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TEXT-Fitch Rates Los Angeles, CA 2012 TRANs 'F1+'; Affirms Outstanding Bonds
June 14 (Fitch) Fitch Ratings has assigned an 'F1+ rating to the following: --$1.2 billion Los Angeles (city), California 2012 tax and revenue anticipation notes (notes). The notes will be sold via negotiation on June 27, 2012.
In addition, Fitch affirms the following ratings: --$1.2 billion in outstanding Los Angeles general obligation bonds at 'AA-'; --$57.8 million in outstanding Los Angeles judgment obligation bonds, series 2009-A and 2010-A at 'A+'; --$1.5 billion in Municipal Improvement Corporation of Los Angeles (MICLA) refunding certificates of participation (refunding program AY), series 2005, and lease revenue bonds, series 2006-A, 2007-A, 2007-B1, 2007-B2, 2008-A, 2008-B, 2009-A, 2009-B, 2009-C, 2009-D, 2009-E, 2010-A, 2010-B, 2010-C, 2010-D, 2012-A, 2012-B, and 2012-C at 'A+'; --$390.7 million in Los Angeles Convention and Exhibition Center Authority (convention center authority) lease revenue bonds, series 2003A and 2008A at 'A+'; --$282.2 million Los Angeles sanitation equipment charge revenue bonds, series 2003-A, 2003-B, 2004-A, and 2005-A, and solid waste resources revenue bonds, series 2006-A, 2009-A, and 2009-B at 'AA-'; --$22.2 million City of Los Angeles Landscaping and Lighting District 96-1 assessment bonds, series 2000, 2001, and 2002 at 'AA-'. The Rating Outlook is Stable.
The notes are secured by a first lien and charge against unrestricted general fund revenues attributable to fiscal 2013. To the extent that these moneys are insufficient to repay the notes in full at their maturity, the notes will be paid from any other legally available unrestricted moneys. The GO bonds are secured by ad valorem property taxes levied without limitation on rate or amount upon taxable properties within the city. The MICLA COPs and lease revenue bonds, and convention center authority lease revenue bonds, are secured solely by the city's covenant to budget and appropriate lease rental payments for use and occupancy of various facilities and equipment. The judgment obligation bonds are secured by the city's absolute and unconditional obligation to pay principal and interest to refund an obligation imposed by law. The sanitation equipment charge revenue bonds and solid waste resources revenue bonds are secured by a first lien on pledged solid waste resources fee revenues, including penalties and interest, net of administrative costs. The City of Los Angeles Landscaping and Lighting District 96-1 assessment bonds are secured by a first lien on 82% of parcel tax assessment revenue and 100% of delinquent penalties and interest.
KEY RATING DRIVERS CITY'S INHERENT ECONOMIC IMPORTANCE:
The city is the commercial and cultural center of a very large, diverse economy that is starting to show slight revenue and property market improvements, despite an unemployment rate which remains very high. ONGOING STRUCTURAL IMBALANCE: The city's four-year financial projections continue to indicate a significant structural imbalance despite cost control measures which have reduced, but not closed, the gap. Fitch believes the structural imbalance will be difficult to resolve without significant economic improvement, a stronger assessable tax base, and further personnel expenditure reductions.
NECESSITY OF ONGOING BENEFIT REFORM:
Building on pension and benefit reforms already implemented, further pension and benefit reform remains necessary to achieve out-year budget balancing. LOW RESERVES: The city continues to rebuild its low reserves which do not yet meet its own minimum policy goal, and liquidity remains tight.
CHALLENGING POLITICAL ENVIRONMENT:
The city's challenging political and labor relations environment can hinder its ability to respond swiftly to budgetary pressures.
STRONG SHORT-TERM DEBT COVERAGE:
Fitch's highest short-term rating of 'F1+' on the notes reflects the sound repayment structure and good coverage of note repayment set-asides when substantial available and borrowable funds are considered, which largely offset any risk of cash flow variances.
Fitch expects the city's debt ratios to remain affordable.
