Fitch Ratings Cautious on MoCo Budget

Following is the statement by Fitch Ratings, an agency that assesses bond risk, on the effect that Montgomery County’s budget problems may have on its creditworthiness. Currently, Fitch, like Standard & Poor’s and Moody’s, rates MoCo’s general obligation bonds at AAA – the highest possible rating. But Fitch is warning that could conceivably change if the county does not meet its reserve targets.

Following is the full statement from Fitch. We’ll have our own take on their assessment at the bottom of this blog post.

March 25, 2010 12:53 PM Eastern Daylight Time

Fitch Rates Montgomery County, Maryland's $23MM COPs 'AA+'; $30MM Ltd Obligs 'AA'; Outlook Stable

NEW YORK--(BUSINESS WIRE)--Fitch Ratings assigns the following ratings to Montgomery County, Maryland (the county) bonds:

--$22.9 million certificates of participation (public transportation equipment acquisition), series 2010 'AA+';

--$30.3 million taxable limited obligation certificates (facility and residential projects), series 2010A 'AA'.

Fitch also affirms the following outstanding ratings:

Montgomery County, Maryland

--$1.9 billion general obligation (GO) bonds at 'AAA';

--$30.5 million certificates of participation (Equipment Acquisition Program) at 'AA+';

--$35 million lease obligations (Metrorail Garage Projects) at 'AA'.

Maryland Economic Development Corporation

--$33.9 million lease revenue bonds at 'AA+'.

Montgomery County Revenue Authority

--$19.1 million lease obligations (Germantown Indoor Swim Center Project) at 'AA+';

--$11.8 million lease obligations (Conference Center Project) at 'AA'.

Maryland-National Capital Park and Planning Commission (M-NCPPC)

--$42.6 million Montgomery County GOs at 'AAA'.

The Rating Outlook is Stable.

RATING RATIONALE:

-- While reserves have declined, Montgomery County retains considerable flexibility to reverse a structural imbalance due in part to weakened revenues during the current recession. The rating encompasses the county's stated expectation that it will restore reserves to policy levels in fiscal 2012.

-- A considerable and formidable economic base, anchored by the extensive presence of the U.S. government and expanding broadly into biotechnology, shows excellent prospects for continued expansion. Strong wealth and unemployment indicators underscore the county's economic strengths.

-- Overall debt levels are moderate, amortization is rapid, and capital needs are expected to remain manageable.

-- Payment on non-general obligation debt issues are subject to annual appropriation, and their ratings depend largely on sound legal provisions and the level of essentiality provided by assets that secure each series of debt.

KEY RATING DRIVERS:

-- Failure to restore reserves to levels consistent with the 'AAA' rating and the county's long-standing policies could place downward pressure on the rating.

-- Economic growth is expected to continue at a measured pace, allowing management to address infrastructure expansion and renewal in a timely manner without undue fiscal strain.

SECURITY:

The GOs are secured by the full faith, credit, and taxing power of Montgomery County. Non-general obligation debt is secured by payments subject to annual appropriation and the level of essentiality provided by assets that secure each series of debt.

CREDIT SUMMARY:

Bordering Washington, D.C. and northern Virginia, Montgomery County's wealthy suburban economy is fueled by a large U.S. government presence, with depth and diversity added by the strong and expanding biotechnology sector. Completion is expected in 2011 on the Silver Spring Inter-modal Transit Center, a $194 million mixed use development and transportation hub in one of the county's four central business districts. The county's unemployment rate has been well below state and national averages since at least 1998, with the December 2009 rate of 5.2% significantly below the state's 7.1% and the nation's 9.7% (rates are not seasonally adjusted). Various economic indexes have consistently ranked the county, which had an estimated 2008 population of 950,680, among the wealthiest in the nation.

The recent diminishment of reserves from historically sound levels reflects structural budget gaps that were increased by anemic income tax revenues. The fiscal 2008 budget somewhat reversed unsupportable spending growth trends, although at the conclusion of the fiscal year the county's unreserved general fund balance decreased from 11.8% to 5.9% of the $2.8 billion of expenditures, transfers out, and other uses. Fiscal 2009 income tax shortfalls propelled an additional fund balance draw-down, to 3.5% of spending, although inclusive of a fully funded $119.6 million revenue stabilization fund (RSF), total reserves were a sound 7.7% of spending and exceeded the county policy of 6% of total resources.

