Fitch Downgrades Suffolk County, NY GO Bonds to 'A-'; Outlook Stable

NEW YORK--()--Fitch Ratings has assigned an 'A-' rating to the following Suffolk County general obligations (GO) bonds:

--$49.15 million public improvement serial bonds 2016 Series A.

The bonds are being issued to fund various capital projects and are expected to sell via competition the week of June 19th.

Additionally, Fitch downgrades the following ratings:

--Long-Term Issuer Default Rating (IDR) to 'A-' from 'A';

--1.5 billion in outstanding GO debt to 'A-' from 'A'.

The Rating Outlook is Stable

SECURITY

The bonds and notes are general obligations of the county with a pledge of its faith and credit and ad valorem tax, subject to the 2011 state statute limiting property tax increases to the lesser of 2% or an inflation factor (the tax cap law). This limit can be overridden annually by a 60% vote of the county legislature.

KEY RATING DRIVERS

The downgrade to 'A-' from 'A' reflects a combination of application of Fitch's revised criteria, published on April 18, 2016, and recent financial performance which fell short of Fitch's expectations. The revised criteria include an analysis of the adequacy of reserves given budgetary flexibility and revenue volatility. The county's lack of available reserves following a history of their use to fund operations led Fitch to assess financial resilience as limited. The county's low long term liability burden, moderate carrying costs for debt and pensions and strong legal ability to increase revenues from a diverse and wealthy base are positive credit features.

Economic Resource Base

Suffolk is among the wealthiest counties in the state and nation, benefiting from its proximity to New York City and a well-educated work force. The county encompasses the eastern two-thirds of Long Island including the Hamptons and Fire Island. The county's population of approximately 1.5 million is one the largest of any county in the state outside of New York City.

Revenue Framework: 'a' factor assessment

The county has significant independent legal ability to increases revenues. However, Fitch believes general revenue growth will remain below the rate of inflation as they have over the last decade.

Expenditure Framework: 'a' factor assessment

The county has demonstrated its ability to control expenditures including consolidating departments, negotiating labor union concessions, and reducing its workforce. The natural pace of expenditure growth is expected to remain above expected revenue growth given weak revenue performance and the demands of contractual workforce spending.

Long-Term Liability Burden: 'aaa' factor assessment

The total debt and unfunded pension liability account for a modest 8.1% of county per capita personal income. The New York State pensions are well funded but the county's OPEB liability is considerable and the county has taken minimal steps to control its growth.

Operating Performance: 'bbb' factor assessment

The county lacks reserves to address fiscal pressures in the event of moderate economic downturn scenario. Fitch believes that county would be challenged to maintain current service levels without raising revenues.

RATING SENSITIVITIES

An inability to maintain at least minimal reserves could lead to further rating deterioration. A continued improvement in cash flow borrowing and evidence of the ability to accumulate at least a modest cushion without increasing dependence on one-shots could improve the rating.

CREDIT PROFILE

The county benefits from a diverse economy in close proximity to New York City. Income levels are above average with 2015 per capita personal income of 119% of the nation. Full market value at $271 billion is up about 6% from 2015 and market value per capita of $180,000 is strong. The county is home to Brookhaven National Laboratory (employing 3,150), an atomic energy research facility which is expected to expand; and Stony Brook University's Technology Incubator including two centers for Advanced Technology. Fitch expects the property tax base to grow at a moderate pace given significant economic development activity including targeted programs to grow the technology industry and ongoing transportation improvements that are expected to create jobs and attract new residents.

The county's unemployment rate remains lower than the state and national rates. The April 2016 county unemployment rate was 4.1% compared with 4.6% and 4.5% for the state and national levels, respectively. The labor force grew by 1.7% in 2015 after a trend of low growth for several years.

Revenue Framework

The majority of the county operating revenues come from sales tax collections (44%) and property taxes (22%). Overall, revenue growth has been lagging behind the rate of inflation due to slow growth in sales tax collections and declining property valuations. Fitch expects this trend to continue absent significant economic development.

New York State law requires property tax revenue increases be limited to the lesser of CPI or 2% annually, unless a supermajority of the local governing body vote for a larger increase. The ability to override the cap provides substantial legal flexibility to raise revenues the county. Any increase in the sales tax rate would require state approval.

