Correction: Fitch Upgrades Pinal County, AZ's IDR and Excise Tax Revs to 'AA'; Outlook Stable
Fitch Ratings upgrades the following bonds of Pinal County, Arizona to 'AA' from 'AA-':
--$39 million pledged revenue refunding obligations, tax-exempt series 2015A;
--$3.7 million pledged revenue obligations, taxable series 2015B;
--$52.7 million pledged revenue obligations, series 2014;
--$36.74 million pledged revenue refunding obligations, series 2014.
Fitch also upgrades the Pinal County, Arizona Issuer Default Rating (IDR) to 'AA' from 'AA-'.
The Rating Outlook is Stable.
The series 2014 and 2015 pledged revenue obligations are payable from a second-lien pledge of the county general excise tax revenues in favor of the county's Third Loan Repayment Agreement and 2010 obligations, a third-lien pledge of net state shared revenues in favor of the county's Second and Third Loan Repayment Agreements and 2010 obligations, and a first-lien pledge of vehicle license tax (VLT) revenues.
KEY RATING DRIVERS
The upgrade of the Long-Term IDR to 'AA' reflects application of Fitch's revised criteria for U. S. state and local governments that was released on April 18, 2016. The rating reflects the county's sound revenue framework, solid expenditure flexibility, low long-term liability burden, and demonstrated gap-closing capabilities. The 'AA' excise tax revenue obligation (ETRO) rating reflects a solid coverage cushion and Fitch's expectations for strong pledged revenue growth. The ETRO rating is capped at the county's IDR.
Economic Resource Base
Pinal County is adjacent to Maricopa County, southeast of Phoenix and north of Tucson. The county's population of 413,044 reflects rapid 7% compound annual growth rate (CAGR) between 2000 and 2011 and slower 2% CAGR thereafter. The local economy includes mining, agriculture, manufacturing, trade, health services and professional and business services.
Revenue Framework: 'aa' factor assessment
Fitch expects Pinal County to realize solid revenue growth through the medium term based on an expanding ad valorem tax base and state shared revenue growth. The county has ample independent legal ability to adjust its ad valorem tax rate due to its carry forward of unused allowable levy increases.
Expenditure Framework: 'aa' factor assessment
Pinal County exercises discretion over employee compensation, its largest functional expenditure. The county's carrying costs are a low 8.7% of fiscal 2015 governmental spending.
Long-Term Liability Burden: 'aaa' factor assessment
The county's long-term liability burden is a low 7% of personal income. Fitch expects the long-term liability burden to remain consistent with an 'aaa' assessment, as population and income growth are likely to be aligned with additional debt needs and full actuarially-based funding should limit growth in net pension liabilities.
Operating Performance: 'aa' factor assessment
Fitch expects the county to maintain an adequate financial cushion through a moderate economic downturn based on its ample revenue-raising capacity and solid expenditure flexibility. The county demonstrates consistent efforts to maintain financial flexibility.
Financial Flexibility: The rating assumes maintenance of adequate financial flexibility consistent with the county's current rating.
Pinal County's traditional mining and agriculturally-based economy has diversified over the past decade, benefiting from its location adjacent to Maricopa County. Government accounts for 34% of the county's fiscal 2015 employment base, followed by trade, transportation and utilities (16%), professional and business services (11%) and educational and health services (10%). There is a moderate 11% concentration among top 10 taxpayers representing utility, mining, energy, retail, and telecom enterprises.
Pinal County's fiscal 2017 ad valorem tax base (reflecting a two-year assessment lag) is up for the third consecutive year by a total of 6.6%, following a four-year decline of 31% associated with the Great Recession and regional housing collapse. The county is well positioned to participate in the regional economic expansion underway, based on its proximity to the Phoenix metropolitan area, developable properties and ongoing transportation improvements.
Pinal County's fiscal 2015 general fund revenues are comprised primarily of property tax revenues (50%), state shared revenues (31%), and local sales tax revenues (9%).
General fund revenues realized strong 5.2% CAGR between fiscal 2004 and 2014 on increasing sales tax and state shared revenues and an expanding ad valorem tax base (which peaked in fiscal 2010). Modest revenue declines between fiscal 2012 and 2014 resulted from contraction of the ad valorem tax base and a $0.20 cent drop in the primary tax rate for those three years. A further contraction of fiscal 2015 revenues resulted largely from an $11 million revenue loss due to termination of the county's Immigration and Customs Enforcement (ICE) prisoner contract, not entirely offset by moderate gains in sales tax and state shared revenues. Fitch's expectation for solid revenue growth in the medium term is based on continuation of the economic expansion underway throughout the region. This expansion is evidence by three consecutive years of growth in the county's ad valorem tax base through fiscal 2017, six consecutive years of growth in local sales tax revenues through fiscal 2016 and five consecutive years of growth in state shared revenues through fiscal 2016.
