Fitch Affirms Kern County, CA's $173MM POBs at 'A'; Outlook Stable

SAN FRANCISCO--()--Fitch Ratings has affirmed its 'A' rating on the following Kern County (the county), CA's outstanding pension obligation bonds (POBs):

--$173 million POBs, series 2003A.

In addition, Fitch affirms the county's implied general obligation (GO) rating at 'A+'.

The Rating Outlook is Stable.

SECURITY

The bonds are an unconditional obligation of the county.

KEY RATING DRIVERS

SATISFACTORY FINANCIAL PROFILE: The county's financial position presently is satisfactory, with healthy reserve levels. Fund balances are likely to be drawn upon to support operations over the near term due to anticipated revenue declines, but are expected to remain adequate for the rating.

PROPERTY TAX DECLINE EXPECTED: The county's tax base is highly concentrated in oil production properties that have been preliminarily assessed at a much lower value for fiscal 2016 due to the sharp drop in oil prices. The county's general fund and fire fund expect to lose approximately 6% and 14% of total revenues (relative to fiscal 2014), respectively, due to the tax base decline.

HOSPITAL PRESSURES EASING: Management reports general fund transfers in support of Kern Medical Center (KMC) are expected to decline in fiscal 2015 relative to 2014 as hospital operations stabilize. However, other spending pressures are expected over the near term with increasing pension-related fixed costs, additional operating support of the county fire fund, and operating costs associated with a new jail facility.

CONCENTRATED ECONOMY: The regional economy is centered on oil and gas production and agriculture, industries that are expected to be negatively affected by the decline in oil prices and the ongoing drought. Any significant job losses in these industries could negatively impact the county's structurally high unemployment rate and below average income levels.

SECURITY CHARACTERISTICS: The POBs rating reflects the general credit characteristics of the county as well as the security features supporting the POBs.

RATING SENSITIVITIES

REDUCED FINANCIAL CUSHION: Fitch views the county's unrestricted general fund reserve (net of any outstanding loans to KMC) and traditionally conservative budgeting practices as important factors in supporting the current rating. A material reduction beyond current projections would likely lower the unrestricted fund balance below levels commensurate with the level of financial risk facing the county, leading to negative rating action.

CREDIT PROFILE

Kern County is located in the southern portion of California's Central Valley, about 100 miles northwest of Los Angeles. The county board declared a fiscal emergency on Jan. 27, 2015 as part of a financial strategy to manage projected operating deficits caused by declining property tax revenue, rising fixed costs from pensions and POBs, and future costs associated with a new jail facility. The declaration permits the board to tap certain reserves and triggers clauses in labor contracts that allow for negotiations on staffing levels.

CURRENTLY SOUND RESERVES

The county's unrestricted general fund reserve is sound at approximately $173.8 million (23.5% of spending) at the end of fiscal 2014. However, approximately $38.1 million of the unrestricted balance is on loan to KMC due to the medical center's weak financial position and low cash levels; it may not be available for immediate repayment if needed. The unrestricted fund balance remains satisfactory at 18.3% of spending after deducting the funds on loan.

Fund balances are budgeted to increase in fiscal 2015 with the addition of $20.3 million for future repayment of a KMC-related liability to the state. Based on favorable financial performance through Dec. 31, 2014, management expects to build the unrestricted reserve beyond original budgetary estimates; the additional surplus will be designated to support KMC and retirement costs.

REVENUE DECLINE PROJECTED FOR FISCAL 2016

The projected revenue decline in fiscal 2016 is significant, estimated at approximately $32 million or 6% of operating revenues (based on fiscal 2014). The decline is largely driven by preliminary estimates of assessed value (AV) that reflect large losses from oil properties due to the sharp drop in oil prices. While the figures are preliminary and subject to change, oil properties are projected to lose more than 40% of their value, resulting in a nearly $44 million revenue loss to the county. The loss is somewhat offset by projected increases in other AV categories and sales tax revenue gains, reducing the full impact on the general fund.

INCREASING COST PRESSURES

Management's flexibility to reduce expenditures to match the projected revenue decline is constrained to some degree by increasing fixed costs, particularly pension contributions and POB debt service payments. General fund pension and POB costs are expected to climb by approximately $13.4 million (1.8% of fiscal 2014 spending) in fiscal 2016. Another limitation is a lean budget following multiple years of constrained spending.

