Fitch Rates Los Angeles County, CA Notes ‘F1+’ & LA County Capital Asset Leasing Corp Revs ‘A+’

The following is from Fitch Ratings on June 2:

Fitch Ratings has assigned an 'F1+' rating to the following Los Angeles County, California tax and revenue anticipation notes (notes):

--$900 million 2014-15 notes.

The notes will be sold via negotiation on June 4.

Fitch has also assigned an 'A+' rating to the following Los Angeles County Capital Asset Leasing Corp. (the corporation), California lease revenue bonds:

--$29.5 million lease revenue bonds, series A (LAC-CAL Equipment Program).

The lease revenue bonds will be sold competitively on June 17.

In addition, Fitch affirms various other outstanding ratings as listed at the end of this press release, including the county's 'AA- ' implied unlimited general obligation (ULTGO) bond rating.

The Rating Outlook is Stable.

SECURITY

The notes are general obligations of the county, secured by unrestricted general fund revenue attributable to fiscal 2015, including requirements to set aside the first such funds received during specified time periods for note repayment.

The 2014 LAC-CAL bonds are secured by county departments' equipment lease rental payments to the corporation. The county covenants to budget and appropriate annually sufficient equipment lease rental payments from any source of legally available funds, subject to abatement.

The county's outstanding lease revenue bonds and COPs are also secured by the county's covenant to budget and appropriate, subject to abatement.

KEY RATING DRIVERS

SOLID FINANCIAL MANAGEMENT: Financial operations are well managed with strong general fund balances. The general fund returned to positive operations in fiscal 2013.

ONGOING GENERAL FUND SUPPORT FOR HEALTH SYSTEM: The county is working hard to take advantage of health care reform to strengthen its Department of Health Services' (DHS) financial position. However, DHS' finances remain vulnerable to state and federal funding changes and heavy social service expenditures, and will continue to need significant general fund support.

SIGNIFICANT LONG-TERM LIABILITY EXPOSURE: While the county has a moderate overall debt burden, it also has increased pension contribution costs in fiscal 2015, a costly retiree medical program, and a large other-post employment benefits (OPEB) unfunded accrued actuarial liability (UAAL).

LOCAL ECONOMY IMPROVING: The diversity and maturity of the county's vast economy and tax base help offset its evident cyclical vulnerability. Improving economic indicators, particularly related to the county's tax base and revenue streams, counterbalance the relatively high unemployment rate.

STRONG SHORT-TERM DEBT COVERAGE: The notes' short-term rating corresponds to the county's implied ULTGO bond rating. The combination of pledged revenues and court-verified borrowable resources provide very strong debt service coverage for the notes. Full note principal and interest set-asides occur well in advance of note maturity.

LEASE RATINGS REFLECT ABATEMENT RISKS: The one-notch rating distinction between the county's implied ULTGO rating and the majority of its COPs and lease revenue bonds represents the county's covenant to budget and appropriate for lease payments, subject to abatement. There is a further one-notch distinction for non- standard leases for Department of Social Services buildings which the county leases but does not purchase, due to increased non- appropriation risk since the county will not own the facilities upon lease maturity.

SOUND EQUIPMENT LEASE PROGRAM: The equipment lease financing program has a strong 31-year history, the bonds' lease features are typical of California lease transactions, and the debt matures rapidly since it is matched to the leased equipment's useful life. All of the leased equipment is essential to county departments' service delivery and is in current use.

RATING SENSITIVITIES

The rating is sensitive to shifts in fundamental credit characteristics including the county's strong financial management practices, its level of general fund support for DHS, and the size of its retiree burden. The Stable Outlook reflects Fitch's expectation that such shifts are unlikely.

CREDIT PROFILE

STRONG SHORT-TERM DEBT COVERAGE

Fitch's 'F1+' notes rating reflects the sound note repayment structure, strong coverage of all note repayment set-asides, particularly when borrowable funds are included, and the large size of the borrowable resources relative to the set-aside amounts. The repayment deposit structure sets aside 100 percent of principal and interest well in advance of note maturity.

