Fitch Downgrades Fresno County, CA Pension Oblig Bonds to 'A' on Criteria Change; Outlook Stable

Fitch Ratings has downgraded the following ratings on Fresno County, CA (the county) obligations based on review of the credit under Fitch's revised criteria for U.S. state and local governments:

--$216.5 million taxable pension obligation refunding bonds (POBs), series 2004 to 'A' from 'A+';

--Issuer Default Rating to 'A+' from 'AA-'.

The Rating Outlook is Stable.

SECURITY

The POBs are payable from any legally available source of funds.

KEY RATING DRIVERS

The 'A+' IDR reflects the county's weak revenue framework, adequate gap-closing ability, moderately low liabilities relative to income, and good spending flexibility.

Economic Resource Base

Fresno County is located in the southern portion of California's San Joaquin Valley, halfway between Los Angeles and Sacramento. With a population of approximately 952,000, the county serves as the regional hub for services, commerce and trade for the agriculturally-centered southern San Joaquin valley.

Revenue Framework: 'bbb' factor assessment

Revenues have been stagnant over the past decade, with growth below the level of inflation. In addition, under the state constitution, the county has very limited ability to increase revenues without voter approval.

Expenditure Framework: 'aa' factor assessment

The county's expenditure flexibility is judged to be solid, with moderate carrying costs for debt service and pensions. However, the pace of spending is expected to be above that of revenues going forward given the limited expected growth in revenues.

Long-Term Liability Burden: 'aa' factor assessment

The county's liability burden, including overall debt and direct pension liabilities, is moderately low relative to the county's resource base.

Operating Performance: 'a' factor assessment

The county's reserves and inherent budget flexibility provide adequate gap-closing capacity relative to its expected revenue volatility in a moderate downturn scenario. However, the county has continued to support its operations with no deferral of required spending and has made prudent use of reserves for capital and other projects during the recovery.

RATING SENSITIVITIES

Reserve Levels: Reserve levels are judged to be just adequate based upon expected revenue volatility given the county's budget flexibility. A reduction in reserve levels could result in negative rating pressure.

CREDIT PROFILE

The regional economy is heavily dependent on agriculture and food manufacturing. After government, which accounts for about 19% of county employment, agriculture is the largest employment sector at about 15%. As is common in agricultural communicates, unemployment rates are consistently higher than state and national levels. In addition, median household income levels are low at 72% of state and 81% of national averages.

Revenue Framework

Intergovernmental revenues accounted for nearly 70% of general fund support 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.

General fund revenues, adjusted for accounting changes, have lagged behind inflation and overall U.S. economic performance over the past 10 years. Based on the large share of revenues from intergovernmental sources, and continued spending controls at the state and federal levels, Fitch expects revenue growth to continue to lag behind U.S. GDP despite local economic improvements.

Like 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.

The county's general fund revenues have been adjusted for the FAST tool in order to account for 1) an accounting change in fiscal 2014 in which the majority of state and federal revenues were moved out of the general fund and 2) an accounting issue in which over $300 million in food stamps revenues was erroneously included in the fiscal 2010 general fund revenues.

Expenditure Framework

Approximately 68% of general fund spending is related to public assistance programs, primarily funded by state and federal sources, followed by public safety at 28%.

The pace of spending is expected to be greater than that of revenues given the very low historical revenue growth.

Spending flexibility is solid with carrying costs for debt service and pension contributions accounting for 16% of spending, and the county adding back service cuts made during the recession. The county has no spending related to retiree healthcare as it has never offered other post-employment benefits (OPEBs). The county cut positions, implemented layoffs, and imposed salary reductions during the economic downturn and had been reversing these actions at a gradual pace providing some future spending flexibility. Labor contracts are in place with 23 bargaining units with expiration dates ranging from December 2016 through July 2018. Terms of the contracts appear affordable, including 2% salary increases each year. The county has experienced a contentious relationship in recent years with Service Employees International Union (SEIU), which represents about 63% of employees and which went on a three-day strike in 2012. However, the county's recent agreement with SEIU resolved all of the pending Public Employment Relations Board issues.

Long-Term Liability Burden

The county's long-term liability burden is low to moderate with overall debt and pension equal to about 10.3% of personal income. However, amortization is relatively slow and approximately one-third of its outstanding debt is POB capital appreciation bonds with rising debt service.

The county participates in the Fresno County Employees' Retirement Association (FCERA) and the plan's Fitch adjusted ratio of assets to liabilities is 80%.

The county's main capital need is the $88 million West Annex Jail project, 90% of which has been funded by a grant provided by the California Board of State and Community Corrections under SB 1022. The county has already set aside its required $8.8 million match. The county will close its old jail and move existing staff to the new jail upon completion in late 2019 and thus expects operating costs to be relatively stable. The additional staff needed at the new jail will be funded from state and federal sources as they are primarily health and human services positions.

The county has set aside $18 million and budgeted an additional $10 million in fiscal 2017 (both included in the assigned general fund balance) related to POB litigation. The county refunded its POBs in 2002 and extended the term of the bonds by 10 years, resulting in increased debt service payments. The US Department of Health & Human Services (DHHS) indicated it would not accept for federal reimbursement purposes about $55 million in pension debt service payments spread out over fiscal 2015 to 2019. The county intends to appeal any disallowance of reimbursement.

Operating Performance

Although reserves have been quite steady at about 10% even through the recent economic downturn, the county has a limited cushion relative to its above average degree of revenue volatility. The county's solid performance during the recession was aided by its policy of reducing costs consistent with revenue reductions. The deficit in fiscal 2014 was related to an accounting action in which general funds were reclassified as behavioral health and social services.

The county has managed its budget primarily through cost-cutting with no deferral of required spending. The county increased its employee count over the past several years in part to restore cuts made during the recession and 49 positions were added as part of lawsuit and consent decree related to ADA improvements at the county jail. These positions are being fully funded by state and federal sources. The county's practice with regard to state programs has been 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 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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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1012520

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