LA's credit rating downgraded due to 'structural imbalance' amid $1 billion deficit

Standard & Poor's 500 downgraded its credit rating of city of Los Angeles general obligation bonds, citing its “weakening financial position and an emerging structural imbalance.” Los Angeles faces a $1 billion deficit, having burned through its once-record reserves in just two years.

Los Angeles Mayor Karen Bass is currently seeking a state bailout, but given that the state says it has “no capacity” for new spending commitments, it’s unclear if the funding will materialize.

S&P warns that if trends continue, it could further downgrade the city’s credit rating, which would further increase borrowing costs due to higher associated risk of default.

At AA-, the new rating still means the city’s bonds are investment grade and well above the junk bond threshold of BB+. However, without changes, S&P warns that there’s a one-in-three chance that it could downgrade the city’s credit rating yet again, reflecting anticipated difficulty in cutting runaway spending.

“The negative outlook also acknowledges various difficulties that could challenge the city's efforts to achieve structural balance and restore its reserve fund in the near term: heightened litigation risk, limited flexibility to unilaterally reduce personnel costs under current labor contracts, and slowing economic growth, notwithstanding any additional lasting economic and revenue impacts from the wildfire events across Los Angeles County in January 2025,” wrote S&P.

Under the last budget from former mayor Eric Garcetti, Los Angeles had a record $648 million in reserves. Bass spent half of the reserves in just one year, leading City Controller Kenneth Mejia to warn in 2024 that the city is “going broke,” and would soon have so little reserves left it would be required to declare a “fiscal emergency” — highlighting how the city’s financial woes are structural and pre-date the January wildfires.

S&P also warned that liabilities from the city’s utilities — noting the Los Angeles Department of Water and Power in particular, which often faces fire-related lawsuits — could also lead to a downgrade, as the city ultimately carries the liability from its utilities.

“We could also lower the rating if additional debt issuance or heightened litigation or contagion risk associated with its utilities (i.e., Los Angeles Department of Water and Power) materially weakens our view of the city's debt and liability profile,” continued S&P.

However, should the city balance its budget and restore its reserves to its goal of 5%, S&P says that it could adjust the city’s credit rating outlook from negative to stable, which would pause the city’s credit rating slide.