SAN FRANCISCO--(BUSINESS WIRE)--Fitch Ratings has affirmed the following El Monte Public Financing Authority, California's (the authority) bonds:
--$18.8 million lease revenue bonds (City Yard Project) series 2010A & B at 'BB+'.
In addition, Fitch affirms the following rating for El Monte, CA (the city):
--Implied general obligation bond at 'BBB'.
The Rating Outlook is revised to Negative from Stable.
SECURITY
The city has covenanted to budget and appropriate lease rental payments, subject to abatement, to the authority for use of its public works yard and its civic center complex from any available funds to the city.
KEY RATING DRIVERS
NEAR-TERM CHALLENGES DRIVE OUTLOOK REVISION: The Negative Outlook reflects Fitch's concern over the city's ability to manage rising labor and pension costs and service restoration pressures even if the temporary sales tax measure is reapproved by voters, given continued weakness in the economy and persistent management turnover.
ADEQUATE FINANCIAL POSITION: The city's liquidity and general fund reserve positions remain adequate, supported in part by a property tax override levied in perpetuity for pensions. However, Fitch believes the city's current financial cushion is vulnerable given financial pressure over the next few years.
MANAGERIAL/REPORTING CONCERNS SOMEWHAT ABATED: Fitch is somewhat less concerned about management following a reversal of its stated intent in May 2012 to violate the city's legal obligation to pay its LRB debt service from any available source of funds if sufficient tax increment revenues had not been received from the county. The low rating also reflects Fitch's ongoing concerns about the quality, timeliness and transparency of the city's financial disclosure though the unqualified audits the past two years are positive developments.
DSRF DRAW LESS LIKELY: Fitch's concerns about a draw on the debt service reserve fund are lower given that several debt service payments have been made subsequent to RDA dissolution and the new tax increment distribution process continues to stabilize. A cash flow loan from the city was subsequently repaid with tax increment.
WEAK ECONOMIC INDICATORS: The city is poised to benefit from its location within the broad and diverse Los Angeles regional employment market but remains constrained by high unemployment, low wealth and income indicators and elevated poverty levels.
MODERATE DEBT LEVELS: Debt ratios are moderate and amortization is average. Carrying costs are moderate but increasing due to rising pension costs.
RATING SENSITIVITIES
FINANCIAL DETERIORATION: The city remains challenged by its limited economy and rising cost profile which threaten to reduce the current acceptable level of financial cushion. The rating would be downgraded if the city's revenue streams are unable to support rising costs while maintaining ample reserves and liquidity.
DSRF DRAW: A draw from the bonds' DSRF, while not anticipated, would trigger a downgrade.
CREDIT PROFILE
The city serves a population of 114,436 and covers 10 square miles approximately 12 miles east of downtown Los Angeles.
FINANCIAL OPERATIONS AND DISCLOSURE IMPROVING
The city released its fiscal 2011 audit approximately 10 months after the end of its fiscal year as it addressed deficient internal controls that resulted in a qualified fiscal 2010 audit. The internal control issues stemmed largely from delays in the city's cash reconciliation process and inadequate documentation of city loans to the RDA. Further complications included a reduction in key accounting personnel and deficient record-keeping and accounting processes. The fiscal 2011 and 2012 unqualified audits suggest that progress has been made though Fitch remains concerned about the city's financial disclosure practices.
After fund balance restatements in four of the past five years, fiscal 2012 did not have any governmental fund balance re-statements. However, financial statements are difficult to interpret due to a large number of interconnected funds (loans to and from funds with negative fund balances). Including internal service funds, eight funds have a combined negative fund balance of over $5 million necessitating general fund interfund loans of $3.9 million (7% of general fund spending).
The audit notes the aggregate amount of such loans to non-major governmental funds from the general fund; however, Fitch must rely on un-audited representations from management regarding the nature of such loans and the likelihood and timing of repayments. Based on recent years' internal control issues, Fitch views this as a material weakness. Management noted that approximately 17% of the combined deficit is overstated as it represents capital spending in advance of reimbursements received.
