Fitch Affirms Winchester, VA's IDR at 'AA+'; Outlook Stable
--Issuer Default Rating (IDR);
--$106.2 million general obligation (GO) public improvement bonds, series 1999A, 2005, 2006, 2007 and refunding bonds series 2011, 2012, 2013 and 2014.
The Rating Outlook is Stable.
The bonds are general obligations of the city backed by its full faith and credit and unlimited taxing power.
KEY RATING DRIVERS
The 'AA+' IDR reflects the city's strong financial position and superior inherent budget flexibility highlighted by an unlimited revenue raising capacity, that can be tapped as needed. The modest long-term liability position is expected to remain manageable going forward given the city's history of cash funding its capital needs, limited debt plans, and small net pension liability.
Economic Resource Base
The city of Winchester is located in the Northern Shenandoah Valley region along Interstate-81 in northern Virginia. The city is roughly 75 miles west of Washington D. C and has a population of 27,284. The city anchors a small regional center for health services, retail, and manufacturing that extends into West Virginia. Unemployment rates tend to register below national averages, but above those of the commonwealth.
Revenue Framework: 'aaa' factor assessment
General fund revenues are primarily funded from property taxes, but are also supported by a mix of sales, meals and accommodation taxes, and business fees. These revenues have increased faster than national economic expansion in recent years as they include policy actions to raise the millage rate. The property tax rate for local governments is unlimited in the Commonwealth of Virginia resulting in a broad capacity to respond to revenue decline in a moderate economic downturn scenario.
Expenditure Framework: 'aa' factor assessment
Fitch believes the city has a solid capacity to cut spending in response to an economic downturn highlighted by a moderate fixed cost burden and a labor environment that provides flexibility to management. The city allocates resources to school spending well in excess of the state's required local effort, providing additional cost-cutting flexibility if necessary.
Long-Term Liability Burden: 'aa' factor assessment
The city's long-term liabilities are a moderate burden as measured against personal income at 11.6%. Debt levels are not expected to significantly increase based on the city's future capital needs and a low net pension liability that is expected to be maintained.
Operating Performance: 'aaa' factor assessment
General fund reserves are consistently maintained above a conservative 20% fund balance policy and provide exceptionally strong gap closing capacity based on the city's superior budget flexibility and historically low revenue volatility.
STRONG FINANCIAL FLEXIBLITY: The city's strong financial flexibility is a key strength in the 'AA+' rating, balanced against a more moderate long-term liability burden. Although no changes are currently anticipated, the rating is sensitive to shifts in the relative strength and relationship of these key rating factors over time.
Winchester is the population, retail, and health services center for a relatively small population of 133,836 residing within the Winchester metropolitan statistical area (MSA) that comprises surrounding Frederick County, VA and Hampshire County, WV. Healthcare and social services is the leading industry within the city led by Valley Health System with more than 1,000 employees. Shenandoah University, a private liberal arts institution with an approximate enrollment of 3,800 lends additional stability to the local economy.
The city's retail sales per capita are approximately 3x the Virginia average, evidence of the strength of the local business community which includes Wal-Mart, a leading taxpayer and employer in the city. Job growth in Winchester since the recession has outpaced much of the rest of the Commonwealth. Several notable manufacturers add diversity to the economy including Rubbermaid and O'Sullivan Films. The dominance of retail and manufacturing sectors on annual payroll translate to resident income metrics that measure between 70% and 90% of state and national norms, respectively.
Approximately half of general fund revenues are derived from property taxes and another 40% are derived from other taxes that include retail sales, meals and accommodation taxes, and business license fees. The tax base of the city is well below the fiscal 2007 peak due to the impact of the Great Recession, but has shown steady recovery since fiscal 2012.
General fund revenue increased at a 4.8% compound annual growth rate over the past decade, based on a combination of the city's expanding tax base and also on policy action the city has taken to increase tax rates. Property taxes are an increasing portion of general fund revenues due to a total 50% increase in the ad valorem tax rate over the last decade. The increases have paid for school capital projects including a new elementary school and renovations to the high school, while also offsetting the tax base declines of the recession. Other taxes and fees, such as for sales, meals, and accommodations and business licenses, have shown strong growth due to economic expansion.
There are no legal limitations on the city's ability to increase either the property tax rate or levy, providing the city with independent revenue-raising authority.
Appropriations to the city school system consume close to 40% of the general fund budget followed by public safety at about a quarter of the budget. The public school system in Virginia is funded by a mix of state and local revenues. The amount of local contributions is determined by the city council, and based on the state determined performance standards for the school system. Winchester Public Schools, a component unit of the city, is primarily funded by the city with less than half of revenues coming from the Commonwealth. The city funds the school budget 140% above the state's required local expenditure. Fitch considers the budgeted amount over the required contribution as discretionary spending that adds cost-cutting flexibility if needed.
As with most local governments, Fitch expects spending growth will likely be near to slightly ahead of revenue growth, partially due to growing school enrollment estimated to increase by 12% over the next seven years.
Fixed carrying costs associated with debt service, required pension payments and actual other post-employment benefits (OPEB) payments consumed 13.8% of governmental spending in fiscal 2015. Most of these carrying costs are derived from debt service payments that are frontloaded due to a rapid amortization rate of 72% of principal paid in 10 years. The city has broad discretion over headcount and the terms of employee wages and benefits given the absence of collective bargaining. Headcount, while down slightly in the post-recession years, is now above the fiscal 2008 peak. The city also budgets a significant amount of paygo capital funding each year and included $1.3 million (1.6% of spending) in the fiscal 2016 budget. Management reports they are up to date on capital needs.
Long-Term Liability Burden
The combined burden of overall debt and net pension obligation is moderate at 11.6% of personal income (city only, not including component units). This metric is primarily driven by the city's debt obligations, which equates to 10.5% of personal income, and includes no overlapping debt due to the nature of independent cities in Virginia. Planned debt issuance in the five-year capital plan approximates roughly the amount of outstanding debt scheduled to mature over the period so debt ratios should remain stable. The most recent five year CIP includes about $36 million in GO debt, primarily for roads, sidewalks and buildings.
City employees are enrolled in a defined benefit plan administered by the Virginia Retirement System as an agent multiple employer plan. The ratio of assets to liabilities is 88% as of June 30, 2015, and the remaining net pension liability of $11.2 million is a low 1.1% of personal income.
The school board is a component unit of the city and reports a net pension liability for teachers at $44.4 million, or an additional 4.2% of personal income, while assuming a 7% return on assets.
Fitch expects the city to continue to adhere to its fund balance policy which translates to a 'aaa' reserve safety margin considering the city's low revenue volatility and its budgetary strengths that include an unlimited ability to adjust property tax rates. Fiscal 2015 ended with a minimal use of reserves and unrestricted fund balance totaled $21.6 million or 26.7% of spending, well below the original budget's planned $3.5 million use of reserves and in excess of the city's conservative 20% fund balance policy.
Management has taken a proactive approach when developing the budget and does not postpone or defer liabilities, as evidenced by making full actuarially-based pension payments and staying up to date on capital needs. Additionally, financial results typically outperform projections. Fiscal 2016 ended with an estimated break-even after transfers for paygo capital projects, well ahead of the $1.75 million deficit in the original budget. The fiscal 2017 budget appropriates $1.35 million of fund balance, which would lower the fund balance to a still sound 23% of spending if fully utilized. The fiscal 2017 budget is an approximate $1 million increase over the previous budget (a 1.2% increase) and includes a 2% merit increase for employees and a 2% increase in education spending.