Fitch Upgrades Ocean City, MD's IDR to 'AA' on Criteria Change; Outlook Stable
--Issuer Default Rating (IDR) to 'AA' from 'AA-';
--$81.7 million general obligation bonds to 'AA' from 'AA-'.
The Rating Outlook is Stable.
SECURITY
GO bonds are general obligations payable by the full faith and credit and unlimited taxing power of the town.
KEY RATING DRIVERS
The 'AA' IDR and GO rating are based on the town's solid financial profile which is underscored by a superior degree of inherent budget flexibility in the form of revenue and spending control. Debt levels are somewhat elevated as a percent of the year-round population's personal income, but less so compared to market value and when the metric considers the island's visitor statistics. The town's economy and finances are notably dependent on tourism activity.
The upgrade reflects application of Fitch's revised criteria for U. S. state and local governments, which was released on April 18. The revised criteria highlight the town's strong revenue framework and outstanding gap-closing capacity, and provide a more focused consideration of the tourism-based economy.
Economic Resource Base
Ocean City is located along the Maryland coast in Worcester County (GO bonds rated 'AA'/Outlook Stable), approximately 135 miles from the city of Baltimore, Maryland and 150 miles from Washington D. C. Its status as a popular vacation area is evidenced by an average summer weekend population estimated at more than 250,000 compared to a year-round residential population of approximately 7,000.
Revenue Framework: 'aa' factor assessment
Fitch expects revenues to rise at a solid pace going forward despite recent performance that is slow by historical standards. The town enjoys strong revenue flexibility given the independent legal ability to increase property taxes without limitation.
Expenditure Framework: 'aa' factor assessment
The natural pace of spending growth is expected to be in line with to marginally above that of revenue. Carrying costs associated with debt service and retiree benefits are moderate, and control over staffing, wages, and benefits is satisfactory.
Long-Term Liability Burden: 'aa' factor assessment
The combined burden of debt and unfunded pension liabilities is somewhat elevated in relation to personal income, but this mostly reflects the low year-round population. Liabilities are significantly more moderate when compared to market value.
Operating Performance: 'aaa' factor assessment
The town's superior inherent budget flexibility, in the form of strong revenue and expenditure controls, supplemented by the maintenance of solid reserves, provide a high level of financial resilience that Fitch expects the town to maintain throughout an economic downturn.
RATING SENSITIVITIES
SHIFT IN DEBT OR ECONOMIC EXPECTATIONS: Fitch views the town's key rating factors as stable; however, rating pressure may stem from an increase in debt and associated carrying charges beyond current expectations or a shift in Fitch's expectations for solid long-term revenue growth.
CREDIT PROFILE
Tourism and hospitality is the leading employment sector which is reflective of the town's seasonal economy. As such, top employers include several hotel and restaurant establishments including the Harrison Group and O. C. Seacrets. The popularity of this destination remains strong, evidenced by room tax revenues that continue to increase year-over-year.
County unemployment rates exhibit a pattern similar to that of tourist arrivals. The Worcester county unemployment rates averaged 12% from January-April 2016, the traditional off-season for tourism, and dropped to an average of about 7% from May-August.
Revenue Framework
The town's revenue base is dominated by property taxes at about 52% of fiscal 2016 general fund revenues and tourism taxes (room occupancy, admission and amusement taxes) at 19%. Total general fund revenues are expected to continue to increase in the recovery given strong economic activity.
The town's general fund revenue growth has trended above U. S. GDP growth over the last decade, increasing at a 10-year CAGR of 3.3% through fiscal 2015. Revenue growth does not include any property tax rate increases or adjustments but the town's assessed value (AV) has increased by an average annual rate of 8% between 2004 and 2014. AV declined 1% in 2016 reflecting the triannual reassessment of residential property and is expected to decline another 1% in 2017 reflecting the triannual reassessment of commercial property. However, capital investment is continuing within the town with the construction of four new hotels totaling nearly $50 million in construction value.
Property tax revenues and rates are not subject to any legal cap. The town also has the independent legal ability to increase the room tax by a half a percentage and the admissions tax another 1% (about $2 million in additional revenue, or 3% of spending).
Expenditure Framework
The town's largest expenditure is public safety at roughly 46% of general fund expenditures, followed by public works at 22%.
Based on the town's history of structural balance and no immediate significant spending pressures, Fitch expects spending growth to remain in line with revenues.
Approximately a quarter of the town's workforce is unionized (Fire and Police). While arbitration is binding there are no minimum staffing requirements and strikes are not permitted. New minimum wage rates effective July 1, 2017 are expected to modestly impact spending on wages as the town typically hires about 1,000 temporary summer employees.
The town's fixed cost burden is moderate, with carrying costs for debt, pensions, and other post-employment benefits (OPEB) equaling 15% of fiscal 2016 governmental expenditures, with debt service accounting for 6%. The 10-year principal amortization rate is rapid at over 75% of principal retired in 10 years.
Long-Term Liability Burden
Overall net debt plus the town's unfunded pension liability equals a somewhat elevated 24% of personal income, with about 40% of the total attributable to overlapping debt of the county. However, when the overall liability burden is compared to market value, the metric equals a low 2%.
The town's future debt needs are affordable. The town recently completely a feasibility study of the convention center in conjunction with the Maryland Stadium Authority. If approved, the town's share ($14 million) would be funded by GO bonds sold in fiscal 2018 compared to outstanding net direct debt of $42 million.
Fitch views as positive the town's efforts to limit its pension and other post-employment benefit (OPEB) liabilities. The town closed its defined benefit plan for general employees to new employees in fiscal 2011 but the single-employer defined benefit plan for public safety employees remains open. General employees hired after 2011 participate in a mandatory defined contribution plan. As of April 1, 2016 the aggregate reported funded ratio for both plans was 78%. Using a Fitch adjusted rate of return of 7% the funded ratio declines to 74%. The aggregate unfunded pension liability represents about 7% of personal income.
OPEB obligations as of March 2016 were 45% funded. The unfunded actuarial liability of $28 million represents 5% of personal income.
Operating Performance
The town's consistently high level of fundamental financial flexibility comes from a combination of revenue and spending control supplemented by management's ability to consistently maintain high reserve levels over an extended period of time. Fiscal 2016 ended with an unrestricted general fund balance of $19 million or a high 23% of spending which is well in excess of the town's formal operating reserve policy of 15%.
The town proved its financial resilience and strong budget management through the great recession by offering a retirement incentive program to reduce full time positions by 15%, reducing capital spending and holding salaries flat for four years. Fitch expects the town to make similar operational changes as needed during a future economic downturn.
The fiscal 2017 budget of $75.4 million is a 1.8% increase above fiscal 2016 and includes a slight reduction in the property tax rate. The budget funds a pay increase for general employees of an average 2.3%. The budget also funds $5.9 million of pay-go capital spending and includes a $1.2 million appropriation of fund balance which is in line with prior years and the town does not typically utilize due to conservative budgeting.
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