In addition, the county legislature has demonstrated its ability to increase existing revenue streams or implement new ones. For example, expanded traffic and parking violation fees were adopted in 2014, and the 2016 budget includes an increase in real property tax map verification fees and a new fine for false home and fire alarms which are included in the 2016 adopted budget. The county has capacity to implement new fees for services and fines for parks and recreation, consumer affairs and could increase the energy use tax from the present level of 2.5% to 4.0% (which is estimated to yield $33 million).

Under the Suffolk County tax act, the county is responsible for uncollected taxes for school districts and towns. In fiscal 2015, the county issued $100 million in general obligation tax anticipation notes for unpaid property taxes from 2012 through 2015.

Expenditure Framework

Public safety, economic assistance and health services are the county's main spending items, including state mandates such as the county-funded health and social service programs. New York State also requires counties to provide local funding for mandated Medicaid services, although the state now covers all annual spending increases.

The pace of spending growth absent policy actions is likely to be above the level of expected revenue growth given expected contractual labor cost increases as well as state mandated programs. The county's conversion of county health centers to federally qualified centers and sale of its nursing home will have a lasting but modest effect on the pace of future county operating costs.

The county is both deferring some pension costs and repaying prior deferrals that were authorized by the state. In the near term annual pension requirements should be fairly level. Over time pension payments are likely to increase, but the rolling off of prior deferrals should keep annual increases moderate for some time.

The county's carrying costs for debt, pension and OPEB costs accounted for less than 14% of 2014 general fund expenditures. Over 95% of the county workforce is represented by collective bargaining units. The collective bargaining framework in New York makes adjustments to personnel spending challenging. Despite this impediment, the county had 1,195 (12%) fewer employees in 2015 than it did in 2012. The majority of the reduction occurred in 2012, resulting from a layoff of over 400 employees, attrition and early retirements.

The county generally settles long-term labor contracts with fairly generous terms for its employees given slow revenue growth. For example, in 2013 the county agreed to an eight-year contract with the county detective union including an average annual increase of 4.9% from 2014 through 2018. The county also agreed to "no lay off" provisions in contracts settled after the large lay-off in 2012, although new employees were required to pay a portion of health care costs. As new contracts are settled beginning later this year, management has the ability re-negotiate this provision, which would reduce the constraints in the coming years. Public safety contracts lowered starting salaries for new employees and reduced stepped longevity increases, so as long-term employees retire, the increases in labor costs should abate somewhat.

The county executive has the ability to issue executive orders to declare a fiscal emergency in instances of significant projected budgetary gaps. Under the declaration, the budget office has the ability to embargo 10% of each department's unspent discretionary appropriations to be held in reserves, but there is no ability to adjust contractual labor spending. In addition, the county has reported that it could choose to separate Suffolk County Community College into a separate taxing entity, thereby saving the County $35 - $40 million annually.

Long-Term Liability Burden

The total debt and unfunded pension liability account for a modest 8.1% of county per capita personal income. Debt amortization is rapid with 76.8% of principal paid within ten years.

The county participates in well-funded New York State pension plans. As of March 31, 2015, the employees' and police and fire plans had funded ratios of 92% and 93%, respectively. Using Fitch's more conservative 7% discount rate assumption the plans' funding levels would still be sound at an estimated 87% and 88%. The county has taken advantage of the ability granted by the state to amortize most of the increase in annual pension payments since 2012 for near-term budget relief. The program ends in 2020. The amortization balance of $383 million must be paid within 12 years. Fitch believes that the future pension payments will remain manageable given the strength of the state plans' funded positions.

Fitch has some concerns about the unfunded actuarial accrued liability for other post-employment benefits (OPEB) of $4.65 billion as of Dec. 31, 2015, or a sizable 5% of personal income. The county continues to fund its OPEB liability on a pay-as-you-go basis as there is no authority under present state law to establish a trust account or reserve fund for this liability.

Operating Performance

In the event of a moderate economic downturn, Fitch believes the county would be challenged to maintain current service levels without raising revenues given the lack of reserves and just adequate spending flexibility. Long-term rating stability will depend on minimizing the structural budget gap and the accumulation of at least minimal reserves.

