Fitch Upgrades Cranston RI's IDR to 'AA-'; and GO Bonds to 'AA+'
OREANDA-NEWS. Fitch Ratings has assigned a 'AA+' rating to the following city of Cranston, RI general obligation (GO) bonds:
--$8,145,000 GO refunding bonds, series 2016A.
The bonds are scheduled to price on June 1 via negotiation. Proceeds will be used to advance refund a portion of the city's outstanding series 2008 GOs for savings.
In addition, Fitch has upgraded the city's Long-Term Issuer Default Rating (IDR) to 'AA-' from 'A' and the rating on the city's outstanding series 2010A, 2012A, 2013A, and 2015A GO bonds and series 2012B and 2015B GO refunding bonds to 'AA+' from 'A' . The GO bond rating at two notches above the city's IDR reflects application of Fitch's revised criteria for U.S. state and local government credits, which was released on April 18, 2016. The revised criteria give rating credit above the IDR in the limited circumstances of statutory liens and visibility during bankruptcy, where Fitch believes there are distinct and significantly superior prospects for ultimate recovery in the event of a municipal bankruptcy.
The bonds are general obligations of the city backed by its full faith and credit and unlimited taxing authority. The Rhode Island State General Assembly enacted amendments to Section 45-12-1 of the General Laws to provide GO bondholders with a statutory lien on ad valorem taxes and general fund revenues of cities and towns with priority over creditors in the event of a bankruptcy of the issuer. Fitch believes that this provides bondholders a substantial preferential right in a bankruptcy proceeding.
KEY RATING DRIVERS
GENERAL OBLIGATION BOND RATING: Cranston's 'AA+' GO rating is two notches above the city's IDR. The two-notch uplift reflects the statutory lien security attached to GO bonds issued in Rhode Island and the resulting enhanced recovery considerations.
ISSUER DEFAULT RATING: The upgrade of the city's IDR to 'AA-' from 'A' reflects the stabilization of city and school fund operations along with an expectation for continued management of the city's long-term liabilities. Very strong budget monitoring practices result in attention to any shortfalls in revenues during the year, helping to achieve balanced to surplus operations over the past five fiscal years. Management's willingness and ability to raise revenues and reduce expenses, coupled with an increase in state school aid funding, have resulted in adequate reserves and improved financial flexibility. Financial projections for fiscal end 2016 for both the general and school fund are for balanced operations to slightly positive results.
Economic Resource Base
The city, with a population of about 81,000, benefits from its location proximate to the state capital and access to major highways. Management initiatives to spur economic development within the community have contributed to job growth and helped offset some tax base declines. There is no concentration in the tax base, and leading taxpayers consist primarily of real estate development properties.
Revenue Framework: 'aa' factor assessment
Revenue growth over the past 10 years has approximated inflation over the same period, and Fitch expects that trend to continue in the absence of tax increases. Property taxes make up the bulk of the city's revenues providing for predictability and stability. Statutory tax levy restrictions limit annual tax levy increases to 4% with some exceptions permitted, providing for a reasonable amount of tax revenue raising flexibility.
Expenditure Framework: 'a' factor assessment
Expenses have been recently controlled due to local pension reform efforts and stabilization of the city's school fund, but Fitch expects that the city will need to continue to manage expenses closely to match slow revenue growth. Spending flexibility is adequate.
Long-Term Liability Burden: 'aa' factor assessment
Unfunded pension liabilities are elevated but offset by very low debt levels. These combined liabilities represent a moderate 11% of personal income. Fitch does not expect debt levels to materially change over the next few years and the city fully funds its pension and OPEB annual required contributions, which should keep these liabilities manageable.
Operating Performance: 'aa' factor assessment
The city's general fund reserve levels are at the highest level in years providing for a sound level of flexibility in conjunction with the city's other budget controls. In addition, the school fund has fully eliminated its deficit position through better expense management and increases in state funding, better positioning it to maintain stable operations. Management retains the ability to make cuts in spending if necessary and has done so during economic downturns.
Financial Management: The IDR and GO rating are sensitive to management's ability to manage its finances through changes in the economic cycle and maintain an adequate level of reserves.
Cranston is a primarily residential community located just south of the capital city of Providence. The city had an estimated 2014 population of 81,037 reflecting 2.2% growth since 2000. Assessed valuation had declined for the past several years, however, new development and a slight improvement in housing values have contributed to recent growth of 4% in fiscal 2016 and a modest increase is projected for fiscal 2017. Wealth levels exceed state averages and unemployment levels continue to improve but are above national rates. The city's residents are older and the percentage with bachelors' degrees is less than the state and nation.
The city's primary revenue source is property taxes, which represent about 85% of general fund revenues. State and federal revenues provided to the city (exclusive of school aid) was only 7.5% of revenues in fiscal 2015 and can vary each year depending on grant programs that are offered. Charges for services make up 6% of revenues.
Fitch expects Cranston's revenues to continue to perform in line with the historical pace in the absence of policy action. Moderate increases in the tax base over time should help support tax revenue growth and Fitch expects that management will increase revenues as necessary.
State statute limits annual increases in the tax levy to 4% above the prior year's levy while insulating the city from loss of revenues from decreases in the property tax base. Certain exceptions exist in the law to exceed the 4% limit but require a 4/5ths approval from the city's council, and in certain instances, the state auditor general. Debt service costs are not restricted by this levy cap.
