Fitch Rates Lubbock, TX's $36.3MM Series 2016A GO Rfdg Bonds 'AA+'; Outlook Stable
--$36.3 million GO refunding bonds, series 2016A.
In addition, Fitch has affirmed the city's Issuer Default Rating (IDR) at 'AA+' and the 'AA+' rating on the approximately $1 billion (pre-refunding) in outstanding GOs and certificates of obligation (COs).
The Rating Outlook is Stable.
The series 2016A GO bonds are expected to price via negotiation the week of Oct. 3. Proceeds of the GOs will be used to refund certain outstanding obligations for debt service savings.
The GO bonds and COs are payable from a limited ad valorem tax pledge of the city, not to exceed $2.50 per $100 taxable assessed valuation (TAV).
KEY RATING DRIVERS
The 'AA+' IDR and limited tax ratings reflect the city's high level of demonstrated and anticipated operating financial resilience through a typical economic cycle. This assessment is underpinned by a generally favorable revenue profile and superior inherent budget flexibility. Fitch believes general fund revenue growth prospects are solid with limited expected volatility; the revenue profile is augmented by the city's ample revenue-raising ability. Continued population and economic growth should also keep the liability burden moderate. Carrying costs are expected to remain manageable given the rapid principal amortization of city's debt and comparable levels of self-support from various enterprise funds.
Economic Resource Base
The city of Lubbock is located in northwest Texas, and it serves as the retail/trade, educational, and health care hub for the surrounding, largely rural region. The steadily growing population base is presently estimated at 244,000. Local educational attainment levels are comparable to those of the U. S. due in part to the outsized presence of Texas Tech University.
Health care, education, and government comprise the area's largest non-agricultural employment sectors. Unemployment remained low at 4% in July 2016, slightly below state and national averages. Fitch expects the local economy will continue exhibit its historically stable profile, and expand at a moderate pace with further population, job, and income gains.
Revenue Framework: 'aaa' factor assessment
Fitch expects general fund revenues should naturally grow at a pace that exceeds inflation, but below U. S GDP due to continued population and economic expansion and despite periodic stagnation in sales taxes historically. The city retains significant ability to raise its property tax rate to generate additional revenue.
Expenditure Framework: 'aa' factor assessment
Solid expenditure flexibility is derived from management's prudent budgeting practices, ability to adjust its labor costs if needed, and moderate carrying costs. Fitch expects growth-related spending demands to be matched by revenue gains, keeping their trajectories aligned with revenues over time.
Long-Term Liability Burden: 'aa' factor assessment
The long-term liability burden is moderate at 12% of personal income. Fitch believes further economic and population growth should keep the burden in line with the 'aa' assessment.
Operating Performance: 'aaa' factor assessment
The city's ample revenue-raising ability, sound expenditure control, and use of its strong reserve cushion should enable the maintenance of a high level of financial flexibility during cyclical downturns.
Financial Flexibility: The rating is sensitive to material deterioration of the city's operating flexibility and revenue-raising ability in its property tax rate as these credit strengths provide an important counter-balance to the possibility of further sluggishness or decline in sales taxes, the city's largest operating revenue source.
The city's tax base is largely residential with minimal taxpayer concentration. TAV trends typically reflect steady, moderately-paced expansion. TAV grew by a somewhat stronger than average 7% in fiscal 2017, primarily a result of property appreciation. Fitch believes the generally stable local economy and a steadily growing population base support the likelihood of further, moderate TAV growth, inclusive of the various residential and retail/commercial projects underway or planned on the west side of the city and near Texas Tech University's large 35,000 student campus.
Near-term TAV trends should also be boosted by recently announced construction plans of Monsanto Company. An approximately $100 million state-of-the art cotton seed processing facility is projected to open in late 2017. The site is expected to become Monsanto's primary U. S. hub for all commercial cotton seed processing operations.
The general fund relies heavily on sales taxes. Sales taxes from a 1% levy comprised 37% or $62 million of total operating revenue in fiscal 2015, followed by property taxes (30%) and payments in lieu of taxes from enterprises (19%). Sales tax performance remained relatively resilient over the recession, flattening for one year before regaining steady, positive growth over fiscals 2010-2015. However, this recent trend appears to have slowed in fiscal 2016. Management attributes the relatively sluggish year-over-year sales tax performance to the reduced discretionary income of those regional shoppers affected by the now depressed energy sector.