SPECIAL REVENUE AND ASSESSMENT BONDS CONTINUE TO PERFORM WELL:
The city's sanitation equipment charge revenue bonds and solid waste resources revenue bonds and the City of Los Angeles Landscaping and Lighting District 96-1 assessment bonds all continue to perform well, with strong debt service coverage even under severe Fitch stress tests.
Los Angeles is an important economy and by virtue of its size and diversity is well positioned to benefit from eventual national economic recovery. Substantial recessionary pressures caused sharp tax revenue declines. However, based on recent revenue performance, the city is experiencing revenue and property base stabilization which is expected to continue into fiscal 2013. Fiscal 2012 sales tax revenues, which are highly sensitive to the state of the economy, are up 7.9% year-over-year, but remain below pre-recession levels. Following two years of relatively slight declines, taxable assessed value (TAV) increased by 1.3% in fiscal 2012. The city is projecting a further 1.1% TAV growth in fiscal 2013.
Signs of economic improvement are not yet translating into significant lowering of the unemployment rate. The stubbornly high 13.1% unemployment rate in March 2012 is only slightly less than a year prior (13.4%) while representing an improvement over the July 2010 peak of 14.7%. High unemployment, the weak property market, and slow economic growth in the near term will all continue to weigh on the city's tax revenue growth. While the city has taken significant budgetary actions in response to economic contraction and its personnel-related expenditure pressures, the time taken to achieve the necessary political consensus, as well as the longer-term budget initiatives still in development, indicates how politically difficult it is for the city to respond nimbly. Rebuilding the general fund reserves will need ongoing concerted action from all of the stakeholders.
FINANCIAL OPERATIONS STILL UNDER CONSIDERABLE PRESSURE
In fiscal 2011, the city was faced with an initial $492 million budget gap on budgeted general fund revenues of $4.4 billion and $54 million in additional budget shortfalls during the year. The gap was closed with a combination of recurring and non-recurring measures. Consequently, fiscal 2011 ended with a strengthened total general fund balance of $520.1 million (11.8% of spending), up 19% from the year prior. The $493.8 million unrestricted general fund balance (the sum of committed, assigned, and unassigned fund balances under GASB 54) equaled 11.2% of spending. Fiscal 2011's net general fund surplus of $83.6 million was the first surplus in some years. For the general fund in fiscal 2012, after closing an initial $336.3 million budget gap and a $72 million mid-year budget gap, the city is closing a further year-end budget gap of $18.4 million caused by a combination of expenditure increases and revenue shortfalls.
In all cases, the city has relied on a mixture of recurring and non-recurring solutions. Similarly, for fiscal 2013, the city closed an initial budget gap of $238 million with approximately 63% recurring solutions and 37% non-recurring solutions. Due to its reliance in fiscal 2013 on non-recurring solutions and partial funding of 209 positions, the city expects to have to solve another significant budget deficit in mid-fiscal 2013. The city's budget outlook projects budget deficits for fiscal years 2014 (negative $216 million), 2015 (negative $327 million), 2016 (negative $297 million), and 2017 (negative $265 million), indicating the ongoing nature of the city's remaining structural deficit, even after the cost control actions taken to date. While the city has demonstrated its ability to balance its budget annually, Fitch considers solving budget deficits of this magnitude in the future will only grow more difficult.
The city retains a range of budget options to achieve structural balance in the medium to long term, but meaningful budget impacts will require tough political decisions and further labor concessions. Fitch is concerned about the city's growing bank for overtime accrued by police officers. Accrued overtime hours which are not used for time off would likely be paid out when individual police officers resign or retire. While the city intends to reduce this liability through managed leave, those hours which are not used as leave will become more expensive over time given future agreed wage increases. Such a liability could be problematic if the economy does not support sufficient revenue growth. The city also has large potential liabilities related to litigation which could materially affect the city's general fund position, in particular approximately $773 million in claims connected to the city's former utility users' tax on telephone services. Any settlement of such magnitude would likely be funded through judgment bonds which would not significantly increase the city's currently above-average debt burden, but would put a moderate additional strain on ongoing resources.