About 63% of the city's direct general fund expenditures are for public safety when excluding general fund transfers of property tax revenues representing the city's contributions to the school fund. Of the combined city and school budget of $275 million about 55% represents school spending followed by 28% for public safety.
Future spending growth is not expected to be out of the norm, but Fitch does expect the natural pace of spending growth to be above that of revenue growth, requiring ongoing cost control. Implementation of pension reforms to the city's closed defined benefit pension plan effective in fiscal 2014 and stabilization of the city's school fund is expected to benefit the city's budgets going forward.
Pension contributions are expected to continue to increase going forward due to low funded levels for both the city's closed plan and the state teachers' plan. Contributions for all plans participated in by the city and school's employees currently comprise a slightly high 13% of fiscal 2015 governmental spending. Carrying costs for combined city and school spending for debt, pensions and OPEB were manageable at 19% of fiscal 2015 governmental spending. The city has recently begun making the full annual required contribution (ARC) towards its OPEB while the school fund makes annual pay as you go contributions.
After a period of contention and maintenance of a deficit position, school fund performance continues to be positive due to better internal spending controls and an increase in state school funding. The school fund had a $3.6 million net operating surplus (after transfers) for fiscal 2015. This amount included a one-time $1.6 million transfer from the city for which $1.3 million was to help fully eliminate the school fund's negative balance. The state fair funding formula for education aid has resulted in an extra $3.4 million aid to the city for fiscal years 2016 through 2018, helping to restore school fund stability.
Long-Term Liability Burden
Total outstanding debt and unfunded pension liabilities represent a moderate 11% of total personal income. Overall net debt levels are low with debt to market value at 0.7%, and levels are not expected to materially change due to manageable plans for future debt and a rapid principal amortization rate of 77% over 10 years.
The city's aggregate unfunded pension liability for its city-run plan and state-operated plans (as of July 1, 2014) was an estimated $381 million (using Fitch's 7% rate of return) or 5.2% of market value. The ratio of the fiduciary net position to the Fitch-adjusted total liability was 57%.
The plan contributing the most to this liability is the closed city-run defined benefit pension plan offered only to police and fire personnel hired before July 1, 1995. Management has made significant efforts to address its compounding pension costs by successfully negotiating and implementing court-approved reforms to the city plan effective fiscal year 2014. Even with these reforms, the pension plan is still severely underfunded as of July 1, 2015 at only about 20% (using Fitch's 7% rate of return) and the estimated Fitch-adjusted net pension liability is $274 million (3.75% of market value).
The pension reforms include a suspension of cost of living adjustments (COLA) every other year for 10 years, and a reduced COLA in years 11 and 12. The amortization of the unfunded liability was revised to 30 years beginning in fiscal 2014, also helping to reduce the ARC to more manageable levels and control growth. The plan has 458 participants of which 32 are active employees (as of July 1, 2015).
City contributions ranged between 83% and 95% of the pension ARC in fiscals 2009 - 2013. The city began making full contributions in fiscal 2014 and is now required to continue pursuant to city ordinance and court order. Total contributions for pensions, including for the state-operated municipal employees and teachers' pension plans, represented 13% of total governmental spending for fiscal 2015. Costs associated with the state teachers' plan are expected to grow as the plan is considered weakly funded by Fitch.
The city contributed $4.8 million or a notable 107% of the ARC in fiscal 2015 for other post-employment benefits (OPEB). The unfunded OPEB liability as of July 2015 was $56 million. The school department's unfunded OPEB liability was $13 million as of July 2015 and combined with the city's unfunded OPEB liability equates to just 0.9% of market value.
Cranston's financial resilience comes from a combination of expenditure cutting and revenue increases that have resulted in a sound reserve cushion that Fitch expects the city to maintain at adequate levels throughout the economic cycle. The impact of a moderate economic decline scenario on revenues is likely to be limited due to the fact that the city's primary revenue source is property taxes and the city has the legal ability to maintain or increase by 4% its tax levy even with a decline in taxable values. Fitch expects that in such an event management would address the shortfall through an increase in revenues and expenditure management as it has done in the past.
Management has prudently raised revenue when necessary to address shortfalls and to meet growing expenditures. In fiscal 2011 the city approved a 9% tax levy hike to make up for a significant reduction in state revenue that included the loss of $11 million in motor vehicle reimbursement. The city had a practice of underfunding its pension ARC but, as noted above, with the recent court approved reforms it will not be permitted to do this.
The city's general fund results for fiscal 2015 show a small decline in fund balance but this is attributable to the one-time transfer to the school fund representing primarily a waiver of the school department's final deficit reduction payment. Although total general fund balance declined as a result of these transfers, the city's unrestricted general fund only marginally declined and equaled a solid 10.6% of spending. Property tax revenues continue to be strong due to tax collection efforts and departments have managed expenditures within their budgets.
Management is predicting balanced operations for the general fund for fiscal 2016 and a modest surplus for the school fund. The fiscal 2017 budget was recently adopted and includes no tax rate increase but a modest increase in the tax levy as a result of the 1% projected growth in the tax base. The overall budget is up 3% and includes moderate increases in employee-related costs and an increase in city aid to the school fund of $800,000 to assist in the school's transition to a full day kindergarten schedule. No use of fund balance was included in the budget.