Fitch Affirms Queen Creek, AZ Excise Tax Revs, Upgrades Imp Dist Bonds; Outlook Stable

AUSTIN, Texas--(BUSINESS WIRE)--During the course of routine surveillance, Fitch Ratings has taken the following rating action on Queen Creek, Arizona:

--$25.3 million excise tax and state shared revenue obligations, series 2007 affirmed at 'A+';

--$50.3 million improvement district no. 1 improvement bonds upgraded to 'A-' from 'BBB+'.

In addition, Fitch assigns an implied unlimited tax general obligation (ULTGO) bond rating of 'A+'.

The Rating Outlook is Stable.

RATING RATIONALE:

--The 'A+' rating on the ULTGO and excise tax bonds reflects the town's sizable reserves maintained over the past several fiscal years despite significant declines in various economically sensitive revenue sources and sharp tax base declines; results have been aided by aggressive cost cutting measures instituted over the past four years.

--The upgrade to 'A-' on the improvement district bonds is based primarily on the statutory framework providing for town support of debt service payments if necessary (which was recently tested and proved sufficient as the town assumed ownership of delinquent property and assessment payment responsibility). The town now owns more than 50% of district property.

--The town's large debt burden is a concern given the reduction in certain development-related revenues historically used to support the high carrying costs. The town has minimal near term borrowing plans, as capital needs have declined with the economic slowdown.

--Home prices have declined sharply due to the area-wide housing collapse, and foreclosure and vacancy levels remain elevated.

--Management remains a positive credit factor, as evidenced by the series of major spending reductions adopted during recent annual budget cycles.

--Debt service coverage from pledged excise tax revenues has declined over recent years but remains strong.

KEY RATING DRIVERS:

--Maintenance of financial flexibility is key, given four years of spending cutbacks and management remarks that to date little economic recovery is apparent in the town.

--Future assessment nonpayment by property owners in the improvement district would place additional financial pressure on the town's budget, likely resulting in a debt profile no longer consistent with the current rating.

SECURITY:

The excise tax and state shared revenue obligations are secured by a first lien on local excise taxes and a pledge of state shared revenues subordinate only to certain outstanding Greater Arizona Development Authority (GADA) loans.

The improvement district bonds are secured by special assessments imposed upon real property within the district assessed for expenses associated with various infrastructure improvements. Statutory provisions require the town to make up any assessment deficiency prior to scheduled debt payments and provide for prompt disposition of the property if the entire assessment liability is not satisfied. Bondholders benefit from the requirement that the town loan the district sufficient funds for timely debt service payments should a district property owner be delinquent. The town must also assume title to the delinquent property and responsibility for assessment payment if the property is not acquired at tax sale.

CREDIT SUMMARY:

A previously fast-growth community in the Phoenix metropolitan area, Queen Creek has witnessed a sharp drop in residential development activity, with corresponding declines in economically sensitive revenues and home prices. Sales tax receipts remain the primary general fund revenue source but fell from a recent peak of nearly $14.4 million or 60% of general fund revenues in fiscal 2007 to a projected $9.3 million in fiscal 2011 (57%); a drop of more than 35%. Other revenues, including development fees and state shared income and sales tax revenues, also have declined over this timeframe. In an effort to diversify its revenue stream, the town in fiscal 2008 instituted a property tax to support emergency services expenditures. Property taxes generated $6.1 million in fiscal 2010.

Town management has responded aggressively to the revenue declines with a variety of spending reductions, including elimination of vacant positions, layoffs, a retirement incentive program, a 6.25% across the board salary reduction, elimination of cost-of-living pay increases and reductions in merit increases, and cuts in discretionary spending such as training and travel. As a result of these efforts, general fund expenditure totals shrunk from nearly $21 million in fiscal 2008 to an estimated $16.6 million for fiscal 2011. Operating reserves have remained healthy, despite some recent drawdowns. The unreserved general fund balance for fiscal 2010 was $10.8 million or 59% of spending, down from $13.4 million (70%) in fiscal 2009. Management expects fiscal 2011 results to be break-even, with no change in general fund reserves.