The notes are secured by a first lien on unrestricted revenue received in December 2014 and January and April 2015 (projected $3.7 billion), which is estimated to cover note principal and interest 4.1x. Funds for repayment will be set aside based on an aggressive schedule beginning in December 2014 at which time 35 percent of the principal will be set aside. By January 2015, 70 percent of the estimated principal will be set aside. The full amount will be set aside by April 2015 plus the estimated interest ($18 million).

Fitch notes that fiscal 2015's projected cash flow shows two of the three note set-asides occurring in months with negative net ending balances. During those two months, note set-aside coverage falls below 1.0x based solely on the monthly net ending balances. However, factoring in available borrowable resources, coverage during all three set-aside months is very strong at 12.8x-19.5x.

The county's projected pool of resources available for interfund loans remains ample (between $3.3 billion and $5.8 billion on a monthly basis in December 2014 and January and April 2015). Borrowable resources consist primarily of property tax collections and monies in transit, held in trust by the county prior to being distributed to the various taxing agencies and governmental units within the county. The general fund itself ultimately receives about one-third of all borrowable resources. Fitch notes that the county has a long history of outperforming its initial cash flow projections.

SOUND EQUIPMENT LEASE PROGRAM

The 2014 LAC-CAL bonds are the latest installment in a 31-year program of lease revenue bonds issued to refund bond anticipation notes (BANs) that funded the purchase of essential equipment which the corporation leases to county departments. Bondholder protections include a bond-funded reserve of the lesser of $1 million or total remaining unpaid principal and interest, an additional reserve of excess county payments, and mandatory insurance coverage including two years of rental interruption insurance to address abatement concerns. All pieces of equipment are in current use, and their average useful life exceeds the weighted average bond maturity.

SOLID FINANCIAL MANAGEMENT

The 'F1+' notes rating also incorporates the county's long-term credit quality. The implied long-term ULTGO rating of 'AA-' reflects the county's diverse and mature economy, low direct debt burden, sound financial reserves, and prudent management efforts to achieve fiscal balance amid ongoing and sizable financial pressures. These pressures stem from a heavy social service spending burden, state funding changes, the historic fiscal imbalance in the county's DHS, a large unfunded pension liability, and a costly retiree medical program.

General fund support for DHS contributed significantly to net operating deficits after transfers during fiscal years 2009-2012. Fiscal 2013 saw a return to positive general fund operations and ended with a total general fund balance of $2.880 billion (19.4 percent of spending) and an unrestricted general fund balance of $2.566 billion (17.2 percent of spending). This unrestricted general fund result represented a 10.3 percent increase from the prior year's balance of $2.327 billion (16.2 percent of spending).

The county is projecting that it will end fiscal 2014 with a modest surplus, increasing the total general fund balance to between $2.9 billion and $3 billion. For the second time in six years, the county did not have to close a budget gap for its fiscal 2015 recommended budget and is not planning major spending cuts. The county is projecting increases in its property tax (4.1 percent) and sales tax (3.9 percent) revenues. However, these increases will be offset to some degree by agreed employee remuneration increases.

The county's rainy day reserve fund is now $232 million, a $35 million increase since fiscal 2013 year-end. The reserve equates to 4.6 percent of its ongoing locally generated revenue. Its policy goal is 10 percent. A recently enacted policy will require the county to allocate at least 10 percent of surplus revenues to either building up the rainy day reserve and/or its recently established OPEB trust.

DHS FINANCIALS IMPROVING BUT GENERAL FUND SUPPORT STILL REQUIRED

DHS ended fiscal 2013 with a $120.6 million operating surplus and is projecting to maintain its current financial balance through fiscal 2014. DHS' fiscal 2015 budget was balanced with no revenue or appropriation placeholders. As DHS' financial position has improved, county hospital cash flow loan balances declined, from $1 billion in fiscal 2011 to $770 million in fiscal 2013. They are spiking back up in fiscal 2014, to a projected $971 million, as Affordable Care Act provisions settle in. However, the county is anticipating that hospital loans will return to around $704 million in fiscal 2015 and stay around that level for the following two to three years.

