Fitch Rates Riverside County (CA) Teeter Notes 'F1+'; Affirms LT Obligations; Outlook Stable

SAN FRANCISCO--()--Fitch Ratings has assigned an 'F1+' rating to the following Riverside County, California (the county) Teeter obligation notes (the notes):

-- $88 million 2015 series D (tax-exempt).

The notes are expected to sell via negotiation the week of Sept. 29. Proceeds will refund a portion of the county's outstanding 2014 notes and fund an advance of delinquent property taxes to local taxing agencies participating in the county's Teeter Plan.

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

The Rating Outlook on the long-term obligations is Stable.

SECURITY

The notes are secured by delinquent property taxes and proceeds from the sale of tax-defaulted properties, and have been legally validated as a binding obligation of the county. They are additionally secured by any lawfully available moneys from the county's general fund.

Outstanding lease revenue bonds (LRBs) and certificates of participation (COPs) are secured by 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

SOUND NOTE STRUCTURE: The 'F1+' short-term rating reflects the county's long-term general credit quality correlating to the ULTGO rating and the notes' sound security structure. The notes are supported both by pledged property tax delinquencies and the county's general fund. In addition, the county has the option of refinancing the notes through the county investment pool if necessary and retains access to substantial borrowable resources.

NARROWLY BALANCED OPERATIONS: Fiscal 2015 operations resulted in a surplus, reserve levels are satisfactory, and Fitch expects revenues to benefit from economic tailwinds. However, policymakers will need to exercise spending restraint given several years of expected modest deficits, limited revenue raising capabilities per state limitations, and expenditure pressures.

RECUPERATING HOSPITAL OPERATIONS: The hospital enterprise (Riverside University Medical Center or RUMC) has experienced rapid operational improvement over the past year following years of fiscal distress, reducing potential pressure on the county's general fund.

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 (OPEB) 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.

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 NOTE STRUCTURE

The Teeter plan is an alternate procedure for collection of property taxes authorized under state code and practiced by most California counties. Under the Teeter plan counties advance the full property tax levy to taxing jurisdictions, while retaining penalties and interest for themselves as taxes are paid, either by property owners or through sales of tax-defaulted properties. Substantial interest and penalty rates on delinquent taxes ensure that counties benefit from this program. The fiscal 2016 budget includes $25 million, or 3.5% of discretionary general fund revenues, from the Teeter program.

The 'F1+' short-term rating is based on Fitch's view of the county's general credit quality, as reflected in its 'AA-' implied ULTGO rating.

The notes are supported both by uncollected property taxes and the county's general fund. Note proceeds will finance an advance of $36 million in current year tax delinquencies and refund $52 million in outstanding Teeter obligations. The notes are expected to be repaid from delinquent tax collections, with any balance remaining after the October 2016 maturity financed from the issuance of notes in fiscal 2016. In addition, the county retains the option of refinancing the notes through the county treasurer's investment pool (Fitch rating of 'AAA/V1'), if necessary. Additional security is provided by approximately $1.57 billion in borrowable resources.

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 salary and benefit increases 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 several years of small general fund surpluses. However, maintenance of sound finances will require judicious expenditure decisions by policymakers given near term modest projected discretionary spending deficits.

Operations have benefitted from several years of growing property tax revenues, by far the county's largest discretionary source of revenue, in combination with recent years' significant expenditure reductions.

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. The county performed better than expected for fiscal 2015 with an estimated $30 million surplus.

The county's five-year forecast includes deficits in discretionary spending beginning in fiscal 2016 through 2018 before a return to balance in fiscal 2019 due to various expenditure pressures. These include rising pension costs, negotiated wage hikes, increased insurance costs, and the operating costs of the correctional facility expected to open in fiscal 2017. The 'AA-' ULTGO 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 continues its recovery with solid gains of 3.9%, 7.7%, and 5.8% in fiscal years 2014-2016, bringing AV to just 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 an estimated $4,727 per capita (4.8% of AV), reflective of high overlapping debt levels. Debt amortization is moderate, 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 its 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 was 85% funded as of fiscal year end 2014.

Fitch also affirms the following ratings:

-- 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+';

-- Riverside County 2015-2016 tax and revenue anticipation notes (TRANs) at 'F1+';

-- Riverside County Teeter Obligation Notes series 2014D and (taxable) series 2014E.

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 and Zillow.

Fitch recently published an exposure draft of state and local government tax-supported criteria (Exposure Draft: U.S. Tax-Supported Rating Criteria, dated September 10, 2015). The draft includes a number of proposed revisions to existing criteria. If applied in the proposed form, Fitch estimates the revised criteria would result in changes to fewer than 10% of existing tax-supported ratings. Fitch expects that final criteria will be approved and published by Jan. 20, 2016. Once approved, the criteria will be applied immediately to any new issue and surveillance rating review. We anticipate the criteria to be applied to all ratings that fall under the criteria within a 12-month period from the final approval date.

Applicable Criteria

Exposure Draft: U.S. Tax-Supported Rating Criteria (pub. 10 Sep 2015)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869942

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

Dodd-Frank Rating Information Disclosure Form
https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=990959

Solicitation Status
https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=990959

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

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Contacts

Fitch Ratings, Inc.
Primary Analyst
Shannon Groff, +1-415-732-5628
Director
650 California St., 4th Floor
San Francisco, CA 94108
or
Secondary Analyst
Karen Ribble, +1-415-732-5611
Senior Director
or
Committee Chairperson
Doug Scott, +1-512-215-3725
Managing Director
or
Media Relations, New York
Sandro Scenga, +1-212-908-0278
sandro.scenga@fitchratings.com

Contacts

Fitch Ratings, Inc.
Primary Analyst
Shannon Groff, +1-415-732-5628
Director
650 California St., 4th Floor
San Francisco, CA 94108
or
Secondary Analyst
Karen Ribble, +1-415-732-5611
Senior Director
or
Committee Chairperson
Doug Scott, +1-512-215-3725
Managing Director
or
Media Relations, New York
Sandro Scenga, +1-212-908-0278
sandro.scenga@fitchratings.com