Fitch Affirms San Luis Obispo County, CA IDR at 'AAA'; Outlook Stable

SAN FRANCISCO--()--Fitch Ratings affirms the following San Luis Obispo County, CA (the county) obligations:

--$146.2 million pension obligation bonds (POBs) series 2003A, 2003C and 2009A at 'AA+';

--$12.9 million lease revenue refunding bonds, series 2012A, issued by the San Luis Obispo County Financing Authority (the authority) at 'AA+';

--Issuer Default Rating (IDR) at 'AAA'.

The Rating Outlook is Stable.

SECURITY

The POBs are secured by an absolute and unconditional obligation of the county to make payments equal to debt service.

The lease revenue bonds (LRBs) are secured by lease payments made by the county to the authority under a covenant to budget and appropriate. The payments are subject to abatement. A debt service reserve is cash-funded at the standard three-prong test.

KEY RATING DRIVERS

The 'AAA' IDR reflects the county's low long-term liability burden, strong revenue growth prospects and expenditure framework which support its exceptionally strong financial resilience. Despite legal restrictions on tax increases, revenue growth has been strong reflecting the growing tax base.

Economic Resource Base

The county comprises 3,300 square miles along California's central coast mid-way between San Francisco and Los Angeles. With a population of 283,815, the county includes seven cities as well as many unincorporated communities. The county seat is the city of San Luis Obispo (IDR 'AA+'/Outlook Stable). The county's economic base is stable with major sectors including government (county, California Polytechnic State University, a state hospital, correctional facility), agriculture and tourism.

Revenue Framework: 'a' factor assessment

Revenue growth has exceeded inflation and performed in line with U.S. economic performance of the last decade and Fitch expects this trend to continue. The county's legal ability to raise revenues is constrained by state constitutional provisions that require voter approval for tax increases.

Expenditure Framework: 'aaa' factor assessment

The county's fixed cost burden is relatively low and it has demonstrated a robust ability to manage spending in times of economic stress.

Long-Term Liability Burden: 'aaa' factor assessment

Overall debt and net pension liabilities are low relative to the county's resource base. Further, the county has limited additional capital needs.

Operating Performance: 'aaa' factor assessment

The county's reserve balances provide exceptionally strong gap-closing ability, given its solid expenditure flexibility and low revenue volatility.

RATING SENSITIVITIES

UNDERLYING ECONOMIC TRENDS: The rating is sensitive to a significant shift in the economy. While Fitch believes such a shift is unlikely, a sustained downturn could result in weakened revenue performance leading to budgetary pressure.

CREDIT PROFILE

San Luis Obispo County, which includes the Paso Robles regions, is the third largest producer of wine in the state after Sonoma and Napa Counties and wine grapes are the second largest agricultural crop in the county after strawberries. Assessed value was remarkably stable through the downturn, decreasing less than 3%. Government represents the major employment sector, contributing to the stable economic profile. The county and California Polytechnic State University, with a student population of about 20,000, are the largest employers, with 2,800 and 3,000 and employees, respectively. Leisure and hospitality are also a large economic component, partly the result of beach and central-coast vineyard attractions. The county also has a large utility sector, primarily due to the presence of PG&E, which employs 1,900 people and operates the Diablo Canyon nuclear plant, whose twin reactor licenses expire in 2024 and 2025.

The tax base has low concentration, though the top taxpayer (PG&E) accounts for about 6% of taxable AV. As many had anticipated, PG&E recently announced its decision to close the Diablo Canyon Power Plant over the next nine years. Though PG&E had applied for a 20-year extension, it recently announced the planned closure of the facility over a nine-year period. PG&E has offered to make whole the tax implications, which typically equal $8.9 million annually, over the intermediate term. Management estimates that the decommissioning of the plant could take decades.

Revenue Framework

Property taxes provide 38% of general fund revenues and nearly 30% of revenues are pass-through public assistance funds from state and federal sources.

Fitch expects revenue growth to remain in line with or above U.S. economic performance, based on historical performance and continued economic stability.

California's constitution requires voter approval of tax increases, limiting the ability of the county to independently control revenues. Property tax growth is constrained by a fixed tax rate and an annual limit on assessed value increases on taxable property absent a change in ownership.

