Criteria shift lands Los Angeles County a second triple-A rating

Los Angeles County rode into the market this week on a high note after getting a one-notch upgrade to AAA from Fitch Ratings.

The county’s finance team, led by Morgan Stanley, priced $700 million of 2024-25 tax and revenue anticipation notes Tuesday with 5% coupons maturing in June 2025 at 3.25%.

“We set our expectation at 3.25% on Friday, and we nailed it Tuesday,” said Daniel Wiles, the county’s assistant treasurer and tax collector for finance and investments. “So that’s where it landed, which showed we were pretty much right on.”

Last week’s jobs report and this week’s Federal Open Market Committee meeting may have stolen the thunder a bit from the county’s rating upgrade, but county officials are hoping for a lift when they price up to $900 million in lease revenue bonds in two series this summer.

The improved rating brings the county’s triple-A designations to two. S&P Global Ratings affirmed its AAA issuer credit rating ahead of the deal. It holds an Aa1 issuer rating from Moody’s Ratings and stable outlooks from all three agencies.

“There was a little bit of an uptick for Treasury deals after the jobs number report came out, but that hasn’t translated to the MMD (Municipal Market Data),” Wiles said. “It took a little bit of the wind out of our sails.”

The notes carry short-term ratings of F1-plus from Fitch, MIG 1 from Moody’s and SP-1-plus from S&P.

The U.S. economy added 272,000 jobs in May 2024, a much better-than-expected report, John Veit, a vice president for J.P. Morgan Wealth Management, wrote in a note on Monday.

“Our strategists’ view is that the May jobs data underscores the idea that the economy remains stronger than many people think,” Viet wrote. “And the Fed will need to see further confirmation in economic data that the economy is cooling, before considering rate cuts later this year.”

The Federal Reserve stayed the course on rates in this week’s FOMC meetings on Tuesday and Wednesday and indicated in its post-meeting statement that only one rate cut may come this year.

The county, which receives the majority of its revenue from property tax payments split between November and February, has been issuing tax revenue anticipation notes to smooth out cash flow since 1977, according to the preliminary offering statement for the TRAN.

The county anticipates issuing about $750 million in new money lease-revenue bonds this year to support the Vermont corridor project and the first phase of the UCLA Harbor project, with the remainder of the $900 million for refunding, Wiles said.

Fitch cited its new U.S. local government rating criteria as a major driver for the upgrade.

The upgrade was “good timing,” Wiles said. “We knew it was under consideration. We had asked for an upgrade specifically in our rating presentation. We did it because our bankers had run Fitch’s model and came up with a result of AAA.”

Wiles said it’s not a huge priority to convince Moody’s to follow suit.

“We are pretty satisfied with the two triple-As; and those are probably the ratings we will use for the two series of lease revenue bonds,” he said.

Outstanding lease revenue bonds carry ratings a notch lower than the agencies’ issuer ratings of the county.

The county’s lobbying didn’t sway Fitch in its assessment, but Karen Ribble, a senior director and lead analyst on the rating, confirmed the county’s bankers did use the criteria correctly and came to the same conclusion Fitch analysts did when running the county’s data through the rating agency’s new criteria.

“We were happy they were able to do it,” Ribble said, because one of the goals was to make the assessment process more transparent, so issuers and their teams could do exactly what the county’s finance team did.

The Fitch upgrade came as part of the change the rating agency made to its U.S. public finance local government rating criteria in September, which is expected to be a boon for issuers that receive an upgrade, but it could also mean a downgrade for others.

Fitch analysts said during an October presentation that the new criteria is expected to impact roughly 35% of its local government ratings. The rating changes, evenly split between upgrades and downgrades, are expected to be mostly one-notch, Fitch analysts said during the online presentation.

Fitch doesn’t yet have data regarding how many other local government ratings have been affected, Ribble said. All of the anticipated changes are expected to be completed by September, a year out from the launch, Ribble said.

Fitch analysts Ribble, who was lead on the report, and Michael Rinaldi ticked off several factors supporting the county’s triple-A rating.

Those included the county’s financial resilience, midrange demographics including population growth, income levels, educational attainment, unemployment rates and its ability to cover its long-term liability burden.

The new criteria also includes a one-notch positive analytical factor “recognizing the county’s role as the center of an important and growing metropolitan statistical area with a vital role in the national economy,” Ribble said.

The county’s MSA is the second largest in the U.S. and generates 5.4% of U.S. gross domestic product. With 9.7 million people, it’s the nation’s most populous county, with more residents than 40 of the 50 states.

The county’s size and its massive tax base, equal to $1.997 trillion of assessed value in 2023-24, according to an online investor presentation for the notes, also support the rating.

“The new criteria uses metrics to evaluate economic and demographic strengths,” Ribble said. Large cities and counties have a more diverse mix in terms of wealth and employment, and Los Angeles County’s large GDP makes it more resilient to economic cycles over time, she said.

The county has $2.6 billion in lease revenue bond debt, which is “not much for an entity our size,” Wiles said.

“That helped us some, though it’s not as important as in past years because their criteria changed,” he said.

“We used to look at overall debt, per capita income times population, but the new criteria only uses direct debt,” Ribble said. “The county benefits from that, because it used to include Los Angeles Unified School District debt.”

Fitch’s review looked at the $2.6 billion in lease revenue debt and the county’s estimate of up to $3 billion in liabilities from sex abuse litigation as a result of Assembly Bill 218, combined with its pension liabilities for a total liability burden of $25 billion.

AB 218 and companion Assembly Bill 2777 extended the statute of limitations for childhood sexual abuse victims to file civil claims. The result was that it also extended the liability for schools, counties, and cities back to the 1970s. Issuers began including their potential liabilities in bond disclosure last year.

The liability the county faced from the cases was part of the discussion with Fitch about whether it would be able to maintain the level of reserves it has historically, Ribble said. It’s reserve levels are viewed by Fitch as one of the county’s strengths.

The county’s reserves were 19.5% of the general fund in 2021, and it has 23.7% of its general fund in reserves for fiscal 2023, giving it a decent cushion, Ribble said.

For AB 218 and 2777 cases that have been served, “the county is currently estimating that liability of approximately $940 million could be realized in fiscal year 2023-24, and approximately $1.2 billion could be realized in fiscal year 2024-25 and thereafter,” according to the disclosure documents for the TRAN. “The county cannot predict how many additional claims will be received, and when and the extent to which liability will be incurred in any particular year.”

The laws apply to children under 18 or adults who were victimized when they were minors.

The brunt of the county’s liability stems from children abused in the foster care system, according to the bond disclosure documents for the TRAN.

By May 12, 2023, the county had been served with 782 lawsuits involving 2,324 plaintiffs, who allege they were sexually assaulted while in Department of Children and Family Services and/or Probation Department placements from 1958 to 2019, according to the note disclosure. The county anticipates roughly 1,300 additional lawsuits will be served based on reports received of cases that have been filed, but not yet served, according to the document.

The alleged perpetrators include “foster parents, family members of foster parents, county employees, staff or residents from group home facilities, including MacLaren Children’s Center, a temporary housing facility that closed in 2003 and various probation camps and halls.”