Fitch Rates Manhattan, KS ULTGO Bonds 'AA+'; Outlook Stable

NEW YORK--()--Fitch Ratings has assigned an 'AA+' rating to the following city of Manhattan, Kansas (the city) bonds:

--$13,115,000 general obligation (GO) bonds, series 2014-A;

--$9,760,000 taxable GO bonds, series 2014-B.

The bonds are expected to be sold via competitive sale the week of May 19. Proceeds will be used to redeem previously issued short-term debt that funded various city capital projects (2014-A) and make economic development loans (2014-B).

In addition, Fitch affirms the following ratings:

--$101,125,000 outstanding ULTGO bonds at 'AA+';

--$8,250,000 sales tax special obligation revenue (STAR) bonds, series 2009-1 at 'AA-';

--$29,530,000 taxable STAR bonds, series 2009-2 at 'AA-';

--$19,980,000 senior lien special obligation revenue (TIF) bonds, series 2009A at 'AA-';

--$5,375,000 transportation development district (TDD) sales tax bonds at 'AA-'.

The Rating Outlook is Stable.

SECURITY

The ULTGO bonds 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 sale tax (6.15%, down from 6.3% as of July 1, 2013) collected within the north project area (coterminous with the TDD), and state sale tax (6.15%), city (1%) and local (.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 (1%) and local (.306%) sales tax collected within the north project area, and incremental property tax collected within the north and south project areas. Local sale 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 regional community, which includes Fort Riley and Kansas State University (KSU). Further, the regional economic prospects are strong, with continued assessed valuation growth through the recession, low unemployment rates, above-average per capita personal income, and notable economic developments projected to come online over the long term.

ROBUST RESERVES MITIGATE REVENUE CONSTRAINTS: The city's robust reserve position across governmental funds is the key credit strength supporting the high rating given the city's dependence on sales taxes and the above-average cost of carry for all tax-supported debt.

STRONG MANAGEMENT: The city's 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 EXPECTED TO DECLINE: The city's debt burden is high. 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. 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.

RATING SENSITIVITY

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.

SALES TAX PERFORMANCE: Appropriation debt service remains covered by dedicated, primarily sales tax, revenues. Sales tax underperformance could result in the need for general fund support which, even if modest, could pressure the rating given the city's heavy reliance on sales taxes to support general operations.

CREDIT PROFILE

Manhattan is located in northeastern Kansas in Riley and Potawatomie County, roughly 55 miles west of Topeka. The 2012 population of 56,069 is up 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 19,400 military personnel located 10 miles west of the city limits, and Kansas State University (KSU) with roughly 24,000 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 grew 4.8% in 2014 and weathered the housing market downturn well, up 17.2% since 2008. Approximately one fifth of the city's value is tax exempt due to KSU's notable presence in the city. Positively, year-to-date building permits values through April are up year-on-year by 6.7% after some softening last year. Property tax revenues represent a small 10% of general fund resources.

City income indicators are mixed and the city's poverty rate (27.6%) is above average compared to 12.6% for the state and 14.3% 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 4% in March 2014, down from year prior (4.5%) and well under state (5.1%) and national (6.8%) averages.

ROBUST RESERVES PROVIDE IMPORTANT FLEXIBLITY

The city's finances are marked by conservative budgeting and a reliance on economically sensitive sales tax revenues. Fund balance levels have declined from prior years and remain adequate; however, further deterioration in the city's financial flexibility may result in downward rating action.

The city beat its 2012 budget handily but reported results below break-even projections. Audited results show a $654,000 operating deficit after transfers equal to 2.7% of spending. Management reports that the marginal draw on fund balance was a result of underperformance in fees for services as well as $200,000 in one-time capital spending. Positively, sales tax (roughly 40% of general fund revenues) strongly outperformed budget, up 14.1%.

The city ended fiscal 2012 with a $2.7 million unrestricted fund balance, representing 11.3% of spending. The city importantly has additional financial flexibility outside of the general fund in various discretionary accounts. Combined, available balances total a strong 44% of general fund spending in 2012. Fitch expects reserve levels to decline over the intermediate term as the city intends to use some discretionary funds for capital improvements. While Fitch views the use of a portion of these balances for one-time capital spending as appropriate, maintenance of robust reserve levels and conservative budgeting adequate to offset concerns about an economically sensitive revenue base is fundamental to rating stability.

Management reports $1.7 million year-end fund balance (cash-basis) for 2013, reflecting an approximate $1 million operating deficit (4% of spending). Management projects that audited performance will show an approximate $500,000 draw on fund balance which would have been larger if not for the $400,000 transfer in from discretionary funds. While year-end performance beat the budgeted $2.5 million use of fund balance, performance was below mid-year estimates due to departmental spending and softening of revenues. Revenue for the year was flat year-on-year and under budget while expenditures were strongly favorable to budget (6.6%).

The city's 2014 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 1% increase in 2014 from 2012 budget.