Favorably, DHS pressures continue being partially alleviated by the extension of a federal section 1115 waiver through Oct. 31, 2015. The waiver facilitated increased enrollment of newly eligible Medi-Cal patients under health care reform which is improving DHS' payor mix. Negotiations with the federal government have commenced over furthering extending the waiver to cover the future costs of uninsured patients.

SIGNIFICANT LONG-TERM LIABILITY EXPOSURE

The county's overall debt burden is a moderate $3,802 per capita or 3.2 percent of market valuation. Principal and interest amortization is slow at approximately 33 percent in 10 years.

The county faces sizeable long-term liabilities in terms of its unfunded pension and OPEB liabilities. As of June 30, 2013, the pension system's UAAL was $13.3 billion and its funded ratio was 75 percent using the county's 7.5 percent assumed rate of return. Fitch estimates the funded ratio at 71.1 percent when adjusted to reflect a more conservative 7 percent rate of return. There has been significant deterioration since fiscal 2007 when the UAAL was $2.5 billion with a 93.8 percent funded ratio (using an assumed 7.75 percent rate of return).

The county's cash contributions to the pension system, which are equal to the annually required contribution (ARC), continue to grow, to a projected $1.4 billion in fiscal 2015 from $676.7 million in fiscal 2006. Fitch considers the ongoing increase to be manageable and notes that a recently implemented pension tier with lower benefits for new hires should slightly decrease costs over time.

The county also has a $25.7 billion UAAL for OPEB, which it has begun to address by recently establishing an OPEB trust which, at its current balance of $466 million, funds approximately 1.8 percent of the liability. The county aims to increase its OPEB trust funding from future surplus revenues. Fitch views the OPEB funding effort as important for the county's long-term fiscal stability but recognizes the county has a funding challenge as the county's recent pay-as- you-go contributions have been only 20 percent-22 percent of its actuarially required contributions. A new OPEB tier with lower benefits for new hires is currently working its way through the county's legislative process. The combined carrying costs for debt service, pension ARC, and OPEB pay-go in fiscal 2013 were very manageable at 11.2 percent of total governmental spending.

CONTINUED HIGH UNEMPLOYMENT, BUT TAX BASE REBOUNDING STRONGLY

The county's unemployment rate (8.7 percent in March 2014) remains higher than the state's (8.4 percent) and the nation's (6.8 percent). However, there has been growth in both employment opportunities and the labor force which has brought the unemployment rate down from 9.9 percent a year prior. The county's socioeconomic characteristics are below-average relative to the state and largely on par with the nation.

Due to the county's highly developed and mature nature, taxable assessed valuation (TAV) losses were relatively low at 0.5 percent and 1.9 percent decreases in fiscal years 2010 and 2011 respectively, indicating a significant Proposition 13 cushion. Since then, the property market has rebounded with 1.4 percent, 2.2 percent, and 4.7 percent TAV increases in fiscal years 2012-2014 respectively, and an estimated 5.1 percent TAV increase in fiscal 2015.

OUTSTANDING DEBT RATED BY FITCH

Fitch has affirmed the following outstanding ratings:

--Implied county ULTGO bond rating at 'AA-';

--$71.1 million county certificates of participation (COPs), series 1993 Disney Parking Project and 2012 refunding COPs (Disney Concert Hall Parking Garage) at 'A+';

--$25.4 millionLos Angeles County Capital Asset Leasing Corp. lease revenue bonds (LAC-CAL Equipment Program), series 2011A at 'A+';

--$1.156 billionLos Angeles County Public Works Financing Authority lease revenue bonds, series 2005 (Calabasas Landfill Project), lease revenue bonds (multiple capital projects), 2010 series A (tax-exempt) and series B (Build America Bonds), and lease revenue bonds (multiple capital projects II), series 2012 at 'A+';

--$76.8 millionSonnenblick-Del Rio El Monte Asset Leasing Corp. senior COPs, series 1999 (Department of Public Social Services Facility) and series 2001 (Department of Public Social Services Facility - Phase II) at 'A';

--$35.8 millionSonnenblick-Del Rio West Los Angeles Leasing Corp. senior COPs, series 2000 (Department of Public Social Services Facility) at 'A'.

The full report is available at 'fitchratings.com'.

((Comments on this story may be sent to [email protected]))