The county has had a negative available general fund balance since fiscal 2009 due to a combination of operating deficits and accounting changes associated with the issuance of tobacco settlement asset backed bonds in 2008 and 2012. The bonds were secured by a pledge of future tobacco settlement revenues. The associated assets are recognized in the Suffolk Tobacco Asset Securitization Corp. fund (STASC) but the deferred inflow of resources is recorded in the general fund. Fitch's analysis combines the available reserves in the general and STASC funds for consistency with other local governments' accounting presentations in which long-term debt is not reflected on the general fund balance sheet. Fitch also includes in available reserves the tax stabilization fund, which totaled $49 million at the end of 2014.

The county has continued its efforts to reduce budget gaps with recurring revenues and cost reductions, although actual performance has resulted in operating deficits in most recent years. Headcount has been reduced by about 1,189 positions since 2012. All county health centers will have been converted to federally qualified centers in 2016; the county nursing home facility has been closed. However, sales tax revenues are typically over-estimated and union contracts have been settled with increases that exceed likely revenue growth and contain no-layoff clauses.

The 2015 budget contained the third consecutive property tax increase to fund the police district, which is outside of the general fund. The county aggressively budgeted sales tax growth at 4.87%. Based on unaudited 2015 results, the county's unrestricted general fund deficit will increase by $36 million due to a delay in the sale of the nursing home property into 2016. The sale is expected to provide $15 million in unbudgeted revenues in 2016. In addition, expenditures were $11 million over budget primarily due to public safety overtime costs.

The county has reduced its reliance on one-time revenues in recent years although the 2016 budget includes over $93 million in one-shots including amortizing a net $44.6 million in annual pension costs, just under the maximum allowable amount, $5 million in property sales and $28.2 million borrowing from of Assessment Stabilization Reserve Fund (ASRF), which provides funds for sewer capacity and tax payer relief. Sales tax collections were below budgeted projections by 2.2% in 2014 and 5.2% in 2015. The 2016 budget assumes a 3.55% increase in sales taxes from 2015 actual collections; however, Fitch believes this projection is somewhat aggressive based on recent trends. Based on year-to-date results the projected 2016 operating deficit is $40 million.

Officials expect to minimize the budget shortfall through a mitigation plan expected to generate $66 million through expenditure savings and revenue enhancements. Under the provisions of the fiscal emergency declaration, the county expects to embargo $10 million in departmental appropriations; however the county has additional capacity to increase the embargo. Fitch believes the plan will do little to address the larger structural imbalance

In order to manage cash flow needs the county issues short-term revenue anticipation notes (RANS) annually and tax anticipation notes (TANs) twice each year. Proceeds of the RANs fund operations in anticipation of state and federal aid, and TANs fund current and delinquent property tax collections. The county has a long history of issuing TANs in advance of property tax collections; however, note par increased after consecutive general fund deficits from 2008 through 2012, peaking at $625 million in 2013. For 2016, total note issuance is expected to decrease to $555 million (16.3% of budgetary expenses).

In addition to cash flow borrowing, under a referendum approved on the November 2014 ballot the county received authorization to borrow from the ASRF through 2017 to provide budgetary relief. The ASRF provides funding to the county's sewer funds for stabilization of sewer rates and fees in addition to infrastructure and capital improvements within the sewer districts. Funds from 0.25% of the county's sales tax revenues are deposited in the county water protection fund with 25% transferred to the ASRF. The current ASRF fund balance is $104.2 million. All amounts borrowed from the ASRF must be repaid by 2029, with payments commencing in 2018. The ASRF repayments would require a 5% minimum annual payback of outstanding amounts borrowed.

Additional information is available at 'www.fitchratings.com'.

In addition to the sources of information identified in the applicable criteria specified below, this action was informed by information from Lumesis and InvestorTools.

Applicable Criteria

U.S. Tax-Supported Rating Criteria (pub. 18 Apr 2016)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=879478

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Contacts

Fitch Ratings
Primary Analyst
Shannon McCue, +1-212-908-0593
Director
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Matthew Wong, +1-212-908-0500
Director
or
Committee Chairperson
Amy Laskey, +1-212-908-0568
Managing Director
or
Media Relations, New York
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Shannon McCue, +1-212-908-0593
Director
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Matthew Wong, +1-212-908-0500
Director
or
Committee Chairperson
Amy Laskey, +1-212-908-0568
Managing Director
or
Media Relations, New York
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com