Fitch Upgrades Essex County, NJ's GOs to 'AA+'; Assigns 'F1+' to BANs
--$24,520,000 general improvement bonds, series 2016A;
--$80,000,000 county vocational school bonds, series 2016B (New Jersey School Bond Reserve Act);
--$1,250,000 county college bonds, series 2016C; and
--$1,250,000 county college bonds, series 2016D (County College Bond Act).
In addition, Fitch assigns an 'F1+' rating to the following notes to be issued by the county:
--$58,550,000 bond anticipation notes (BANs), series 2016.
The bonds and notes will be sold via competitive sale on or about Sept. 1. The bonds are being issued to finance various county capital projects and vocational school and Essex County College improvements. The notes are being issued to finance various capital improvements.
Fitch has upgraded the following county ratings to 'AA+' from 'AA':
--$175 million outstanding GO bonds;
--$368 million outstanding Essex County Improvement Authority (county guaranteed) bonds;
--Issuer Default Rating (IDR).
The Rating Outlook is Stable.
The GO bonds and the BANs are backed by the county's full faith and credit and unlimited taxing authority. The county's vocational school bonds are additionally supported by the New Jersey School Bond Reserve Act; the series 2016D county college bonds are additionally supported by the state's County College Bond Act. The county unconditionally and irrevocably guarantees the payment of the Essex County Improvement Authority bonds and has pledged its unlimited taxing authority to bondholders.
KEY RATING DRIVERS
The upgrade reflects a combination of positive credit trends and application of Fitch's revised criteria for U. S. state and local governments, released on April 18, 2016, which incorporate the use of scenario analysis in the rating process. The 'AA+' IDR and GO ratings reflect the county's exceptionally strong gap-closing capacity, stable but slow-growing revenue base, and solid operating performance. The county's strong financial profile reflects a wealthy property tax base, manageable expenditure growth demands and a demonstrated ability to reduce expenditures during economic downturns. Fitch expects long-term liabilities to remain low based on manageable capital needs and a history of full funding of pension actuarially determined contributions (ADC).
The 'F1+' short term rating corresponds to the 'AA+' rating on the county's outstanding GO bonds, supporting strong market access for long-term debt.
Economic Resource Base
Essex County is situated in northeastern New Jersey approximately 10 miles directly west of downtown Manhattan. The county is densely populated and highly developed and has an estimated 2015 population of 797,434, up 1.7% since 2010. The county includes a mix of wealthy suburbs around an urban core, including the city of Newark, which accounts for more than one-third of the county's population.
Revenue Framework: 'aa' factor assessment
Essex County's operating revenues have been relatively stable; in the 10-year period through 2014, revenue growth was in excess of CPI but below U. S. GDP growth for the same period. Growth in revenues was derived from a combination of tax rate increases and tax base growth. Fitch expects continued slow revenue growth without tax increases, reflective of a moderate improvement in housing values and a moderate level of new improvements. The county has substantial ability to raise tax rates as necessary in response to a moderate economic downturn, but is subject to a state statutory annual 2% tax levy cap with certain exceptions.
Expenditure Framework: 'aa' factor assessment
The natural pace of spending growth is expected by Fitch to be in line with to slightly above natural revenue growth over time. Fixed carrying costs for long-term liabilities claim a moderate proportion of governmental spending. The county has adequate controls over employee headcount and wages, and has demonstrated the flexibility and willingness to cut spending during economic downturns.
Long-Term Liability Burden: 'aaa' factor assessment
Fitch anticipates Essex County's long-term liability burden to remain low based on a manageable capital plan and history of full funding of its pension ADC. The county's overall debt and adjusted unfunded net pension liabilities associated with state-operated plans are estimated at a low 7.4% of personal income.
Operating Performance: 'aaa' factor assessment
Fitch expects the county to manage through periods of economic decline while maintaining a sound financial cushion on the basis of its high level of budgetary flexibility and history of sound financial management throughout the economic cycle.
