Fitch Affirms Midland, TX's GO Bonds and COs at 'AAA'; Outlook Stable
--$103.5 million tax and limited pledge revenue certificates of obligation (COs), series 2007, 2009, 2012, and 2014;
--$16 million general obligation (GO) refunding bonds, series 2006B and 2014.
The Rating Outlook is Stable.
The GOs, revenue bonds, and COs are payable from a property tax limited to $2.50 per $100 of taxable value. The revenue bonds and COs are additionally secured by a de minimis pledge of net utility system revenues, not to exceed $2,500.
KEY RATING DRIVERS
The 'AAA' rating reflects the city's robust financial cushion, expenditure flexibility, revenue-raising capability, and low long-term liability burden.
Economic Resource Base
The city is the county seat for Midland County (GO bonds rated 'AAA') and is the main service center for the Permian Basin in west Texas. The city's 2015 estimated population of 132,950 is 25% higher than 10 years prior.
Revenue Framework: 'aaa' factor assessment
The city of Midland has realized strong 10-year revenue growth and maintains sizable ad valorem tax rate capacity. The 'aaa' assessment incorporates the local economy's energy concentration and associated revenue-base volatility in addition to the long-term viability of the U. S. energy industry.
Expenditure Framework: 'aa' factor assessment
Solid expenditure flexibility results from strong workforce control and moderately low carrying costs. Fitch expects expenditures to grow in line with revenues, but notes adjustments to spending may be necessary in the case of revenue volatility.
Long-Term Liability Burden: 'aaa' factor assessment
The city typically cash-funds capital needs, resulting in a low debt burden. Pensions are well funded, and near-term capital needs are modest.
Operating Performance: 'aaa' factor assessment
Fitch expects the city to demonstrate an exceptional strong degree of gap closing ability and financial resilience during an economic downturn based on its healthy reserves, strong expenditure flexibility and high independent revenue-raising ability in relation to potential revenue declines.
Spending Flexibility: The rating is sensitive to management's ability to adjust spending in light of volatile revenues.
The Permian Basin is one of the country's oldest and largest oil and gas reservoirs; however, real oil, gas and other mineral values comprised less than 2% of the city's fiscal 2016 taxable assessed value (TAV), since most exploration and production occurs outside of city boundaries. The well-documented energy sector decline that began in 2014 has significantly affected the Permian Basin area. Rig counts have fallen sharply since 2014 from a peak of 568 to 142 as of June 2016.
The top 10 taxpayers make up a moderate 7.5% of the tax base but industry concentration is evident with seven of the top 10 in oil and gas. Major employers are in education, medical, energy/mining, and governmental sectors.
The revenue base is dominated by a voter-approved local sales tax at about 40% of total general fund revenues and property taxes at one-third, followed by franchise fees at 13%.
Over the last decade general fund revenues have grown at a compound annual growth rate (CAGR) of 5.8%, in excess of both U. S. economic performance and CPI. Sales tax revenues more than doubled over this time period due to the precipitous increase in the price of crude oil, driving a boom in exploration and production and associated services. Council developed a strategic plan to use sales tax funds in excess of a certain amount (one-third of general fund revenues) for non-recurring uses, one-time capital improvements, or to enhance fund balance reserves in order to maintain a minimum of 30% in reserves, slightly above the 25% formal fund balance policy level.
The in-kind decline in energy prices produced a significant contraction in sales tax revenues; fiscal 2016 year-to-date results show a roughly 20% decline compared to a year ago, levels that are more consistent with 2013 trends. In contrast, the residential portion of the tax base has proven resilient through the downturn, driving an overall increase in the preliminary TAV in fiscal 2017 through new properties and increasing home sale prices. Fitch's 'aaa' assessment incorporates volatility of the city's' revenues, particularly sales tax revenues, to the energy sector.
Strong sales tax revenue growth has allowed the city to reduce its ad valorem tax rate from $0.642 per $100 TAV in fiscal 2006 to $0.3805 in fiscal 2016, providing ample capacity below the statutory cap of $2.50. If a proposed tax rate results in an 8% year-over-year levy increase (based on the prior year's values), the rate increase may be subject to election if petitioned by voters. Management typically adopts an effective tax rate plus 3%.
Fitch anticipates the potential for a decline in TAV in the next couple of years depending on the direction of oil prices and energy sector trends. The 'aaa' revenue framework assessment incorporates Fitch's expectation that the city will raise the tax rate to maintain sound revenue growth during the downside of economic and energy cycles.
The city's largest spending area is public safety, which makes up a bit less than half of general fund spending. Spending growth in that area has trended in line with general fund expenditure growth.
The city exercises considerable expenditure flexibility through full control of workforce costs and moderately low carrying costs. Fiscal 2015 carrying costs were 11.9% of governmental spending and principal amortization is swift.
The pace of spending on operating functions is likely to remain in line with revenue growth. Fitch does not anticipate pressure on service levels given the city's maturity.
Long-Term Liability Burden
The city's long-term liability burden is estimated by Fitch at a very low 3% of personal income due to high wealth and low debt. Upcoming tax-supported debt plans have yet to be finalized but remain modest in nature.
The city participates in the Texas Municipal Retirement System (TMRS), an agent multiple-employer defined benefit plan. Additionally, the city pays into the Firemen's Relief and Retirement Fund, a single-employer defined benefit pension plan.
Under GASB Statement 68, the city reports a fiscal 2015 TMRS net pension liability (NPL) of $27.8 million, with fiduciary assets covering 90% of total pension liabilities at the plan's 7% investment return assumption and based on a Dec. 31, 2014 valuation date. The city reports a fiscal 2015 Firemen's NPL of $41.8 million, with fiduciary assets covering 60% of total pension liabilities at a 7% return assumption (adjusted by Fitch as a substitute for the plan rate of 8%). The Firemen's valuation date is Dec. 31, 2013. The NPL of both plans represents less than 1% of personal income.
The city has maintained robust reserve levels and continued to do so during the most recent economic recession, which was relatively mild in the region. The city is expected to manage through economic downturns while preserving a superior level of fundamental financial flexibility. General fund reserves are well above the city's reserve policy, a level that withstands the moderate economic downturn stress evaluated using the Fitch Analytical Sensitivity Tool (FAST).
The city practices conservative budgeting and has implemented cost savings initiatives when necessary. For the current fiscal year management has cut $2.8 million from general fund spending to account for the decline in sales tax revenues. Operationally, management plans to end the year break-even, but may use up to $2.1 million in reserves for one-time projects. Fiscal 2015 unrestricted fund balance stood at $71 million, or a very high 64% of expenditures, providing ample cushion in the case of further revenue contraction.
Budget discussions for fiscal 2017 are underway and the city has made a commitment to maintaining operational balance. Historically, management has promptly responded with budgetary measures to yield stable operating performance in years of contracting or stagnant revenue, and similar action would be expected if deemed necessary in the near term.