Fitch Rates Municipal Improvement Corporation of Los Angeles, CA Lease Revs 'A+'; Outlook Stable
OREANDA-NEWS. Fitch Ratings has assigned an 'A+' rating to the following Municipal Improvement Corporation of Los Angeles (MICLA), California lease revenue bonds:
--$298.1 million taxable lease revenue refunding bonds, series 2015-A (Los Angeles Convention Center).
The bonds are scheduled to sell via negotiation by Nov. 3, 2015.
In addition, Fitch affirms the following ratings:
--$1.670 billion outstanding MICLA lease revenue bonds, series 2006-A, 2007-B1, 2007-B2, 2008-A, 2008-B, 2009-A, 2009-B, 2009-C, 2009-D, 2009-E, 2010-A, 2010-B, 2010-C, 2010-D, 2012-A, 2012-B, 2012-C, 2014-A, and 2014-B at 'A+';
--$253.1 million outstanding Los Angeles Convention and Exhibition Center Authority (convention center authority) lease revenue bonds, series 2008A at 'A+';
--$887.7 million outstanding Los Angeles (the city) general obligation (GO) bonds at 'AA-';
--$37.5 million outstanding Los Angeles judgment obligation bonds, series 2009-A and 2010-A at 'A+'.
The MICLA taxable lease revenue refunding bonds, series 2015-A will refund all outstanding convention center authority lease revenue bonds, series 2008A. (In addition, the series 2015-A bonds will refund all of the convention center authority's taxable lease revenue bonds, 1998 series A, which are not rated by Fitch, and up to $9.4 million in outstanding MICLA commercial paper notes.)
The Rating Outlook is Stable.
The MICLA and convention center authority lease revenue bonds are payable solely from the city's lease rental payments for use and occupancy of various facilities and equipment, subject to abatement. The city covenants to budget and appropriate for such lease rental payments annually.
The series 2015-A bonds do not require a debt service reserve fund.
The GO bonds are payable from ad valorem property taxes levied without limitation on rate or amount upon taxable properties within the city. The judgment obligation bonds are secured by the city's absolute and unconditional obligation to pay principal and interest to refund an obligation imposed by law.
KEY RATING DRIVERS
CITY'S INHERENT ECONOMIC IMPORTANCE: The city is the commercial and cultural center of a very large, diverse economy that is benefitting from revenue and property market improvements, despite an unemployment rate which remains above-average.
STRENGTHENED RESERVES VULNERABLE TO SPENDING PRESSURES: The city's robust general fund reserves appear to be somewhat vulnerable to current calls for increased operational spending.
REDUCED BUDGETARY STRUCTURAL IMBALANCE: In contrast with previous forecasts, the city's most recent four-year financial projections forecast general fund structural balance by fiscal 2019. However, some of the key underlying assumptions no longer apply or are optimistic which could challenge the city's ability to reach structural balance within the next four years.
SIGNIFICANT LIABILITIES: The city is facing significant liabilities related to its pension systems, other post-employment benefits (OPEB), banked police overtime, and lawsuits. The city is having some success in negotiating financially viable litigation settlements.
MODERATE OVERALL DEBT BURDEN: Fitch expects the city's annual debt service, actuarially required pension contributions, and OPEB pay-as-you-go costs to remain manageable given limited new money debt issuances, despite ongoing significant pension and OPEB costs.
STABLE OUTLOOK: The rating is supported by Los Angeles' strong financial management practices and ongoing ability to reduce its general fund structural imbalance. The Stable Outlook reflects Fitch's expectation that the city will maintain its financial management focus on achieving structural balance.
Los Angeles is an important economy and by virtue of its size and diversity is well positioned to benefit from current national economic strength. The city is experiencing good revenue and property base growth which is expected to continue beyond fiscal 2016. The tax base proved to be resilient during the recession, and considerable property development currently underway should bolster future taxable valuation growth.
The unemployment rate remains above-average at 8% in July 2015 but much better than a year prior (9.5%) or the July 2010 peak of 14.7%. It continues to be higher than the state (6.5%) and the nation (5.6%). Positively, employment opportunities are growing faster than the workforce. The city's socioeconomic characteristics remain somewhat mixed, as would be expected for such a large urban area.
STRENGTHENED RESERVES VULNERABLE TO SPENDING PRESSURES
Fiscal 2014 ended with an unrestricted general fund balance of $852.9 million (17.4% of spending), up 39.9% from the year prior, representing the fourth year of a net operating surplus after transfers. The city added $61 million to the budget stabilization fund and $21 million to the reserve for economic uncertainties.
The city projects that its fiscal 2015 year-end emergency reserve, contingency reserve, budget stabilization fund, and reserve for economic uncertainties cumulatively amount to $467.8 million or 9.1% of general fund revenues, well in excess of the city's 5% reserves policy goal. These reserves are contained within the unassigned general fund balance. This level of reserves is expected to support strong fiscal 2015 general fund balance results.
The fiscal 2016 general fund budget meets the city's goal of having all one-time revenues ($138 million) devoted to one-time expenditures ($169 million). The $31 million one-time expenditure gap will be covered by ongoing revenues, a significant improvement over the city's past practice of having one-time revenues covering ongoing programs. The fiscal 2016 budget also exceeds the city's 1% capital funding policy for only the fourth time since fiscal 2006.
Current fiscal 2016 projections indicate emergency reserve, contingency reserve, budget stabilization fund, and reserve for economic uncertainties cumulatively amounting to $601.4 million or 11.2% of general fund revenues. However, this level of reserve funding appears to be vulnerable to rising service demands, particularly the current calls for increased funding for homeless services (potentially by up to $100 million annually). City administrators have stated that they do not wish to see reserves fall below 6% of general fund revenues.
