Fitch Ratings, one of the nation’s top credit rating agencies, has given a top rating of AA+ to the revenue lease bonds the City of West Hollywood has issued to fund major construction projects. However, its generally optimistic report on the city’s financial condition includes some statements of caution because of the impact of the COVID-19 pandemic on the city’s tourism business.
The AA+ ratings apply to series A and B of $80 million in lease revenue bonds issued this year. The City Council at its May 18 meeting approved the issuance of up to $100 million in bonds. That money will be used for a number of projects, including funding Stage 2 of the redevelopment of West Hollywood Park, paying for the acquisition of the lot on the northwest corner of Santa Monica Boulevard and Sweetzer and the construction of a parking lot on the southwest corner of Santa Monica Boulevard and Crescent Heights.
Also receiving AA+ ratings are the $17 million in bonds issued in 2013 for construction of the automated parking garage behind City Hall and the purchase of the Werle Building on Sunset Boulevard, which is home to addiction recovery group meetings. Fitch has given a AA+ rating to $81 million in bonds issued in 2016 to fund Phase 2 of the redevelopment of West Hollywood Park and the renovation of the Werle Building as well as generate revenue to pay off higher interest bonds issued in 2009.
The bonds are issued through the West Hollywood Public Financing Authority (PFA), a structure that allows the city to issue bonds without putting them on the ballot for voter approval.
Fitch has given the city a Triple A (AAA) rating in its ranking of the overall likelihood that a city will not default on paying back money generated through the bond sales.
Fitch’s report of the ratings says the AAA ranking “reflects the city’s highest level of gap-closing capacity, which results from strong revenue performance and high reserves, supported by strong financial management practices. The city also benefits from a moderately low long-term liability burden, strong revenue growth prospects, and ample expenditure flexibility given a moderately flexible labor environment.
In issuing the high ratings, an announcement from Fitch said it considered the fact that “general fund revenue growth has outpaced inflation and national economic performance. Fitch expects continued above-average revenue growth supported by ongoing tax base gains and commercial expansion.” However, it notes that that “the city’s legal ability to raise revenues is constrained by state constitutional provisions that require voter approval for tax increases.”
“Based on the city’s current spending practices and recurring operating surpluses, Fitch expects the natural pace of expenditure growth to be below revenue growth. Expenditure flexibility is ample given a moderately flexible labor environment.”
Coronavirus Impacts on West Hollywood
However, Fitch noted that a slower and more prolonged recovery from the COVID-19 shutdown could possibly lead to a “negative rating action/downgrade.”
“The ongoing coronavirus pandemic and related government containment measures worldwide create an uncertain global environment for U.S., state and local governments and related entities in the near term,” it said. “As severe limitations on economic activity only began very recently, most state governments’ fiscal and economic data do not reflect any credit impairment. Material changes in revenues and expenditures are occurring across the country and are likely to worsen in the coming weeks and months as economic activity suffers and public health spending increases. Fitch’s ratings are forward looking in nature; as such, Fitch will monitor developments in state and local governments as a result of the pandemic as they relate to severity and duration and incorporate revised expectations for future performance and assessment of key risks.”
Fitch said it assumes recovery from the financial impact of COVID-19 “begins from the third quarter of 2020 onward as the health crisis subsides after a short but severe global recession. “
“West Hollywood is a tourism, nightlife and entertainment destination that borders Beverly Hills and Los Angeles,” the Fitch report notes. “Its dependence on sales and transient occupancy taxes (TOT or hotel room taxes) makes it particularly exposed to the current economic downturn. The city has saved significant resources that position it well to weather a downturn in its key economic sectors. Sales and hotel taxes account for approximately 40% of general fund revenues, while relatively stable property taxes provide nearly 23% of general fund revenues.”
“Near-term revenue growth will be dependent on social distancing restrictions, recurrence of the virus and containment issues, and consumers’ willingness to spend and travel. Fitch expects a longer recovery for TOT assuming travelers’ hesitancy after the pandemic and time needed to rebuild consumer confidence. A long-term inability to redraw visitors to the city after the pandemic could cause sustained revenue declines and downturn pressure on the revenue framework assessment.”
“Fitch believes revenue losses are likely to be significant, given the current downturn’s outsized impact on discretionary consumer spending. The city is preparing its fiscal 2021 budget assuming a nearly 20% revenue loss which it is addressing by asking departments to cut spending by 15% to 20%, cancelling public events, and holding numerous positions vacant. The city also has a large number of contracted services that can be adjusted as needed. City officials are additionally seeking to shift capital funding sources, including issuing the current lease revenue bonds, to free up general fund resources.”
The Fitch report said West Hollywood would benefit from the local housing market. It noted that the city’s revenues from property taxes fell during the housing-led recession by a relatively modest 3% in fiscal 2011 before rebounding by 66% through fiscal 2019.
“The prospects for further tax base growth are strong, with new developments under construction or going through the planning process. These new developments will augment not just property tax revenues, but also transient occupancy tax and sales tax revenues.”
Ability to React to the Downturn
The Fitch Report notes that the City of West Hollywood has a large general reserve fund and, as a contract city that obtains services from under contract from other sources, it has the ability to reduce its spending somewhat.
“The city had available unrestricted general fund reserves of $137 million, or 130% of general fund spending at the end of fiscal 2019,” the Fitch report noted. “The city’s government-wide liquidity was also very strong with about $215 million, or 604 days, cash on hand at the end of fiscal 2019. Given the city’s prompt budget actions and exceptionally strong reserves, Fitch expects the city to maintain general fund reserves well above the reserve safety margin requirement for the ‘AAA’ financial resilience assessment through Fitch’s baseline economic downturn scenario.”
The report said Fitch believes revenue losses are likely to be significant, given the current downturn’s outsized impact on discretionary consumer spending. It noted that “the city is preparing its fiscal 2021 budget assuming a nearly 20% revenue loss which it is addressing by asking departments to cut spending by 15% to 20%, cancelling public events, and holding numerous positions vacant. The city also has a large number of contracted services that can be adjusted as needed. City officials are additionally seeking to shift capital funding sources, including issuing the current lease revenue bonds, to free up general fund resources.”
As a contract city, approximately 45% of the city’s annual expenditure budget is spent on contracts, the Fitch report states. “Of these, approximately 21% are for critical services such as public safety. The city has the flexibility to reduce the remaining 24% (largely allocated to social and transit services contracts) as needed. Additionally, 5% of the general fund budget is allocated to capital improvements which could be deferred if necessary.”
“The city has ample general fund expenditure flexibility,” Fitch reports. “Fixed costs related to debt service, pensions, and OPEB (other post-employment benefits) represented a moderately low 13% of fiscal 2019 governmental spending, with some upward pressure on the city’s pension system contributions as CalPERS www.calpers.ca.gov (the state’s public employee retirement system) seeks to improve its funded ratio. However, city expenditures benefit from a moderately flexible labor environment. The city’s ability to predict and manage its personnel expenditures relative to available resources is facilitated by five-year labor contracts with reopeners related to health care reform. Two city contracts are in negotiations since they end at the end of fiscal 2020 while the third ends in fiscal 2021. Furthermore, the city has considerable discretion to scale back various social services that are not legally required, although such cuts could be politically difficult. The city can also scale back, defer, or cancel pay-as-you-go capital projects, if necessary. The city has used this flexibility and consistently ended each year with a net operating surplus after transfers.
The city has little ability to increase its revenue. Increases in property taxes, which account for about 23% of general fund revenue, are limited by state law and require voter approval. Fees, charges for services, and parking and fines can be raised to recover the costs of providing related services.