Fitch Rates Riverside County (CA) $84MM Teeter Notes 'F1+'
--$84 million 2016 series A (tax-exempt).
The notes will sell via negotiation on or around Sept. 27. Proceeds will refund a portion of the county's outstanding series D Teeter obligation notes and an advance of unpaid property taxes for agencies participating in the Teeter Plan.
The notes are secured by delinquent property taxes and proceeds from the sale of tax-defaulted properties, and have been legally validated as a binding obligation of the county. They are additionally secured by any lawfully available moneys from the county's general fund.
KEY RATING DRIVERS
The 'F1+' note rating reflects the county's long-term general credit quality correlating to the county's Issuer Default Rating (IDR) of 'AA-' and the notes' sound security structure. The notes are supported both by pledged property tax delinquencies and the county's general fund. In addition, the county has the option of refinancing the notes through the county investment pool if necessary and retains access to substantial borrowable resources.
On June 2, 2016, Fitch affirmed the county's IDR at 'AA-' with a Stable Outlook based on the county's healthy financial performance and demonstrated ability to make spending cuts given its limited ability to independently raise revenues. It further reflected the county's reduced exposure to its hospital enterprise, which has experienced rapid operational improvement over the past two years. The county will need to continue to demonstrate spending restraint as it manages projected modest deficits over the next several years.
Economic Resource Base
Riverside County's economy is large, diversified and well-situated for long-term growth. It has an affordable housing stock, capacity for additional development, proximity to employment centers including San Bernardino, Orange County, and Los Angeles, and a location along a major distribution route. The county is exposed to considerable housing market and tax base volatility as it was one of the worst-affected regions in the country during the economic downturn. However, both the housing market and assessed values (AVs) have improved significantly over the past several years and a large amount of state revenue in the budget moderates the effect of this cyclicality on overall revenues.
Revenue Framework: 'a' factor assessment
Revenue growth has been in line with or above that of the U. S. economy and Fitch expects that trend to continue. However, the county's ability to raise revenues is limited by state law.
Expenditure Framework: 'aa' factor assessment
The county's carrying costs are affordable and it has demonstrated expenditure flexibility through its ability to cut staffing if needed through layoffs and furloughs. Approximately 64% of discretionary spending is related to public safety. Fitch expects the pace of spending growth in the absence of policy action to be roughly in line with or somewhat above revenue growth.
Long-Term Liability Burden: 'aa' factor assessment
The county's overall debt and pension burden, the bulk of which comes from overlapping debt, is moderate relative to personal income and Fitch expects it to remain in this range.
Operating Performance: 'aa' factor assessment
The county has maintained a healthy financial profile by exercising its ability to cut spending during the most recent downturn and reducing its exposure to its hospital operations. Spending restraint will continue to be required given the modest deficits indicated in the county's five-year forecast related to negotiated wage hikes, rising pension costs, increased insurance costs and operating costs related to a new correctional facility. In addition, the county will need to manage considerable ongoing costs stemming from an inmate class action lawsuit for additional health and mental health professional staffing. Fitch believes the county's capacity to manage these challenges, as well as cyclical declines, is very strong.
Maintenance of Financial Performance: Continued ability to manage spending in light of limited revenue flexibility is key to maintaining the rating at the current level.
The county is the fourth largest in the state covering 7,177 square miles with a population of approximately 2.35 million. It is a high-growth region with less maturity than its coastal neighbors; as such, the county is likely to experience higher than average economic volatility over the foreseeable future.
State and federal health and social services pass-through funds comprise a substantial portion of the county's budget, as is typical for California counties. The county's non-discretionary general fund revenues are primarily provided by state funds and federal funds, which account for an estimated 44% and 20% of fiscal 2016 budgeted revenues. General fund discretionary revenues (i. e., excluding state and federal funds) are primarily generated by property taxes, which account for 43% of fiscal 2016 budgeted discretionary revenues, followed by the motor vehicle in lieu payment at 30%.
Historical general fund revenues have been generally above U. S. economic performance. Property tax revenues have increased each of the last four years, with AV increasing 5.8% in fiscal 2016. The fiscal 2017 budget assumes an additional 4.5% increase based upon projected AV growth of 5%.
The county has limited capacity to independently raise revenues under state law, particularly Propositions 13 which generally allows for a maximum increase of 2% annual in property tax assessments other than resales taxes and Proposition 218 which requires voter approval for new or increased general taxes.
Discretionary spending is focused on public safety, which accounts for 64% of the discretionary fiscal 2016 budget, health and sanitation at 13%, and public assistance at 5%.
The pace of spending growth is likely to be marginally higher than revenues in the absence of policy action, as evidenced by the county's projected deficits over the next few years given rising pension costs, negotiated wage hikes through at least fiscal 2017, operating costs of the correctional facility, and ongoing costs related to an inmate lawsuit settlement.
The county's fixed costs burden is relatively low with carrying costs for debt, pensions, and retiree healthcare accounting for 10% of fiscal 2015 governmental spending. The county has a productive relationship with bargaining units with two-year contracts for its five units expiring by June 30, 2017. The contracts are not subject to binding arbitration and strikes are not permitted. The county has demonstrated its capacity to implement layoffs and furlough in times of revenue decline.
The county estimates the ongoing cost of a recently settled inmate class action lawsuit at about $40 million per year. This compares to a fiscal 2016 total discretionary budget of $785 million and overall budget of $4.77 billion. It has identified offsets, including adjusting and delaying staffing for the new East County Detention Center and establishing a requirement for county departments to absorb any staffing cost increases. In addition, the county plants to implement recommendations from a Strategic Plan for Criminal Justice produced by KMPG for the county and a preliminary jail utilization report provided by California Forward, a bipartisan governance reform organization. The county expects implementation of both to result in considerable costs savings, as well as revenue recovery.
Long-Term Liability Burden
The county's overall debt and pension liabilities are moderate at 16% of personal income.
Debt is primarily in the form of overlapping debt ($9 billion), with net direct debt of $1.3 billion.
The county offers five pension plans through CalPERS. The county's overall pension funding ratio based on a Fitch adjustment to a 7% return assumption is 78%, for an adjusted net pension liability of $1.9 billion. The county's other post-employment benefits (OPEB) liability is negligible at just $7 million.
The county has demonstrated a high degree of financial resilience through spending restraint and financial management policies. The board policy minimum for reserves is 25% of discretionary revenues; the reserve is currently $224 million, or nearly 31%. The unrestricted general fund balance at year-end fiscal 2015 was $270 million, or 9.6% of total general fund spending. Fitch expects that the county would maintain reserves at solid levels throughout a moderate economic downturn.
In an example of proactive management, the county negotiated pension reforms in advance of the state-wide reforms, resulting in a lower tier pension and increased employee contributions. The county also initiated a hiring freeze and early retirement program, as well as across the board budget cuts, during the economic downturn.
The county has continued to exercise spending restraint during the economic recovery. It prepares and adopts a five-year discretionary spending plan with each budget cycle. The most recent five-year plan projects modest deficits through fiscal 2018 and includes remediation strategies.
In recent years, the county took swift action to address large deficits in its Riverside University Medical Center (RUMC). It initiated a rapid turnaround plan with the assistance of Huron Consulting Services, resulting in rapid improvement and reducing the county's financial exposure.