Fitch Rates Sugar Land, TX's Series 2016 COs 'AAA'; Outlook Stable
OREANDA-NEWS. Fitch Ratings has assigned a 'AAA' rating to the following Sugar Land, TX (the city) limited tax obligations:
--$19.2 million combination tax and revenue certificates of obligation (CO) series 2016.
The bonds will be used for various citywide capital projects that largely benefit streets, drainage, and the utility system as well as pay the costs of issuance.
The series 2016 COs are expected to price via competitive sale May 3rd.
The Rating Outlook is Stable.
The COs are secured by a pledge of ad valorem taxes limited to $2.50 per $100 taxable assessed valuation (TAV). The 2016 COs are additionally payable from a limited, subordinate lien pledge on the net revenues of the waterworks and sewer system.
KEY RATING DRIVERS
STRONG SOCIOECONOMIC BASE: Steady population gains, above-average wealth characteristics, and high educational attainment underpin the city's strong demographic profile.
REGIONAL ECONOMY PARTICIPANT: The city is part of the expansive Houston metropolitan statistical area (MSA) economy, which has outpaced the nation in job and income growth due to a strong energy sector and diversification in other sectors. The local and regional economy remains vulnerable to energy price variability.
ELEVATED DEBT BURDEN: Key debt ratios are down slightly, but remain very high for the 'AAA' rating category. This risk is tempered by low retiree liabilities.
STRONG FINANCIAL PERFORMANCE & POSITION: The city retains ample reserves and liquidity due to historically positive operating margins and conservative budgeting practices. These reserves provide a good fiscal cushion against unforeseen budget challenges and flexibility to fund capital outlays and one-time initiatives with general fund resources. The city maintains extensive financial policies and procedures, and also practices multi-year forecasting for budgeting and capital purposes.
SALES TAX EXPOSURE MITIGATED: The general fund's heavy reliance on economically sensitive sales tax revenues is mitigated by the strong fund balances and low property tax rate.
The superior 'AAA' rating is predicated upon the city's financial, demographic and economic strengths, which mitigate to a degree concerns over the high debt burden. A change in these factors and/or material increases in overall debt levels beyond the increases currently anticipated by Fitch could place downward pressure on the rating.
Sugar Land is a suburban community located about 20 miles southwest of Houston (LTGOs rated 'AA'/Stable Outlook) in Fort Bend County. The city's 2016 population is estimated at 87,000.
AFFLUENT SUBURB OF HOUSTON WITH STABLE RESOURCE BASE
Sugar Land is located in the broad Houston MSA and residents have direct access to Houston's central business district via a major highway. Energy and petrochemical manufacturing remain the principal industries of the Houston economy. However, the area economy has also diversified into biomedical research, healthcare, aerospace, and international trade via the Port of Houston. The MSA is home to 26 Fortune 500 corporate headquarters.
The roster of top Sugar Land employers also reflects an energy industry presence, as four of the top 10 are energy firms: Fluor Corporation, Schlumberger, Nalco/Champion, and Baker Petrolite Corporation. The city also has a notable healthcare sector, and the University of Houston operates a branch campus in the city. Management reports additional investment is underway with planned expansion by some of its top employers, including Methodist Hospital, Memorial Hermann Healthcare Systems, the relocation of Nalco/Champion and Schlumberger headquarters, and a new Texas Instruments research & development facility. Fitch expects these developments will further strengthen the city's employment and tax base over time.
The city's workforce is highly educated, which has continued to attract business investment. The percentage of residents possessing a bachelor's degree is nearly double the national standard. The local unemployment rate exhibited a narrow band of movement during the recession, peaking at a relatively low 6.5% in 2010.
The city's economic momentum has slowed modestly year-over-year due the stability of its other employment sectors outside of energy and those of the larger Houston MSA. The city's jobless rate of 3.6% in February 2016 remains low, but is up slightly from 3.3% a year ago. The city's unemployment rate remained below the MSA (4.7%), state (4.3%), and U.S. averages (5.2%). Wealth and income levels are high, with median household income equal to 2x that of the nation. The poverty rate is exceptionally low and market value per capita is a strong $166,000.
The Houston MSA economy made a robust post-recessionary recovery due in part to the strength of the energy sector. However, Fitch believes low oil prices may dampen the pace of growth over the near term. It is also Fitch's opinion that the state's various petrochemical centers should benefit from lower energy prices, which may serve as a partial offset to any economic softening. (See Fitch press release 'Oil Price Decline Likely to Have Targeted Effect on Local Texas Economies & Revenues' dated Jan. 13, 2015).
TAV GAINS STRENGTHEN
TAV growth slowed but notably remained on a positive trajectory throughout the national recession, steadily strengthening since fiscal 2011. The city realized a strong 12% TAV gain in fiscal 2016 to $12.1 billion, attributable in part to healthy appreciation of existing properties. The expansion of key roadways has enhanced access and also spurred robust development in recent years. Ongoing mixed-use developments such as Lake Pointe Town Center, Imperial Redevelopment, and Telfair--in addition to the aforementioned corporate expansions--support the city and Fitch's forecasts for continuing TAV growth over the near and intermediate term.