The fiscal 2012 internal service fund deficit stems from a $3.2 million deficit in the city's self-insurance fund that has improved by $745,000 from fiscal 2011. Fitch remains concerned about the funds' ability to repay the general fund in a timely manner and the potential impact on general fund balances.
LIQUIDITY, GENERAL FUND CUSHION ADEQUATE BUT VULNERABLE
The fiscal 2012 audit reports the general fund produced a small $200,000 operating surplus (after transfers), raising the unrestricted fund balance to $8.6 million (16.2% of expenditures and transfers out). The total fund balance also remained basically flat at $27.5 million (51.6%) after declining the prior year from $106.2 million (225%) due mostly to a restatement that effectively wrote off the general fund's receivable from its now dissolved RDA. The restatement has no impact on the bonds' credit rating as Fitch did not view the receivable as an available resource in prior reviews.
The fiscal 2012 audit also reports a $2 million (52%) increase in general fund cash bringing it to an adequate $6.2 million. In addition, the general fund has access to $21.9 million of borrowable cash (as of fiscal year-end 2012) in the city's retirement fund. The city levies a property tax override as a fixed percentage of AV to pay for pension costs and spends the proceeds a year in arrears, resulting in a historically comfortable pool of internal borrowable resources. The fund has generated a surplus ranging from $390,000 to $1.66 million the past three years. Fitch anticipates this resource will continue to be available although is concerned that rising pension costs may require contributions above the yield from the levy. Management notes that tax proceeds are currently just sufficient to meet annual CalPERS costs.
Although management did not provide budget to actuals, it estimated a small surplus for fiscal 2013. Fitch notes that the fiscal 2014 budget was approved on time and shows breakeven general fund operations. This includes about $1.7 million in carryover spending to offset $1 million in assumed reduction related to the April 2014 sunset of Measure GG sales tax and an increase of $2.6 million in the city's fire services contract with Los Angeles County. The budget also includes across the board departmental reductions of 9.6%.
PRESSURES ESCALATE IN 2015
The city placed a sugary drink consumption tax on the November 2012 ballot, which would have generated revenues in the range of $3 million to $7 million, and declared a fiscal emergency so that the voter approval threshold could be lowered to just 50%. However, the measure failed by a remarkable 77%. Management maintained that the fiscal emergency did not reflect short-term insolvency, which is consistent with the city's audited fund balance and borrowable resources. However, it reflected significant budgetary pressure.
The city's five-year Measure GG 1/2-cent sales tax expires in April 2014 and currently generates about $4 million annually, or 7.9% of fiscal 2012 revenues. If the sales tax measure is not extended the city could face substantial financial headwinds with $2 million in deferred wage increases on closed labor contracts (expiring Dec. 31, 2015) and backfill of lost grant funds. As such, the city plans to place a renewal of its sales tax measure on the November 2013 ballot and has identified cuts totaling 8% of fiscal 2012 spending in the event it does not pass. These are substantial and include cuts of $2.8 million to the police department (9.5% of full-time positions), $475,700 to public works (7.5% of full-time positions), and $200,000 or more to parks and recreation, city manager, and economic development among others.
Actions previously considered by the city (including the sale of the city's water system, privatization of various public works functions, and outsourcing of an aquatic center) are reportedly no longer on the table. Management cites labor relations as strong, and Fitch notes that the city's unions have provided material concessions in prior years that may bode well for productive negotiations in future years, if further concessions are required.
MANAGEMENT AND DSRF DRAW CONCERNS SOMEWHAT ABATED
The city has covenanted to pay for debt service from any available source, though the city has intended for its redevelopment agency (RDA) and water and sewer enterprises to pay debt service per cooperative agreements. Management took the position in May 2012, which it has since reversed, that the city would not make its full debt service payment if the county failed to remit sufficient tax increment revenues to the RDA in a timely manner.
The concern stemmed from RDA dissolution complications (per AB 1X 26). In the event of a related shortfall, the city would have drawn from the LRB DSRF, which management and the city's attorney considered an available source of revenue to the city per the bond indenture. Fitch believes this would have constituted a payment default under the lease, and potentially could have led to severe repercussions, including an interest rate hike to 12%, repossession of the leased assets by the trustee, and acceleration of all remaining principal payments and accrued interest.