STRONG FINANCIAL FLEXIBILITY: The rating is sensitive to shifts in the county's strong financial management practices and maintenance of fundamental financial flexibility throughout the economic cycle.
The county features a broad and diverse economic base with representation from the telecommunication, commercial aviation, higher education, health care, pharmaceuticals, and financial services sectors. Substantial employers include St. Barnabas Hospital, Verizon, Prudential Insurance, and Rutgers University-Newark. An excellent transportation infrastructure provides residents of the county with access to employment opportunities throughout the New York-Newark-Jersey City metropolitan statistical area (MSA). The MSA ranks as the largest employment base in the country with nearly 8.9 million non-farm jobs.
The county's tax base remains significant at $84 billion on an equalized basis in 2016 or $105,000 per capita. After an aggregate 16.5% decline since 2009 the tax base improved modestly in 2015 and 2016 by 1.5% and 1%, respectively. Home prices throughout the county improved modestly the past three years, according to the Zillow Home Value Index, and Zillow forecasts slightly better growth over the next year.
Newark's weak income and unemployment metrics are balanced against the remainder of the county, which includes wealthier suburban communities such as Millburn, Glen Ridge, and Livingston. As such, overall income and unemployment metrics are mixed. Unemployment rates typically exceed state and national averages.
The county's primary source of revenues is derived from property taxes representing approximately 50% of fiscal 2015 current fund revenues (excluding fund balance utilized). The other primary source of revenues is derived from the state and federal government. County taxes are collected by the underlying municipalities within the county and paid to the county treasurer on a quarterly basis. The county receives its share from the first taxes collected by each municipality, assuring 100% collections.
Current fund revenues are expected by Fitch to generally track the level of inflation over time largely due to expectations for modest tax base and population growth.
New Jersey counties operate under two separate spending cap laws. The 1976 law limits increases in the tax levy to the lesser of 2.5% or an inflation index - the Implicit Price Deflator for State and Local Government Purchases of Goods and Services computed by the U. S. Department of Commerce; however, increases up to 3.5% in the tax levy are allowed by adoption of a resolution of the county freeholders whenever the index is less than 2.5%. A second test effective since budget year 2011 limits growth in the tax levy to 2%, which is the level of growth that Fitch applies for the purposes of assessing independent legal revenue raising capacity. The state's tax cap laws are based on the prior year's levy and not taxable assessed values (TAV), thereby mitigating the effect of a decline in TAV.
Importantly, each test includes exemptions from the caps for the value of new construction and additions to the tax base, increases in debt service, certain increased pension contributions and healthcare costs. Expenditures mandated as a result of certain emergencies are also exempt. Local governments may bank that portion of the maximum tax levy that is not used for a period of three years. The county reports it has $8.7 million (2.1% of the total 2016 tax levy) in banked capacity available to be utilized for its 2017 budget, if necessary.
Employee related salaries, wages and health insurance and retirement programs drive the county's costs. The county budget funds a mix of administrative functions, public safety related to its correctional facility, a large health and welfare program funded primarily through state and federal grants, and its law and justice department (county clerk, county prosecutor and county sheriff). Other expenses are associated with the county's college and vocational schools and its extensive park and recreational facilities. The county executive retains general control over centralized functions such as hiring, wages, and purchasing regulations.
The tax levy and spending limitations laws referenced earlier limit increases in annual appropriations which Fitch would expect should generally align the pace of revenue and spending growth over time.
Fixed costs for debt service, pension and other post-employment benefits (OPEB) represent a moderate 19% of fiscal 2015 current fund spending, without consideration of self-support. Fitch expects fixed costs to remain close to this level as no material debt plans are in place for the near term; pensions, currently 4.4% of spending, are likely to see moderate annual funding increases due to current funded levels. The county is required to make full, actuarial contributions to the state administered pension plans except under very limited circumstances, unlike the state itself. The county's debt amortization is very rapid with 84% of principal paid off over 10 years contributing to higher annual debt service costs than if such amortization were slower.