Expenditure Framework

Public safety accounts for about 40% of general fund spending while public assistance pass-throughs account for about 28%. The county has a board policy not to provide additional funding for any programs whose state funding has been cut.

The natural pace of spending growth is likely to be in line with to marginally above revenue growth. The county is currently negotiating labor contracts and anticipates modest annual increases in wages and benefits.

Expenditure flexibility is solid. Carrying costs, including debt service, pension and other post-employment benefits (OPEB) payments, equal about 10% of governmental spending. The board recently approved a tax measure to fund road work for the November elections. If it passes, it would potentially ease the burden on the general fund, which currently contributes approximately $3 million per year for this purpose. Further, the county currently provides an overmatch to state funds that it could relatively easily trim back to mandated levels.

The county retirement fund's most recent actuarial report indicated that the unfunded liability has increased due to low earnings, a reduction in the assumed rate of return, and an updated mortality rate table. The contribution rate for fiscal 2017 will increase 3.5% above the budgeted amount; employees are required to pay for half of any increase up to 2% per year, or more depending on the bargaining unit.

Long-Term Liability Burden

Long-term liabilities are low, with overall debt and net pension liability at 6.5% of personal income. The net pension liability comprises 48% of the liability, with direct debt and overlapping debt accounting for 25% and 28%, respectively. Capital needs include a women's jail and juvenile hall, both of which will be funded with a mix of state funding and county funds that have already been set aside. The county is expected to borrow about $6 million backed by the general fund but paid for with airport fees and passenger charges in order to complete a new airport terminal. No additional debt is expected in the near term.

In 2010 the county prudently established an irrevocable trust to address its OPEB liability, equal to $38.3 million based on a June 30, 2015 actuarial study. The trust's funded ratio is equal to 36.9% (at a discount rate of 7.28%).

The San Luis Obispo County Employees Retirement Plan, which includes county employees as well as superior court and other agencies within the county, had a funded ratio of approximately 71.6% as of Jan. 1, 2013 (as reported in the fiscal 2015 audit) adjusted for a 7% assumed rate of return. In order to address pension costs, in fiscal 2011 the county implemented a tier 2 plan which raised the retirement age to 60 from 55 and limited the cost of living increase for the majority of employees. It also began shifting a portion of the pension contribution to employees, who now pay 50%. Further, approximately 25% of its workforce is currently covered under tier 3, subject to the state's Public Employee Pension Reform Act of 2013.

Operating Performance

San Luis Obispo County's reserves afford it exceptionally strong capacity to withstand a moderate economic downturn, given solid expenditure-cutting flexibility and low expected revenue volatility. Fitch believes the county is well positioned to maintain a high level of financial flexibility throughout the economic cycle. The county's unrestricted fund balance at fiscal year-end 2015 was a high $263.3 million, or 65% of spending.

The county's consistently strong financial performance is due largely to conservative budgeting and planning. As such, in fiscal 2015 the county generated an operating surplus after transfers for a seventh consecutive year, equal to $32 million (8% of spending). In order to trim the budget during the recession, the county eliminated about 200 vacant positions.

Budget management at times of recovery has been strong, as reserves have continued to increase following the economic downturn. The county continues to operate tight expenditure controls, add to its reserves, and prefund its OPEB liability. Management proactively established a five-year plan in 2007 to address expected budgetary pressures that was later extended to seven years due to the slower than expected economic recovery. The county took a variety of actions to close budget gaps including elimination of additional vacant positions following a board policy not to backfill cuts in state funds. As a result, the county not only closed annual structural imbalances ranging from $2 million to $30 million, but generated sizable surpluses.

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/site/re/879478

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Contacts

Fitch Ratings
Primary Analyst
Shannon Groff
Director
+1-415-732-5628
Fitch Ratings, Inc.
650 California Street, 4th Floor
San Francisco, CA 94108
or
Secondary Analyst
Stephen Walsh
Director
+1-415-732-7573
or
Committee Chairperson
Arlene Bohner
Senior Director
+1-212-908-0554
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 Street, 4th Floor
San Francisco, CA 94108
or
Secondary Analyst
Stephen Walsh
Director
+1-415-732-7573
or
Committee Chairperson
Arlene Bohner
Senior Director
+1-212-908-0554
or
Media Relations
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com