2010-02-18 21:21:05 -

Fitch Ratings assigns an 'A-' rating to $129 million County of Sacramento's 2010 refunding certificates of participation (COPs). In addition, Fitch downgrades to 'A-' from 'A' the following.

--$930.5 million pension taxable pension funding bonds, series 1995A, B & C, series 2003A & B, series 2004C-3, and series 2008;

--$36.8 million COPs, series 2006;

--$46.3 million COPs, series 2007.

The Rating Outlook for all ratings is Negative.

The 2010 COPs are expected to sell via negotiation on March 3, 2010.

RATING RATIONALE.

--The downgrade to 'A-' from 'A' for Sacramento County's (the county) pension and lease obligations is based on the significant reduction in fund balance in fiscal 2009 which has severely limited the county's financial flexibility as it continues to

face declining revenues and increasing fixed costs.

--The Negative Outlook reflects the continued challenges to closing several years of projected budget gaps as well as the weak economy.

--The county's financial position is stressed as exhibited by extremely narrow cash and fund balance levels. With revenues projected to fall in fiscal years 2011 and 2012, the county will be challenged in implementing further cost reductions given the significant budget cuts, including about 1,000 lay offs, done in fiscal 2010 and pressure to preserve both public safety and social services. Fitch notes that the projected budget gaps partially result from the county's rising labor and debt service costs.

--The fiscal imbalance stems from the collapse of the local real estate market followed by a severe statewide recession which has resulted in cuts to intergovernmental revenues which accounts for about two-thirds of the county's total general fund revenues and primarily funds social services. In contrast, early in the decade, the long-term structural imbalance was partially obscured by the rapid growth in property values and development, resulting strong annual gains in property tax revenues, which make up the vast majority of the county's discretionary revenue.

--The economy has been hard hit, marked by sizable property value declines, high unemployment rates which exceed the state average and accelerating job losses. Metro area job losses for the 12 months to November 2009 were the largest in the state.

--The county's debt amortization is very slow and debt service is rising; however, even including overlapping debt, the county's debt burden remains moderate and the county has no plans to issue additional new money debt.

--The county still has a large amount of synthetically fixed variable rate debt, resulting in exposure to availability of liquidity or letter of credit banks as well as high costs to restructuring these obligations due to large negative swap termination values.

--The county's management - including a new COO since 2007 and interim CEO - are making positive changes to the organization and putting in policies and procedures which will help the county slowly return to fiscal health, although this will require the economy stabilizing.

WHAT COULD TRIGGER A DOWNGRADE.

--Inability to implement the planned level of spending cuts for the remainder of fiscal 2010 and to adopt a fiscal 2011 budget without an operating deficit.

--Further economic deterioration, particularly a decline in assessed valuation (AV) beyond the estimated 2%-3%, further deferring the county's return to at least a moderate fund balance position.

SECURITY.

The 2010 refunding COPs are secured by lease payments made by the county for use and occupancy of its main detention facility. Security is enhanced by 24 months rental interruption insurance, a covenant to budget and appropriate and a cash-funded reserve fund sized at 125% of average annual debt service.

CREDIT SUMMARY.

The Sacramento economy is still in recession, shedding jobs in all major sectors in the year to December 2009. The county lost 6.3% of its jobs over the same period, compared to 5.2% statewide, resulting in an unemployment rate of 12.5% compared to 12.3% statewide. As the state capital, government employment had long been a stabilizing force in the economy, but the state's continued fiscal challenges have resulted in significant reductions in its local workforce. The largest job losses in that period have been in construction (down 21%), information and professional and business services (each 8%) and manufacturing (7%). The median area home price has declined about 51% since 2006, after regaining some ground the last few months, and foreclosure rates among non-agency loans are a high 15%, but are about the same level as a year prior. Negative amortization loan levels are also above average.

After several years of rapid development and home appreciation contributing to strong growth in AV and property tax revenues, AV growth slowed to 1.3% in fiscal 2009 and declined 7% in fiscal 2010. While some indicators suggest that the residential property market may have bottomed out, the commercial real estate sector has since softened as evidenced by 2,500 outstanding appeals with a total requested reduction of about 4.7% of the county's total AV. The ultimate reduction will likely be less than requested.

Property tax revenues made up about 19% of general fund revenues in fiscal 2009 while intergovernmental revenues accounted for 65%. As a result, the county is very vulnerable to the state's budget cutting.

While county officials plan to pass through any state funding cuts by reducing the impacted services, the state generally passes its budget sometime into the fiscal year, leaving the county with less than a full year to implement necessary spending reductions.

The county's fiscal year 2009 audit revealed a fund balance reduction of $127 million, reducing the fund balance to just $21 million, a marginal 1% of spending. This is a lower fund balance than the county estimated close to June 30, 2009, due to several auditor requirements which resulted in deferring and writing off state revenues as well as categorizing a large inter-fund transfer as a loan. Fitch notes that the county's reserves as recorded on their budget basis are higher at about $73 million at the end of fiscal 2009. For fiscal 2010, the county has budgeted to use about $22 million in fund balance carryover and reserves. A midyear budget report projects actual revenues to be about $10 million below budget (mostly supplemental property and sales tax revenues) and the county executive has directed departments to make spending cuts of $15.4 million which will carry forward into future years. This will begin to address the county's estimated $122 million fiscal year 2011 budget gap resulting from one time sources used in fiscal 2010 ($53 million), increased labor costs pursuant to existing contracts ($44 million), increased pension bond debt service ($5 million), partial repayment of fiscal year 2010 interfund borrowing ($12 million), and lower property tax revenues ($8 million).

Fitch acknowledges the efforts to make permanent reductions to the county's budget, as well as a recently adopted policy to rebuild reserves when revenue growth returns. However, the challenges are still very large and it may take several years to return the county's financial position to its pre-recession level.

The county's direct and overlapping debt levels are affordable, but the county's debt profile is complex and inflexible. About $541 million of outstanding debt is swapped with negative termination values. In addition, debt restructuring a few years ago resulted in rising pension obligation bond debt service costs, contributing to the county's budget pressures and leaving few options for restructuring this time.

Applicable criteria available on Fitch's website at www.fitchratings.com : .

--'Tax-Supported Rating Criteria,' dated Dec. 21, 2009.

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

Additional information is available at www.fitchratings.com : .

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Fitch Ratings, San FranciscoKaren A. Ribble, +1-415-732-5611Alan
Gibson, +1-415-732-7577orCindy Stoller, +1-212-908-0526(Media
Relations, New York) cindy.stoller@fitchratings.com : mailto:cindy.stoller@fitchratings.com