In response to steep mid-year revenue adjustments in fiscal 2010 totaling $145 million, inclusive of $120 million of projected income tax shortfalls, the county implemented rigorous expenditure controls totaling $100 million and ultimately projected utilizing up to $102 million of the RSF in addition to undesignated general fund balance. Total undesignated reserves across all tax-supported funds including the RSF are expected to decline to a low $77 million on a budgetary basis, and the county projects total reserves to equal approximately 2% of spending, below the 5% that was announced as a one-year revision to policy. The unreserved general fund balance coupled with the RSF, a measure consistent with Fitch's analysis of financial flexibility, is projected to equal a slim 2.7% of spending.

Fitch believes the county retains additional flexibility in its proven success in overriding charter limitations on property tax growth, although the income tax rate is currently at the state maximum of 3.2%. The proposed fiscal 2011 budget includes a proposed energy tax increase as well as furloughs, lay-offs, and programmatic reductions that are intended to eliminate the $780 million deficit, restore $37 million to the RSF, and increase the undesignated general fund balance to $126.9 million. Should the county attain its objectives, it will restore reserves to the modified 5% policy, although Fitch is concerned that insufficiently conservative revenue projections may impede the county's attainment of its goal. The county has stated that by fiscal 2012 it will eliminate the currently projected $212 million structural deficit and will restore reserves to its 6% policy. Fitch's current rating and Stable Outlook assume the county will be successful, but failure to achieve the fiscal 2011 and 2012 financial goals could result in a credit profile that is inconsistent with the current rating category.

Overall debt levels are moderate at $2,536 per capita and 1.5% of market value. Amortization remains rapid with 70.7% of outstanding principal retiring within 10 years. The fiscal years 2009-2014 amended capital improvement plan totals $3.7 billion and allocates substantial funding for schools (35%), transportation (27%), and public safety (9%). Major sources of funding include GO bonds and intergovernmental revenue. Although the county does not formally budget pay-as-you-go capital financing, it intends to return to $32.5 million annually beginning in fiscal 2012, in contrast to the minimal $300,000 projected for fiscal 2010.

Applicable criteria available on Fitch's web site at www.fitchratings.com include:

-- 'Tax-Supported Rating Criteria' (Dec. 21, 2009;

-- 'U.S. Local Government Tax-Supported Rating Criteria' (Dec. 21, 2009).

Additional information is available at www.fitchratings.com.

Our Take:

Fitch is focused on the county’s ability to set aside 6% of its general fund into reserve. The agency notes the county’s long-term economic advantages and history of maintaining adequate reserves, but also describes the county as suffering “structural budget gaps that were increased by anemic income tax revenues.” Fitch will clearly consider any continuous reserve funding below the 6% level as grounds for a possible future downgrade.

This comment caught our eye: “Fitch believes the county retains additional flexibility in its proven success in overriding charter limitations on property tax growth, although the income tax rate is currently at the state maximum of 3.2%.” Translation: the county can always break the charter limit on property taxes, so it has a way to get out of trouble. Did anyone tell Fitch about the 2008 Ficker Amendment, which requires votes by all nine Council Members to pass a property tax hike exceeding the rate of inflation? It will be interesting to see if any of the County Council incumbents commit to not breaking the charter limit next year during the election season. If any winning Council Member makes such a commitment and actually keeps it, that will force VERY hard spending choices in what is sure to be another tough budget year in 2011.

Overall, we expect these sorts of pronouncements by Fitch and other agencies will exert significant influence over the budget debate. No County Executive or County Council wants to go down as the one who lost our AAA bond rating. The reason is not only economic, but also political and cultural. The county’s top bond rating is the ultimate proof of its reputation for good government. If the county ever lost it, that would be a powerful symbol of the county’s slide from national preeminence. It’s hard to enough to admit to our competitive problems with Fairfax. A more comprehensive indicator of decline would be very tough to take.