Current estimates reflect a projected operating deficit in fiscal 2016 of approximately $27 million. Management's strategy for closing the imbalance includes $12.4 million in cost reductions (including a $3 million reduction made at mid-year fiscal 2015) and the use of approximately $8 million in reserves. The remaining $6.7 million gap is likely to be absorbed through a combination of additional savings and reserves.

Future budget gaps are expected to be managed similarly, with incremental budgetary reductions and ongoing use of reserves. The emerging budgetary structural imbalance is a concern, although Fitch notes the county typically has outperformed conservative budget projections. While reserve levels are currently sound, a recurring use of fund balance to support operations that materially eroded reserve levels would not be consistent with the current rating.

Fitch notes that the county faces additional budgetary challenges over both the near and medium term that could impact operating performance. These risks include the ongoing financial support of KMC (the county-owned and operated hospital), future increases in expenditures from a new jail (expected in fiscal 2018), funding for needed capital investments, deficit balances in two internal service funds, and potential payments due to successful AV appeals.

In addition, the loss of property tax revenue due to lower oil prices is also expected to leave a $17 million (14% of fiscal 2014 revenues) budgetary gap in the county's fire fund. The general fund may need to support the fund if costs cannot be restructured to match the lower revenue levels.

SIGNIFICANT PENSION LIABILITY

As of fiscal 2014, the county's unfunded actuarial accrued pension liability was approximately $2.2 billion or a sizable 2.1% of AV. The funded ratio is estimated at a weak 60.8% using a 7.5% discount rate, or a weaker 57.6% using Fitch's more conservative 7% investment return assumption.

The county's high annual contribution rates (15.1% of governmental expenditures in fiscal 2014), along with escalating POB payments, are expected to increase through fiscal 2021 when one series of POBs reaches final maturity. The general fund's portion of the increased contribution and debt service payment for fiscal 2016 is $13.4 million (1.8% of fiscal 2014 spending). Additional increases after fiscal 2016 are more modest at $332,585 and $1.1 million in fiscals 2017 and 2018, respectively.

MODERATE DEBT LEVELS

Overall debt levels for the county are moderate at $2,555 per capita and 2.5% of AV. Management reports no additional debt plans presently. The pace of debt amortization is above average with approximately 69% of outstanding principal retired within 10 years.

CONCENTRATED ECONOMY AND TAX BASE

The economic hub and seat of the county is the city of Bakersfield. The area economy has been diversifying out of the county's historically dominant agricultural and energy sectors, but remains fundamentally driven by these two industries.

The sharp drop in oil prices has raised concerns about potential retrenchment of the oil production industry within the county with corresponding job losses. While widespread layoffs are not yet being reported, a prolonged period with low oil prices likely would negatively impact the region's labor market.

The ongoing drought is also expected to negatively affect the county's economy to some degree. While the county's water banking system may lessen the drought's impact relative to other affected areas, agricultural decisions are being made due to a lack of water that may reduce output or limit growth from this important part of the local economy.

The county's structurally high unemployment rate was 9.6% (November 2014) compared to state and national levels of 7.1% and 5.5%, respectively. Per capita income levels are below average at 72% of the national average.

The tax base is highly concentrated, with approximately 32% of AV attributed to oil and gas values and the top three taxpayers, all from the oil and gas industries, making up approximately 26% of AV. This concentration increases the county's exposure to the volatility inherent in the energy sector, as demonstrated in the preliminary AV estimate for fiscal 2016. While AV grew 18.4% in fiscal 2015, preliminary estimates for fiscal 2016 reflect a potential decline of 16%.

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, 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

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=686015

U.S. Local Government Tax-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=685314

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=979418

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Contacts

Fitch Ratings
Primary Analyst
Matthew Reilly
Director
Fitch Ratings, Inc.
+1 415-732-7572
650 California St., 4th Floor
San Francisco, CA 94108
or
Secondary Analyst
Stephen Walsh
Director
+1 415-732-7573
or
Committee Chairperson
Steve Murray
Senior Director
+1 512-215-3729
or
Media Relations:
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Matthew Reilly
Director
Fitch Ratings, Inc.
+1 415-732-7572
650 California St., 4th Floor
San Francisco, CA 94108
or
Secondary Analyst
Stephen Walsh
Director
+1 415-732-7573
or
Committee Chairperson
Steve Murray
Senior Director
+1 512-215-3729
or
Media Relations:
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com