The Palisades, Eaton, and Hughes wildfires in the Los Angeles area may be the costliest ever in California, with at least 28 deaths, around 130,000 displaced residents, and property damage estimates of up to $45 billion. Although the cause of the fires is still unknown, California utilities have come under scrutiny for possible mismanagement and/or their role in potentially starting the fires. As a result, several municipal borrowers in the region – including the Los Angeles Department of Water and Power (LADWP or the Utility), the largest municipal electric utility provider in the United States – have exhibited material spread widening since the fires (see Figure 1). The size of the potential liability underscores the risks facing municipal utilities and the considerations facing active managers as they navigate increasingly severe climate events. With that context, we take a closer look at LADWP’s current exposure to liability risk from the Palisades fire.
LADWP: Under Pressure
Located in the City of Los Angeles, LADWP provides water and electric services to 1.6 million retail and commercial accounts throughout Los Angeles and several cities on its borders. The Utility has approximately $20 billion of municipal debt outstanding, including approximately $13 billion of debt associated with the Power Division. The Palisades fire, the largest of the three fires with over 23,000 acres burned, is within LADWP’s service area. In California, utilities are subject to “inverse condemnation” laws which omit a negligence standard and hold a utility strictly liable for damages if the utility’s equipment is determined to have caused a fire. Given the dense population and high property values in the service area for LADWP, the cost of damages related to a fire would be steep.
Figure 1
Los Angeles Department of Water and Power* yield widening versus Bloomberg California 1-15 Year Municipal Intermediate Index (%, YTW)
Source: Blackrock. *A custom composite of all LADWP CUSIPs in the Bloomberg California 1-15 Year Municipal Intermediate Index.
While LADWP’s service territory is not considered a “high wildfire risk” by the California Public Utilities Commission (CPUC) and the U.S. Forest Service due to its urbanized terrain and robust vegetation management programs, this has not stopped mounting speculation that LADWP’s Power Division may be to blame. For example, state and local officials have publicly criticized the Utility for not turning off the electric grid in certain affected areas, a standard practice for many utilities when a wildfire occurs. However, turning off the grid was not a protocol included in LADWP’s formal wildfire response plan, which was approved by the State of California’s Office of Energy Infrastructure Safety. Furthermore, most of the Utility’s electrical polls are steel and have already been hardened.1
In addition, LADWP’s Water Division has also come under attack for, among other things, failure to maintain a nearby reservoir that was out of service, as firefighting efforts throughout the Palisades were hampered by poor water pressure. A lawsuit has already been filed against LADWP’s Water Division directly related to the empty reservoir and the Utility’s decision to keep it closed.
Potential Outcomes for LADWP’s Power Division
The U.S. Bureau of Alcohol, Tobacco, Firearms and Explosives (ATF) is working to discover what caused the Palisades fire. Causes could range from fireworks to one of LADWP’s electrical towers in the vicinity of the fire’s origin. Below, we consider the potential outcomes from an investor’s perspective.
Outcome 1:
If LADWP’s utility wires are at fault, the size of claims would dwarf the Utility’s available insurance and liquid assets. In addition, LADWP may come under further modest negative rating agency action. Despite this concern, LADWP would likely remain financially viable, and we would not expect the Utility’s debt to suffer permanent principal impairment. Favorably, the Utility has enormous scale as it provides an essential service to nearly 4 million people throughout the City of Los Angeles. Unlike investor-owned utilities, LADWP has rate-raising authority that is not subject to the regulatory purview of the CPUC or any other state or federal agency. This allows it to raise rates without regulatory approval.
In addition, LADWP has de-levered over the past four to five years, leaving it room to issue several billion dollars of revenue bonds without risk of a ratings change (See Figure 2). We believe the Utility would also have the option to pursue a ratepayer reduction bond to fund the settlement of claims over time. In the past, utilities that have experienced costly disasters have received such state legislature-approved financing vehicles. These vehicles allow a portion of rates on customer bills supporting the ratepayer reduction bond to be securitized while providing cost of financing advantages to the issuer.
