Fitch Affirms Sonoma County, CA POBs at 'AA'; Outlook Stable

SAN FRANCISCO--()--Fitch Ratings has affirmed Sonoma County, CA's (the county) obligations as follows:

--$443.56 million pension obligation bonds (POBs), series 2003A, 2003B and 2010A at 'AA';

--Issuer Default Rating (IDR) at 'AA+'.

The Rating Outlook is Stable.

SECURITY

The county's POBs are secured by an absolute and unconditional obligation of the county to appropriate principal and interest.

KEY RATING DRIVERS

The county's 'AA+' IDR reflects its moderate fixed cost burden and solid expenditure flexibility, low liability burden, and good reserve levels relative to budget flexibility, given its limited revenue framework and somewhat volatile intergovernmental revenues.

Economic Resource Base

Sonoma County is located in the northern San Francisco Bay area and its major population centers (Santa Rosa, Petaluma, and Rohnert Park) are within commuting distance of San Francisco. The county is part of the broad and diverse San Francisco Bay Area economy. Agriculture, particularly viniculture, remains particularly significant and both production and export demand are growing. Other important contributors to the county's economy include tourism, health care, and technology.

Revenue Framework: 'a' factor assessment

Total general fund revenue growth overall has performed below inflation; however, when intergovernmental funds are excluded revenues have exceeded inflation and been in line with U.S. economic performance. 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: 'aa' factor assessment

The county's fixed cost burden is moderately low relative to its budget and management has demonstrated a robust ability to control 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 reports manageable additional capital needs for the near- to intermediate-term.

Operating Performance: 'aaa' factor assessment

The county has maintained a good operating cushion despite a history of elevated volatility in intergovernmental revenues.

RATING SENSITIVITIES

Maintenance of Reserves: The rating is sensitive to a significant draw on reserves, which along with good spending flexibility serve as a buffer to potential revenue contraction.

CREDIT PROFILE

The local economy benefits from wine production and tourism, proximity to the San Francisco Bay Area employment market, and above-average wealth levels. The tax base experienced modest declines during the downturn but has since surpassed prior peak levels, and exhibits low concentration. The county's unemployment rates generally trend below the state average and in line with the national average. Income indicators for county residents are about 18% above the national average.

Revenue Framework

Intergovernmental revenues accounted for nearly 22% of the general fund total in fiscal 2015 and represent state and federal support for mandated health and human services programs managed by the county, including transfer payments, as well as sales taxes reserved for public safety. Discretionary county spending is primarily supported by property taxes, which accounted for about 57% of fiscal 2015 general fund revenues.

Total general fund revenues grew at a compound average growth rate (CAGR) of 1.4% over the 10 years ending fiscal 2014 when adjusting for an accounting change (human services revenues were moved from the general fund into a special revenue fund in fiscal 2008). However, general fund revenues less intergovernmental revenues, which include mostly pass-through state and federal funding, exhibited a stronger CAGR of 3.5%.

Similar to other California local governments, the county's independent legal ability to raise revenues is limited by state constitutional provisions which require voter approval for tax increases. The county may increase fees and charges for services, but is generally limited to the cost of services provided.

Expenditure Framework

Public safety accounts for roughly 55% of general fund spending and transfers out, while health and human services is the second largest category at around 20%.

The pace of spending over the near term is expected to be in line with to moderately above that of revenue gains.

The county has good spending flexibility, with carrying costs for debt service and pension contributions accounting for a moderately low 12.5% of fiscal 2015 governmental spending. Labor contracts are in place with bargaining units through fiscal 2018. Terms of the contracts appear affordable, including 3% cost of living adjustment for fiscal 2017 and no adjustment for fiscal 2018. Although strikes are prohibited when contracts are in place, the county did experience a strike last year by its largest union, the Service Employees International Union, after its contract expired. Management attributed the action to pent-up wage demands, which it indicated were satisfied with the current contract.

The transient occupancy tax (TOT) generates approximately $12 million-$13 million per year, of which 25% or about $3 million-$4 million is allocated to the general fund with the remainder allocated to the county advertising campaign. According to management, if needed the advertising moneys could be redirected to the general fund. Further, in November 2016 voters approved a ballot measure increasing the TOT rate from 9% to 12% to provide approximately $4.6 million additional funding for roads, among other uses. The additional funding is expected to relieve some pressure from the general fund.

A half-cent sales tax ballot measure to support county parks failed in the November 2016 election. The county had planned for the $18 million-$20 million estimated revenues to be generated by the tax to provide additional relief to the general fund, which currently supports parks spending.

Long-Term Liability Burden

The county's long-term liability burden is low, with overall debt and pension equal to about 6.6% of personal income. Amortization of outstanding debt is average with about 64% of principal retired within 10 years. The county participates in the Sonoma County Employees' Retirement Association (SCERA), and the plan's estimated ratio of assets to liabilities is 87% based on a Fitch-adjusted assumed investment return rate of 7%. The county's unfunded liability for other post-employment benefits (OPEB) declined to a still elevated $270 million, or 1.1% of personal income, after it took steps to slow further growth. Measures included capped benefits for newer hires, the establishment of an irrevocable trust, and annual contributions well in excess of pay-go requirements.

The county's main capital needs are road repairs and maintenance, which were budgeted at approximately $17 million in each of fiscals 2016 and 2017 compared to prior annual outlays of about $7 million. As discussed, the recently approved TOT rate increase will provide about $4.6 million per year additional funding for roads. In addition, the county will finance an airport terminal expansion to accommodate new routes with approximately $12 million-$15 million in certificates of participation backed by the general fund. However, the county intends to pay the debt service with passenger facility charges and an expected but not yet approved FAA grant. Finally, the county expects to build a new justice center in the next few years at an estimated cost of $67 million, which it will fund with a combination of pay-go, grants, and possibly some additional debt. Management has already set aside $8 million in tobacco settlement moneys for this purpose.

Operating Performance

An analysis using the Fitch Analytical Sensitivity Tool indicates total general fund revenues would be expected to decline about 5.4% in a moderate economic downturn when adjusted for historical accounting changes. However, total general fund revenues less primarily pass-through intergovernmental revenues (the county's policy is to not backfill state and federal funding cuts) would be expected to decline only about 1.2%. The county has maintained a reserve equal to at least 18% of spending or greater each of the last seven years, providing a sound cushion to offset historical volatility in intergovernmental revenues.

The county has effectively managed its budget primarily through cost-cutting, including layoffs and furloughs during the last economic downturn - with no deferral of required spending. The county's practice with regard to state programs is to adjust expenditures to the amount of revenues that are received from the state and for departments not to use county funds to pay for these program costs.

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, +1-415-732-5628
Director
Fitch Ratings, Inc.
650 California Street, 4th Floor
San Francisco, CA 94108
or
Secondary Analyst:
Karen Ribble, +1-415-732-5611
Senior Director
or
Committee Chairperson:
Steve Murray, +1-512-215-3729
Senior Director
or
Media Relations:
Elizabeth Fogerty, +1-212-908-0526
New York
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst:
Shannon Groff, +1-415-732-5628
Director
Fitch Ratings, Inc.
650 California Street, 4th Floor
San Francisco, CA 94108
or
Secondary Analyst:
Karen Ribble, +1-415-732-5611
Senior Director
or
Committee Chairperson:
Steve Murray, +1-512-215-3729
Senior Director
or
Media Relations:
Elizabeth Fogerty, +1-212-908-0526
New York
elizabeth.fogerty@fitchratings.com