As illustrated by this map, wildfires in the City of Los Angeles metropolitan area are affecting not only that city but other area jurisdictions as well.

The city and other local governments may see partial or total destruction of public projects that were financed with lease revenue bonds. In the State of California, these types of bonds carry abatement risk: the obligor has the right to stop paying debt service in whole or in part if the project financed with proceeds is, similarly, entirely or partially unavailable for use.

As an example, the official statement for the 2024 Series H lease revenue bonds issued by the Los Angeles County Public Works Financing Authority contains the following language:

Similar provisions are included in the official statement for the 2023 Series A certificates of participation sold by the Los Angeles Unified School District and the offering memorandum for the Series A-D lease revenue commercial paper notes sold by the Los Angeles County Capital Asset Leasing Corporation. The commercial paper notes are secured by letters of credit from Bank of Montreal, U.S. Bank National Association, Bank of America, N.A., and Sumitomo Mitsui Banking Corporation.

The risk of nonpayment on abatement bonds is typically mitigated by the obligor’s maintenance of two years’ rental interruption insurance, which is intended to pay debt service in the event of abatement, and of property/casualty insurance in amounts that will either repair the property or call outstanding bonds. Debtwire Municipals notes that insurance companies operating in California will undergo significant stress as a result of wildfire losses.

Because lease revenue bonds and similar securities are essential to the financing of California’s infrastructure, the state and its subdivisions have historically made every effort to not abate debt service payments on lease rental bonds when natural disasters occur. The magnitude of possible damage to public works caused by the recent wildfires, however, combined with what will be the straitened financial situation of local governments, could change the outlook for this market sector.

Greg Clark, Debtwire’s Head of Municipal Research, is a municipal analyst with more than four decades of experience at a rating agency, broker-dealers, commercial banks, bond insurers, and a hedge fund. He is also a former chairman of the National Federation of Municipal Analysts and of the Municipal Analysts Group of New York.