Downgrade

LIHUE —  Fitch Ratings, a global credit rating agency, has downgraded the County of Kauai’s long-term credit grade, citing consistent rises in expenses, stagnant growths in revenues and waning balances in county reserve funds.  

Before news of the downgrade was released two weeks ago, the County of Kauai had obtained Fitch Rating’s second highest grade, “AA,” which can be used by investors to determine the county’s creditworthiness for specific loans. 

Those loans are used to fund a wide range of projects islandwide, such as housing and road work.

These loans, called general obligation bonds, are specifically dependent on the county’s credit rating because they are secured by its pledge to use legally available resources, including tax revenues, to repay investors, or bond holders.

“The downgrade to AA- is based on the county’s reduced financial flexibility following a substantial reduction in reserves over the past several years,” an April 24 Fitch Ratings report read. “Expenditure growth has repeatedly outpaced revenue gains, resulting in recurring operating deficits and drawdowns in fund balance.”

This decision, some county officials say, comes on the heels of an unanticipated decision by state lawmakers to increase the amount of transient accommodations taxes, commonly known as the TAT, that are shared among the state’s four counties from $93 to $103 million over the next two years.

Although the move will equate to a $1.4 million bump in revenues for the County of Kauai, it is far below the more than $10 million windfall that many county officials were expecting to offset projected budget shortfalls for the next fiscal year. That extra revenue, Fitch Ratings noted, is particularly important because it’s the county’s second largest source of general fund revenue.

“The county has responded to operating deficits with property tax rate increases and may also benefit from recent growth in assessed (property) values and proposed state legislation to eliminate a cap on counties’ share of transient accommodation tax,” the Fitch Ratings report read. “Such increases may help restore operating balance but do not appear sufficient enough to raise revenues to previously high levels.”

Having one of the county’s three credit agencies downgrade its rating, some officials say, is an unsettling wake up call for the Kauai County Council and Mayor Bernard Carvalho Jr.’s administration, which is now tasked with restructuring the county’s budget and reshuffling future priorities.  

“Particularly troubling in the agency’s report on the downgrade was their concern about the structural issues with the county’s finances,” Kauai Mayor Bernard Carvalho Jr. wrote in his revised 2014-2015 budget message to the County Council on Wednesday. “Clearly, we must conduct a full re-evaluation of revenues, expenditures and operating practices if we are to regain our previous bond rating.”

An unbalanced plan

The downgrade, according to the Fitch Ratings report, “reflects the county’s diminished financial position and prospects for further declines.”

Part of the reason for this, Fitch Ratings officials noted, was the inability of county officials to balance their spending trends with revenue generating measures — a move that ultimately slashed the county’s general fund balance by more than half between 2013 and 2010, according to county budget documents.

“Fund balance drawdowns have resulted from an ongoing imbalance between general fund revenue and spending trends, which remains unresolved,” the Fitch Report read.  

In the years leading up to 2010, the county’s general fund experienced a significant swell in taxpayer money — largely fueled by soaring property tax revenues and uncapped access to the state’s TAT revenues, which are charged to operators of short-term visitor accommodations. 

Real property tax revenues, according to Fitch Ratings, comprised more than two-thirds of general fund revenues in 2013 alone.

Between 2002 and 2010, the county’s general fund balance ballooned from nearly $12.4 to $68.8 million as the county’s real property tax revenues more than doubled from $38.4 to $91.4 million, according to county budget documents. 

The amount of TAT revenue collected, according to Hawaii Tourism Authority documents, also swelled from $150 million in 2004 to $224.2 million in 2010. The County of Kauai’s share of those revenues, in turn, rose from $9.7 million in 2004 to $14.6 million in 2010.

But all of that changed in 2010 when the county’s real property tax revenues began declining, according to county budget documents. By 2013, those revenues had dropped to $78.4 million, a 14 percent dip from $91.4 million in 2010.

The state Legislature, in 2011, then issued a $93 million cap on the amount of TAT revenues that counties shared among each other. This also placed a flat $13.5 million limit on the amount of TAT revenues that the County of Kauai could collect. 

Although the county’s two main sources of revenue were declining, the amount of taxpayer money spent from the general fund was not, according to county budget documents.

“The county’s general fund expenditures rose steadily throughout the (economic) downturn and show no signs of abating,” Fitch Ratings officials noted in their report.

County officials, in fact, withdrew $35.2 million in taxpayer money from the general fund to pay for county services between 2011 and 2013, according to county budget documents. No money at all, however, was drawn out of the general fund between 2003 and 2010.

“Fitch considers unrestricted fund balance a key credit factor for the county given its narrow economic base and vulnerability to declines in discretionary consumer spending,” Fitch Ratings officials wrote. “Reduced reserves also leave the county less well-equipped to manage future budgetary pressures.” 

The next step ahead

Though news of the credit rating downgrade has struck a nerve among many county officials, some say it is not too late to turn things around.

County Finance Director Steve Hunt said the recent move by Fitch Ratings will have little effect on the county’s borrowing power, since its two other credit agencies — Moody’s Investor Service and Standard and Poor’s Ratings Service — have not taken any action against the county, at least for now.

“I’m not sure if this indicator by Fitch, which was the most recent activity, will have any influence on the other rating agencies … but certainly it’s a strong message that we need to get our house in order and we need to have a budget that is sustainable and we need to have a reserve policy formally developed and long-term budget strategies need to be in place,” Hunt said.

In his revised budget message to the County Council, Carvalho called on the seven-member board to adopt several key tax and fee increases — namely those to increase the county’s resort and hotel real property tax rate, solid waste tipping fee and vehicle weight tax — which could raise an additional $6.7 million in revenue during the upcoming fiscal year, according to current budget projections.

Carvalho said he and his administration are also taking a firm stance on asking the County Council to lower the minimum percentage of real property taxes that must be dedicated to the county’s Public Access, Open Space and Natural Resources Preservation Fund from 1.5 percent to 0.5 percent.

This would, according to Carvalho’s budget proposal, allow his administration to redirect $849,805 in taxpayer money to the county’s reserve fund for emergencies or natural disasters “without additional drain on the general fund.” 

Some critics, however, say this proposal would also decrease money set aside for public access and open space projects by 62 percent from nearly $1.4 million to $518,233 during the 2014-2015 fiscal year.

“We realize there is resistance to reducing the open space allocation, however, we feel that this is a prudent and reasonable trade-off until structural stability is achieved,” Carvalho wrote in his latest budget message.

The county’s budget team, he added, will also be preparing a five-year plan over the next six months aimed at determining “how to achieve financial stability and sustainability.”

“The result of this analysis will be the basis of our budget proposal for fiscal year 2016 and will also be the first step toward moving the bond rating in a positive direction,” Carvalho wrote.

And if the County of Kauai does not change its ways, Fitch Ratings officials warned, the result may not be a good one.

“An inability to restore general fund structural balance after fiscal (year) 2014 would likely add downwards rating pressure,” Fitch Ratings officials concluded in their report. 

• Darin Moriki, county government reporter, can be reached at 245-0428 or dmoriki@thegardenisland.com. Follow him on Twitter at @darinmoriki.