Fitch Rates New Haven, CT's Series 2016A GOs 'A-'; Outlook Stable
--$121,750,000 GO bonds, series 2016A.
The bonds are being issued to finance various city and school related projects and to refund a portion of the city's outstanding GO bonds for debt service savings. Bonds will be sold via negotiation on or around Aug. 10.
In addition, Fitch affirms the city's following ratings:
--$562 million in outstanding GO bonds at 'A-';
--Issuer Default Rating (IDR) at 'A-'
The Rating Outlook is Stable.
SECURITY
The bonds are general obligations of the city, backed by its full faith and credit and unlimited taxing power.
KEY RATING DRIVERS
New Haven has been making a slow financial recovery following the economic downturn but current financial flexibility remains limited. Fitch expects future costs tied to salaries, medical benefits and pensions to pressure the budget but expectations for moderate revenue growth from an improving economy and new state revenues should support these spending pressures. Long term liabilities are expected by Fitch to remain close to current levels as the city has fully funded or exceeded annual pension contribution requirements and debt amortization levels are rapid at approximately 75% of principal retirement over 10 years.
Economic Resource Base
New Haven is located on the north shore of the Long Island Sound about 75 miles north of New York City and is home to Yale University. The city's population is estimated at 130,322 for 2015, up 5.3% since 2000.
Revenue Framework: 'aa' factor assessment
New Haven's primary source of revenues is property taxes, and general fund revenue growth of about 3.7% annually over the past 10 years has exceeded both U. S. GDP and CPI for the same period. Growth in revenues was derived from a combination of tax rate increases and tax base growth. Fitch expects future revenue growth to be in line with inflation absent policy action, as a number of new developments are either underway or proposed and are expected to improve the tax base or result in higher payment in lieu of tax (PILOT) revenues. Local governments in Connecticut have an unlimited taxing authority.
Expenditure Framework: 'a' factor assessment
Expenses have been recently controlled due to local pension reform efforts and prudent efforts to reduce public safety overtime costs, but Fitch expects that the city's overall spending needs will increase in the future at a pace above natural revenue growth. Employee related medical, salary and pension costs are expected to continue to drive spending. Carrying costs related to long-term liabilities (currently about 18% of government spending) are expected to remain elevated.
Long-Term Liability Burden: 'a' factor assessment
Unfunded pension liabilities and debt levels are a moderately high 27% of personal income. Fitch expects liability levels to increase moderately based on proposed future debt issuances, the rapid scheduled amortization of outstanding debt (75% in 10 years), and low pension funded levels.
Operating Performance: 'bbb' factor assessment
Cost containment measures and one-time savings from bond refundings have helped stabilize operations but reserve levels remain very low. New state legislation that provides for new revenues to the city in fiscal 2017 will provide some budget relief, and Fitch expects a gradual restoration of reserves to more adequate levels. The city's propensity for maintaining a low level of financial reserves combined with strong revenue raising capacity and adequate spending flexibility suggest an adequate level of financial resilience to economic cycles and the potential for stressed operations in a downturn.
RATING SENSITIVITIES
STRUCTURAL BALANCE; RESTORATION OF RESERVES: Fitch expects the city to achieve and maintain structural balance in the near term and to gradually restore reserves to more adequate levels. Projections of tax base and state revenue growth and improved expenditure containment will be critical to these efforts and to maintaining the current rating.
CREDIT PROFILE
New Haven serves as a regional center for higher education, health care, transportation and the arts. The presence of the city's top two employers, Yale University and Yale New Haven Hospital, provide stability to the economy and continues to attract development and investment from biotechnology, pharmaceuticals and life-science companies.
Significant new developments have contributed to the city's tax base growth and a number of projects are reportedly in the pipeline and are expected to increase employment opportunities in the city.
The most recent property revaluation, effective October 2011, showed an increase in the city's market value of 16% to $8.6 billion. Between valuations, tax base changes reflect only property improvements, new additions or appeals activity but not the results of sales of property. Taxable values, net of exemptions, for the four year period through October 2015 were up a modest 1.3%. A new tax base revaluation will be performed effective Oct. 1, 2016 for the fiscal 2018 budget.
The city's unemployment rate remains elevated but improved to 7.1% in May 2016 from 7.5% a year prior. Wealth levels are below state and national averages, as has historically been the case, but are somewhat influenced by the level of students residing in the city. The city's 2013 poverty rate is a very high 26.5% compared to the national average of 15.4%.
Revenue Framework
Property taxes represent approximately 48% of fiscal 2017 budgeted general fund revenues. Management has the independent legal ability to raise taxes without limit and has made increases in its tax levy when needed to meet expenditure growth. Municipal revenue sharing grants provided by the state have been subject to cuts recently, but the city has benefitted from legislation passed in fiscal 2015 that boosts the PILOT payments provided by the state to municipalities with state-owned or tax-exempt college and hospital properties beginning in fiscal 2017. New Haven has budgeted $14.6 million in state PILOT aid or 2.8% of the fiscal 2017 general fund budget. The net increase in state aid for fiscal 2017 compared to fiscal 2016 is $10.1 million or 2% of budget as the state did make cuts to other grant programs.
Fitch expects future revenue growth to be in line with inflation absent policy action, as a number of new developments are either underway or proposed and are expected to result in strong building permit revenues, growth in the tax base, and higher state PILOT revenues derived from building improvements and expansions planned by Yale University.
Expenditure Framework
New Haven's spending is primarily for education and city employee salary and benefits. Fitch expects the city's overall spending needs will increase in the future at a pace above natural revenue growth due to the demands of weakly funded pensions and the general rise in employee medical and salary costs.
