Fiscal pressures on California's counties are mounting despite modest improvement in the state's overall economy, Moody's Investors Service said.
As the worst recession to hit California since the Great Depression begins receding, the state's 58 counties are not likely to immediately reap the resulting rewards, Moody's said in a special municipal credit report.
A restructuring of the state's relationship with local governments has permanently reduced county revenues, Moody's said. Consequently, revenue and spending pressures on counties will not disappear, the agency said.
Nevertheless, county ratings "have shown remarkable resiliency" during the economic downturn, which began in 1991, Moody's said.
In the last two years, Moody's has downgraded the credit ratings of four of the 44 California counties it rates -- Los Angeles, San Bernardino, San Diego, and San Francisco.
"Counties such as [these] have seen their credit fundamentals negatively affected and their credit ratings decline over the last several years," Moody's said.
Recently, "county managers have faced challenges that are unprecedented in our lifetimes," Moody's said. "That only four counties have seen their ratings lowered speaks to their success."
Nonetheless, the creditworthiness of the 44 California counties rated by Moody's has declined since 1991 when compared with credit ratings of all U.S. counties rated by the agency.
For example, in 1991, 48.2% of county issues nationally were rated A1 or higher by Moody's, and in California, 57.7% of county issues were rated A1 or higher.
Today, in contrast, 40.2% of county issues nationally have an A1 or higher rating from Moody's, while in California only 25.2% of counties are rated A1 or better.
"However, the proportion of California county credit ratings at the lower end of the investment-grade rating scale remains favorable," Moody's said. "Only 8.4% of [California] issues are rated below Baal, compared to 10.2% for all U.S. counties."
Currently, the percentage of California county issues -- both general obligations and lease obligations -- that are rated Aal by Moody's totals 0.7%. The percentage of Aa-rated issues is 4.5%; followed by A1, 20.0%; A, 43.9%; Baal, 22.6%; and, finally, below Baal, 8.4%.
Tight management
The percentages are skewed by the inclusion of Los Angeles County. The state's largest county has more than 60 lease obligation ratings, mostly rated A.
The recession and state budget realignments "caused some rating changes," Moody's said. But "proactive and prudent county management in many instances sustained ratings."
"Reorganization and cost-cutting efforts positioned some counties to address future fiscal problems," the agency said. "Modest economic growth. may provide some minor benefits, but the outlook for the next two years is one filled with challenges."
Moody's 20-page report scheduled to be released this week was prepared by Moody's assistant vice president Kevork Khrimian and senior analyst Michael Roberge.
Reached for comment, Khrimian and Roberge said company policy prohibited them from discussing whether any credit rating actions on California counties are, or are not, in the works.
However, as of last week, Roberge said the agency is "current on ratings" of the counties. But, he said, the analysts could not comment on actions contemplated "for fiscal 1995 and beyond."
Khrimian characterized as "amazing" how some California counties "have been keeping themselves afloat" during the fiscal stress.
Several counties have turned to new revenue sources, including one-time financings for short-term financing relief.
A number of counties have adopted socalled Teeter plans in fiscal 1994. Under California law, the technique allows counties to pass along property tax levies to local governments. Then, the county is allowed to keep money received from delinquent taxes and penalties.
Other counties have issued taxable notes, then invested proceeds in investments whose yield is higher than the taxable rate on the notes.
Another method counties have found to raise revenue is the issuance of long-term debt to eliminate unfunded pension liabilities.
"California is creative in general," Khrimian said in discussing the spectrum of financing strategies counties are employing to generate revenues.
"California counties are desperate," he said. "When you put creative and desperate together, this is what comes out."
In its special report, Moody's focused on the state's 17 largest and most credit-sensitive counties. The counties have combined debt outstanding totaling $8.3 billion -- about 90% of the dollar volume of obligations rated by Moody's in California.
Many of the 17 counties "have been hit hard by the national recession and state-level budgetary restructuring," Moody's said.
Statistics on the 17 counties reviewed in the report suggest continued economic weakness in California, Moody's said. For example, unemployment rates in the counties in April 1994 were above those for the yearearlier period.
"Recent economic reports suggest modest improvement for late 1994, but that improvement is far from the robust growth achieved during the 1980s," Moody's Said. "This fact suggests that economic growth alone will be insufficient to improve California counties' fiscal woes."
Property tax shift
Also of concern to Moody's is the state-level budgetary restructuring in which the state's property tax shift from counties totaled $525 million in fiscal 1993 and $2 billion in fiscal 1994.
The shifts were made to offset state education expenses. "These funding realignments have inevitably had a negative effect on counties' credit quality," Moody's said.
Though Moody's report focused on 17 counties, all California counties faced declining revenues and increasing expenditures between 1990 and 1992, the agency said.
"Important economic indicators, such as unemployment rates, taxable sales, and public assistance case loads, deteriorated significantly," the agency said. "All of California's 58 counties had higher unemployment rates in 1992 than in 1990."
California counties share certain credit weaknesses and strengths "relative to the recession and state restructuring," Moody's said.
Weaknesses include limited spending flexibility, increased demands for public protection, declines in discretionary revenues, and volatile revenue sources. Strengths include "proactive and prudent county" management and relatively low debt levels.
"Also, various cost-cutting efforts and revenue-generating initiatives have positioned some counties to better address future fiscal problems," Moody's said.
Looking toward the future, California counties can expect to face continuing budgetary pressures from the state, Moody's said.
Also possible in the next few years are political pressures and changes in criminal sentencing laws that could increase the courts' burdens and spending for public protection.
And, Moody's said, federal health care reform might affect counties "in undetermined ways."
Moody's also observed that the counties' discretionary revenues are declining.
Moody's noted that in November 1993, California voters approved Proposition 172, a permanent extension of a half-cent sales tax earmarked for public safety purposes. The sales tax revenues are expected to replace about 70% of lost property tax revenues that the state has shifted away from the counties. But the annual revenues from Proposition 172 are restricted to public protection.
"Substituting property taxes with sales taxes -- a more volatile revenue source -- makes counties increasingly vulnerable to economic fluctuations," Moody's said. "Thus, as the economy worsens, sales tax revenues generally decline, and health and welfare case loads generally increase, magnifying the impact of the fiscal stress."
In terms of geographic impact of the national recession, southern California was especially hard hit, Moody's said, in particular because of defense and aerospace cutbacks "as well as the effects of a rapidly growing immigrant population."
Asked to elaborate, Khrimian said "the immigrant population puts pressures on California counties.
"When the immigrant population can't get a job, they get on welfare," he said. "Their kids are born in county hospitals. It places disproportional weight on the counties because of the service the immigrants require."
Also, he said, counties are required to provide mandated services.
The Moody's report said one financial disaster that befell southern California earlier this year appears to be manageable.
A Jan. 17 earthquake centered in Los Angeles' San Fernando Valley "is not expected to cause credit deterioration in the short run," the agency said. "In fact, the infusion of federal moneys may actually provide a short-term stimulus.
"However, the earthquake's longterm impact will be unknown for some time," Moody's said.