Further spending cuts are included in the fiscal 2012 budget, as management notes no material improvement in local economic activity. The general fund budget totals $16.1 million, down 10% from the $17.8 million budget amount for fiscal 2011. The budget also includes the elimination of 42 full-time and part-time positions and the elimination of six vacant positions; the town will continue with reduced work hours and pay levels that were instituted earlier in the recession. The budget also includes a manageable application of $500,000 of general fund reserves.

The town's debt burden is high, with overall debt per capita and as a percentage of current market value at $5,000 and 4.9%, respectively. Debt repayment on the town's outstanding excise tax and assessment debt is slow at about 36% retired in 10 years, and annual debt service costs are high at more than 20% of general government and related spending. Coverage on the series 2007 excise tax bonds and parity GADA loans remains solid despite recent revenue weakness and is estimated at 5.4 times (x) in fiscal 2011 (high coverage is expected given that the excise taxes represent the majority of general fund revenues.) In addition to the outstanding excise tax bonds, the town's debt profile includes $50 million in assessment bonds and more than $25 million in GADA loans for general government projects. Future capital needs have declined as the economy has cooled, and management reports no near-term borrowing plans.

The improvement district was formed to facilitate the construction of street improvements in Queen Creek and concurrently encourage commercial and residential development within the district. Major tenants at the two large commercial development projects originally slated for the district include Target, Kohl's, PetsMart, WalMart, Staples, Walgreens and a number of smaller specialty stores, banks and restaurants. Town officials estimate that these projects, which are adding approximately 1.3 million square feet of retail space to the local market, are roughly 85% and 90% occupied presently.

In accordance with the improvement district bond statute, the town last year took temporary title to a 17-acre undeveloped tract in the district following non-payment of an assessment and subsequent public auction; the town also assumed the annual $450,000 assessment liability for this property. The foreclosure process on delinquent properties is generally prompt and considered by Fitch to be a positive credit factor. Because the previous owner has not paid the entire $6.5 million assessment lien due, the town will take clear title to the property in mid-July and is considering development options.

This addition increases the town's proportionate share of district assessments from 40% (for the town hall and library) to 53%. Fitch believes the town has made the necessary budgetary adjustments to make the additional assessment payments, and the prime location of the tract should make it attractive for development when the commercial real estate market stabilizes. While the improvement district rating reflects the strong statutory provisions obligating the town to pay assessments, Fitch notes that given the constrained revenue environment, the town's ability to absorb 100% of district assessments (should that occur) is limited. Carrying costs for debt are already high and a meaningful increase to the debt service burden on the budget would likely have a negative impact on the town's overall credit quality.

Home prices in Queen Creek have dropped sharply since peaking at nearly $373,000 in 2008; the current median home value is estimated at $250,000. This erosion is evidenced in taxable value declines of more than 20% since fiscal 2009, and management anticipates another 9% drop in fiscal 2012. Residential permits appear to have bottomed out at around 140-150 per year, well below the more than 1,700 recorded at the height of the building boom several years ago. Management reports foreclosure and vacancy rates of 2.6% and 11%, respectively.

The town participates in two state-sponsored pension programs, the Arizona State Retirement System (ASRS) for nonpublic safety personnel and the Arizona Public Safety Personnel Retirement System (PSPRS) for public safety employees. The funding level for ASRS at June 30, 2010 was roughly 77%, and the funding level for PSPRS at June 30, 2009 was roughly 120%. The combined annual required payment for both plans in fiscal 2010 represented slightly more than 5% of general fund expenditures. While contribution rates for both plans have increased recently, management expects modest near term relief from recent legislative action that shifted more of the contribution burden from participating governments to employees. Post-employment health benefits are offered through these state retirement programs.

Additional information is available at 'www.fitchratings.com'.

In addition to the sources of information identified in Fitch's Tax-Supported Rating Criteria, this action was additionally informed by information from Creditscope, University Financial Associates, S&P/Case-Shiller Home Price Index, IHS Global Insight, Zillow.com, and the National Association of Realtors.

Applicable Criteria and Related Research:

--'Tax-Supported Rating Criteria', dated Aug. 16, 2010;

--'U.S. Local Government Tax-Supported Rating Criteria', dated Oct. 8, 2010.

For information on Build America Bonds, visit www.fitchratings.com/BABs

Applicable Criteria and Related Research:

Tax-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=548605

U.S. Local Government Tax-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=564566

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