SAN FRANCISCO--(BUSINESS WIRE)--Fitch Ratings has assigned an 'A+' rating to the following Municipal Improvement Corporation of Los Angeles (MICLA), California lease revenue bonds:
--$29.6 million series 2014-A;
--$51.4 million refunding series 2014-B.
The bonds are scheduled to be sold via negotiation on Sept. 10, 2014. The bonds are subject to optional, mandatory sinking fund, and extraordinary redemption prior to final maturity.
In addition, Fitch affirms the following ratings:
--$991.9 million outstanding Los Angeles general obligation (GO) bonds at 'AA-';
--$44.6 million outstanding Los Angeles judgment obligation bonds, series 2009-A and 2010-A at 'A+';
--$1.362 billion outstanding Municipal Improvement Corporation of Los Angeles (MICLA) refunding certificates of participation (COPs; refunding program AY), series 2005, and 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, and 2012-C at 'A+';
--$303.1 million outstanding Los Angeles Convention and Exhibition Center Authority (convention center authority) lease revenue bonds, series 2003A and 2008A at 'A+'.
The Rating Outlook is Stable.
The MICLA lease revenue bonds and COPs and the convention center authority lease revenue bonds are secured solely by the city's covenant to budget and appropriate lease rental payments for use and occupancy of various facilities and equipment, subject to abatement.
The GO bonds are secured by 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 stubbornly high.
BUDGETARY STRUCTURAL IMBALANCE: The city's four-year financial projections indicate decreasing structural imbalance, but some of the underlying assumptions rely on further labor concessions and static levels of service provision which will likely prove difficult to achieve.
CHALLENGING POLITICAL ENVIRONMENT: The city's challenging political and labor environment can hinder its ability to respond swiftly to budgetary pressures. Labor is reluctant to agree to further concessions, and the public's desire for service restorations could create spending pressure.
MANAGEABLE LONG TERM OBLIGATIONS: Fitch expects the city's debt ratios to remain moderate but notes the increasing pension and other post-employment benefit (OPEB) costs resulting from past investment losses and the liabilities associated with both banked police overtime and litigation.
The rating is sensitive to shifts in fundamental credit characteristics, including the city's strong financial management practices and ongoing ability to reduce its general fund structural imbalance.
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. The city is experiencing good revenue and property base growth which is expected to continue through fiscal 2015 and beyond. 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 elevated at 8% in May 2014 but much better than a year prior (10.7%) or the July 2010 peak of 14.7%. Nevertheless, it continues to be higher than the state (7.1%) and the nation (6.1%). The city's socioeconomic characteristics remain somewhat mixed, as would be expected for such a large urban area. The recent Los Angeles 2020 Commission report focused particularly on a net decline in non-farm job employment over the past decade, poor job creation, significant income inequality, and lower educational metrics.
FINANCIAL OPERATIONS STILL UNDER PRESSURE
Despite an initial significant budget gap, fiscal 2013 ended with a strengthened unrestricted general fund balance of $609.8 million (13% of spending), up 12.8% from the year prior and the third year in a row to end with a net operating surplus after transfers.
In fiscal 2014, the city faced an initial general fund gap of $216 million and a smaller $37 million mid-year budget gap, the majority of which will likely be closed at year-end through use of reserves and savings. The city expects to end fiscal 2014 with a similar or larger unrestricted general fund balance than in fiscal 2013, well above the 5% reserve policy.
The city is projecting that its fiscal 2014 emergency reserve, contingency reserve, and budget stabilization fund will cumulatively amount to at least 8.4% of general fund revenues (once fiscal 2015 encumbrances, departmental reappropriations, and loan reconciliations have been factored in), up from 5.1% in fiscal 2013. This strengthening of general fund balance and reserves is despite 60% of civilian employees refusing to give up an already agreed-to 5.5% pay increase on Jan. 1, 2014 on the grounds that the increase was negotiated in return for already implemented labor concessions.
To close a further, larger budget gap of $433 million in fiscal 2015, the city again relied on a mixture of recurring solutions (57%) and non-recurring solutions (43%). However, unfunded budget components which could pressure budget balance during fiscal 2015 are related to public safety labor costs, an ambulance augmentation program, and street resurfacing and repairs. Nevertheless, the city has budgeted to meet or exceed its policy goal of devoting 1% of general fund expenditures to capital improvement projects for the second consecutive year, as well as maintaining its cumulative reserves above the 5% policy level.
The city is projecting decreasing general fund budget gaps in fiscal years 2016-2018 and then, for the first time since 2009, a general fund budget surplus of nearly $24 million in fiscal 2019. 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 and no significant workforce growth). However, in a stronger economic environment it will be challenging for the city to ask employees to contribute more to benefits while offering no cost of living adjustments to pay. Sworn personnel are likely to seek remuneration increases, and residents are also likely to expect service restorations as the economy improves.
The city has demonstrated that it can implement significant actions to respond to economic contraction and its personnel-related expenditure pressures, and management retains a range of budget options to achieve greater structural balance. However, implementing them will require difficult 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 failure of a May 2013 ballot measure to increase the sales tax rate indicates that new tax revenues will be hard to achieve.
MODERATE OVERALL DEBT BURDEN
Net overall debt is moderate at $4,159 per capita and 3.6% of market valuation. Amortization of direct debt is rapid at approximately 72% in 10 years. Fitch expects that the overall debt burden to increase but remain manageable as the city issues additional new debt. Debt levels also could increase if the city funds potential adverse legal settlements through judgment bonds (as discussed below).
For fiscal 2013, 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 68.7% and 83.1% respectively. Using Fitch's more conservative 7% discount rate, the funded ratios were weaker, estimated at 63.5% for LACERS and 76.8% for FPPP. Both pension systems have large unfunded actuarial accrued liabilities ($4.7 billion and $3 billion, respectively). 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).
There has been an administrative challenge to the new civilian pension tier. On Aug. 25, 2014, the City Employee Relations Board ruled that the city's action in creating the new civilian retirement tier was illegal because the city did not meet and confer with labor representatives on the matter. The board ordered the city to rescind the implementation of the new civilian pension tier. The board also granted the city's application for stay pending a decision by the court of appeal. In the event that the board prevails, the short-term cost impacts to the city are minor (approximately $4 million in fiscal years 2014 and 2015) but significant over 30 years (an estimated $3.9 billion to $4.3 billion).
Despite successful negotiations to cap retiree health benefit costs, there are challenges currently working their way through the legal system and the city's annual OPEB contributions will continue to rise. LACERS' OPEB funded ratio was 71.9% in fiscal 2013, compared to a high of 78.6% in fiscal 2011. FPPP's OPEB prefunding ratio is a much weaker 38.5%. However, both these levels of prefunding remain notably high for municipal OPEB systems.
The city has considerable banked overtime accrued by police officers. The accrued 2.6 million hours are currently valued at approximately $120 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 are promoted to captain or leave city employment. This approach risks creating considerable 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 is considering increasing the funding available for police overtime to $70 million (more in line with historical annual police overtime costs), up from the $30 million currently available.
The city also has large potential general fund liabilities related to litigation. At June 30, 2013, the city had $771.5 million in probable general fund legal liabilities and a further approximately $500 million in pending general fund litigation. Major adverse settlements would likely be funded through judgment obligation bonds which would put additional strain on ongoing resources and boost debt levels.
In fiscal 2013, combined debt service payments, annually required pension contributions, and OPEB pay-as-you-go costs were a manageable 20.8% of total governmental fund 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