Figure 2
Los Angeles Department of Water and Power's power division has been reducing leverage (gross debt / cash flow available for debt service ratio)
Source: LADWP, PGIM Fixed Income.
In our estimation, bonding out $20 billion of property damages with a ratepayer reduction bond would raise the average LADWP customer’s power bill by a manageable 10%. This assumes the City of Los Angeles will share some responsibility for claims. There would likely be consternation among affected residents and politicians given the already high electric rates in both the city and state, but this framework would be the least disruptive to LADWP customers. Given this resilience, current spread levels on LADWP bonds may provide an attractive entry point.
Outcome 2:
If LADWP’s Power Division is found to have not caused the Palisades fire, it would still likely need to increase leverage to support capital expenditures intended to replace damaged equipment and harden infrastructure further for future wildfire prevention. Under this scenario, we believe the impact on LADWP’s balance sheet and financial metrics would be modest. Furthermore, we would expect credit spreads on LADWP bonds to materially tighten from current levels.
The Outcome for LADWP’s Water Division Is Less Clear
The lawsuits against LADWP’s Water Division are more complicated as inverse condemnation laws may apply, even if the Water Division was not at fault for starting the fire. In 2012, a Southern California water district (Yorba Linda Water District) was found liable under inverse condemnation because the utility failed to maintain fire hydrants that could have prevented fire damage. LADWP is being sued by residents of Pacific Palisades for failure of the Water Division to properly manage water supplies that may have combatted the blaze. We estimate that water rates would need to rise far more than the 10% we estimate for the Power Division if $20 billion in property damage claims were to accrue to the Water Division. With that stated, it is our view that the damages would likely be socialized among LADWP’s Power and Water Divisions, and the City of Los Angeles may shoulder some of the costs.
A Fractured Insurance Market & Rising Rates
The long-term impact of the fires is difficult to ascertain as there are many second order effects to consider. However, it’s clear that there will be mounting pressure on residents from the aggregate impact of higher insurance costs and utility rates. Furthermore, the higher cost of living could lead to outmigration from the state.
Insurance companies have been decreasing their exposure to wildfire risk in California for many years. Increasingly, residents have turned to the state’s insurer of last resort, FAIR, which has a deductible under its own reinsurance policies that exceeds the plan’s cash on hand. This program may need comprehensive reform or access to additional capital. To help mitigate the issues, California recently allowed private insurers to raise rates to reflect modeled catastrophe risks and to pass on the cost of reinsurance in exchange for writing 85% of their coverage in high-risk areas. The quid-pro-quo may leave insurers worse off and accelerate the pull-back of coverage further.
In addition, water and utility rates – especially in Southern California where water is naturally less abundant— may need to reprice to reflect the reality of hardening infrastructure and the increasing frequency of recovering costs for liabilities incurred during wildfires.
Implications of California’s Wildfires for LADWP
LADWP’s credit trajectory will be dependent on the result of the investigation, although we believe the Utility has the resources to recover from the recent fires and current spread levels may largely reflect downside risks. However, the spread widening exhibited by the Utility is a reminder that fires are becoming more prevalent and large municipal utilities are not immune to intensifying climate risks. We hope that the recent outbreak will serve as an inflection point for state and local officials, leading to improvements in water and utility infrastructure, firefighting resources, and polices that mitigate the State of California’s risk to fires.
1 Physical improvements to plant and equipment, including power lines and supporting structures, making them more resistant to extreme heat and damage from wildfires.
The comments, opinions, and estimates contained herein are based on and/or derived from publicly available information from sources that PGIM Fixed Income believes to be reliable. We do not guarantee the accuracy of such sources or information. This outlook, which is for informational purposes only, sets forth our views as of this date. The underlying assumptions and our views are subject to change. Past performance is not a guarantee or a reliable indicator of future results.
