Moody's Press Release
$1.5 BILLION OF DEBT AFFECTED
NEW YORK, Sep 22, 1999 -- Moody's has raised the ratings on $1.5 billion of outstanding debt of Orange County, California. The stand-alone and underlying ratings on its Pension Obligation Bonds have been upgraded to A1 from Baa2; the underlying rating on the county's 1995 Refunding Recovery Bonds has been upgraded to A1 from Baa3; the underlying rating on the county's 1996 Refunding Recovery Certificates of Participation (COPs) has been upgraded to A2 from Baa2; the ratings on two pre-funded equipment financings and two fixed asset COPs have been upgraded to A2 from Baa3; and the county's equipment lease financing has been upgraded to A3 from Ba1. At this time Moody's has also assigned to the county an issuer (implied general obligation) rating of Aa3. The outlook for all of the county's rating remains positive. A listing of the rating actions associated with each financing is appended at the end of this Update.
The upgrades of Orange County's debt reflect the county's demonstrated ability and willingness to operate within the reduced operating budget which resulted from its bankruptcy, its continued prudent fiscal management including a commitment to debt reduction, a satisfactory fiscal position by comparison with its peers, and a diversified and thriving local economy.
Rising debt service and pension costs over the next few years will continue to pose a budget challenge and the county has significant unmet capital needs. But proceeds from the settlement of litigation resulting from the collapse of the county's investment pool and proceeds from the nation wide tobacco industry settlement provide the county with the resources to decrease debt and address deferred capital needs. It is also noted that, even after the significant increase in debt from the recovery-related financing, the county's debt levels are moderate.
While the litigation challenging elements of the recovery plan (the White Case) remains under appeal, the outcome of a similar suit in Los Angeles County suggests that the county will ultimately prevail. Further, Moody's believes that the state legislature would take any needed corrective action in the unlikely event the county were to lose the case.
FINANCIAL RESULTS DEMONSTRATE BOTH THE SUSTAINABILITY OF EARLIER BUDGET CUTS AND OFFICIALS' COMMITMENT TO PRUDENT FISCAL MANAGEMENT
Upon emerging from bankruptcy in June 1996, it was not clear that the significant cuts made in the county's operating budget during the bankruptcy would be sustainable. In addition, the county's elected and appointed leadership was entirely new and had no long-term track record of fiscal management. Financial results over the last three years, however, demonstrate the county's ability and willingness to sustain earlier budget cuts as well as officials' commitment to prudent fiscal management.
Reflecting healthy growth in discretionary revenues, effective expenditure controls, and a conservative approach to budgeting, the county showed modest operating surpluses in fiscal 1997 and 1998 ($16.1 million and $26.5 million, respectively). Fiscal 1999 results are expected to be strong, with general purpose revenues exceeding budget by 7% and expenditures at 10% below budget. The fiscal 2000 budget projects 8% growth in General Fund revenues to $1.8 billion. It is balanced using reasonable assumptions and no significant one-time funds to cover ongoing programs.
The county is committed to maintaining healthy fund balances, which have increased in recent years. Total fund balances for fiscal 1997 and 1998 equaled $136.3 million and $162.8 million respectively. Because the county has substantial reserves outside the General Fund, primarily the TRAN reserve established at the time the county emerged from bankruptcy, total available fund balances are dramatically higher and are also continuing to grow, standing at $211.2 million in fiscal 1997 and $224.9 million in fiscal 1998.
As part of its emphasis on systematic financial management, Orange County developed and adopted a long-term strategic plan. The quality and thoroughness of this plan are noteworthy, especially compared to the long-term planning efforts of other California counties. Among the strategic priorities identified by the county are continued commitment to early repayment of bankruptcy-related debt and funding of specific capital projects. Annual contribution towards pay-go funding of the county's priorities is a key component of the plan.
In accordance with the strategic plan, in fiscal 1999 funds were established for general fund contingency, debt defeasance, and capital projects. The fiscal 2000 adopted budget includes increases in each of these funds. The contingency fund is budgeted to grow to $20 million, and the debt defeasance fund to $27 million. The largest is the strategic priorities fund, established for planned future capital projects and associated operating costs, which is budgeted to grow to $76 million in fiscal 2000. To date the county has used its reserves to defease $31 million of 1995 Refunding Recovery Bonds and retire a small ($2.9 million) equipment lease.
CURRENT FISCAL CONDITION COMPARES FAVORABLY TO OTHER LARGE CALIFORNIA COUNTIES.
Orange County's financial flexibility as measured by its general fund cash position and fund balances is commensurate with that of other California major metropolitan counties, while its total cash and reserve levels are significantly above those of its peers.