Fitch believes TAV has some sensitivity to oil prices, although modestly positive TAV growth also appears feasible to Fitch over the near term given an active housing market, ongoing retail and commercial investment, and historical tax base performance.
VOLATILE SALES TAX RECEIPTS
Sales taxes provide the largest share of operating support at roughly one-half of general fund revenues. As a reminder of the economic vulnerability of this revenue source, sales tax revenues dropped by 5% in fiscal 2010 before expanding by a cumulative 14% over fiscals 2011 - 2012 and then stalled with a modest 2% decline in fiscal 2013. Sales tax revenues once again grew strongly over fiscal 2014 - 2015.
Management indicates fiscal 2016 sales tax performance through February 2016 has softened however. Receipts are up modestly year-over-year, although this gain remains slightly below the 2% sales tax growth (or $2 million) anticipated in the budget. Nonetheless, Fitch believes the city's extensive financial planning efforts and conservative budgeting practices, as well as the allocation of 10% of base sales tax revenue to non-recurring expenses, mitigate much of the risk associated with sales tax concentration and volatility.
FINANCIAL FLEXIBILITY MAINTAINED
Consecutive years of operating surpluses after transfers from fiscal years 2005 - 2010 yielded healthy general fund reserves. Officials more recently have used reserves to fund pay-as-you-go capital improvements, pursuant to a city policy that allows the use of reserves exceeding the city's prudent fund balance policy minimum of 25% of recurring operating expenditures.
The general fund concluded fiscal 2015 with a modest $530,000 operating surplus after transfers (1% of spending) that reflects $3.4 million of transfers to fund larger capital projects as well as fleet and equipment replacement. Year-end results improved upon the modest drawdown ($1.1 million) budgeted given stronger sales tax performance. Unrestricted general fund balance totaled a high 35% of spending ($28.5 million). Liquidity also remained strong. Year-end cash and investment balances in the general fund provided slightly more than four months of cash-on-hand, which was in the five-year historical range of between four and five months.
The adopted $83.7 million fiscal 2016 budget is up roughly $5.3 million or nearly 7% from the adopted fiscal 2015 budget and forecasts a modest $1.2 million use of fund balance for capital and non-recurring items. The budget incorporates a sizeable $5.1 million for pay-as-you-go capital spending, particularly directed toward the city's drainage needs. The year's strong tax base growth is anticipated to generate an additional $1.7 million in property tax revenue with a flat total tax rate. Management indicates revenue and expenditure trends remain generally on track with budget year-to-date, although some tightened hiring for vacant positions may occur to offset slightly sluggish sales tax performance.
The property tax rate remains one of the lowest in the state for cities in this population range at just under $0.32 per $100 TAV. Fitch views positively the city's track record of conservative budgeting and year-end results that outperform original forecasts. Additionally, Fitch views as reasonable the city's out-year budget projections through fiscal 2019 which demonstrate adherence to the 25% minimum reserve target.
RETIREE LIABILITIES WELL-FUNDED
All 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 $19.2 million, with fiduciary assets covering 89.3% of total pension liabilities at the plan's 7% investment rate of return assumption. The NPL represents less than 1% of the district's fiscal 2016 market value. The city made its full actuarially determined pension contribution of $6.7 million fiscal 2015. Other post-employment benefit (OPEB) contributions paid by the city are nominal.
DEBT BURDEN TO REMAIN ELEVATED OVER THE MEDIUM TERM
Debt ratios are down slightly given the year's strong TAV gain, but remain very high for the rating category at approximately 6.3% of full market value and $10,463 per capita, largely reflective of the overlapping debt of Fort Bend ISD (ULT bonds rated 'AA+'/Stable Outlook) and municipal utility districts. The city's high debt load warrants attention and will remain a key credit focus in Fitch's future reviews. Affordability concerns over the high per capita debt levels are somewhat mitigated by residents' above-average income levels and the plan to repay a portion of the outstanding debt with dedicated facility rental payments that are not expected to be part of general operations.
The fixed-cost burden for debt service, pension ARC and OPEB pay-go is moderate at approximately 13% of governmental expenditures in fiscal 2015. This calculation excludes the debt service costs of outstanding COs that are repaid with dedicated enterprise revenues, which Fitch considers to be self-supporting. The rate of principal amortization for property tax-supported debt has slowed somewhat with recent issuances for the performing arts center, but it remains above-average at 55% in 10 years.
The city's adopted, comprehensive fiscal 2016 capital budget totals roughly $60 million, which is part of the formal five-year capital improvement plan (CIP). Issuance of an additional $7.4 million in new money GO bonds is expected later in the current calendar year. The five-year CIP totals $233 million and calls for adding up to $114 million of tax-supported debt issuance through 2020. This is down somewhat from last year's CIP and management indicates capital plans retain a level of flexibility in the out years. The city's above-average pace of debt retirement, coupled with the positive prospects for continuing TAV and population gains, would substantially but not completely absorb the additional debt. In support of the planned tax-supported debt issuances, it is presently estimated that a tax rate increase of $0.01 per $100 TAV would be required in fiscal 2019, which is somewhat less than and later than previously projected given strong TAV performance.