Source(s) of data (unless otherwise noted): PGIM Fixed Income, as of January 2025.
For Professional Investors only. Past performance is not a guarantee or a reliable indicator of future results and an investment could lose value. All investments involve risk, including the possible loss of capital.
PGIM Fixed Income operates primarily through PGIM, Inc., a registered investment adviser under the U.S. Investment Advisers Act of 1940, as amended, and a Prudential Financial, Inc. (“PFI”) company. Registration as a registered investment adviser does not imply a certain level or skill or training. PGIM Fixed Income is headquartered in Newark, New Jersey and also includes the following businesses globally: (i) the public fixed income unit within PGIM Limited, located in London; (ii) PGIM Netherlands B.V., located in Amsterdam; (iii) PGIM Japan Co., Ltd. (“PGIM Japan”), located in Tokyo; (iv) the public fixed income unit within PGIM (Hong Kong) Ltd. located in Hong Kong; and (v) the public fixed income unit within PGIM (Singapore) Pte. Ltd., located in Singapore (“PGIM Singapore”). PFI of the United States is not affiliated in any manner with Prudential plc, incorporated in the United Kingdom or with Prudential Assurance Company, a subsidiary of M&G plc, incorporated in the United Kingdom. Prudential, PGIM, their respective logos, and the Rock symbol are service marks of PFI and its related entities, registered in many jurisdictions worldwide.
These materials are for informational or educational purposes only. The information is not intended as investment advice and is not a recommendation about managing or investing assets. In providing these materials, PGIM is not acting as your fiduciary. PGIM Fixed Income as a general matter provides services to qualified institutions, financial intermediaries and institutional investors. Investors seeking information regarding their particular investment needs should contact their own financial professional.
These materials represent the views and opinions of the author(s) regarding the economic conditions, asset classes, securities, issuers or financial instruments referenced herein. Distribution of this information to any person other than the person to whom it was originally delivered and to such person’s advisers is unauthorized, and any reproduction of these materials, in whole or in part, or the divulgence of any of the contents hereof, without prior consent of PGIM Fixed Income is prohibited. Certain information contained herein has been obtained from sources that PGIM Fixed Income believes to be reliable as of the date presented; however, PGIM Fixed Income cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed. The information contained herein is current as of the date of issuance (or such earlier date as referenced herein) and is subject to change without notice. PGIM Fixed Income has no obligation to update any or all of such information; nor do we make any express or implied warranties or representations as to the completeness or accuracy.
Any forecasts, estimates and certain information contained herein are based upon proprietary research and should not be interpreted as investment advice, as an offer or solicitation, nor as the purchase or sale of any financial instrument. Forecasts and estimates have certain inherent limitations, and unlike an actual performance record, do not reflect actual trading, liquidity constraints, fee. These materials are not intended as an offer or solicitation with respect to the purchase or sale of any security or other financial instrument or any investment management services and should not be used as the basis for any investment decision. PGIM Fixed Income and its affiliates may make investment decisions that are inconsistent with the recommendations or views expressed herein, including for proprietary accounts of PGIM Fixed Income or its affiliates.
Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and low-interest rate environments increase this risk. Reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Mortgage- and asset-backed securities may be sensitive to changes in interest rates, subject to early repayment risk, and while generally supported by a government, government agency or private guarantor, there is no assurance that the guarantor will meet its obligations. High yield, lower-rated securities involve greater risk than higher-rated securities; portfolios that invest in them may be subject to greater levels of credit and liquidity risk than portfolios that do not. Investing in foreign-denominated and/or -domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. Currency rates may fluctuate significantly over short periods of time and may reduce the returns of a portfolio. Commodities contain heightened risk, including market, political, regulatory and natural conditions, and may not be suitable for all investors. Diversification does not ensure against loss.
