Tucson gets a downgrade and a negative outlook from Fitch Ratings as it prepares to issue $78 million of debt.
The report reads:
OBLIGATIONS:
–$20 million general obligation (GO) bonds, series 2012-C (2015) ‘AA-‘
–$36.6 million general obligation refunding bonds, series 2015 ‘AA-‘;
–$20.7 million certificates of participation (COPs), refunding series 2015 ‘A+’.
The GO bonds and COPs are scheduled for negotiated sales on or around June 3. GO proceeds will finance street improvements in the city and refund a portion of the city’s outstanding GOs for interest savings. COP proceeds will be used to refund outstanding certificates for annual interest savings.
In addition, Fitch downgrades the following ratings:
–$214.8 million GO bonds outstanding (pre-refunding) to ‘AA-‘ from ‘AA’;
–$259.2 million COPs outstanding (pre-refunding) to ‘A+’ from ‘AA-‘;
–$11 million Rio Nuevo Multipurpose Facilities District (MFD) COPs (City of Tucson Convention Center Expansion Project), series 2009 to ‘A’ from ‘A+’.
The Rating Outlook is Negative.
SECURITY
The GO bonds are payable from an unlimited ad valorem tax levied against all taxable property in the city. The COPs are payable from lease payments from the city to the trustee, subject to annual appropriation by the city. The Rio Nuevo MFD COPs are payable from lease payments from the city, subject to annual appropriation. The leased property consists of the recently renovated Tucson Convention Center.
KEY RATING DRIVERS
ONGOING FINANCIAL CHALLENGES: The downgrade is due to a persistent structural budgetary imbalance, driven primarily by increasing outlays for employee benefits and economically sensitive revenue gains that will not keep pace. Preliminary fiscal 2015 operating results indicate a use of reserves to close a spending gap, a trend expected to continue into fiscal 2016.
MANAGEABLE DEBT, WEAK PENSION FUNDING: Debt levels remain affordable and the pace of GO and COP debt repayment is well above average. All three pension plans for Tucson employees are underfunded, and contributions for the state-sponsored police and fire plans are very high and increasing.
ECONOMIC RECOVERY UNDERWAY: Recovery from the severe recession continues at a moderate pace, as evidenced by a number of economically sensitive indicators. The regional economy remains diverse and relatively stable, with a good mix of higher education, military and government employment.
COPS RATING LOWER: The one-notch distinction between the GOs and COPs is a function of the COP lease structure, the payments for which are subject to annual appropriation. All leases since 1999 are governed by a master indenture which requires one appropriation for all outstanding leases. The two-notch distinction on the Rio Nuevo MFD COPs reflects the non-essential nature of the leased property.
RATING SENSITIVITIES
ABILITY TO RESOLVE IMBALANCE: A recent court ruling that will force pension contributions higher and a revenue shortfall in fiscal 2015 highlight the operational strains facing Tucson management and elected leaders. Implementation of a plan to close the structural budget gap – through some combination of revenue enhancements and spending reductions – and meaningful progress toward that goal over the next several years is necessary to prevent further negative rating action.
CREDIT PROFILE
Tucson is located in southern Arizona and is the state’s second largest city, with an estimated population of 529,000.
ONGOING FINANCIAL PRESSURES
Spending pressures continue despite a concerted effort in recent years to curb outlays. General fund spending declined by more than 15% from fiscal 2009 to fiscal 2012, but increasing personnel costs (led by pension contributions) contributed to an 8% spending increase and the draw on reserves in fiscal 2013. General fund spending in fiscal 2014 was down slightly more than 1% and a $12 million operating surplus (after transfers) was recorded, although results were aided by a legal settlement and a debt restructuring.
The fiscal 2014 year-end unrestricted general fund balance of $50.8 million was 10.7% of spending, which is below policy target levels and somewhat weak given the volatility of the city’s revenue base. The current fiscal 2015 projection is for a general fund operating deficit (after transfers) of roughly $8 million. Management reports economically sensitive revenues came in short of budget projections, and that transit subsidies contributed to spending pressures. General fund liquidity remains weak – general fund cash and investments at fiscal 2014 year-end totaled only $1.5 million. However, the city uses an investment pool account to manage cash citywide; the April 30, 2015 balance was roughly $239 million.
