Fitch Downgrades Sacramento County, CA POBs and COPs to 'BBB+' on Criteria Change; Outlook Stable
--Issuer Default Rating (IDR) to 'A-' from 'A';
--$990.3 million pension obligation bonds (POBs) series 1995A, 2003B, 2008, 2011A, 2011B and 2013 to 'BBB+' from 'A-';
--$144.1 million certificates of participation (COPs), series 2006, 2007 and 2010 to 'BBB+' from 'A-'.
The POBs are absolute and unconditional obligations imposed by law and are payable from any money lawfully available to the county. The COPs are supported by the county's covenant to budget and appropriate lease payments for use and occupancy of certain essential facilities. Lease payments are subject to abatement and supported by cash-funded debt service reserves.
KEY RATING DRIVERS
The downgrade of the IDR to 'A-' reflects the county's challenged revenue framework and operating performance, somewhat offset by its limited long-term liabilities.
Economic Resource Base
Sacramento County is home to California's state capital and nearly 1.5 million residents, while also serving as a regional employment center. The county was in the midst of a residential construction boom prior to the last recession and employment levels and home values remain below pre-recession peaks despite recent gains.
Revenue Framework: 'bbb' factor assessment
General fund revenues have lagged behind overall U. S. economic performance and inflation over the past 10 years, partly due to declines in assessed values and related property tax receipts. Fitch expects future revenue performance in line with the level of inflation as property values continue to recover. The county has limited independent legal ability to increase general fund revenues.
Expenditure Framework: 'a' factor assessment
Based on the county's current spending profile, Fitch expects future expenditure requirements to exceed revenue growth. The county has an adequate ability to cut expenditures, as demonstrated by its performance in the last recession, but faces considerable obstacles in implementing such reductions.
Long-Term Liability Burden: 'aa' factor assessment
Long-term liabilities for debt and pensions are affordable relative to the county's resource base.
Operating Performance: 'bbb' factor assessment
Reserve levels remain weak and put the county at risk of fiscal distress in a moderate economic downturn. Budgets are generally balanced but the county maintains substantial deficits outside the general fund.
Financial Flexibility Key: The rating is sensitive to changes in the county's financial flexibility, particularly as represented by unrestricted general fund balance. An inability to attain at least a modest fund balance cushion during the current economic expansion could increase downward rating pressure.
Sacramento County's economy was slow to recover following the last recession but employment and income growth have recently begun to outpace the nation. Construction growth has been notably strong and population growth appears likely to support continued economic improvement.
Intergovernmental revenues accounted for nearly 70% of general fund support in fiscal 2015 and represent state and federal support for mandated health and human services programs managed by the county, including transfer payments, as well as sales taxes reserved for public safety. Discretionary county spending is primarily supported by property taxes.
General fund revenues have lagged behind inflation and overall U. S. economic performance over the past 10 years. Based on the large share of revenues from intergovernmental sources, and continued spending controls at the state and federal levels, Fitch expects revenue growth to continue to lag behind U. S. GDP despite local economic improvements.
Like other California local governments, the county's independent legal ability to raise revenues is limited by state constitutional provisions which require voter approval for tax increases. The county may increase fees and charges for services, but is generally limited to the cost of services provided.
Health and human services represent approximately 57% of general fund expenditures, with public safety accounting for an additional 37%. In addition to countywide functions such as jails and social services, the county provides a broad range of municipal services to more than one-third of residents living in unincorporated areas.
Based on the county's below average revenue performance and heavy reliance on state and federal funding, Fitch expects future spending demands to outpace available revenues. Local economic improvement sufficient to reduce demand for the county's health and human services programs could reverse this expected trend, but ongoing growth in labor costs will continue to challenge county budgets.
The county made deep cuts in staffing during the last recession but faces considerable obstacles to reducing expenditures. Health and human services programs are largely reimbursement based, limiting savings from cuts to these programs, and demand for public safety services can challenge cuts in this area as well. Positively, carrying costs for debt service and retiree benefits are moderate at 16% of governmental expenditures in fiscal 2015.
The county's progress in repaying advances from other funds has been slow. Loans to the general fund during the recession exceeded $75 million at their peak, and were estimated by management at $44 million at the end of fiscal 2016. The majority of this balance is due to the county's self-insured workers' compensation fund. The county has reduced such advances incrementally over the past several years but has no schedule for full repayment.
Long-Term Liability Burden
Liabilities for overall debt and the county's pension plan are low at 9.5% of personal income as of fiscal 2015, but could see renewed growth due to anticipated borrowing by overlapping entities. More than three-quarters of the county's net direct debt is for POBs and management has no near-term plans for additional borrowing.
Employees participate in a county-sponsored cost-sharing multi-employer pension plan with a Fitch-estimated funded ratio of 86% as of fiscal 2015. Other post-employment benefits are funded on a pay-go basis and the county's net liability is relatively low at 0.2% of personal income as of fiscal 2015.
The county retains one swap on a single series of POBs with a negative termination value of approximately $133 million as of September 2016.
Low reserve levels put the county at risk of fiscal distress in a moderate economic downturn. The county reported a negative unrestricted balance at the end of fiscal 2015 and would be challenged by an unanticipated revenue decline. Management expects to report a small but positive fund balance upon completion of its 2016 audit, but improvement to date has been slow. Ongoing deficits in the county's internal services funds are a key factor in the general fund's continued weakness.
Annual budgets are typically balanced but the county has been slow to restore financial flexibility despite an improving economy. General fund balances remain very low or negative and advances made during the recession have yet to be fully repaid. Fitch expects this vulnerability to continue given the absence of a schedule for restoring general fund reserves.