SAN FRANCISCO--(BUSINESS WIRE)--
Fitch Ratings has assigned an 'F1+' rating to the following:
--$1.325 billion Los Angeles (city), California 2013 tax and revenue anticipation notes (TRANs, or notes), series A-C.
The notes will be sold via negotiation on June 26, 2013. They are not subject to redemption prior to final maturity.
In addition, Fitch affirms the following rating:
--$1.1 billion in outstanding Los Angeles general obligation (GO) bonds at 'AA-'.
The Rating Outlook is Stable.
The notes are secured by a first lien and charge against unrestricted general fund revenues attributable to fiscal 2014. To the extent that these moneys are insufficient to repay the notes in full at their maturity, the notes will be paid from any other legally available unrestricted moneys.
The GO bonds are secured by ad valorem property taxes levied without limitation on rate or amount upon taxable properties within the city.
KEY RATING DRIVERS
CITY'S INHERENT ECONOMIC IMPORTANCE: The city is the commercial and cultural center of a very large, diverse economy that is starting to benefit from revenue and property market improvements, despite an unemployment rate which remains stubbornly high.
DECREASING STRUCTURAL IMBALANCE: The city's four-year financial projections indicate decreasing structural imbalance but some of the underlying assumptions rely on further labor concessions which might be difficult to achieve.
CHALLENGING POLITICAL ENVIRONMENT: The city's challenging political and labor relations environment can hinder its ability to respond swiftly to budgetary pressures. Improvements in some revenue streams and slightly improved reserve levels could reduce labor's willingness to make further concessions.
AFFORDABLE DEBT: Fitch expects the city's debt ratios to remain affordable but notes the increasing pension and OPEB costs resulting from past investment losses.
STRONG SHORT-TERM DEBT COVERAGE: Fitch's highest short-term rating of 'F1+' on the notes reflects the sound repayment structure and good coverage of note repayment set-asides when sizable liquid borrowable funds are considered, which largely offset any risk of cash flow variances.
The rating is sensitive to shifts in fundamental credit characteristics including the city's strong financial management practices and ongoing focus on diminishing its general fund structural imbalance. The Stable Outlook reflects Fitch's expectation that such shifts are unlikely.
Los Angeles is an important economy and by virtue of its size and diversity is well positioned to benefit from the current national economic recovery. Substantial recessionary pressures caused sharp tax revenue declines in the recent past. However, the city is now experiencing revenue and property base growth which is expected to continue into fiscal 2014 and beyond. Following two years of slight declines, taxable assessed valuation (TAV) increased by 1.3% in fiscal 2012 and 2.5% in fiscal 2013. The rebounding local residential, commercial, and industrial property markets are expected to augment future TAV growth.
The unemployment rate remains stubbornly high at 11% in March 2013, an improvement over the year prior (12.4%) and the July 2010 peak of 14.7%. The city's socioeconomic characteristics remain somewhat mixed, as would be expected for such a large urban area.
CITY'S OVERALL FINANCIAL OPERATIONS STILL UNDER PRESSURE
Despite significant budget gaps, fiscal 2012 ended with a strengthened unrestricted general fund balance of $540.6 million (11.9% of spending), up 9.5% from the year prior, and another net operating surplus after transfers (fiscal 2011's surplus had been the first in some years).
In fiscal 2013, the city had to close an initial general fund gap of $238 million, followed by a small $7 million mid-year gap. To do so, the city again relied on a mixture of recurring solutions (63%) and non-recurring solutions (37%). The city anticipates that it will end fiscal 2013 with further strengthening of its unrestricted general fund balance and reserves in line with its 5% reserves policy goal.
The fiscal 2014 general fund budget is showing further improvement by closing a smaller $216 million general fund gap with 71% ongoing solutions and 29% one-time solutions, without layoffs, furloughs, or needing to declare a fiscal emergency (for the first time since fiscal 2008). In addition to closing the budget gap, the city is increasing its budget for new services and facilities by $121 million, and will meet its policy goal of devoting 1% of general fund expenditures to capital improvement projects for the first time. The city also anticipates exceeding its 5% general fund policy goal, as well as more adequately funding its budget stabilization fund (increasing it to $61.5 million), and setting aside $21 million for economic uncertainties. The city would need to draw down the latter reserve if it cannot eliminate an already agreed 5.5% pay increase due on Jan. 1, 2014 for 60% of civilian employees. Labor strongly opposes its elimination, since the increase was negotiated in return for already implemented labor concessions.
The city is projecting decreasing general fund budget gaps going forward, from $153.4 million in fiscal 2015 to $95.7 million in fiscal 2017. It then projects, for the first time since 2009, a general fund budget surplus of $5.9 million in fiscal 2018. Some of the underlying assumptions appear reasonable (for example, ongoing steady revenue improvement and no significant workforce growth). Fitch notes, however, that labor will likely strongly contest the personnel expenditure assumptions. In an improving economic environment, which both improves the city's financial position and potentially results in rising living costs for employees (particularly given the rebounding housing market), it will be challenging for the city to achieve health care premium copay increases from employees while at the same time providing 0% cost of living adjustments through fiscal 2018.