The county's general fund net cash and investments represented 4.6% and 4.7% of revenues in fiscal years 1997 and 1998 respectively, at or above the median for California major metropolitan counties. Orange County's net cash adjusted for interfund borrowings grew from 8.2% to 9.2% of revenues in fiscal 1997 and 1998 as compared with the major metropolitan county medians of 6.5% and 9.9%. As mentioned above, the county has substantial resources outside the General Fund. By either measure, if the county's TRAN reserve is included, its cash position would have been significantly above the medians in both years.
Total General Fund balances, at 9.1% and 11.1% of revenues in fiscal 1997 and 1998 respectively, were above and showed improvement as compared to peer group medians of 8.7% and 9.9%. Unreserved general fund balances were at the major metropolitan county medians of 4.8% and 6.6% in fiscal 1997 and 1998 respectively. When the county's other reserves are taken into account Orange County's strong position becomes evident: available fund balances were 14.0% of revenues in fiscal 1997 and 15.4% in fiscal 1998, more than twice the major metropolitan county medians of 6.3% and 7.7% for the respective fiscal years.
LITIGATION SETTLEMENTS AND COUNTY'S SHARE OF TOBACCO SETTLEMENT WILL FUND STRATEGIC PRIORITIES INCLUDING CAPITAL NEEDS
Among the more significant challenges facing Orange County in coming years are its escalating debt service schedule, a scheduled increase in pension contributions, and its unmet capital needs.
As noted above, the county has defeased portions of its 1995 Recovery Bonds. Despite this action, the county's debt service is still scheduled to increase significantly in the medium term. Over the course of fiscal years 2003 and 2004 annual debt service is scheduled to jump by over 10%, then gradually increase through 2012. The county anticipates receiving within several months $285 million as its share of litigation proceeds associated with its bankruptcy. The county expects to use these proceeds, which are in addition to the funds earmarked for debt reduction in its 2000 budget, to reduce debt service on its recovery financings and/or pension obligation bonds.
Orange County also has significant capital needs, notably in the area of public safety. In its 1998 strategic plan the county projected that more than $800 million in capital and operating funding would be needed over the ten-year planning horizon to address all unmet needs. The county has begun about half of the identified projects using pay-go funding. The most significant commitments have been to the second of a five-phase jail expansion, deferred maintenance and ADA compliance projects, and court space needs. These commitments are at or above the amounts suggested in the strategic plan, and demonstrate the county's good faith efforts to address its pent-up demands.
Tobacco settlement funds are being considered to address capital needs and/or further debt reduction. State-specific finality, as defined in the master settlement agreement, has not been reached, which could impact the distributions expected. Current schedules suggest that the county will receive approximately $35 million annually. Use of the funds is intended to be unrestricted but many constituencies, including both local activists and the state, are interested in guiding its application. The county has conservatively chosen to make no firm plans for use of these funds and they have not been included in the county's budget.
DESPITE SIGNIFICANT AMOUNT OF DEBT RESULTING FROM BANKRUPTCY, CURRENT DEBT LEVELS ARE MODERATE
One of Orange County's historic credit strengths had been its low debt level. However, in order to finance its recovery from bankruptcy the county issued significant amounts of debt, which in fiscal 1998 comprised 61% of the county's $1.6 billion total debt outstanding. Although the recovery debt represented a significant increase for the county, by most measures the current debt level is moderate. Relative to the size and wealth of the county, fiscal 1998 direct debt levels - $599 per capita, 0.9% of assessed value, and at 2.1% of 1996 personal income - are moderate, equal to the median for major metropolitan California counties. The county's debt levels relative to its internal resources are high. Debt service in fiscal 1998 accounted for 10.4% of operating expenditures, nearly double the metropolitan county median of 5.7%. The county's net lease burden, at 5.9% in both fiscal 1997 and 1998, is well above the median 3.7%.
COUNTY'S ECONOMY IS DYNAMIC AND WELL-DIVERSIFIED; WEALTH AND INCOME LEVELS ARE HIGH
Orange County was hit fairly hard by the early 1990s recession due to declines in the aerospace/defense sector, but the overall diversity and resilience of its economy has been demonstrated by the rapidity with which growth in other sectors offset these losses. Overall between 1992 and 1997, the county showed a 9.2% increase in jobs as compared with the statewide 8.3%. Orange County's unemployment rate has throughout the decade been consistently lower than the state and national rates, and, at 2.9% in 1998, was the second lowest among all California counties. The vibrancy of the county's economy is also evident from its growth in taxable sales, which since 1993 has exceeded the state rate each year. The county measured 91% on an employment diversity index calculated by Moody's, reflecting distribution of employment across industries in 1997 nearly as broad as the state as a whole.
Continued growth seems likely. Noteworthy projects include Walt Disney Company's new $1.4 billion theme park, 750-room hotel and retail complex scheduled to open by 2001 and the $550 million Pointe Anaheim, located across from Disneyland, comprised of three hotels with 1,050 rooms and 565,000 square feet of retail space.
