Fitch Rates Manhattan, KS ULTGO Bonds 'AA+'; Outlook Stable
OREANDA-NEWS. Fitch Ratings has assigned an 'AA+' rating to the following city of Manhattan, Kansas (the city) bonds:
--$5,930,000 general obligation (GO) bonds series 2015-A;
--$5,290,000 general obligation (GO) bonds series 2015-B.
The bonds and notes are expected to be sold via competitive sale Nov. 17. Bond proceeds will be used to redeem previously issued short-term debt that funded various city capital projects.
In addition, Fitch affirms the following ratings:
--Approximately $88.565 million outstanding ULTGO bonds at 'AA+';
--$6,010,000 temporary notes, series 2014-05 at 'AA+';
--$6,480,000 sales tax special obligation revenue (STAR) bonds, series 2009-1 at 'AA-';
--$27,450,000 taxable STAR bonds, series 2009-2 at 'AA-';
--$19,125,000 senior lien special obligation revenue (TIF) bonds, series 2009A at 'AA-';
--$5,250,000 transportation development district (TDD) sales tax bonds, series 2010 at 'AA-'.
The Rating Outlook is Stable.
The ULTGO bonds and notes are secured by the city's full faith and credit and its ad valorem taxing power, without limitation as to rate or amount.
The TDD, STAR, and TIF bonds are secured by the city's pledge of any legally available funds, subject to annual appropriation, as well as a cash-funded debt service reserve for each series. The bonds are also secured by the following, which in each case are the intended sources of repayment:
The TDD bonds are special limited obligations secured by a pledge of, and lien upon, a 0.5% sales tax levied within the TDD (coterminous with a development known as the north project area).
The STAR bonds are special limited obligations secured by a pledge of the state sales tax (6.5%, up from 6.15% as of July 1, 2015) collected within the north project area (coterminous with the TDD), and state, city (1%) and local (0.306%) sales tax collected within another development known as the south project area.
The TIF bonds are special limited obligations secured by a pledge of city and local sales tax collected within the north project area along with an incremental property tax collected within the north and south project areas. Local sales tax revenues from the south project area are also available if the STAR bonds are fully repaid prior to final maturity.
KEY RATING DRIVERS
REGIONAL ECONOMIC ENGINE: The city serves as the economic and cultural center for the region, which includes Fort Riley and Kansas State University (KSU). Regional economic prospects are strong, with continued assessed valuation growth, low unemployment rates, above-average per capita personal income, and notable economic developments projected to come online over the long term.
SOUND BUT DECLINING RESERVES: The city's finances are marked by conservative budgeting and a reliance on economically sensitive sales tax revenues. Fund balance levels remain adequate. However, further deterioration in the city's financial flexibility may result in downward rating action.
STRONG MANAGEMENT: The city's financial management is strong, with frequent and robust financial, economic, and debt reporting, careful cost controls, conservative budgeting of economically sensitive revenues, and a good expenditure cushion should revenues underperform.
HIGH DEBT BURDEN: The city's debt burden is high but has declined in recent years. Pension payments are rising but will remain low.
APPROPRIATION DEBT RATING: The 'AA-' rating on the TDD, STAR and TIF bonds reflects the city's commitment to appropriate annually for debt service and the lack of a security interest in and non-essentiality of the financed projects.
FINANCIAL FLEXIBILITY: Fitch expects the city to maintain its long practice of conservative budgeting and maintenance of strong financial flexibility as a key mitigant to Fitch's concerns about high debt and dependence on economically sensitive revenues. Any deterioration in the financial profile would likely cause a downgrade.
HIGH DEBT LEVELS: Fundamental to the rating is the expected reduction of debt levels over the intermediate term due to city issuance of new debt at a slower pace and the rapid amortization of outstanding debt. Continued high debt levels could pressure the rating negatively.
Manhattan is located in northeastern Kansas in Riley and Potawatomie Counties, roughly 55 miles west of Topeka. The 2014 population estimate of 56,078 increased 25% since 2000 through both real gains and limited annexations.