Management reports the RDA ultimately received sufficient revenues from the county to meet its Aug. 1, 2012 debt service payment and it does not anticipate similar complications moving forward. Management stated that debt service for the LRBs is contained on the agency's recognized obligation payments schedule (ROPS), which was approved by the state's department of finance.
Management further noted that its policy stance has shifted since May 2012, and that the city would adhere to its covenant to budget and appropriate for debt service in the event of a potential tax increment revenue shortfall, regardless of the cause of any such shortfall.
While concerns related to management are somewhat lessened, management has experienced significant turnover the last several years, with the finance director and city manager leaving in fall 2012. The interim finance director, with the city since January 2013, also recently departed leaving the interim assistant finance director as head of the Finance Department. Such turnover raises concerns about continuity of operations.
RDA CASH FLOW TIMING ISSUES
The city's RDA continues to face cash flow issues resulting from dissolution legislation that resulted in its inability to fully pay both its tax allocation bonds and its LRBs on a timely basis. Management fully paid the LRBs from tax increment, necessitating a $564,000 draw from the TAB's DSRF, which was subsequently replenished. However, AB 1X 26 states that TABs have a lien on tax increment revenues that is senior to all other debts of the agency. If the city has begun paying its TABs on such a basis, then there would have been insufficient tax increment to pay debt service on the LRBs, necessitating that the city find an alternate source of liquidity or draw on the LRB DSRF.
As expected, the city provided a cash flow loan to ensure that both the LRBs and the TABs were fully paid from tax increment in fiscal 2013. This loan was approved for repayment from the next succeeding tax increment receipts by the state Department of Finance. Approximately $4.3 million in tax increment was received in fiscal year 2013 to pay less than $2 million in debt service on the TABs. Management expects that the city will receive enough tax increment on a go forward basis to pay debt service on the 2007 TABs. However, management stated its commitment to continued short-term cash flow loans as long as necessary.
UTILITY FUND LEASE PAYMENTS
The city remains vulnerable to thin water system operating margins and may have to subsidize water obligations in the future. Under a sublease agreement related to the 2010 lease revenue bonds, the water fund and sewer fund are to make payments to the general fund of $200,000 and $300,000 annually. The water fund is also required to make debt service payments on $17 million refunding revenue bonds, series 2006. In addition, under an $18.4 million capital lease agreement, the water fund is obligated to make annual lease payments to the general fund subject to the availability of surplus revenues.
Water fund financial performance appears to be weak with debt service coverage on the 2006 revenue bonds hovering around 1.0x for the last five years and liquidity that has declined over the last several years to $1.5 million in fiscal 2012 (or 416 days cash on hand). The sewer fund does not have any debt and its liquidity has increased to $6.5 million (about 1,000 days). As such, the sewer system appears able to continue to make their portion of the 2010 lease payments, while Fitch remains concerned about the water fund's ability to make such payments.
LOCAL ECONOMY STILL WEAK, BUT TAX BASE REMAINS RESILIENT
The local economy remains weak, though some economic indicators are improving. The April unemployment rate was high at 11.5%, though down from 13% year over year due to strong employment growth. Household income levels are low at 68% and 79% of state and national averages, respectively. The 22% local poverty rate exceeds the county and state averages of 16.3% and 14.4%, respectively. The economy's bright spot is its mature tax base, which fell only 2.1% during the downturn, and has since posted two years of modest gains. The tax base contains minimal concentration among its top 10 taxpayers, which make up 6.6% of AV.
MODERATE DEBT; RISING PENSION COSTS
The city's debt burden is moderate at $2,340 per capita, or 4.5% of AV. Carrying costs (debt service, pension costs, and OPEB contributions), are moderate at 19.2%. The city's carrying costs could become a pressure point as escalating pension rates may begin to outstrip growth in related pension tax revenues.
Contact:
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.
Applicable Criteria and Related Research:
--'Tax-Supported Rating Criteria' (Aug. 14, 2012);
--'U.S. Local Government Tax-Supported Rating Criteria' (Aug. 14, 2012).
Applicable Criteria and Related Research:
Tax-Supported Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=686015
U.S. Local Government Tax-Supported Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=685314
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=799477
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