Fitch Rates Riverside County TRANs 'F1+'; Affirms LT Obligations'; Outlook Stable

SAN FRANCISCO--()--Fitch Ratings has assigned an 'F1+' rating to the following Riverside County, California (the county) tax and revenue anticipation notes (TRANs):

--$250 million 2015-2016.

The TRANs will sell via negotiation on or about the week of June 1. Proceeds will support the county's cash flow and pre-pay the county's annual CalPERS contribution.

In addition, Fitch affirms the 'AA-' implied unlimited tax general obligation (ULTGO) rating in addition to various long-term county ratings as detailed at the end of this release.

The Rating Outlook is Stable.

SECURITY

The TRANs are general obligations of the county, secured by unrestricted general fund revenue attributable to fiscal 2016.

Outstanding lease revenue bonds (LRBs) and certificates of obligation (COPs) are payable from the county's covenant to budget and appropriate payments for the use of various leased assets, subject to abatement. The pension obligation bonds (POBs) have been legally validated as an absolute and unconditional obligation of the county.

KEY RATING DRIVERS

STRONG TRANS DEBT COVERAGE: The 'F1+' TRANS rating reflects strong debt service coverage with consideration of extensive borrowable resources and some set-asides that occur well in advance of note maturity.

CLOSELY BALANCED OPERATIONS: The county's financial operations are structurally balanced, reserve levels are satisfactory, and Fitch expects revenues to benefit from economic tailwinds. However, policymakers will need to exercise spending restraint given narrowly balanced operations, limited revenue raising capabilities per state limitations, and expenditure pressures.

RECUPERATING HOSPITAL OPERATIONS: Fitch revised the Outlook on the 'AA-' long-term rating to Stable from Negative earlier this month reflecting reduced risk to the county's finances given the hospital enterprise's (Riverside University Medical Center, or RUMC) rapid operational improvement over the past year following years of fiscal distress.

DIVERSE, GROWING ECONOMY: The county's economy is large, diverse, and well-situated for growth given its proximity to large southern California employment markets, competitive home prices, and the availability of developable land. As a high-growth region with less maturity than its coastal neighbors, the county is likely to experience higher than average economic volatility over the foreseeable future.

SOUND DEBT PROFILE: The county's other post-employment benefits (OPEBs) obligation is minimal, debt amortization is moderate, carrying costs are low, and the county's pension plans are adequately funded due to POB issuances. However, debt levels are moderate to high due largely to overlapping debt.

SOUND LRB STRUCTURE: The 2015 LRB's one-notch rating distinction from the GOs reflects the sound lease structure, including standard lease lease-back provisions, the overall essentiality of the leased assets, and standard insurance provisions. The debt service reserve fund is cash-funded to half of the IRS maximum.

RATING SENSITIVITIES

MAINTENANCE OF SOUND FINANCES: Material weakening of the county's financial position, whether caused by a reversal of RUMC's recent financial improvements or other factors, could result in negative rating action. The Stable Outlook reflects Fitch's expectations that such an event is not likely.

CREDIT PROFILE

SOUND TRANS DEBT SERVICE COVERAGE WITH LARGE BORROWABLE RESOURCES

Fitch's 'F1+' rating reflects the sound note repayment structure, strong coverage of all note repayment set-asides when borrowable funds are included, and the extremely large size of the borrowable resources relative to the set-aside amounts. The notes equal 8.0% of the county's annual revenues, which Fitch views as moderate, and is a slight decline from the prior two years.

The first set-aside is on Jan. 31, 2016 and pays 60% of the note's debt service. The second is on May 31, 2016 and pays the remaining 40% of debt service ahead of the note's final maturity date of June 30, 2015. Set-asides are deposited with an outside paying agent.

Cash flow note coverage (CFNC) at the first set-aside, measured by projected month-end cash balances plus note proceeds over note debt service, is a satisfactory 1.75x and jumps to an extremely high 12.2x with consideration of $1.6 billion of borrowable resources. CNFC at the second set-aside is also satisfactory at 1.66x and rises to 17.4x with borrowable resources.

Cash management policies are prudent, including daily cash flow reports, monthly cash flow meetings, and cash flow reports provided publicly on a quarterly basis. The county's estimates as of March 2015 for cash flow in fiscal 2015 are close to initial projections on a net basis and Fitch rates the county's investment pool 'AAA'.

RUMC TURNAROUND PLAN SHOWING IMPRESSIVE EARLY RESULTS

RUMC's financial position improved markedly over the past year. The enterprise has enhanced operating performance through improved efficiencies and better revenue cycle management with the assistance of Huron Consulting and a permanent management team in place.

Fitch views positively the longer term strategy to develop a clinically integrated network and partner with other providers and payors but believes the plan is ambitious and subject to execution risk.

RUMC's fiscal position deteriorated substantially until recently, running cash flow deficits from fiscal years 2010-2014 ranging from $8 million to $43 million annually. The enterprise's cash position deteriorated in lockstep, necessitating a $41 million borrowing from the county pool by fiscal year-end 2014 in addition to a $26 million loan from the county's waste management enterprise to pay consultant fees.

In response to these pressures, the county instituted a rapid turnaround plan with the assistance of Huron Consulting Services. Major elements of the plan included replacing key members of hospital management with experienced turn-around experts, significantly lowering ongoing expenditures, improving collections, and implementing a business plan to address challenges from the Affordable Care Act.