REGIONAL ECONOMIC ENGINE
The city's stable economy is anchored by Fort Riley, a military base with 21,065 military personnel located 10 miles west of the city limits, and KSU with roughly 24,500 students located within the city. Longer-term, the city is anticipating additional economic growth associated with the construction of the U.S. National Bio and Agro-Defense Facility (the facility), which broke ground in 2010 and which management projects will be fully operational around 2020. Shorter-term, construction activity related to the facility will benefit the city.
Taxable assessed valuation (TAV) grew 4.8% in both 2014 and 2015 and weathered the housing market downturn well, up 21% since 2008. Approximately one-fifth of the city's value is tax-exempt due to KSU's notable presence in the city. While private developers have several projects in progress, the recently tempered pace of development has resulted in a 55% decline in building permit revenues. State legislators recently approved a property tax lid, effective fiscal 2018, that requires municipalities to receive voter approval for increases in the property tax levy that exceed the rate of inflation. While property tax revenues represent a small 10% of general fund resources, Fitch will monitor the effect of the tax lid for potential restriction on revenue raising flexibility.
City income indicators are mixed and the city's poverty rate (24.2%) is high compared to 13.6% for the state and 15.5% for the nation. The city's large student population skews the city's poverty rate and may not accurately reflect the students' full economic impact, with purchasing power garnered from external sources. This factor is an important contributor to the city's sales-tax dependent financial profile.
The city's unemployment rate is very low at 3.3% in August 2015, down from August 2014 (3.8%) and well under state (3.8%) and national (4.9%) averages.
SOUND RESERVES PROVIDE IMPORTANT FLEXIBILITY
The city ended fiscal 2014 with a $2.6 million unrestricted fund balance, representing 10% of spending. Fitch's rating relies on the city's additional financial flexibility outside of the general fund in various discretionary accounts. Combined, available balances total a strong 60% of general fund spending in 2014.
The city beat its 2014 budget and reported results ahead of break-even projections. Fiscal 2014 audited results show a $280,000 operating surplus after transfers, equal to 1.08% of spending and up from fiscal 2013's deficit of $471,000. Management reports that the marginal increase in fund balance is the result of an increase in both sales tax revenues and in the property tax levy due to positive TAV trends. Management expects that sales tax (roughly 60% of general fund revenues) will continue to grow.
The city's 2015 budget represents a largely steady-state budget, with an increase in spending driven by a full year of operations at two new fire stations. As with prior years, the city budgeted use of fund balance as well as contingency operational and debt service support. Further, the city assumes conservatively a 3% increase in spending in 2015 from 2014 budget.
Performance year to date is positive, with expenditures coming in under budget and sales tax ahead of the prior year's flat performance. The city has additional budgetary flexibility from the county sales tax, renewed in late 2013, of which the city receives two-thirds. This additional revenue was not included in the county's 2015 budget. The city has dedicated 30% of this source to the city's bond and interest fund.
The rating is based on Fitch's expectation that the city will maintain a good financial cushion given the city's regular and comprehensive interim reporting coupled with strong cost controls, conservative budgeting, and a comfortable expenditure reduction cushion. Fiscal 2016 is anticipated to maintain these budgeting practices and continue reflecting positive performance.
CONTINGENT OBLIGATION TO COUNTY POLICE DEPARTMENT
City taxpayers support almost all of the Riley County Police Department (the department) with a dedicated property tax levy outside of the city's direct control. However, the department is presented in the city's governmental fund financial statements. The city has back-stopped the county police department previously but not since implementation of the dedicated property tax levy in 2001. Expenditures in 2014 represented 14% of city governmental spending.
HIGH DEBT BURDEN; MODERATE CAPITAL NEEDS
A key credit factor supporting the high rating is Fitch's expectation that rapid amortization of existing debt (74% of GO debt retired in 10 years) will outpace the additional bond issues, thereby reducing the very high debt level over the long term. In addition, Fitch expects new issuance to slow in the coming years which will aid future declines. The city's overall debt load totals $5,269 per capita and 8.3% of market value, fueled by the city's rapid growth.
Tax-supported debt service represents a considerable claim on resources at 22.3% of governmental fund spending in 2014. STAR bond prepayments reflect a required turbo structure which elevates debt service payments but supports quicker debt reduction.