Tucson relies heavily on economically sensitive sales tax and state shared revenues for operations, and collections have posted moderate annual gains the past three fiscal years following severe recessionary declines. Local sales tax revenues typically comprise roughly 40% of general fund revenues, and they have posted four consecutive years of gains after sliding by more than $35 million (or 18%) from fiscal 2007-2010. Receipts registered a 2.4% gain in fiscal 2014, on the heels of a 3.5% increase the prior year. Projected fiscal 2015 revenues are up only 1% to $189.3 million, which is below budget projections and contributing to the expected loss for the year.
State shared revenues (state sales and income tax), which comprise nearly 25% of general fund revenues, registered a steep 28% decline from fiscal 2008-2012. Both sources have posted gains in subsequent years; state shared sales tax revenue climbed nearly 5% in fiscal 2013 and 6% in fiscal 2014, and state shared income tax revenue rebounded 18% and 9%, respectively, in these two years. Projected fiscal 2015 state shared receipts are also trending below budget, adding to revenue concerns.
ONGOING BUDGETARY ADJUSTMENTS
The city’s cost-cutting efforts have been notable, including the elimination of roughly 1,250 positions (20%) since fiscal 2009, salary freezes, benefit adjustments, city-wide department spending cuts, and various revenue enhancement measures. The proposed fiscal 2016 budget does not include any staffing reductions, suggesting less personnel flexibility going forward. The proposed budget also does not include any step or merit pay increases.
Efforts to achieve structural budgetary balance received a setback recently with a state Supreme Court ruling against state public safety pension program reforms. The ruling means Tucson’s contributions for police and fire pensions will climb sharply for next several years, exceeding 50% of compensation. As a result of these and other pressures, the proposed fiscal 2016 budget includes one-time measures (land sales, use of roughly $9 million in reserves) to close a roughly $18 million budget gap. The direction of the city’s rating and Outlook over the coming credit review cycles will be determined by the city’s ability to identify and implement additional revenue and spending changes to materially close the structural budget deficit.
DEBT MODERATE, PENSION FUNDING WEAK
Including street and highway user revenue debt and COPs, both direct and overall debt levels of the city are moderate. In addition, amortization of tax-supported debt is well above average at more than 80% retired in 10 years. The new money GO bonds represent the third installment of a $100 million authorization narrowly approved by voters in 2012 for street improvements.
The city maintains a single-employer pension program for non-uniformed personnel, and the city and uniformed staff contribute to state-sponsored public safety retirement programs for police and fire retirees. The city’s plan had a funded ratio of roughly 70% as of June 30, 2014 using a 7% investment rate assumption. The public safety retirement plans are both poorly funded – each was slightly below 40% as of June 30, 2014; the funding levels drop to only about 35% using a 7% investment assumption. The combined unfunded liability of all plans is high at more than 4% of estimated 2015 market value.
Fitch notes the weak funding levels for all programs as a negative credit factor. The public safety plans are hampered by a less than one-to-one ratio of active-to-retired employees. Contribution rates for both plans are very high, and the additional increases scheduled for the next several years will maintain pressure on the city’s finances. The city recently made adjustments to the local non-uniformed plan (which is the largest of the three) which are projected to stabilize contribution amounts and shorten the time horizon to full funding.
In addition, the city contributes to post-employment medical benefits on either a percentage of premium basis or a flat-rate basis (depending on certain retirement program parameters), and finances these costs on a pay-go basis. Total carrying costs for fiscal 2014 (debt and benefit contributions) were moderate at 20% of governmental spending, despite increasing pension costs and rapid debt repayment.
ECONOMIC RECOVERY UNDERWAY
Tucson is the second largest city in Arizona. Growth of the city’s residential base has slowed from its peak in 2001, when it recorded 3,800 single-family home permits. An average of 350 new housing permits have been issued annually the past several years, but that number is up from a recent low of 240 in fiscal 2011. Home prices are also showing improvement, with the March 2015 median sale price of $172,000 up nearly 6% from the prior year and 37% higher than the 2011 low. Services, military, higher education (University of Arizona), and government are the area’s prominent employment sectors.
Public and private investment in downtown Tucson has accelerated in recent months due in part to a new street car rail system that extends from downtown to the university campus (operations began in July, 2014). Management reports roughly $900 million invested in various public and private projects since 2008.
Unemployment levels historically have been below those of the state, and the most recent monthly numbers are consistent with that trend. The February 2015 rate of 5.9% was down from 6.7% recorded in the same period last year, and was generally in line with the state (6.2%) and U.S. averages (5.8%) for the month. Local employment totals also were up for the 12-month period ending in February, registering a solid 4.2% increase to roughly 239,000 workers; employment totals are now approaching pre-recession totals.
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