News Column

Fitch Upgrades El Monte PFA, California's LRBs to 'BBB-'; Outlook Stable

August 8, 2014

SAN FRANCISCO--(BUSINESS WIRE)-- Fitch Ratings has upgraded the following El Monte Public Finance Authority, California (the authority) bonds:

--$18.7 million revenue bonds (City Yard Project) series 2010A and 2010B to 'BBB-' from 'BB+';

--Implied general obligation bonds (GOs) to 'BBB+' from 'BBB' for the city of El Monte, California (the city).

The Rating Outlook is revised to Stable from Negative.

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 from any available funds of the city. The bonds are additionally secured by a cash-funded debt service reserve fund sized to the IRS maximum.

KEY RATING DRIVERS

IMPROVED FINANCIAL, MANAGERIAL PERFORMANCE: The upgrade reflects material improvements to the city's financial position and management practices. These include passage of a five year sales tax override extension, a fifth year of structurally balanced general fund operations and the third year with an unqualified audit. The city's early efforts to develop a comprehensive plan to maintain structural fiscal balance over the long-term is also a credit positive.

FISCAL, MANAGERIAL CHALLENGES REMAIN: The city faces rising pension costs and a large deferred wage increase beginning in 2016 that will require expenditure restraint by policymakers, despite the city's improved financial position. Also, the financial management team has faced substantial turnover in recent years, which Fitch views with concern.

TWO-NOTCH DISTINCTION: The two-notch distinction between the implied GOs and the revenue bonds reflects statements made by management in 2012 that called into question the city's willingness to pay revenue bond debt service from any available source, as legally required. Although management has since confirmed its legal commitment, Fitch is likely to maintain a two-notch distinction until sufficient time has passed under a stable management team.

SATISFACTORY DEBT PROFILE: Debt levels and principal amortization are moderate, the city's capital improvement plan is relatively small, and there are no plans for additional long-term debt. Plans to fund a recently created OPEB trust are viewed favorably. Although carrying costs are moderate, they are expected to rise with escalating pension costs.

WEAK, IMPROVING LOCAL ECONOMY: The local economy is weighed down by very low income levels and high yet improving unemployment. These weaknesses are somewhat mitigated by the city's location within the extremely large and well diversified Los Angeles employment market, large commercial projects planned and under construction, low taxpayer concentration, and a mature housing market that resulted in resilient assessed valuation (AV) levels during the recession.

RATING SENSITIVITIES

MANAGERIAL STABILITY, SUSTAINABILITY PLAN: Evidence of improved managerial continuity and successful implementation of a prudently crafted fiscal sustainability plan, now under way, could lead to positive rating action.

FINANCIAL DETERIORATION: Unexpected and substantial deterioration of the city's general fund operations or financial management practices could lead to negative rating action.

CREDIT PROFILE

The city serves a population of about 116,000 and covers 10 square miles approximately 12 miles east of downtown Los Angeles.

IMPROVED FINANCIAL OPERATIONS, BUT WEAKNESSES REMAIN

The upgrade in part reflects the city's improved financial operations, with fiscal 2013 marking the city's fifth consecutive general fund audited surplus, raising the city's unrestricted fund balance to a solid $11.5 million (22.6% of expenditures and transfers out). The city's satisfactory operating results are estimated to continue, with an unaudited fiscal 2014 surplus of $400,000 and a budget that is nearly balanced for fiscal 2015 net of reserve set-asides and contingencies.

The city's financial profile was boosted significantly by passage of Measure GG, a five year extension of a sales tax override, approved by a high 71% of voters in November 2013. The tax is estimated to generate $4.2 million annually. The city's fiscal 2014 budget assumed failure of the override and management had prudently implemented significant expenditure reductions that were largely reversed following voter approval of the sales tax extension. The sales tax provides management with time and resources to prepare for the eventual sunsetting of the tax in an environment expected to be pressured by rising pension costs, and pent up wage and service level pressures.

The city faces $2 million of deferred wage increases that take effect on January 1, 2016 absent an overriding labor agreement, and pension costs are expected to rise significantly from current levels. Policymakers will need to continue exercising expenditure restraint to maintain structural balance given these pressures. The low 'BBB+' GO rating in part reflects concern about whether these pressures will be adequately addressed based on recent years' high managerial turnover and financial reporting issues. Demonstrated ability to deal with these pressures moving forward could result in a positive rating action.