The city has a $177 million capital improvement plan (CIP) through 2020, which management believes is a conservative estimate of the city's capital needs. Included in this plan is a major airport expansion project totaling about $30 million, which is expected to be chiefly financed with federal moneys and revenue bonds. Management expects that the remainder of the CIP will be funded through bond proceeds, including general obligation and revenue bond issuances.
SELF-SUPPORTING APPROPRIATION-BACKED DEBT REQUIRES GROWTH
The various development project debt is first paid from sales tax revenues and incremental property tax revenues generated in the north and south project areas. Overall coverage has been thin the past three years, but the bonds have been self-supporting since issuance. The city has also pledged any legally available funds, subject to annual appropriation, if the primary security pledge proves insufficient.
An economic downturn could cause concurrent declines in the city's sales tax and sales-tax-supported special district debt that compound pressure on the city's finances. However, KSU provides the city a great deal of insulation: retail sales grew in each year of the most recent economic recession. Further, Fitch believes that the city's healthy cash balances, have the potential to help the city manage ably an economic contraction.
The STAR bonds include a turbo repayment feature whereby all excess pledged revenues associated with the bonds must retire outstanding related principal. The feature has already prepaid $7.4 million in principal ahead of schedule. However, Fitch views as a risk to STAR bond coverage changes in the state sales tax. The state's recent increase in its sales tax rate to 6.5% from 6.15% (as of July 1, 2014) reflects a positive outlook. However, when coupled with the prior sales tax change from 6.3% down to 6.15% (July 1, 2013) the inherent instability of the tax is highlighted. Consequently, it is important to note the risk of future material sales tax changes and the threat to coverage. Currently coverage remains strong, with the bonds originally secured at a state tax rate of 5.3%.
Coverage remains thin for TIF and TDD bonds at 1.18x and 1.2x, respectively, in 2014. TDD bonds require 3.5% annual growth in pledged revenues to cover maximum annual debt service (MADS) in 2032. TIF bonds require 1.5% annual growth to cover MADS in 2025, assuming full use of DSRF at final maturity. Management projects stable coverage for 2015 even with the reduction in the tax rate.
CONCENTRATED TAXPAYER BASE FOR CONTINGENT OBLIGATIONS
The north project area encompasses a small 20 acre area that currently consists of 21 retailers including HyVee Supermarket; Petco; Bed, Bath & Beyond; Dick's Sporting Goods; and Best Buy. The south project area is even more limited at 10 acres, with two hotels (Hilton Garden Inn and Candlewood Suites); Hertz; a conference center; a city-owned discovery center; and a city-owned 440-stall parking garage. Most of the retailers rent their property via renewable 10-year leases.
The top retailer accounted for 7% of total sales tax revenues and the top 10 accounted for 25% in 2015. Taxpayer and geographic concentration, required lease renewals during the term of the debt and potential local competition create risk of future tax revenues declining, which could stress the city's finances, given its commitment to support these obligations. Sales tax concentration is expected to decline with the anticipated addition of new retail establishments but remain high.
MODEST POST-EMPLOYMENT BENEFIT COSTS
Manhattan's long-term liabilities related to employment benefits are modest. Employees are covered by state-sponsored pension plans, and the city annually funds its full actuarial required contribution. Additionally, the city allows retirees to participate in its healthcare plan at 102% of the stated premium, resulting in an immaterial unfunded actuarial other post-employment benefit (OPEB) liability.
The combined pension annual required contribution (ARC) and OPEB pay-as-you-go contribution was a low 2.3% of governmental spending in 2014. The ARC was fully funded by the state for both uniform and municipal employee pension plans in 2014, although state statute has allowed for underfunding of the ARC in prior years.
Recent legislative changes at the state level will increase local contribution rates and introduce a new tier of employees. These changes should address poor funding levels and eventually result in more stable annual contributions, which will be shared by employers and employees after the five-year ramp-up period.
Fitch does not believe these increases will present financial pressure to the city, as the city's annual cost will be very low even if it roughly doubles, as projected. The municipal and uniform plans were poorly funded at 62% and 74% as of Dec. 31, 2014, respectively, or a weaker estimated 56.1% and 66.7%, respectively, using Fitch's 7% rate of return assumption.