Management has made significant progress in controlling growth in its long-term liabilities through pension reform efforts and recent changes to health insurance benefits for current employees. Future retiree benefits tied to medical insurance have also been modified for certain employees helping to control growth in the city's long-term retiree medical benefits liability.
The city has the ability to reduce expenses tied to it services. Management has the legal ability to reduce non-public safety staff at any time if necessary. Union contracts are subject to arbitration but a decision may be rejected by a two-thirds vote by city council. Arbitration decisions are required to take into consideration the financial capability of the employer.
Pension costs of $42.8 million (5.5% of governmental spending) in fiscal 2015 are up from $30.6 million in fiscal 2011. Pension costs increase to $45.8 million in fiscal 2016, partly due to several assumption changes recently implemented. Fitch expects annual pension costs to continue to climb due to the low funded status of the plans (see below).
The city's primary expenditure variances have been associated with public safety overtime costs and self-insurance medical benefits. To address these growing costs management has trained and hired new police members and fire fighters to help avoid vacancies and has increased funding for the self-insurance fund in its fiscal 2017 budget to help eliminate the fund's fiscal 2016 operating imbalance.
Long-Term Liability Burden
Long-term liabilities for debt and unfunded pensions represent a moderately high 27% of personal income. Debt levels account for roughly 40% of the metric and are expected to increase moderately taking into consideration future borrowing plans and the rate at which existing debt is repaid. The five year capital improvement plan totals $483 million with anticipated borrowings averaging $57 million over the next five years, equal to approximately 50% of current net debt outstanding. Even with this additional debt, Fitch would expect the city's long-term liability burden factor assessment to remain in the 'a' category.
The city maintains two single-employer defined benefit plans for general city employees and police and fire personnel. Pension funded levels are low despite the city continuing to fund 100% of its actuarially determined pension payment. Based on a measurement date of June 30, 2015, the combined unfunded liability for both plans was equal to an estimated $772 million (or a high 9% of market value) using Fitch's assumed 7% investment rate of return (IRR) and the combined unfunded levels for the plans was 39%. The last valuation was affected by several recent program changes including a 0.25% reduction in the IRR to 8%, a change in the projected payroll growth rate from 4% to 2%, a reset of the actuarial value of assets to market value effective July 1, 2014, and revision of the amortization of the unfunded liability to a fixed period of 30 years for the police and fire plan and 28 years for the general plan.
The city's unfunded OPEB liability was a high $441 million (9% of personal income) as of July 1, 2013, the most recent data available. The city contributed pay-as-you-go contributions of $28.7 million in fiscal 2015, equivalent to 77% of the ARC and 3.7% of fiscal 2015 total governmental spending.
Operating Performance
Management has been successful in controlling certain of its recurring operating expenditures and has relied on one-time savings from bond refundings to help stabilize operations, but reserve levels remain very low. New revenues from the state PILOT program beginning in fiscal 2017 will provide for some much needed budget relief, and Fitch expects a gradual restoration of reserves to more adequate levels. However, fiscal pressure still exists as expenditures associated with employee benefits are expected to continue to grow hampering management's ability to significantly improve unrestricted reserve levels more rapidly.
Operating performance would likely be stressed in a future potential economic downturn due to the city's low reserve levels, although Fitch expects the city would take actions necessary to restore its financial resilience using its unlimited taxing authority and adequate inherent budget flexibility. During the most recent downturn management demonstrated its ability to reduce spending through cost controls, staff reductions, and deferred hiring practices. Fitch expects management would take similar actions if needed to maintain its moderate level of financial resilience.
The projected operating results for fiscal 2016 reflect balanced operations with a carryforward of the fiscal 2015 unrestricted fund balance of $1.7 million (less than 1% of spending). Results reflect the use of approximately $5 million of upfront debt service savings derived from the series 2015B bond refunding to help cover negative expenditure variances related to public safety overtime, lower than anticipated motor vehicle and delinquent taxes, and reductions in state aid. The city's self-insurance reserve, which is reported outside of the city's general fund, is projecting an operating shortfall of approximately $6 million.
The city's fiscal 2017 general fund budget of $523 million was a net increase of $15.5 million or 3% over the prior year, and the second consecutive year of no tax rate increase. The bulk of the spending increase reflects the state of Connecticut's recently approved legislation that boosts the PILOT payments. The budget includes increased appropriations of $2 million for its schools and a $5.9 million increase for its self-insurance fund to help partially eliminate the prior year operating gap. Additionally, $2 million in increased funding was made for pensions, including $0.9 million over annual required amounts, and $405,000 was budgeted over pay-as-you-go for OPEB. An appropriation for fund balance replenishment was made for $1.2 million.
The state of Connecticut's recent budget pressures could result in future cuts to state municipal aid, although the timing and magnitude of any cuts remains unknown. Fitch will continue to monitor the state's response to its recent fiscal challenges, including any potential impact on its local governments.
The proposed bond refunding and new money issuances are projected to provide excess premium and upfront refunding savings to create estimated cash flow savings of $9 million, $5 million and $2 million in fiscals 2017, 2018 and 2019. The modest restructuring of existing debt will achieve a leveling of its pro forma aggregate debt service taking into consideration proposed future debt issuances.
Fitch does not consider the restructuring of debt for cash flow savings a prudent practice, but the city's very rapid debt amortization schedule does provide it with the flexibility to restructure its front-loaded debt to achieve budget relief over the next few years. The 2016 planned refunding achieves net present value savings and does not result in a material impact in the average life of the city's outstanding debt.
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