State law limits the county's ability to make changes to certain revenues. Primary property tax levies, used for operations, are limited to a 2% per annum increase over the maximum allowable levy in the prior year plus taxes on any property not subject to taxes in the prior year. Primary taxes on residential property only are constitutionally limited to 1% of the limited property value. The state allows banking and carry forward of the maximum levy increase, to the extent not fully used. Pinal County has almost $50 million of annual unused capacity in this regard. Although limited, the allowable increase, in conjunction with the county's control over other miscellaneous revenues, provides management with significant revenue raising flexibility in the event of a moderate economic downturn.
The county's fiscal 2015 general fund expenditures were led by public safety (63%), general government (23%), and health and social services (14%).
Fitch expects operational spending growth to generally track the pace of revenue gains over the near term.
Pinal County participates in a flexible meet-and-confer process with sheriff department employees, but as with all employees, retains discretion over work rules and compensation. Additional expenditure flexibility is provided through the county's low carrying costs, representing 8.7% of fiscal 2015 governmental expenditures. Fitch expects the county's carrying costs to remain low based on growth in its overall expenditure budget that should expand at a pace similar to that of its carrying costs (debt service, pension and other post-employment benefit contributions).
Long-Term Liability Burden
The county's long-term liability burden of $781 million is comprised of $554 million in debt and $227 million of net pension liabilities (NPL). The burden represents a low 7% of estimated personal income. Fitch expects the county's long-term liability burden to remain consistent with its 'aaa' assessment based upon population and income growth that are likely to be aligned with regional debt needs.
The county participates in six state-sponsored pension programs for its retirees. The two largest of these are the Arizona State Retirement System (ASRS)-- a cost-sharing multiple-employer (CSME) plan, and the Public Safety Personnel Retirement System (PSPRS)-- an agent multiple-employer (AME) plan. Recent legislation provides modest PSPRS reforms applicable to new hires and eliminates the automatic cost of living adjustments currently in place, which Fitch anticipates will improve long-term plan affordability.
Under GASB 67 and 68, the county reports a fiscal 2015 ASRS NPL of $101 million, with fiduciary assets covering 69.5% of total pension liabilities at the plan's 8% investment return assumption (approximately 63% based on a lower 7% investment rate assumption). The NPL for the county's PSPRS plan is $35 million, with fiduciary assets covering 55% of total pension liabilities at the plan's 7.85% investment return assumption (approximately 50% based on a lower 7% investment rate assumption).
Fitch expects the county to maintain sound financial resilience through a moderate economic downturn based on its ample revenue-raising capacity and solid expenditure flexibility.
The county budgets conservatively and regularly attends to capital improvement and project needs. Fiscal 2016 results are expected to show a return to structural balance following two consecutive years of reserve draws to support operations outside of the general fund.
Excise Tax Revenue Obligation Analysis
The county's pledged revenue obligations are payable from a second-lien pledge of the county's general excise tax revenues, a third-lien pledge of net state shared revenues and a first-lien pledge of VLT revenues. The first lien on county general excise taxes and first and second liens on net state shared revenues are closed.
Fiscal 2015 pledged revenues of $35.5 million are up for the fourth consecutive year and cover maximum annual debt service (MADS) of $14.8 million (fiscal 2023) a sound 2.4x. Fitch anticipates pledged revenues to grow at a pace equal to or greater than the rate of U. S. GDP, consistent with historical trends. The additional bonds test is average at 1.5x, but Fitch does not anticipate that the county will issue to the ABT as the county's sales and state shared revenues support 40% of its general fund operations.
To evaluate the sensitivity of the dedicated revenue stream to cyclical decline, Fitch considers both revenue sensitivity results (using a 1% decline in national GDP scenario) and the largest decline in revenues over the period covered by the revenue sensitivity analysis. Based on the county's 15-year sales tax and state shared revenue history, Fitch's analytical sensitivity tool (FAST) generates a 6.3% scenario decline in pledged revenues. The largest actual cumulative decline in historical revenues is a steep 33% decline between fiscal years 2008 and 2010, reflecting sensitivity of sales and state shared revenues to the economic downturn and regional housing collapse.
Assuming issuance up to the 1.5x ABT, debt service would be covered with a 33% drop in revenues, 5x the scenario results and about as large the actual cumulative revenue decline in the review period. Fitch considers this level of resilience consistent with an 'AA' rating, as performance during the review period reflected a housing bust that disproportionately affected the Arizona economy to an extent that Fitch believes is less likely to be repeated in the future.
Issuing Entity Exposure
The special tax bond rating is limited by Pinal County's 'AA' IDR, as Fitch does not believe that the security insulates the bonds from the general credit of the issuer. Fitch does not view the pledged excise tax revenues as special revenues under section 902(2)(B) of the bankruptcy code, which defines special excise taxes imposed on particular activities or transactions as special revenues.