PHOENIX – Sacramento County’s slow progress in building up its reserves could spell trouble for California’s most bond-indebted county.
Analysts said a relatively gradual buildup of reserves is a potential red flag for the county that is home to the state’s capitol, which has run up billions of dollars of bond debt to fund its pension obligations and to renovate its airport.
Reports compiled by the state controller’s office show that Sacramento County’s indebtedness quadrupled and its debt service nearly tripled in the past decade, far outstripping counties with much higher revenues.
According to that data, Sacramento County’s total bond indebtedness rose from about $500 million in 2005 to more than $2 billion in fiscal 2014. Debt service expenditures of just over $50 million in fiscal 2005 increased to $149 million in fiscal 2014. The county of about 1.5 million residents has had fairly flat revenues during that time, going from $2.62 billion in fiscal 2005 to $2.56 billion in fiscal 2015.
Sacramento County’s bond indebtedness is quite high compared to even much more populous counties or those with far greater revenues.
Its more than $2 billion in debt far outstrips Los Angeles County’s $682 million, but is also much larger than the indebtedness of San Diego County ($754 million), Alameda County ($452 million), and Santa Clara County ($1.2 billion). Of those counties, only Alameda had less revenue in fiscal 2014 than Sacramento.
One key distinction is that the county has borrowed about $1 billion in revenue debt for Sacramento International Airport, which is part of the county airport system. That debt is serviced through airport revenue.
None of the other comparison counties have an airport on their balance sheets.
But Sacramento County has also issued nearly $2 billion in pension obligation bonds since 1995.
Fitch affirmed Sacramento County’s POBs and certificates of participation at an A-minus in August, noting then that the county had about $990 million outstanding in POBs issued in six different series between 1995 and 2013. The POBs are absolute and unconditional obligations imposed by law and are payable from any money lawfully available to the county.
Fitch assigns the county an implied general obligation rating of “A.”
“Their finances are still pretty weak,” Fitch analyst Stephen Walsh said. “They’re making progress, but it’s slow.”
Walsh said that Sacramento County suffered the same way many other issuers did during the great recession, but hasn’t been able to bounce back as well as some others. Most of the signs overall are positive. Fitch’s most recent report noted that total employment levels had surpassed pre-recession levels and that general fund tax revenues grew 6.4% in fiscal 2014- their first solid increase in more than five years.
But Walsh added that the county hasn’t managed to build up enough liquidity during the recovery period to make him confident that they could withstand another economic downturn.
“That’s a red flag for us,” Walsh said.
“The rating is sensitive to changes in financial flexibility, as indicated by unrestricted general fund balance and cash levels,” he and fellow analyst Karen Ribble wrote in the August report. “An inability to attain at least a modest fund balance cushion during the current economic expansion, in anticipation of an eventual slowdown or reversal of economic and revenue growth, would increase downward rating pressure.”
The county’s general fund maintained about one month of annual spending requirements at the end of fiscal 2014, but Fitch said the county had nearly $2 billion in borrowable resources.
Jen Hansen, Standard & Poor’s primary analyst for Sacramento County, noted both the county’s high debt load and its liquidity challenges.
“We consider their debt load to be high, for sure,” Hansen told The Bond Buyer. “We do view their reserves as being not strong. Actually, very weak.”
S&P also rates Sacramento County’s POB debt at an A-minus with the county itself rated a notch higher, both ratings having been upgraded in 2013 due to improving economic performance. Hansen said that the average rating for a city or county is AA-minus, and that Sacramento County posted some pretty ugly financial results during the recession.
“For example, in 2009, they had a negative $128 million general fund result,” she said. “That’s pretty substantial.”
Since then, Hansen said, the county has taken some steps to shore up its overall position, tackling “other post-employment benefits,” i.e. retiree healthcare.
“They have made some good strides on reducing their OPEB costs pretty significantly,” said Hansen.
Neither Fitch nor S&P considers issuing POBs inherently negative, but other market participants have begun to.
In January, the Government Finance Officers Association issued an advisory against using the taxable securities to shore up issuers’ pension funds.
“The use of POBs rests on the assumption that the bond proceeds, when invested with pension assets in higher-yielding asset classes, will be able to achieve a rate of return that is greater than the interest rate owed over the term of the bonds,” the GFOA advisory said. “However, POBs involve considerable investment risk, making this goal very speculative.”
There’s potential double-whammy if the investments purchased with POB proceeds fail to perform as expected.
“Failing to achieve the targeted rate of return burdens the issuer with both the debt service requirements of the taxable bonds and the unfunded pension liabilities that remain unmet because the investment portfolio did not perform as anticipated,” the GFOA wrote.
All of the county’s outstanding POBs are set to reach final maturity within the next 15 years. The county still has one POB-related swap on its books which had a negative termination value of $112 million as of July.
As for the county’s airport operation, it has experienced some annual passenger growth in recent years and is also in the process of developing a hotel project to generate revenue to further offset the debt service.