On average, historical revenue growth in the 10-year period of fiscal 2004-2014 has slightly outpaced U. S. GDP, although this is due in part to fairly consistent, modest increases to the city's operating property tax rate and a voted increase in the operating sales tax rate during this time period. Nonetheless, Fitch anticipates further, moderately-paced population expansion, tax base gains, and economic activity should yield solid, future revenue gains naturally given the ability of city property and sales taxes to capture that growth.
At a total tax rate of $0.54 in fiscal 2017, ample taxing margin remains under the $2.50 per $100 AV cap for operations and limited tax debt service. Outside of this statutory cap, there are no legal limits to management's ability to implement annual property tax increases. 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.
Public safety is the city's largest operating expenditure, consuming about 67% of fiscal 2015 expenditures and transfers out. Fitch believes the pace of spending growth, absent policy actions, should remain equal to or slightly exceed revenue gains, tempered by a history of moderate, steady investments in personnel and capital not projected to require significant catch-up.
The city has demonstrated its ability to control key expenditure items in times of fiscal stress, utilizing a combination of salary and position reductions/freezes in addition to deferral of annual pay-go capital spending. Management's legal control of labor costs and headcount remains strong. Expenditure flexibility is aided by the city's lack of contracts with any of its personnel.
The city's fixed cost burden is moderate. Carrying costs (debt service, net of self-supporting enterprise debt, actuarial and contractual pension payments, and pay-go other post-employment benefits [OPEB] costs,) totaled 21% of fiscal 2015 governmental spending, which incorporates the city's policy-determined, rapid pace of principal amortization (65% retired in 10 years).
Long-Term Liability Burden
The long-term liability burden, including overall debt and unfunded pension liabilities, is moderate at about 12% of personal income. Overall debt is comprised mostly of overlapping debt. Continued overlapping debt issuances are likely to be accompanied with steady gains in personal income, leading Fitch to expect the city's long-term liability burden will remain in line with the 'aa' assessment, inclusive of future debt plans in the city's own multi-year capital improvement plan.
The majority of city employees participate in the Texas Municipal Retirement System (TMRS), a state-wide, joint contributory, hybrid defined benefit pension plan. Under GASB 68, the city reports its share of the TMRS net pension liability (NPL) at $91.8 million, with fiduciary assets covering 85.4% of total pension liabilities at the plan's 7% investment rate of return assumption. The city made its full actuarially determined pension contribution of $16.8 million in fiscal 2015.
The city also has a single-employer pension plan for its firefighters (Lubbock Fire Pension Fund or LFPF). Under GASB 68, the city reports its share of the LFPF net pension liability (NPL) at $64 million, with fiduciary assets covering 74% of total pension liabilities at the plan's 7.75% investment rate of return (IRR) assumption or a slightly lower estimated 70% using a more conservative 7% IRR. The city made its full actuarially approved pension contribution of $6.3 million in fiscal 2015. The combined, Fitch-adjusted NPLs are estimated at $176 million when using a 7% IRR, which represents about 2% of personal income.
OPEB offered by the city include an implicit rate subsidy for health and dental insurance coverage for retirees and their dependents. The city funds OPEB annually on a pay-go basis ($5 million in fiscal 2015), which typically covers about 30% of the actuarially determined annual OPEB cost.
Fitch believes the city maintains an exceptionally strong capacity to manage challenges associated with a moderate economic downturn. The city's high level of fundamental financial flexibility is a result of the various budgetary tools at its disposal, which include revenue-raising authority, the ability to use its historically strong reserve cushion in excess of Fitch's calculated reserve safety margin, and solid expenditure flexibility. The city's superior financial resilience is also underpinned by historically low general fund revenue volatility (inclusive of sales tax performance).
Further, planned use of reserves by city council for street improvements in fiscal 2016 totaled roughly $8 million or about 5% of budgeted spending. Fiscal 2016 year-end results are currently projected to fall modestly below budget given the year's relatively stagnant year-over-year sales tax performance ($3 million or 3% revenue growth was budgeted). Nonetheless, management anticipates the impact will be softened by savings from the year's conservatively budgeted staffing costs, which should maintained reserves at around $34 million or roughly 20% of spending.
Fitch anticipates city management will continue to adhere to its adopted reserve policy that requires reserve levels at no less than 20% of operating revenues (excluding annual transfers from city-owned enterprises) while allowing excess reserves to fund pay-go capital spending, similar to its historical performance. General fund operations have notably incorporated annual pay-go spending for capital project that averaged about $6 million per year over the last seven fiscal years while maintaining stable-to-growing reserves. Management has also periodically funded in excess of its required annual LFPF contribution in order to reduce its outstanding NPL.