Fitch Rates LA County, CA's 2017 Notes 'F1+' & Affirms IDR at 'AA'; Outlook Stable
OREANDA-NEWS. Fitch Ratings has assigned an 'F1+' rating to the following Los Angeles County, California (the county) tax and revenue anticipation notes:
--$800 million 2016-17 notes.
The 2016-17 notes will be sold via negotiation on June 8, 2016. The purpose of the notes is to provide monies to smooth out lumpy fiscal 2017 general fund receipts that support ongoing county operations.
In addition, Fitch has affirmed the following outstanding ratings:
--County Issuer Default Rating (IDR) at 'AA';
--$1.7 billion Los Angeles County Public Works Financing Authority lease revenue bonds (multiple capital projects), 2010 series A (tax-exempt) and series B (Build America Bonds), lease revenue bonds (multiple capital projects II), series 2012, lease revenue bonds (multiple capital projects), series 2015A, lease revenue bonds (master refunding project), series 2015B (tax-exempt) and 2015C (federally taxable), and lease revenue bonds, 2016 series D at 'AA-';
--$64.5 million county COPs, series 1993 Disney Parking Project and 2012 refunding COPs (Disney Concert Hall Parking Garage) at 'AA-';
--$22.7 million Los Angeles County Capital Asset Leasing Corporation lease revenue bonds (LAC-CAL Equipment Program), series 2011A and 2014A at 'AA-'.
Fitch has also upgraded the following ratings:
--$66.5 million Sonnenblick-Del Rio El Monte Asset Leasing Corporation senior COPs, series 1999 (Department of Public Social Services Facility) and series 2001 (Department of Public Social Services Facility - Phase II) to 'AA-' from 'A+';
--$31.6 million Sonnenblick-Del Rio West Los Angeles Leasing Corporation senior COPs, series 2000 (Department of Public Social Services Facility) to 'AA-' from 'A+'.
The upgrade of these COPs' ratings reflects application of Fitch's revised criteria for U. S., state, and local government credits, which was released on April 18, 2016. The revised criteria include more focused consideration of project factors in ratings for appropriation-backed debt; the COPs do not carry any of the additional risk features that Fitch identifies for rating more than one notch below the IDR under the revised criteria.
The Rating Outlook on all of the long-term ratings is Stable.
SECURITY
The notes are general obligations of the county, payable from unrestricted general fund revenue attributable to fiscal 2017 (projected $8.2 billion, estimated to cover note principal and interest 10.2x). Funds for repayment will be set aside based on an aggressive schedule beginning in December 2016 at which time 39% of principal (plus all interest that will accrue on the notes, an estimated $24 million) will be set aside. By January 2017, 79% of the estimated principal will be set aside. The full amount will be set aside by April 2017. The notes are scheduled to be repaid on June 30, 2017.
KEY RATING DRIVERS
The 'AA' IDR reflects the county's strong but cyclical economic underpinnings, exceptionally strong gap-closing capacity despite limits on revenue raising, and moderate liability levels. A demonstrated ability to cut spending and a sound financial cushion offset the county's exposure to both state and local economic cyclicality and Department of Health Services (DHS) operations and related federal and state funding decisions.
The 'F1+' short-term rating on the notes corresponds to the county's IDR. The combination of pledged revenues and court-verified borrowable resources provides very strong debt service coverage for the notes. Full note principal and interest set-asides occur well in advance of note maturity.
The 'AA-' rating for all of the county's rated COPs and lease revenue bonds is one notch below the IDR, reflecting the appropriation requirement for debt service payment.
Economic Resource Base
The county covers 4,084 square miles and includes 88 incorporated cities and 100 school districts. With a population exceeding 10 million, it is more populous than most U. S. states. The county's huge, diversified economy represents approximately a quarter of California's total economy.
Revenue Framework: 'a' factor assessment
The county's independent legal ability to raise revenues is limited by state law. There is also some revenue exposure to state and federal reimbursement delays. However, growth prospects for the economy and revenues are solid, and the county's revenues have demonstrated limited volatility, reflecting the size and maturity of the economy and tax base (which has a large Proposition 13 cushion).