REDUCED BUDGETARY STRUCTURAL IMBALANCE
The city's multiyear projections continue to gradually improve. They are now showing reduced budget gaps in fiscals 2017 ($90 million) and 2018 ($51 million) and surpluses in fiscals 2019 ($36 million) and 2020 ($68 million). This is based on projected revenue growth eventually outstripping projected expenditure growth. Some of the underlying assumptions appear reasonable (for example, ongoing steady revenue improvement given the strengthened regional economy).
However, other assumptions will be challenging to execute. New positions in the fiscal 2016 budget and calls for augmented homeless services indicate the pressure to increase services. Based on recently negotiated labor contracts, employee costs are now set to rise above the levels assumed in the projections, and certain pension reforms are being unwound and replaced by reforms that will generate less savings. Some key labor unions remain firmly opposed to the idea of increased employee contributions to health care premiums. As of January 2016, only a quarter of employees will pay 10% towards their healthcare premium costs, whereas the multiyear projections assumed that all employees would do so.
Fitch acknowledges the significant strides the city has made towards achieving general fund structural balance, particularly through expenditure control. However, the forecasted positive margins remain tiny. The projected $68 million surplus in fiscal 2020 is equivalent to only 1.5% of fiscal 2014 general fund expenditures. As such, the positive margins are vulnerable to further labor cost increases in fiscals 2019 and 2020, expensive litigation settlements, and potential economic changes resulting in actual revenue lower than forecast.
SIGNIFICANT LIABILITIES PRESSURE OPERATIONS
The city reported that its pension systems in fiscal 2014, the Los Angeles City Employees Retirement System (LACERS) and the Fire and Police Pension Plan (FPPP), were funded at 67.4% and 86.6% respectively assuming a 7.5% discount rate. Using Fitch's more conservative 7% discount rate, the funded ratios decline to an estimated 63.9% for LACERS and 82.0% for FPPP. Both pension systems have large unfunded actuarial accrued liabilities ($5.3 billion and $2.4 billion, respectively).
The city has faced significant challenges in attempting to reform its pension system. Negotiations with the coalition of unions (representing approximately 60% of its civilian employees) have resulted in agreement to implement a new pension Tier 3 for incoming civilian employees at the cost of unwinding Tier 2 which would have resulted in greater savings. Approximately 2,000 employees will be transferred from the defunct Tier 2 to Tier 1 (with more generous retirement provisions) at the city's expense.
The city has been successful in negotiating caps to retiree health benefit costs. However, there are challenges currently working their way through the legal system and the city's annual OPEB contributions will continue to rise even if they win the litigation. LACERS' OPEB funded ratio was 72.9% in fiscal 2014, compared to a high of 78.6% in fiscal 2011. FPPP's OPEB prefunding ratio is a much weaker 43.2%. While both these levels of prefunding remain notably high for municipal OPEB systems, there are significant unfunded actuarial accrued liabilities of $721.6 million and $1.58 billion respectively.
The city has considerable banked overtime accrued by police officers valued at approximately $111 million in November 2015. Those hours which are not used for leave will have to be paid out when individual police officers are promoted to captain or leave city employment. This approach risks creating future financial pressure since the stored hours will become more expensive as salaries increase over time. In order to avoid increasing the size of the police overtime bank in fiscal 2015, the city spent $87 million on police overtime compared to the $30 million originally budgeted. The current police labor contract commits to meeting overtime from cash ($85 million in fiscal 2016, $90 million in fiscal 2017, and $100 million in fiscal 2018). The city is starting to buy down the banked overtime, but the initial payment scheduled for November 2015 is relatively small at $4.2 million.
Considerable management attention is being focused on resolving some of the larger litigation liabilities facing the city in a financially sustainable manner. The city has negotiated resolution of an Americans with Disabilities (ADA) access lawsuit related to the poor state of a considerable portion of the city's sidewalks. The negotiated resolution, which would cost the city a total of $1.4 billion over 30 years, is pending federal court approval. Only a portion of the costs will be met from the general fund. The city is also attempting to negotiate a settlement with regard to litigation focused on ADA access to low and moderate income housing to ensure an affordable outcome.
More potentially concerning are two lawsuits disputing the annual Los Angeles Department of Water and Power (LADWP) transfer from the power enterprise to the city's general fund. This transfer represents approximately 5% of annual general fund revenues. In fiscal 2016, the transfer is budgeted at $275 million. This could take years to resolve, particularly since there is comparable litigation occurring elsewhere in the state. Under the Government Claims Act, a final court decision could only apply retroactively to one year prior to the lawsuit's filing. However, if the lawsuits do take years to resolve, this could result in a significant repayment as well as an ongoing 5% reduction in general fund revenues. If necessary, the city could seek voter authorization for the transfers.
Since Fitch's previous review, the city has become party to a number of additional lawsuits which could cost the city more than $10 million each. The city expects most of these cases to be settled and paid out of its reserve for liability resolution (budgeted at $50 million in fiscal 2016).
MODERATE OVERALL DEBT BURDEN
Net overall debt is moderate at $4,002 per capita and 3.1% of taxable assessed valuation. Amortization of direct debt is rapid at approximately 76% in 10 years. Planned new money debt issuances are limited.
In fiscal 2014, combined debt service payments, actuarially required pension contributions, and OPEB pay-as-you-go costs were a manageable 22.7% of total governmental expenditures. Despite ongoing significant pension and OPEB costs, Fitch expects the city's carrying costs to remain manageable given currently limited new money debt issuance plans. However, the city might need to add judgment obligation bonds to its forward debt issuance schedule to address future litigation-related costs.