Employee contracts for law enforcement positions are subject to binding arbitration but a state law passed in conjunction with the 2% spending cap law imposes a 2% cap on arbitration awards. The provision was extended in 2014 and is in effect through Dec. 31, 2017. Management has the flexibility to impose layoffs and furloughs if necessary pursuant to terms of its employee contracts. The county's employee contracts also are in place through Dec. 31, 2017.
Long-Term Liability Burden
Long-term liabilities for debt and unfunded pensions represent a low 7.4% of personal income. About 25% of the liability is in the form of the county's direct debt, with another 50% from overlapping debt. The county's proportional share of the unfunded liability related to two state-administered pension plans, the Public Employees' Retirement System (PERS) and the Police and Firemen's Retirement System (PFRS), reflects the combined net liability of both the state employee portion and local component of the plans, based on recent GASB 57 reporting by the plans. Fitch considers this approach to be conservative as the state employee portion of the plans makes up the bulk of the liability due to their low funded status, requiring a lower adjusted discount rate to be used in the valuation of the aggregate liability. The local components of PERS and PFRS have an estimated aggregate funded ratio of 68% as of July 1, 2015, adjusted by Fitch to assume a 7.0% investment rate of return in place of the plans' 7.9% rate.
The county administers the Essex County Employees' Retirement System (the county system) which has been closed to additional membership since the mid-eighties. The plan's liabilities were funded through the purchase of a group annuity using proceeds of a GO bond issued in 1989; however, the plan's assets were depleted in 2009 so the county has been funding the plan on a pay-go basis since. The 2016 budget contains an appropriation of $2.5 million which is actuarially forecast to steadily descend over the next several years.
OPEB is offered through the state's plan and the county makes pay-as-you-go payments as required by the state. The county paid $21.5 million in 2015 (2.7% of current fund spending). The reported liability equals about 1% of personal income.
Fitch expects the county will continue to maintain sound reserve levels throughout economic cycles given its historically stable revenue performance, high level of inherent budget flexibility in the form of revenue and spending control, and demonstrated commitment to maintaining reserves. The county has experienced steady growth in revenues largely driven by its ability and willingness to adjust its tax rate to maintain an adequate tax levy to support operations, mitigating swings in taxable values.
During the most recent downturn, the county demonstrated its ability to reduce spending through cost controls and staff reductions, and Fitch expects management would take similar actions to maintain its strong financial resilience in future downturns. At times of economic recovery, the county generally takes actions to restore reserves.
The county has experienced generally stable to positive operating results the past seven years supported by careful expenditure management and consistent moderate tax levy increases. Operating results for 2015 reflect a surplus of $13.7 million (net of appropriated fund balance) or 1.7% of spending resulting in an ending current fund balance of $77.4 million (9.6% of spending). The positive results reflect primarily the lapsing of previously appropriated reserves and revenues exceeding expenditures. These results reflect the fourth year of growth in reserves. The county discontinued its use of tax anticipation notes in fiscal 2014 as a result of the improvement in its cash position.
The county uses a cash/modified accrual basis of accounting in accordance with state requirements as opposed to GAAP accounting. When compared to those issuers who use GAAP accounting, the cash/modified accrual basis usually results in lower fund balance levels due to the typically larger current fund expenditure base and the requirement to carry over unexpended appropriation reserves for an additional year. With the inclusion of appropriation reserves, encumbrance reserves and reserves for receivables, which is more in line with GAAP accounting, total unrestricted reserves are 15% of spending.
The county's $769 million budget for 2016 includes a tax levy increase of 1.9%, or $7.9 million in additional revenue, similar to increases made in each of the past four years. The county has entered into shared services agreements with other governmental agencies helping to generate new recurring revenues and also benefits from park and recreational facilities which generate admission and user fees helping offset increases in operating costs.
The budget assumes the use of $12 million in fund balance, the same level budgeted in 2015. The county has a historical practice of using a portion of fund balance to balance its budget at adoption but tends to not have to use it due to conservative budget practices. Based on operating results to date, management is projecting surplus results for 2016 similar to those realized in 2015.