief money runs out. BART, the train system serving downtown San Francisco, had its bond rating downgraded two notches in June, from AA to A+, by S&P Global Ratings largely due to low ridership numbers.
Raiding Reserves
Breed said the outlook revision by Moody’s reinforces the “urgency” of her policy priorities, like public safety and reforming taxes to address office vacancies. Moody’s said the city’s inability to develop long-term solutions for its pressing economic challenges could lead to a downgrade.
Though, a change in outlook by Moody’s doesn’t necessarily mean that the credit rating will be adjusted. It’s merely an opinion about the likely direction of an issuer’s rating over the medium term, according to Moody’s. The company rates about $2.6 billion of general-obligation debt and $1.4 billion of lease-backed debt for San Francisco.
The city has an additional $19.5 billion of debt outstanding across different entities that was unaffected by the rating action, according to the ratings company.
To close the shortfall, Breed has proposed using the city’s reserves. She proffers withdrawing $172 million from different reserves over the next two fiscal years, according to her budget recommendation.
Breed has also asked city departments to propose budget cuts of 5% in fiscal 2024 and 8% in fiscal 2025.
She said that shortfalls are anticipated in future years, and the city will need to cut spending further or raise new revenue. The budget must be approved by the board of supervisors by Aug. 1.
“Deficits require difficult choices,” Breed said in her budget proposal released in May. “This budget includes reductions across departments from current levels of spending, only minimally funds our capital program, and reduces salary budgets in some departments with high vacancy rates.”
Still, there are signs of optimism within the city, such as the growth of artificial intelligence firms based there, like OpenAI, the creator of ChatGPT. And analysts at Moody’s said the city’s “exceptionally large tax base” and “its status as a premier technology and innovation ecosystem” will provide a buffer.
“These credit qualities position San Francisco well to manage its near-term, post-pandemic challenges, including changes in employment conditions, tourism patterns, and retail behavior,” Moody’s said.
–With assistance from Eliyahu Kamisher.
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