Performance year to date is positive, with expenditures coming in under budget and sales tax ahead of prior year despite flat prior-year performance. The city has additional budgetary flexibility from county sales tax renewed in late 2013, of which the city receives two-thirds. This additional revenue was not included in the county's 2014 budget. 30% of this source is dedicated to the city's bond and interest fund.

Fitch thinks the city will continue to manage its finances carefully given flat revenue performance for 2013. 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. Deterioration in the city's financial cushion may lead to negative rating action.

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 2012 represented 14.6% of city governmental spending. Fitch believes that any future general fund support for this obligation would pressure the rating.

HIGH DEBT BURDEN; MODERATE CAPITAL NEEDS

A key credit factor supporting the high rating is Fitch's expectation that rapid amortization of existing debt (82% of GO debt retired in 10 years) will outpace the magnitude of additional bond issues, thereby reducing the very high debt level over time. The city's overall debt load totals $5,383 per capita and 9.4% of market value, fueled by the city's rapid growth.

Tax-supported debt service represents a considerable claim on resources at 25% of governmental fund spending in 2012. This number includes debt repaid from dedicated sources - local sales taxes, special assessments, and STAR, TIF, and TDD pledged revenues. Net of STAR, TIF, and TDD bonds, debt service represents a lower but still elevated 14.7% of governmental spending. Further, STAR bond prepayments reflect a required turbo structure which elevates debt service payments but supports quicker debt reduction.

The city has a $107 million capital improvement plan (CIP) through 2018, 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 $50 million, which is expected to be chiefly financed with federal moneys. Management expects that the remainder of the CIP will be funded through bond proceeds, including general obligation and revenue bond issuance.

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. The city has also pledged any legally available funds, subject to annual appropriation, if the primary security pledge proves insufficient. The bonds have been self-supporting since issuance.

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, the university 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 and property tax revenue raising flexibility, while not tapped during the recent downturn, 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, which continues to reduce outstanding 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 state sales tax. The state's recent changes in its sales tax rate to 6.15% from 6.3% (as of July 1, 2013) highlights the risk of future material sales tax changes and the threat to coverage; however, currently coverage remains strong and the bonds were originally secured at a state tax rate of 5.3%.

Coverage was thin for TIF and TDD bonds at 1.03x and 1.1x, respectively, in 2012. TDD bonds require 3.6% annual growth in pledged revenues to cover MADS in 2032. TIF bonds require 1.5% annual growth to cover MADS in 2025, assuming full use of DSRF at final maturity, and TIF coverage is reportedly depressed in 2012 because of a residential fire in 2011 the district. Management expects coverage to increase as reconstructions come on the tax rolls.

CONCENTRATED TAXPAYER BASE FOR CONTINGENT OBLIGATIONS

The north project area encompasses 20 acres that currently consists of 18 retailers including HyVee Supermarket, Petco, Bed, Bath & Beyond, Dick's Sporting Goods, and Best Buy. The south project area encompasses 10 acres with a 135-room Hilton Gardens and Candlewood hotels, 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 currently accounted for 35% of total sales tax revenues and the top 10 accounted for 97% in 2012. Sales tax concentration is expected to decline with the anticipated addition of new retail establishments. 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.

UNDERFUNDED STATE PENSIONS; RECENT CHANGES CREDIT POSITIVE

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 OPEB liability.

The combined pension ARC and other post-employment benefit pay-as-you-go contribution was a low 1.8% of governmental spending in 2012. The ARC was fully funded by the state for both uniform and municipal employee pension plans in 2012, although state statute 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 thinks that these increases will not present financial pressure to the city, as the city's annual cost is very low and projected to roughly double. The municipal and uniform plans are poorly funded at 60% and 66% as of Dec. 31, 2012, respectively, or a weaker estimated 54% and 60%, respectively, using a 7% rate of return assumption.

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, and National Association of Realtors.

Applicable Criteria and Related Research:

--'Tax-Supported Rating Criteria' (Aug. 14, 2012);

--'U.S. Local Government Tax-Supported Rating Criteria' (Aug. 14, 2012).

Applicable Criteria and Related Research:

Tax-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=686015

U.S. Local Government Tax-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=685314

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=829949

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

Contacts

Fitch Ratings
Primary Analyst:
Stephen Friday, +1-212-908-0384
Associate Director
Fitch Ratings, Inc.
33 Whitehall St.
New York, NY 10004
or
Secondary Analyst:
Eric Friedman, +1-212-908-9181
Director
or
Committee Chairperson:
Jessalynn Moro, +1-212-908-0608
Managing Director
or
Media Relations:
Elizabeth Fogerty, New York, +1 212-908-0526
elizabeth.fogerty@fitchratings.com

Sharing

Contacts

Fitch Ratings
Primary Analyst:
Stephen Friday, +1-212-908-0384
Associate Director
Fitch Ratings, Inc.
33 Whitehall St.
New York, NY 10004
or
Secondary Analyst:
Eric Friedman, +1-212-908-9181
Director
or
Committee Chairperson:
Jessalynn Moro, +1-212-908-0608
Managing Director
or
Media Relations:
Elizabeth Fogerty, New York, +1 212-908-0526
elizabeth.fogerty@fitchratings.com