New York, April 24, 2020 -- Moody's Investors Service has revised the outlooks on the City of Sacramento, CA's issuer rating and lease-backed ratings to stable from positive, and on the city's outstanding transient occupancy tax (TOT) revenue bonds to negative from stable. Concurrently, we affirmed the city's outstanding Aa2 issuer rating; Aa3 on lease-backed obligations with more essential leased assets; A1 on the Lease Revenue Refunding Bonds Series 1993A with a leased asset we consider less essential; A1 on the 2018 TOT Revenue Bonds, Senior Series A and B; and A2 on the 2018 TOT Revenue Bonds, Subordinate Series C. This rating action affects $348 million of the city's $611 million in lease-backed obligations and the city's $283 million in outstanding TOT bonds.
RATINGS RATIONALE
The revision of the outlook to stable from positive for the city's issuer and lease ratings reflects our changed view of the city's likely revenue and reserve trajectory. Our prior expectation was for the city to maintain its strengthened position due to the increase in revenue from a new permanent transaction and use tax, which would both offset increasing pension costs and build reserves, consistent with a then new minimum reserve policy of 17% of general fund and Measure U fund expenditures. Our current expectation is that the coronavirus outbreak will significantly dampen growth of the city's general fund and Measure U revenue, eliminating previously expected surpluses, even if the coronavirus downturn proves short and the recovery relatively rapid. We expect that the city's financial position will narrow, due to rising fixed costs and non-general fund sources used to pay debt service, but remain consistent with the Aa2 rating level.
The negative outlook on the TOT revenue bond ratings reflects our view that the economic downturn resulting from the coronavirus outbreak will materially and negatively impact the city's ability to pay debt service on the bonds from current year revenue in the near term, instead using identified reserves.
The city's Aa2 issuer rating reflects the large tax base that until recently had been fueled by positive trends in employment, housing prices, and building activity, but which will be inhibited by the current economic downturn. The rating also reflects the city's currently very strong financial position, which will provide flexibility to manage expected revenue declines and rising costs. The city had anticipated $45 million in new general fund revenue in fiscal 2020, due to the voters approving an increased, permanent tax rate via the passage of Measure U. While the city will benefit by the increased tax rate, annual receipts will be lowered by the coronavirus downturn, which will also impact other revenue sources. The city's fixed costs are somewhat elevated and are likely to be an increased general fund burden, due to declines in revenue outside the general fund that has been offsetting a significant portion of the general fund debt service. The city's debt level is moderate, but pension and OPEB liabilities are elevated. Notably, the city eliminated OPEB benefits for new employees in 2015 and funded an OPEB trust.
The Aa3 lease-backed ratings are one notch lower than the Aa2 issuer rating. For a California city, Moody's typically applies a one-notch distinction from the issuer rating, reflecting a standard California abatement lease legal structure and leased assets that we view as "more essential." The Aa3 rating applies to the city's 2015 Refunding Revenue Bonds (Master Lease Program Facilities), 2006 Capital Improvement Revenue Bonds, Series B Taxable, and 2006 Refunding Revenue Bonds, Series E (Master Lease Program Facilities), which benefit from the more essential nature of the leased assets within the city's Master Lease Program; and to the city's Lease Revenue Refunding Bonds, Series 1993B, which benefit from the more essential nature of the executive airport and civic center garage, which secure the bonds.
The A1 lease-backed rating is two notches lower than the Aa2 issuer rating. Moody's typically applies a two-notch distinction from a California city's issuer rating reflecting a standard California abatement lease legal structure and leased assets that we view as "less essential." The A1 rating applies to the city's Lease Revenue Refunding Bonds, Series 1993A, which are secured by the city's convention center.
The A1 rating on the city's senior lien TOT revenue bonds reflects the economic strength of the Sacramento area, which has been the fastest growing large city in California with robust growth in travel and tourism, as well as the stabilizing influence of the state capital. While the city had demonstrated solid historical and projected demand for hotel rooms, consistent with the nature of the taxes pledged to repay the bonds, the recent state-mandated social distancing measures have resulted in a sharp drop in hotel occupancy. Favorable debt structure and strong legal provisions are key credit features, but coverage will likely decline from a strong level to somewhat above 1.0 times.
The A2 rating on the subordinate lien bonds reflects the shared features of the senior lien bonds, but the rating distinction reflects the subordinate lien pledge and weaker additional bonds test. Coverage for the subordinate bonds is very likely to drop below 1.0 times in the near term. This is offset by the city's substantial balance in its community center fund available to pay debt service during the downturn.