The city is getting closer to meeting its combined emergency and contingency reserve goal of at least 5% of general fund revenues, achieving 4.6% in fiscal 2012 and budgeting for 4.8% in fiscal 2013. The combined reserve is a subset of the city's unrestricted general fund balance.
STRONG NOTE REPAYMENT STRUCTURE
Fitch's highest short-term rating of 'F1+' reflects a sound note repayment structure, good coverage of five note maturities, satisfactory borrowable funds, and the city's overall credit quality. Fitch notes borrowing is a high 27.4% of forecast fiscal 2013 disbursements and slightly higher than fiscal 2012's, to accommodate the city's intent to prepay its growing pension payment. The city makes five 20% set-asides of principal and interest, each at least 30 days ahead of the next scheduled note maturity. The maturity dates are February 28, March 28, April 25, May 30, and June 27. The city expects unrestricted general fund revenues to provide full debt service coverage of 1.14x to 2.08x on each set-aside date without drawing upon $184 million-$732 million in borrowable funds at the set-aside dates. The projected cash flow, supported by borrowable funds, holds up sufficiently to stress scenarios that envision a 10% reduction in economically sensitive tax revenues or 5% overall expenditure increases, without offsets.
SOLID WASTE RESOURCES REVENUE BONDS PERFORMING WELL
The city's sanitation equipment charge revenue bonds and solid waste resources revenue bonds continue to perform well. Their 'AA-' rating reflects a strong and predictable revenue stream resulting from a flat fee structure charged to a huge customer base of approximately 745,000 households. Strong debt service coverage levels reflect fee rates which are designed to recover costs fully. There is both historical and ongoing commitment from elected officials to implement rate increases to meet the program's operational costs. However, sizable system needs, frequently changing solid waste disposal technology, and environmental regulations mean the significant additional debt will be required. Debt service coverage would remain strong after such a new debt issuance.
LANDSCAPING AND LIGHTING DISTRICT BONDS PERFORMING WELL
The City of Los Angeles Landscaping and Lighting District 96-1 assessment bonds also continue to perform well. Their 'AA-' rating reflects very strong debt service coverage levels which remain strong even under harsh stress scenarios. The assessment burden created by these bonds is very low for the large and diverse taxpayer base. Expenditures are monitored for their compliance with the highly prescribed use of assessment revenues. There is ongoing community involvement in both the individual projects and program oversight. While the initial slim voter approval margin, along with the assessments' limited purpose, could have resulted in appeals and higher delinquency rates, to date appeals have been minimal and collection of the assessment benefits from being part of the city's standard ad valorem property tax collections. Fitch caps most special tax revenue bonds' ratings at the issuing entity's unlimited tax general obligation rating. While the district is separately named from the city of Los Angeles, the two entities share governance and staffing. Therefore, Fitch caps the district's rating at the city of Los Angeles' general obligation rating.
AFFORDABLE DEBT BURDEN BUT SIGNIFICANT PENSION AND OPEB LIABILITIES
Net overall debt is a moderately high $4,683 per capita, or moderate at 4.1% of market valuation. Amortization of direct debt is above-average at approximately 65% in 10 years. Fitch expects that the overall debt burden will remain affordable. For fiscal 2011, the city reported that its pension systems, the Los Angeles City Employees Retirement System (LACERS) and the Fire and Police Pension Plan (FPPP), were relatively well funded at 72.4% and 86.3% respectively. However, using Fitch's more conservative 7% discount rate, funding levels drop to a weak 70.1% for LACERS and a still well-funded 82.5% for FPPP. The city's $725.6 million in fiscal 2011 LACERS and FPPP contributions for general fund departments represented 18.5% of general fund spending. That percentage will continue to remain high. Given recent higher investment returns, changed actuarial assumptions, and labor concessions, by fiscal 2013 the city expects to contribute to its pension systems $848 million or 18.6% of that year's projected $4.6 billion general fund spending. The city's annual OPEB contributions for general fund departments ($773.5 million or 19.8% of fiscal 2011 general fund spending) are projected to grow between $72-$151 million per year through fiscal 2017.
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