AUSTIN, Texas--()--Fitch Ratings downgrades Commerce, Texas' (the city) outstanding general obligation (GO) bonds and certificates of obligation (COs) as follows:
--$7.3 million GO refunding and improvement bonds, series 2003 to 'BBB'
--$1.3 million combination tax and revenue COs, series 2003 to 'BBB' from 'A-'.
The Rating Outlook is revised to Stable from Negative.
SECURITY: The GO bonds and COs are secured by an ad valorem tax levied on all taxable property within the city, limited to $2.50 per $100 taxable assessed valuation (TAV). The COs are additionally secured by a subordinate lien pledge on surplus revenues from the city's waterworks and sewer system.
KEY RATING DRIVERS
FINANCIAL PERFORMANCE FURTHER WEAKENS: The downgrade to 'BBB' from 'A-' reflects additional deterioration of the general fund position on an audited basis and limited operating flexibility despite management's prior expectations. Fitch believes this low rating sufficiently captures the inherent financial and economic volatility that currently characterizes the city's credit profile and is anticipated over the near-term. Management expects modest operating surpluses for fiscals 2011 and 2012, which Fitch believes may be realized given spending reductions implemented and year-to-date financial results. Nonetheless, overall financial performance is and will likely remain weak.
YEAR'S AUDIT DELAYED: The fiscal 2011 audit is scheduled to be completed beyond standard timeframes, comparable to the prior year. Fitch notes that the trend of typically negative accounting adjustments that have occurred over the last four fiscal years (2007-2010) largely outside of management's expectations heightens uncertainty with regards to unaudited results.
LIMITED ECONOMY AND TAX BASE: Area economic conditions remain weak and include below-average wealth levels, although higher education (Texas A&M University at Commerce) is a stabilizing presence. Taxable assessed values (TAV) declined a cumulative 15% in the last three fiscal years (fiscal 2010-2012) and taxpayer concentration is high at nearly 30%. Revenue raising capacity is limited given the city's high tax rate.
HIGH OVERALL DEBT: Overall debt levels are high and will additionally increase given the city's projected GO issuance by fiscal year-end.
WHAT COULD TRIGGER A RATING ACTION
FINANCIAL PERFORMANCE DETERIORATION: Management's inability to evidence modest, measured improvement of financial reserves and liquidity in subsequent fiscal years to adequate levels on an audited basis likely would lead to additional negative rating action. Such improvement may be difficult given the Fitch believes the expected departure of the city's largest taxpayer and utility user within the next few years.
FURTHER PRESSURE EXPECTED FROM IMPENDING LOSS OF TOP TAXPAYER
Located approximately 65 miles northeast of Dallas, the small city of Commerce has a population of about 8,000 residents. The city is anchored by a growing Texas A&M University at Commerce and local wealth levels are below average due in part to the large student population. The limited economy and the city's concentrated tax base (the top 10 taxpayers comprise nearly 30% of TAV in fiscal 2012) have previously been noted as credit concerns. TAV declined a cumulative 15% in the last three fiscal years (fiscal 2010-2012) due largely to declines in residential values and the previous loss of another top taxpayer - Zurn Manufacturing.
Fitch anticipates further, significant financial and economic pressure on the city and its residents over the near term that is yet to be realized given Covidien's (a medical supply manufacturer's) planned departure of the area announced last year. The manufacturer is the city's largest taxpayer at just over 17% of TAV in fiscal 2012 (a large contributor to the higher than average portion of TAV derived from tangible business inventory/stock) as well as one of the larger employers and city water/wastewater users. Management currently anticipates the initial TAV loss of Covidien at the Jan. 1, 2014 valuation date given the roughly one-year delay that has occurred in its departure from the city, which would subsequently impact the city's fiscal 2015 finances.
AUDITED FINANCIAL POSITION WEAKER
Fiscal 2011 audit results are delayed, a trend that has developed in recent years. The fiscal 2010 audit incorporates the most recent audited financial results and includes further deterioration of general fund reserves and liquidity. Although essentially break-even operating results were realized as a result of the year's expenditure reductions (operating deficits of about $800,000 were recognized in the prior two fiscal years), the unrestricted general fund balance in fiscal 2010 declined to a negative $30,000 or a negative 1% of spending. This was down from the very minimal $106,000 unreserved general fund balance or almost 2% of spending recorded in fiscal 2009. Non-restricted cash/investments in the general fund totaled $0 in fiscal 2010, declining from an already very low $46,000 in fiscal 2009. Operating liquidity has been assisted by interfund borrowing as management reports there has been no external short-term borrowing for the city's cash flow needs.
The city's historically stable financial position, characterized by solid general fund reserves and sufficient liquidity, has eroded in recent years in large part to negative prior period adjustments (PPAs) outside of management's expectations. A nearly $1.6 million negative PPA to the general fund occurred in fiscal 2009 based on corrections to the city's accrued liabilities, cash accounts, and accruals lowered reserve levels. For fiscal 2010, there was another negative PPA of $640,000 that did not directly affect the general fund income statement, but largely reversed prior years' accruals of utility accounts receivable and reclassified uncollectible utility accounts in the business/proprietary funds.
Unaudited financial statements provided by management for fiscal 2011 project a better than budgeted operating surplus ($330,000 or nearly 8% of spending in fiscal 2011), which Fitch believes may be realized given spending reductions implemented, credible revenue enhancements, and revenue trends modestly above budget. Nonetheless, fiscal 2011 audited results are again delayed and are not expected to be available until July 2011, 10 months after fiscal year end, which tempers Fitch's perspective.
For fiscal 2012, the approximately $4.1 million general fund expenditure budget was adopted with a $144,000 operating surplus (equivalent to roughly 3.5% of the year's general fund spending), based on city council's priority to restore general fund reserves. The city also raised water and sewer rates as it typically does on an annual basis. Management reports year-to-date revenues and expenditures remain on track with budget, bolstered somewhat by sales tax revenues in the first six months exceeding budget at around 9%. Budget preparations for fiscal 2013 are currently underway and include further expenditure savings that look towards developing an operating surplus of approximately $150,000. Despite management's efforts to improve financial margins, Fitch believes the city will face difficulty in making significant further improvement to reserve levels after Covidien's departure. Currently, the city's operating and maintenance tax rate is relatively high, providing limited revenue raising flexibility. Consequently, further gains likely would be achieved through expenditure cuts or possibly additional revenue enhancements on top of those that will be required to offset the loss of Covidien's tax revenues.
DEBT BURDEN HIGH
Overall debt levels are high due largely to local school district debt and approximate nearly 10% of market value or $3,470 on a per capita basis. City debt levels are more moderate and are assisted by significant self-support from water/sewer revenues. Principal amortization is slightly above average with 55% repaid in 10 years. Management reports plans to issue its remaining $3 million in GO authorization by the end of fiscal 2012 for various street and road projects. Management projects this issuance will minimally impact the debt service tax rate.
Additional information is available at www.fitchratings.com. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
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, National Association of Realtors.
Applicable Criteria and Related Research:
--'Tax-Supported Rating Criteria' (Aug. 15, 2011);
--'U.S. Local Government Tax-Supported Rating Criteria' (Aug. 15, 2011).
Applicable Criteria and Related Research:
Tax-Supported Rating Criteria
U.S. Local Government Tax-Supported Rating Criteria