Expenditure Framework: 'aa' factor assessment
The county demonstrated strong expenditure control during the recession and continues to enjoy considerable expenditure flexibility, although its general fund remains exposed to subsidization of DHS operations. Fitch expects expenditure growth to be roughly in line with revenue growth going forward. Carrying costs will increase as the county pays down its manageable unfunded pension liability and OPEB obligations (still significant despite recent OPEB reform).
Long-Term Liability Burden: 'aa' factor assessment
The county's combined long-term liability (overall debt and pension obligations) as a percentage of total personal income is on the lower end of the moderate range. Overlapping debt makes up about three-quarters of this total.
Operating Performance: 'aaa' factor assessment
Using strong expenditure controls, the county consistently maintains structural balance before transfers out to DHS. This, plus solid reserve funding levels, leaves the county very well positioned to address cyclical downturns. The county has demonstrated an ongoing commitment to bolster its financial cushion during the recent economic recovery, aided in part by DHS's improved financial position.
RATING SENSITIVITIES
Solid Financial Profile: The rating is sensitive to fundamental changes in the county's financial operations and strong budget management.
Manageable General Fund Support for DHS: An unexpected need for greater general fund support of DHS operations which reduces the county's general fund balance cushion and overall financial flexibility could pressure the rating.
CREDIT PROFILE
Los Angeles County is a major economy and manufacturing center, and incorporates a port and an airport that are among the busiest in the world. Taxable AV has grown strongly in the past four years to an all-time high of $1.3 trillion, after very small recessionary declines, reflecting the county's highly developed and mature nature and large Proposition 13 cushion. A further 5% taxable AV increase is expected in fiscal 2017. While the county's median house price has yet to return to its prior peak (2007), house prices and numbers of residential building permits have been rising, while notices of default are at a 10-year low.
Despite these strong economic and tax base characteristics, the unemployment rate is typically higher than the nation's. Wealth indicators are below the state and mixed relative to the nation, reflecting some highly urbanized and low income areas.
Revenue Framework
The majority of general fund revenues come from state and federal funding for social services (almost half of total revenues, although this amount fluctuates significantly through the economic cycle due to caseloads, reimbursement timing, and state budget issues), property taxes (23% of the fiscal 2017 general fund budget), and charges for services (20%).
Since fiscal 2011, there has been good growth in key discretionary revenues. This suggests that future growth should at least mirror economic trends. The fiscal 2017 budget assumes 5% property tax revenue growth and 4% sales tax revenue growth.
The county has very limited independent revenue-raising capacity, particularly due to Propositions 13 and 218 requiring voter approval for tax increases. Revenue-raising ability is largely limited to licenses, permits, fines, and charges for service.
Expenditure Framework
Over half of fiscal 2015 general fund expenditures were on public safety (34%) and health and social services (19%), which is typical for county governments. Public works is another large line item at about 37%.
The pace of spending growth absent policy actions is likely to generally track revenue growth patterns given high-needs communities within the county. Fitch expects the county will continue to control expenditures aggressively.
The county retains a notable amount of expenditure flexibility despite its ongoing support of DHS operations. Its fixed cost burden is moderate with fiscal 2015 carrying costs (for debt, pensions, and OPEB) comprising a moderate 14% of governmental spending.
The county operates within a strong labor environment and labor has the ability to strike. Nevertheless, labor relations are productive and multiyear labor contracts have considerable flexibility. The labor contracts contain layoff and furlough options, and there are no salary or 'me too' reopeners, no binding arbitration constraints on the compensation negotiation process, and no mandatory requirements to consider regional compensation. All but two of the county's 61 labor agreements are now settled through fiscal years 2018 or 2019.
Long-Term Liability Burden
The county's overall debt of approximately $36.9 billion is a moderate burden on resources. Amortization of direct debt principal is average, and all direct debt is fixed rate, although the county's $1.8 billion of direct debt represents less than 5% of the total liability burden. There are no new county bond issuances planned until fiscal 2018 at the earliest (a possible $250 million in lease revenue bonds). In the medium term, the county's identification of $1 billon in deferred maintenance needs might spur the need for new debt, particularly since that figure does not include replacement or refurbishment costs associated with buildings that exceed their useful lives.