We regard the coronavirus outbreak as a social risk under our ESG framework, given the substantial implications for public health and safety. The coronavirus crisis is a key driver for these rating actions. Given its currently strong balance sheet, the City of Sacramento's lease ratings are not susceptible to immediate material credit risks related to coronavirus. However, we anticipate that previously expected growth in revenue from transient occupancy tax (TOT) will not materialize in the near term due to the economic effects of the coronavirus, materially affecting both coverage and balances available for bond debt service. The longer-term impact of coronavirus will depend on both the severity and duration of the crisis. The situation surrounding coronavirus is rapidly evolving. If our view of the credit quality of Sacramento changes, we will publish our updated opinion at that time.
RATING OUTLOOK
The stable outlook for the city's issuer rating and lease ratings reflects our view that the city's financial profile will remain consistent with the current rating level, despite a narrowed financial position resulting from expected revenue declines. Existing strong reserves combined with budget cuts will enable the city to weather the pressures on its revenue and cost pressures in the next 18 to 24 months.
The negative outlook for the city's TOT bond ratings reflects our view that the current coronavirus downturn, even if short lived, will materially affect the credit quality of the TOT bonds and if prolonged would result in further negative pressure on the credit profile.
FACTORS THAT COULD LEAD TO AN UPGRADE OF THE RATINGS
Issuer and lease ratings
- Increased reserves and liquidity
- Resumed growth in general fund and Measure U revenues
- Reduction of debt burden
- Reduction of unfunded pension and OPEB liabilities
- Material improvement to resident wealth measures, including median family income and full value per capita
TOT bond ratings
- Substantial growth in debt service coverage
- Restoration of hotel occupancy rates to normal levels could result in removal of the negative outlook
FACTORS THAT COULD LEAD TO A DOWNGRADE OF THE RATINGS
Issuer and lease ratings
- Protracted deterioration of fiscal position through deficit spending
- Material erosion of the tax base
- Material increase in general fund-supported debt
- Material growth in unfunded pension or OPEB liabilities
- Material decline in non-general fund revenue used to pay lease-backed debt, creating significant fiscal stress to the general fund, could result in widened notching
TOT bond ratings
- Protracted revenue downturn due to the coronavirus outbreak
- Substantial new debt beyond the contemplated potential third lien
- Depletion of available reserves
- Use of the debt service reserve surety
LEGAL SECURITY
The city's lease-backed obligations are secured by standard abatement leases benefiting from 24-month rental interruption insurance and surety-funded debt service reserves. The Aa3-rated bonds are secured by rental payments for use and occupancy of a variety of leased assets under a master lease agreement.
The A1-rated bonds are secured by rental payments for use and occupancy of the city's convention center.
The bonds are secured by a pledge of and lien on TOT taxes generated by the room tax on lodging businesses located within the City of Sacramento, net of a small portion of the TOT revenues used to support the general fund and the visitors' bureau, which are not pledged. The bonds are additionally secured by debt service reserve funds for each lien equal to the lesser of a standard three-prong test. The senior lien bonds have a 1.75 times maximum annual debt service (MADS) additional bonds test (ABT) and the subordinate lien bonds have a 1.15 times MADS ABT. The repayment of the bonds is also secured in part by a TOT revenue surplus account, which was established upon issuance with a current balance of $1.9 million, equal to approximately 10% of MADS.
PROFILE
Sacramento is located at the confluence of the Sacramento and American rivers in the northern Central Valley, 75 miles northeast of San Francisco (Aaa stable). The city encompasses 99 square miles and has over 500,000 residents as of 2018, making it the sixth largest city in the state. It was incorporated in 1849 and is the California (Aa2 stable) state capital and the seat of Sacramento County (A1 stable). The full-service city is governed by a nine-member city council including an elected mayor.
METHODOLOGY
The principal methodology used in the issuer rating was US Local Government General Obligation Debt published in September 2019 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBM_1191097. The principal methodology used in the lease ratings was Lease, Appropriation, Moral Obligation and Comparable Debt of US State and Local Governments published in July 2018 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBM_1102364. The principal methodology used in the transient occupancy tax revenue rating was US Public Finance Special Tax Methodology published in July 2017 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBM_1077147. Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of these methodologies.
REGULATORY DISCLOSURES
For further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.
For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.
Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.
Moody's general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1133569.
At least one ESG consideration was material to the credit rating action(s) announced and described above.
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