ENHANCED FINANCIAL MANAGEMENT PRACTICES DESPITE HIGH TURNOVER

Over the past year the city took a number of prudent steps towards improving its financial policies and long-term fiscal position. Policymakers approved an irrevocable OPEB trust in fiscal 2015, with expectations that pre-funding will begin in fiscal 2016 upon anticipated implementation of a fiscal sustainability plan (see below for more information on the plan). In addition to the successful extension of the city's sales tax override, policymakers prudently approved a reserve to be funded with 20% of Measure GG sales tax revenues. Although the reserve may be used for any board-approved purpose, the city intends to hold the reserve until the potential non-renewal of the tax in five years.

In 2014 City Council authorized a private consultancy to perform a comprehensive assessment of the city's financial condition and trajectory, and to prepare a fiscal sustainability plan, expected to be available in November 2014. The plan will include a 10-year multi-year financial projection and capital improvement plan, with recommendations regarding service delivery options, reserve level targets, and areas of potential expenditure reductions.

The goal of the plan is to ensure long-term structural balance while achieving service delivery targets. Fitch views the city's use of a third-party consultant as a credit positive given recent years' concerns over high managerial turnover and certain financial reporting timeliness and quality issues.

WEAK ECONOMY SHOWING SIGNS OF RECOVERY

The local economy is weak overall despite continued recovery from the recession. Household income levels are low at 68% and 79% of state and national levels, respectively, and poverty levels are high. The city's April unemployment rate registered a high 9.5%, though it has improved from 11.7% the year prior. Educational attainment levels are very low.

The city's tax base is well diversified, with the top 10 taxpayers making up just 6.8% of AV. The tax base also benefits from the maturity of the local housing stock, with AV declining a total of just 2.1% during the recession. Fiscal 2015 AV increased by a moderate 3.8% to a record high $6.3 billion.

Management cited large scale commercial real estate projects in various stages of construction and planning that could ultimately add roughly $750 million to AV (12% of fiscal 2014 AV levels) over three to four years, with significant sales tax generators. These include the redevelopment of a major industrial site, a Super Wal-Mart, a large retail outlet center, and the renovation of a local transportation hub.

ADEQUATE DEBT PROFILE

Overall net debt levels are low to moderate at $1,854 per capita (3.7% of AV) and direct debt amortizes at an average rate of 48% and 62% in five and 10 years, respectively. Capital needs are modest, consisting mostly of street improvements and deferred maintenance. Management expects the improvements will be funded with reserved revenue sources and grants from state and federal sources, and no long-term debt issuances are anticipated. Carrying costs (debt service, OPEB, and pension costs over total governmental expenditures) are moderate at 20%, but are expected to rise given likely pension cost increases.

The city has a pension property tax override that provided for full funding of employee pensions in prior years. However, pension costs have risen to $3 million above pension override revenues, and this gap will worsen if pension costs continue rising faster than AV levels. The pension override fund contains a large fund balance that will absorb the pension funding gap for some years, providing a limited amount of time for management to potentially implement offsetting measures.

The revenue bonds are secured by any available funding source, and the city uses former redevelopment agency (RDA) tax increment and revenues from its water and sewer systems to pay debt service, thus posing no direct burden to the general fund as long as these sources remain adequate, as management anticipates.

Net tax increment revenues amply cover tax allocation bond and revenue bond debt service. The water fund's financial health is somewhat weak, but has improved over the last two audited years with rising liquidity and debt service coverage that has increased to 1.23x in fiscal 2013 from 0.99x in fiscal 2010 (exclusive of rate stabilization fund balances). The sewer fund has no debt and good liquidity, suggesting a solid capacity for continued payment of its portion of the revenue bond debt service.

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=848396

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.



Fitch Ratings

Primary Analyst

Scott Monroe

Director

+1-415-732-5618

Fitch Ratings, Inc.

650 California Street

San Francisco, CA 94108

or

Secondary Analyst

Matthew Reilly

Director

+1-415-732-7572

or

Committee Chairperson

Karen Ribble

Senior Director

+1-415-732-5611

or

Media Relations

Elizabeth Fogerty, +1 212-908-0526

elizabeth.fogerty@fitchratings.com

Source: Fitch Ratings


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