Fitch Upgrades El Monte PFA, CA's LRBs to 'BBB'; Outlook Stable
--$18.7 million revenue bonds (City Yard Project) series 2010A and 2010B.
In addition, Fitch affirms the following rating:
--Implied general obligation bonds (GOs) at 'BBB+' for the city of El Monte, California (the city).
The Rating Outlook is Stable.
SECURITY
The city has covenanted to budget and appropriate (CB&A) lease rental payments, subject to abatement, to the authority for use of its public works yard from any available funds of the city. The city maintains two years of rental interruption insurance. The bonds are additionally secured by a cash-funded debt service reserve fund sized to the IRS maximum.
KEY RATING DRIVERS
ONE-NOTCH DISTINCTION: Fitch revises the distinction between the implied GOs and the revenue bonds to one-notch from two to reflect successful resolution of its dispute with the state regarding use of former RDA tax increment as a source of debt service payment and the city's CB&A revenue bond debt service from any available source, as legally required.
REVENUE INITIATIVES SUPPORT ADEQUATE FINANCIALPERFORMANCE: The city continues to demonstrate a satisfactory financial position. These include the passage of a five-year sales tax override extension through fiscal 2019, a sixth year of structurally balanced general fund operations and a fourth year with an unqualified audit. The city also plans to implement some actions to maintain structural fiscal balance over the long-term as recommended in a recent third-party issued report.
FISCAL CHALLENGES REMAIN: The city faces rising pension costs not covered by a pension property tax override, a large deferred wage increase beginning January 2016, and the expiration of the sales tax override extension in two years. Maintaining operating balance absent voter approval for revenue enhancements will significant expenditure restraint.
SATISFACTORY DEBT PROFILE: Debt levels and principal amortization are moderate, the city's capital improvement plan is relatively small, and there are no plans for additional long-term debt. Plans to fund a recently created OPEB trust are viewed favorably. Moderate carrying costs are expected to rise with escalating pension costs.
WEAK DEMOGRAPHICS, STABLE TAX BASE: The local economy is weighed down by very low income levels and higher than average unemployment. These weaknesses are somewhat mitigated by the city's location within the extremely large and well diversified Los Angeles employment market, large commercial projects planned and under construction, low taxpayer concentration, and a mature housing market that resulted in resilient assessed valuation (AV) levels during the recession.
RATING SENSITIVITIES
FINANCIAL STABILITY, SUSTAINABILITY PLAN: Evidence of successful implementation of a prudently crafted fiscal sustainability plan, now under way, could lead to positive rating action. Similarly, a lack of resolution on looming challenges, including the fiscal 2019 sun setting of the sales tax override and rising retirement fund deficits, could lead to negative rating pressure.
CREDIT PROFILE
The city serves a population of about 116,000 and covers 10 square miles approximately 12 miles east of downtown Los Angeles.
ADEQUATE FINANCIAL OPERATIONS, WEAKNESSES REMAIN
The city's financial operations have improved in recent years, with fiscal 2014 marking the city's sixth consecutive general fund audited surplus. The fiscal 2014 $4.5 million surplus raises the city's unrestricted fund balance to a solid $12.4 million (20.9% of expenditures and transfers out). The city's satisfactory operating results are estimated to continue, with a fiscal 2015 surplus estimated at $800,000 and a fiscal 2016 budget that is balanced net of reserve set-asides and contingencies.
The city's financial profile was boosted significantly, if temporarily, by approval of Measure GG, a five-year extension of a sales tax override, by a high 71% of voters in November 2013. The tax generates approximately $4.35 million annually. The tax sunsets in fiscal 2019 and, as such, management will need to prepare for the potential loss of about 8% of revenues in an environment expected to be pressured by rising pension costs, along with pent up wage and service level pressures.
The city has budgeted for deferred wage increases that take effect on Jan. 1, 2016 absent an overriding labor agreement, and pension costs are expected to rise significantly from current levels. Policymakers will need to continue exercising expenditure restraint to maintain structural balance given these pressures.
POSITIVE FINANCIAL TRAJECTORY DESPITE HIGH TURNOVER
The city has taken a number of prudent steps towards improving its long-term fiscal position. Policymakers approved an irrevocable OPEB trust in fiscal 2015, with expectations that pre-funding will begin in fiscal 2016 upon anticipated implementation of a financial sustainability plan (see below for more information on the plan).
The city prudently approved a reserve to be funded with 20% of sales tax revenues in anticipation of the city's sales tax override expiration in fiscal 2019. Although the reserve may be used for any board-approved purpose, the city intends to hold the reserve until the potential non-renewal of the tax.
The city council authorized a comprehensive independent assessment of the city's financial condition and trajectory resulting in a financial sustainability plan completed in December 2014. The plan includes a 10-year multi-year financial projection and capital improvement plan, with recommendations regarding service delivery options, reserve level targets, and areas of potential expenditure reductions.
LA METRO CITY; BELOW AVERAGE INCOME
The local economy is weak overall with below average incomes and above average poverty and unemployment rates. Household income levels are low at 65% and 75% of state and national levels, respectively, and poverty levels are high at 24%. The city's unemployment rate typically registered above state and national averages. Educational attainment levels are very low.
The city's tax base is well diversified, with the top 10 taxpayers making up just 6.2% of AV. The tax base also benefits from the maturity of the local housing stock, with AV declining a total of just 2.1% during the recession. Fiscal 2015 AV increased by a moderate 4.5% to a record high $6.3 billion.
Management cited large scale commercial real estate projects in various stages of construction and planning that could ultimately add roughly $750 million to AV (12% of fiscal 2014 AV levels) over three to four years, with significant sales tax generators. These include the redevelopment of a major industrial site, a Super Wal-Mart, a large retail outlet center, and the renovation of a local transportation hub.
ADEQUATE DEBT PROFILE
Overall net debt levels are low to moderate at $1,806 per capita (3.4% of AV) and direct debt amortizes at an average rate of 49% and 64% in five and 10 years, respectively. Capital needs are modest, consisting mostly of street improvements and deferred maintenance. Management expects the improvements will be funded with reserved revenue sources and grants from state and federal sources, and no long-term debt issuances are anticipated. Carrying costs (debt service, OPEB, and pension costs over total governmental expenditures) are moderate at 20%, but are expected to rise given likely pension cost increases.
The city has a pension property tax override that provided for full funding of employee pensions in prior years. However, annual pension costs now outstrip annual pension override revenues by $3.4 million, and this gap will worsen if pension costs continue rising faster than AV levels. The pension override fund contains a large fund balance that will absorb the pension funding gap for several years, providing a limited amount of time for management to potentially implement offsetting measures.
The revenue bonds are payable from by any available funding source through the city's CB&A pledge. However, the city fully funds debt service with former redevelopment agency (RDA) tax increment and revenues from its water and sewer systems; with both paying roughly half. The water fund's financial health is challenged with debt service coverage from operations at or below 1.0x just adequate liquidity; 261 days cash on hand. The sewer fund has no debt and good liquidity, suggesting a solid capacity for continued payment of its portion of the revenue bond debt service.
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