The almost $7 billion net pension liability reported for the Los Angeles County Employees Retirement Association (LACERA) should reduce as recent investment gains are smoothed in. Fitch estimates that net pension liability at $10.6 billion using its more conservative 7% investment return assumption. The county consistently funds LACERA at actuarially sustainable levels.
Although OPEB liability is sizable ($27.7 billion in fiscal 2015), the county does have the ability to reduce it. OPEB reforms enacted in 2015 are projected to reduce the UAAL by about 21%. Further, the county is increasing its annual contributions, funded in part by maximizing subvention revenues from other governments. The county is contributing $23 million and $61 million towards OPEB prefunding in fiscal years 2016 and 2017 respectively. In addition to the county's $540 million irrevocable OPEB trust, LACERA has a $50 million reserve for annual health care premium fluctuations.
Operating Performance
Despite state-imposed constraints on its revenue-raising ability, the county has demonstrated notable gap-closing ability on the expenditure side during economic downturns. During the last recession, it generated additional revenue, primarily through federal stimulus funds and health care reform (e. g. client enrollment in managed health care under the Affordable Care Act). On the expenditure side, the county relied on employee attrition, unfilled vacancies, departmental curtailments, efficiency initiatives, 0% COLAs for four to five years (depending on the bargaining unit), and use of reserves and capital funds.
The county has prioritized maintenance of strong general fund balances and continued strengthening of its reserves during the economic recovery, despite increased staffing and salary outlays. After significant position cuts during the recession, the county has staffed board priorities with new positions each year from fiscal 2014 onwards. Strong upward salary and benefits pressure has been addressed through multiyear contracts that spread 10% personnel cost increases over three years.
The county expects to end fiscal 2016 with a total general fund balance in excess of $3.2 billion, in line with its fiscal 2015 result. Fiscal 2016 is expected to end with a Rainy Day Fund of $338 million, 6% of ongoing discretionary revenues (i. e. excluding federal and state pass-through funding), with an additional $26 million budgeted for fiscal 2017. The ultimate goal is to reach 10% of ongoing discretionary revenues. The county is also budgeting $26 million (10% of new discretionary revenues) for its contingency appropriation in fiscal 2017.
The county operates the second largest public health system in the nation. The general fund is responsible for DHS administration, online medical records, and the managed care program. The level of general fund support is stabilizing around 13% of DHS's total budget as DHS operations become financially more viable. The general fund net county contribution (NCC) to DHS has declined significantly due to DHS's more stable revenue streams, improved patient demographics, and operational changes ($653 million budgeted in FY 2017, 13% of total DHS budget, down from a peak of $828 million in FY 2008, 18% of total DHS budget). Given its high general fund balances, the county clearly has the financial capacity to return to a higher level of NCC if necessary. NCC funding is from a mix of general fund (49% budgeted in fiscal 2017), state vehicle licensing fee (42%), and tobacco settlement (9%) revenues. The general fund also provides DHS with working capital loans ($580 million budgeted in June 2017, down from a high of $1.05 billion in June 2011).
DHS's year-end financial results are improving. The county is projecting a surplus of at least $330 million at fiscal 2016 year end, compared to a surplus of only $13 million in fiscal 2011. DHS is benefitting from the recent extension of the former Section 1115 Hospital Financing Waiver for California public hospitals through Dec. 31, 2020. This extension, 'Medi-Cal 2020', removes significant financial uncertainty as Affordable Care Act implementation settles down. From fiscal 2017 onwards, DHS also expects the state to either cease redirecting under AB 85 post-ADA realignment revenues from health to social service programs (compared to the $100 million redirection in fiscal 2016) or for prior year reconciliations to offset future redirections.
The county is currently focused on how best to utilize the approximately $1 billion federal and state funding it receives for single homeless adults, particularly in terms of increased preventive services and service coordination. A number of funding strategies are under consideration for fiscal 2018 onwards to increase funding for homeless services. These include a local personal income tax on high earners (would require state legislative approval), a sales tax increase (within the board's jurisdiction but would require state legislative exemption for three cities already at the sales tax rate cap), a medical marijuana tax (within the board's jurisdiction), or a parcel tax (also within the board's jurisdiction).
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