Orange County's wealth levels are high by comparison both to the state as a whole and to its neighboring counties. Whereas all its neighboring counties showed per capita incomes lower than the state in 1996, Orange County's per capita income was 114% of the state level. Orange County's taxable sales per capita, at $13,043 in 1997, were higher than the California major metropolitan county median of $11,000, and exceeded the rates of all it neighbors by a minimum of $3,000. Assessed value per capita is also high, at $69,447 in 1999 exceeding the median of $67,616 for major metropolitan counties and surpassing the rates of all its neighboring counties by over $11,000.
Y2K ISSUES ARE REPORTEDLY BEING ADDRESSED
Orange County reportedly has identified all mission-critical systems. The county selected replacement rather than retrofit as its primary Y2K strategy, which has raised the cost of compliance somewhat but was deemed to be a better long-term business strategy. The county reports that most of its critical systems are now compliant, including financial systems and the Countywide Accounting and Personnel System. It is noteworthy that interest on the county's 1996 Recovery Certificates of Participation is payable on January 1; however the state intercept program, which deposits funds monthly with the Trustee, is scheduled to make its final deposit with respect to that payment on December 10. It can therefore be expected that the full sum due to bondholders will be available with the Trustee prior to January 1, 2000.
RATINGS ON SPECIFIC ISSUES
Pension Obligation Bonds: The county has outstanding three series of taxable pension obligation bonds: Series 1994A, 1996 Series A, and 1997 Series A. The rating on the Series 1994A has been upgraded to A1 from Baa2. The underlying ratings on the 1996 and 1997 series, which are rated Aaa based upon insurance, have been raised to A1 from Baa2. These bonds are secured by an unconditional, general fund obligation derived from an obligation under state statute to amortize unfunded pension obligations.
1995 Refunding Recovery Bonds: The underlying rating on this issue, which is rated Aaa based upon insurance, has been upgraded to A1 from Baa3. These bonds are unconditional, non-abatable obligations of the county, which were validated on the same basis as Pension Obligation bonds, with the judgment rendered that they were refunding involuntary obligations imposed by law. These bonds are enhanced by a priority lien on motor vehicle license fee (MVLF), but the intercept mechanism lacks many of the legal and procedural strengths of the 1996 Certificates of Participation.
1996 Recovery Certificates of Participation: This rating has been upgraded to A2 from Baa2. General fund lease payments for the use of a number of facilities provide the primary security for the Certificates of Participation (COPs). Repayment is additionally secured by a lien on two county revenues -- the MVLF and sales tax revenues -- both of which are collected by the state. The dedicated revenues alone provided about 1.90 times coverage at fiscal year end 1999, net of debt service on the 1995 Refunding Recovery Bonds which have a priority claim on the MVLF. Unlike other intercepts established by the state, this one provides a statutory lien on the intercepted revenues, a statutory mechanism for the direct payment of these revenues to the trustee, and a legislative commitment to take no action that would impair the debt. While the intercept mechanism represents a credit strength, Moody's does not believe that at the county's current rating levels the added security is sufficient to warrant a rating distinction compared to the county's other leases.
Real Property Lease Financings: The county has outstanding two COPs secured by county leases with the Orange County Public Finance Corporation (OCPFC), the 1991 Civic Center Parking financing and the 1992 Juvenile Justice Center Refunding. Both issues are rated Aaa based on insurance. The underlying ratings on both issues are being upgraded to A2 from Baa3.
Equipment Lease Financings: The county has three leases outstanding secured by equipment. Typically, leases on personal property are rated one level below the lessee's strongest real property leases. Consistent with that practice, the rating on the county's Master lease Schedule No. 2, 1990 equipment certificates are being upgraded to A3 from Ba1. The county has two additional equipment certificates outstanding, OCPFC July 1986 and OCPFC February 1993. The rating on the 1986 certificate is being raised to A2 from Baa3. The underlying rating on the 1993 certificate, which is rated Aaa based on bond insurance, is being upgraded to A2 from Baa3. Ratings on both the 1986 and 1993 certificates reflect the fact that, in both cases, funds have been deposited with the respective trustees which, together with expected interest earnings and the reserve account, should be sufficient to fully pay these two obligations. While not legally defeased, the advanced deposit of funds does mitigate the additional abatement risk associated with personal property.
Moody's outlook for the Orange County's ratings is positive, based upon the possibility that, given the county's underlying economic strengths and commitment to prudent fiscal management, actual economic trends and financial results could exceed the now positive expectations.
The county's capital needs appear somewhat high compared to other large counties in the state, and the magnitude of the county's estimates remains a credit issue reflected in the current ratings. But, the county's estimates are also reflective of the thoroughness of the its long-term planning efforts. Over time, Orange County's needs may prove to be no greater than those of its peers.
Like all California counties, Orange County has very limited financial flexibility and remains highly vulnerable to state budget actions. Absent significant statewide fiscal reforms, these factors will continue to limit the up-side potential of the county's ratings.
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