San Diego County’s pension bonds bumped to AAA as part of Fitch criteria review

Fitch Ratings upgraded San Diego County’s pension obligation bonds to AAA and affirmed a stable outlook during a review ahead of the county’s plans to price a $31.5 million certificates of participation refunding.

Fitch upgraded $211 million outstanding POBs to AAA from AA-plus, matching the agency’s issuer rating for the county. It also affirmed the county’s AAA issuer rating and gave it a stable outlook.

It also affirmed the rating on $299 million in outstanding COPs at AA-plus and $75.4 million outstanding San Diego Regional Building Authority lease revenue bonds at AA-plus. The COPs are expected to price via competitive sale the week of July 8.

Proceeds of the bonds will be used to refund and defease the county’s COPs series 2014A (Edgemoor and RCS Refunding) for debt service savings.

The upgrade reflects implementation of Fitch’s new local government rating criteria, under which the rating agency “considers governmental debt and defined benefit pensions to be effectively equivalent obligations representing ongoing claims on current and future budgetary resources,” wrote Larry Witte, a Fitch director and lead author of the report published Thursday.

The rating has been removed from under criteria observation.

After Fitch announced its new rating criteria in September, it listed 550 ratings as under review. The rating changes, evenly split between upgrades and downgrades, are expected to be mostly one-notch, Fitch analysts said during an online presentation discussing the proposed changes in October.

One of the keys in San Diego County’s POB upgrade —– and it’s related to POBs in California — the entities have covenanted to “pay debt service on these bonds, and because they have done that, we consider them to be obligations of the municipality and to reflect the issuer rating,” Witte said.

“The revenue stream should really be like a broad revenue stream and one entities have control over,” Witte said. “If it were a small tax or isolated fee, we wouldn’t consider it to be equivalent to the issuer rating, but for San Diego County it’s based on just the general revenues of the county.”

In the short sentence in the ratings report, not every situation is covered, Witte said.

Pension obligation bonds can be quite controversial. Some market watchers consider them a risky arbitrage play, while others think if they are done right — short maturities and call features — they are a legitimate tool for dealing with pension obligations. The Government Finance Officers Association issued an advisory in 2015 suggesting local governments should not issue POBs.

All of the POBs under review in the new criteria are in California, Witte said. They include six counties: Sacramento, Sonoma, Fresno and San Luis Obispo; and four cities: Pasadena, Riverside, Pittsburg and Huntington Beach.

Until those issuers face their review — which Fitch hopes to have completed for all credits by September — Witte said he can’t say how the new criteria might apply.

“For a highly rated place like San Diego, we do believe they are triple-A worthy, because we believe the obligation under both types of debt and POB to be the same, it’s possible that there will be non-payment on any debt,” Witte said. “We believe because of the strong nature of the covenant they are the same. We believe the stated willingness to make payments (in the covenant) makes them equivalent to the general obligation.”

San Diego’s lease obligation and general obligation rating were not under criteria observation, he said.

“We didn’t think the criteria would affect those bonds, but we felt the POBs would be affected,” Witte said.

San Diego County also has triple-A issuer ratings from S&P Global Ratings and Moody’s Ratings.