Fitch Rates Honolulu, HI's $583.7MM GOs 'AA+'; Outlook Stable
--$583.7 million series 2016A, 2016B, 2016C, 2016D (taxable green bonds), and 2016E (taxable green bonds).
The bonds are expected to be sold via negotiation during the week of October 3. Approximately $150 million in series 2016A and 2016B proceeds will fund various capital projects. The balance of proceeds will refund all or a portion of several outstanding GO bond issues for interest savings.
In addition, Fitch affirms the following ratings:
--Issuer Default Rating (IDR) at 'AA+';
--$2.75 billion outstanding GO bonds at 'AA+'.
The Rating Outlook is Stable.
The bonds are backed by the city's full faith and credit and supported by an unlimited pledge of ad valorem property tax.
KEY RATING DRIVERS
The 'AA+' IDR reflects the city's strong revenue framework, affordable long-term liabilities, and robust operating performance, somewhat offset by its high carrying costs for debt service and retiree benefits.
Economic Resource Base
Honolulu's economy has proven its stability over the long term, with ongoing growth in tourism activity despite periodic downturns. The city also benefits from its position as the state's political and business center, in addition to substantial defense-related investments. Honolulu's population of 1 million represents approximately 70% of the statewide total. Population and labor force growth have exceeded U. S. medians over the past 10 years and personal income levels are relatively high, although below average in real terms as a result of the state's high cost of living.
Revenue Framework: 'aaa' factor assessment
Property taxes account for more than 80% of general fund revenues and total revenue growth has been strong historically, exceeding overall U. S. economic performance over the past 10 years. The city has unlimited legal authority to modify property tax rates and has made periodic adjustments to increase revenues.
Expenditure Framework: 'aa' factor assessment
Based on recent spending practices and continued strong revenue performance, Fitch expects that city expenditure increases will be in line with to marginally above revenue growth. Carrying costs for debt service and retiree benefits, however, are high relative to similarly-rated entities and could challenge the city's ability to reduce expenditures in a downturn.
Long-Term Liability Burden: 'aa' factor assessment
Long-term liabilities for debt service and pensions are low relative to total personal income, but other post-employment benefits (OPEB) liabilities are exceptionally large and inflexible. Recent statewide reforms to retiree benefits have helped to slow the growth of related liabilities but funded ratios remain relatively low.
Operating Performance: 'aaa' factor assessment
The city is well-positioned to address economic challenges as a result of limited revenue volatility and substantial reserves. Financial management is conservative and budgets are consistently balanced.
Balanced Operations: The rating is sensitive to continued strong operating performance and could be pressured by sustained reductions in reserves or uncontrolled expenditure growth. The Stable Outlook reflects Fitch's expectation that such actions are unlikely.
Honolulu's economy has performed strongly in recent years with increasing diversification, steady growth in tourism and a continued substantial military presence. Tourism activity has been subject to periodic declines historically but has proven resilient over the long term, and unemployment rates have been consistently below the U. S. average. The city also appears likely to benefit from ongoing consolidation of U. S. military activity in the Pacific.
Property taxes provide the chief source of general fund support for the city, with no other revenue source accounting for more than 5% of total revenues. Tax rates are set based on property type, allowing the city to limit the tax burden on residents relative to commercial and resort properties.
Fitch expects Honolulu's revenue growth, absent policy actions, to continue to increase more rapidly than U. S. GDP based on the city's resilient economy and above-average population growth. While revenue gains may be affected by periodic economic shocks, solid growth is expected over the long term.
The city has unlimited legal authority to raise property tax revenues and has regularly adjusted tax rates and property classifications to serve its fiscal needs. Most recently, a new property type classification targeting high value second homes was introduced in fiscal 2015, increasing revenues by approximately 4.5%.
The city provides a broad range of municipal services with the notable exception of elementary and secondary education, which are operated and funded at the state level. Public safety, including related pension costs, accounts for about half of total general fund expenditures.
Fitch expects that the natural pace of spending growth will be in line with to marginally above expected revenue growth based on the city's current spending profile. The recent trend of steady expenditure growth will continue, but ongoing revenue gains are likely to maintain pace.
The city's ability to control personnel expenses is somewhat limited by negotiation of contracts at the state level and relatively strong labor protections, including binding arbitration. Carrying costs for debt service and retiree benefits are also notably high at 28% of governmental expenditures as of fiscal 2014, limiting the city's options for reductions in a downturn. Fitch notes, however, that recent increases in expenditures for retiree benefits are based partly on the city's efforts to accelerate pre-funding of OPEB.
Long-Term Liability Burden
Long-term liabilities for debt and pensions are affordable relative to the city's wealthy resource base at approximately 9% of personal income, but the city's unfunded OPEB liability is also substantial at $1.8 billion as of fiscal 2015, equivalent to an additional 3.6% of personal income. The city has made notable progress in funding its OPEB program, moving from pay-go to nearly full funding of the annual required contribution within the span of several years, but has no ability to reduce accrued benefits.
The city reported a 64% ratio of assets to liabilities in its pension plan for fiscal 2015 under an assumption of 7.65% investment returns. Based on an alternate assumption of 7% returns, Fitch estimates a funded ratio of 59%. Contribution rates are determined by statute and adjusted periodically if the funding period exceeds 30 years. The most recent adjustments to contribution rates were adopted by the state legislature in 2011 with a package of pension reforms, including reduced benefits for new hires and anti-spiking provisions. Investment assumptions have also been reduced incrementally, raising liabilities. Such efforts have helped to slow the growth of pension obligations but material reductions in this liability will likely require both adherence to current contribution practices and achievement of investment return assumptions over the long term.
The city is currently engaged in the construction of a major rail transit project supported by federal funding and a temporary 0.5% general excise tax surcharge. Project costs to date have been addressed through a combination of pay-go funding and short-term borrowing, but the city expects to eventually issue GO debt supported by reimbursements from its rail authority. Recent increases in construction costs could affect the timing and scope of the project, which appears likely to exceed its current budget of $6.9 billion, and borrowing plans remain uncertain.
Substantial reserves and a history of limited revenue volatility contribute to an assessment of strong financial resilience in a moderate economic downturn. Based on historical results, Fitch estimates that a 1% decline in U. S. GDP would reduce city revenues by 2.6% in the first year of a recession, with a return to growth in subsequent years. Unrestricted reserves of $324 million in fiscal 2015 (equal to 25.6% of general fund spending) provide a considerable cushion against revenue declines anticipated in a moderate recession.
The city's budget management is conservative and operations are consistently balanced. Unrestricted reserves have increased substantially in the wake of the recession from 5% of general fund spending in fiscal 2009 to nearly 26% in 2015.