In the United Kingdom, information is issued by PGIM Limited with registered office: Grand Buildings, 1-3 Strand, Trafalgar Square, London, WC2N 5HR.PGIM Limited is authorised and regulated by the Financial Conduct Authority (“FCA”) of the United Kingdom (Firm Reference Number 193418). In the European Economic Area (“EEA”), information is issued by PGIM Netherlands B.V., an entity authorised by the Autoriteit Financiële Markten (“AFM”) in the Netherlands and operating on the basis of a European passport. In certain EEA countries, information is, where permitted, presented by PGIM Limited in reliance of provisions, exemptions or licenses available to PGIM Limited including those available under temporary permission arrangements following the exit of the United Kingdom from the European Union. These materials are issued by PGIM Limited and/or PGIM Netherlands B.V. to persons who are professional clients as defined under the rules of the FCA and/or to persons who are professional clients as defined in the relevant local implementation of Directive 2014/65/EU (MiFID II). In Switzerland, information is issued by PGIM Limited, London, through its Representative Office in Zurich with registered office: Kappelergasse 14, CH-8001 Zurich, Switzerland. PGIM Limited, London, Representative Office in Zurich is authorised and regulated by the Swiss Financial Market Supervisory Authority FINMA and these materials are issued to persons who are professional or institutional clients within the meaning of Art.4 para 3 and 4 FinSA in Switzerland. In certain countries in Asia-Pacific, information is presented by PGIM (Singapore) Pte. Ltd., a regulated entity with the Monetary Authority of Singapore under a Capital Markets Services License to conduct fund management and an exempt financial adviser. In Japan, information is presented by PGIM Japan Co. Ltd., registered investment adviser with the Japanese Financial Services Agency. In South Korea, information is presented by PGIM, Inc., which is licensed to provide discretionary investment management services directly to South Korean investors. In Hong Kong, information is provided by PGIM (Hong Kong) Limited, a regulated entity with the Securities & Futures Commission in Hong Kong to professional investors as defined in Section 1 of Part 1 of Schedule 1 of the Securities and Futures Ordinance (Cap.571). In Australia, this information is presented by PGIM (Australia) Pty Ltd (“PGIM Australia”) for the general information of its “wholesale” customers (as defined in the Corporations Act 2001). PGIM Australia is a representative of PGIM Limited, which is exempt from the requirement to hold an Australian Financial Services License under the Australian Corporations Act 2001 in respect of financial services. PGIM Limited is exempt by virtue of its regulation by the FCA (Reg: 193418) under the laws of the United Kingdom and the application of ASIC Class Order 03/1099. The laws of the United Kingdom differ from Australian laws. In Canada, pursuant to the international adviser registration exemption in National Instrument 31-103, PGIM, Inc. is informing you that: (1) PGIM, Inc. is not registered in Canada and is advising you in reliance upon an exemption from the adviser registration requirement under National Instrument 31-103; (2) PGIM, Inc.’s jurisdiction of residence is New Jersey, U.S.A.; (3) there may be difficulty enforcing legal rights against PGIM, Inc. because it is resident outside of Canada and all or substantially all of its assets may be situated outside of Canada; and (4) the name and address of the agent for service of process of PGIM, Inc. in the applicable Provinces of Canada are as follows: in Québec: Borden Ladner Gervais LLP, 1000 de La Gauchetière Street West, Suite 900 Montréal, QC H3B 5H4; in British Columbia: Borden Ladner Gervais LLP, 1200 Waterfront Centre, 200 Burrard Street, Vancouver, BC V7X 1T2; in Ontario: Borden Ladner Gervais LLP, 22 Adelaide Street West, Suite 3400, Toronto, ON M5H 4E3; in Nova Scotia: Cox & Palmer, Q.C., 1100 Purdy’s Wharf Tower One, 1959 Upper Water Street, P.O. Box 2380 -Stn Central RPO, Halifax, NS B3J 3E5; in Alberta: Borden Ladner Gervais LLP, 530 Third Avenue S.W., Calgary, AB T2P R3.
© 2025 PFI and its related entities.
2025-1179
Collapse Section