As a result of the hospital's turnaround plan, financial performance at RUMC has improved dramatically and rapidly. Unaudited fiscal year-to-date performance to March 31 points to operating income of $23 million with the expectation that the enterprise's $41 million cash deficit will be lowered to between zero to $10 million by the end of the fiscal year. The operating income includes $17 million of net non-recurring revenues.

The enterprise will need to absorb significant costs related to the implementation of electronic medical records and faces execution risks as it looks to transform itself into a competitive regional healthcare provider. The system is further exposed to the scheduled expiration of the waiver, which could significantly affect reimbursement levels in the event that it is not extended or replaced, as management anticipates. While acknowledging these challenges, Fitch does not expect RUMC to materially weigh down the county's financial operations.

SOUND FINANCIAL OPERATIONS SUBJECT TO EXPENDITURE PRESSURES

The county's financial position is sound overall, with satisfactory fund balances, growing revenues, and projected balanced operations over a multi-year period. Maintenance of sound finances will require judicious expenditure decisions by policymakers.

Audited fiscal 2014 general fund operations produced the general fund's second consecutive year of surplus following several years of mostly deficits stemming from recessionary revenue losses. A small net surplus of $6.4 million (0.25% of expenditures and transfers out) raised the fiscal year-end 2014 total and unrestricted general fund balances to satisfactory levels of $364 million (14.2% of expenditures and transfers out) and $244 million (9.6%), respectively. Management anticipates fiscal 2015 operations will also be structurally balanced.

Operations have benefitted from two years of growing property tax revenues, by far the county's largest discretionary source of revenue, in combination with recent years' significant expenditure reductions. Although the county projects continued revenue growth, operations are projected to remain narrowly balanced due to various expenditure pressures. These include rising pension costs, negotiated wage hikes, and the operating costs of the correctional facility expected to open in fiscal 2017. The 'AA-' GO rating assumes the county's financial position remains sound, which may require significant expenditure restraint in future years.

ECONOMIC STRENGTHENING CONTINUES

The county's economy is large, diversified, and well-situated for long-term growth. These strengths are offset, however, by below-average income levels, and a volatile housing market and tax base which, nonetheless, have shown significant improvement over the past two years.

The county's housing market was one of the worst-affected in the nation, with average home values falling over 50%, although assessed value (AV) contracted by a lower 15.7% in fiscal years 2009-2013 due to Proposition 13. Recently the housing market has improved significantly, with large price gains and gradually increasing new construction permits.

AV also has begun recovering with solid gains of 3.9% and 7.7% in fiscal years 2014 and 2015, respectively, though AV remains below its pre-recessionary peak. The county's third-party economist projects 6% annual AV growth over the next five years, though the county uses a more conservative but still sizable 5% assumption in its financial forecasts.

Rapid pre-recessionary growth was spurred by the area's housing affordability, ample developable land, proximity to other employment centers, and location along a major distribution route. As the economy and housing market continue to recover, Fitch believes these attributes will continue to drive population growth, though not to the extent of pre-recession years.

SOLID DEBT PROFILE

The county's debt profile is sound overall. Carrying costs (pension, OPEB, debt service costs over total governmental expenditures) are low at 11%, though the county's debt burden is moderate to high at $4,740 per capita (5.1% of AV), reflective of high overlapping debt levels. This issuance slows debt amortization to moderate from rapid, with 27% and 49% of principal maturing within five and 10 years, respectively. The bulk of the county's capital improvement plan will be financed by the recent LRB issuance, and no further long-term debt issuances are planned.

The county offers five pension plans through CalPERS. The two largest plans, offered to safety and miscellaneous employees, have a combined unfunded actuarially accrued liability of $1.8 billion or 0.6% of market value using Fitch's more conservative 7% investment return assumption. Management prudently established multi-tiered pension systems, and has negotiated for labor groups to pay the employee portion of pension contributions.

The county aggressively addressed its OPEB obligation with a combination of pre-funding through an irrevocable trust and benefit reductions. The resulting liability is small and the plan is 85% funded as of fiscal year end 2014.

Fitch also affirms the following:

--Riverside County POBs, taxable series 2005A at 'A+';

--Riverside County COPs, series 2005A, 2005B, 2007A, 2007B, 2009, at 'A+';

--Riverside County Asset Leasing Corporation (CORAL) COPS, series 2006A and LRBs, series 1997A, 1997B, 1997C, 2013A at 'A+';

--Riverside County Public Financing Authority LRBs series 2012 and 2015 at 'A+';

--Southwest Communities Financing Authority LRBs series 2008A at 'A+'.

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.

Applicable Criteria

Rating U.S. Public Finance Short-Term Debt (pub. 07 Jan 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=846969

Tax-Supported Rating Criteria (pub. 14 Aug 2012)

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

U.S. Local Government Tax-Supported Rating Criteria (pub. 14 Aug 2012)

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

Additional Disclosures

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=985694

Endorsement Policy

https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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Contacts

Fitch Ratings
Primary Analyst
Shannon Groff
Director
+1-415-732-5628
Fitch Ratings, Inc.
650 California St., 4thth Floor
San Francisco, CA 94108
or
Secondary Analyst
Karen Ribble
Senior Director
+1-415-732-5611
or
Committee Chairperson
Jessalynn Moro
Managing Director
+1-212-908-0608
or
Media Relations:
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Shannon Groff
Director
+1-415-732-5628
Fitch Ratings, Inc.
650 California St., 4thth Floor
San Francisco, CA 94108
or
Secondary Analyst
Karen Ribble
Senior Director
+1-415-732-5611
or
Committee Chairperson
Jessalynn Moro
Managing Director
+1-212-908-0608
or
Media Relations:
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com