Fitch notes that the multiyear projections without labor concessions indicate larger general fund gaps through fiscal 2018, declining from $242 million in fiscal 2015 to $83 million in fiscal 2018. Even these projections represent an improvement over previous projections.
The city has taken significant actions in response to economic contraction and its personnel-related expenditure pressures, and retains a range of budget options to achieve greater structural balance. However, implementing them will require tough political decisions and greater political unity than has always been demonstrated in the past, further labor concessions (difficult in light of those already achieved), and new revenues. The recent failure of a ballot measure to increase the sales tax rate indicates that new taxation revenues will be hard to achieve.
STRONG NOTE REPAYMENT STRUCTURE
Fitch's highest short-term rating of 'F1+' reflects a sound note repayment structure, good coverage of three note maturities, substantial available and borrowable funds, and the city's overall credit quality. Fitch notes this TRANs borrowing is 5.5% higher than the city's fiscal 2012 TRANs borrowing, primarily to accommodate the city's intent to prepay its growing pension payments for both civilian personnel ($368 million) and sworn personnel ($576 million). In addition, this TRANs borrowing will provide $400 million for cash flow management purposes.
The city makes five 20% set-asides of principal and interest (Jan. 22, Feb. 27, Mar. 27, Apr. 24, and May 22, 2014), each more than a month ahead of the next scheduled note maturity. The note maturity dates are Feb. 27 (20% of the TRANs principal and interest debt), May 1 (40%), and June 26, 2014 (40%).
The city expects unrestricted general fund ending cash balances to provide full debt service coverage of 1.18x to 2.15x on each set-aside date without drawing upon $228 million-$839 million in liquid borrowable funds available at those set-aside dates. Including borrowable funds increases coverage to 2.34x to 5.27x. The projected ending general fund cash balances, supported by the sizable borrowable funds, hold up sufficiently to stress scenarios that envision a 10% reduction in economically sensitive tax revenues, without offsets (1.38x to 4.52x coverage) or 5% overall expenditure increases, without offsets (1.44x to 5.05x coverage).
MODERATE OVERALL DEBT BURDEN
Net overall debt is moderate at $4,695 per capita and 3.9% of market valuation. Amortization of direct debt is average at approximately 59% in 10 years. Fitch expects that the overall debt burden will become moderately high but remain affordable as the city issues new debt, particularly to address deferred street maintenance.
For fiscal 2012, the city reported that its pension systems, the Los Angeles City Employees Retirement System (LACERS) and the Fire and Police Pension Plan (FPPP), were funded at 69% and 83.7%, respectively. Using Fitch's more conservative 7% discount rate, the funded ratios were weaker, at 63.8% for LACERS and 77.3% for FPPP. Both pension systems have large unfunded accrued actuarial liabilities ($4.5 billion and $2.8 billion, respectively) and are still smoothing in substantial past investment losses ($1 billion and $2.1 billion, respectively). As a consequence, the city's annual contributions to the two pension systems will continue to increase for some time despite recent pension reforms such as the creation of new pension tiers for both sworn and civilian recruits.
Despite successful negotiations to cap retiree health benefit costs, the city's annual OPEB contributions will also continue to rise. LACERS' OPEB funded ratio deteriorated to 71.6% in fiscal 2012, although this level of prefunding remains notably high for a municipal OPEB system. FPPP's OPEB prefunding ratio is a much weaker 37.1%.
The city has a rapidly growing bank for overtime accrued by police officers. The accrued hours are currently valued at $110 million. While the city intends to reduce this liability through managed leave, those hours which are not used for leave will have to be paid out when individual police officers resign or retire. This approach risks creating considerable future financial pressure, since the stored time will become more expensive given future agreed wage increases. Therefore, Fitch notes as a credit positive the inclusion of $15 million in the fiscal 2014 general fund budget to begin paying down the overtime bank, with a further $20 million paydown planned for the fiscal 2015 general fund budget. Fitch also notes, however, that effective long-term management of this liability will require simultaneously tight management of overtime usage to avoid simply shifting overtime costs back onto the annual budget.
The city also has large potential general fund liabilities related to litigation, in particular up to approximately $774 million in claims connected to the city's former utility users' tax on telephone services. Major adverse settlements would likely be funded through judgment bonds, which would put some additional strain on ongoing resources.
In fiscal 2012, combined debt service payments, annually required pension contributions, and OPEB pay-as-you-go costs were a moderate 20.4% of total governmental fund expenditures and transfers out (net of capital expenditures).
Additional information is available at 'www.fitchratings.com'.
In addition to the sources of information identified in Fitch's Tax-Supported Rating Criteria, this action was additionally informed by information from Creditscope, University Financial Associates, S&P/Case-Shiller Home Price Index, IHS Global Insight, and National Association of Realtors.
Applicable Criteria and Related Research:
--'Tax-Supported Rating Criteria' (Aug. 14, 2012);
--'U.S. Local Government Tax-Supported Rating Criteria' (Aug. 14, 2012).
Applicable Criteria and Related Research:
Tax-Supported Rating Criteria
U.S. Local Government Tax-Supported Rating Criteria
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