Amended: Fitch Affirms Royal Oak, MI's GOs at 'AA'

NEW YORK--()--(This document reflects a minor amendment to the original version, published Oct. 31, 2014.)

Fitch Ratings has affirmed the following Royal Oak, Michigan (the city) ratings:

--$21.7 million limited tax general obligation (LTGO) bonds at 'AA';

--$2.2 million Royal Oak Building Authority limited tax general obligation (LTGO) bonds, series 2005 at 'AA'.

The Rating Outlook is Stable.

SECURITY

The LTGO bonds are payable from the city's full faith and credit general obligation limited tax pledge subject to applicable constitutional, statutory and charter limitations.

The Building Authority Bonds are payable from cash rental payments made by the city to the building authority. The city's limited tax full faith and credit has been pledged towards making rental payments.

KEY RATING DRIVERS

POSITIVE ECONOMIC PROFILE: The city's above-average socio-economic profile is characterized by an affluent population and unemployment levels well below state and national averages.

IMPROVED TAX-BASE PERFORMANCE: After a period of modest recessionary declines, the city's taxable value (TV) has stabilized, increasing modestly in fiscal 2014 with more sizable increases projected in future years.

PRUDENT FINANCIAL MANAGEMENT: Management has demonstrated a record of conservative budgeting and careful expenditure control, maintaining balanced operations and ample reserves.

SIZEABLE PENSION AND OPEB COSTS: Pension and other post-employment benefit (OPEB) costs consume an unusually large portion of the city's budget, constraining expenditure flexibility and raising concerns about the future direction retiree benefit costs.

MODERATE DEBT LEVELS: The city's overall debt levels are moderate with rapid amortization and near-term capital needs are manageable.

RATING SENSITIVITIES

STABLE FINANCIAL PERFORMANCE: The rating is sensitive to shifts in fundamental credit characteristics including the city's strong financial management practices and healthy reserve levels.

RETIREE BENEFIT COSTS: While currently manageable within the city's budget framework, Fitch will monitor the direction of these costs as they may become a pressure on the rating.

CREDIT PROFILE

The city is an affluent Detroit suburb located in southeastern Oakland County 10 miles north of downtown Detroit with a 2013 population of 58,946, which has declined modestly over the last decade.

STRONG SOCIOECONOMIC PROFILE

The city is a mature, highly developed community experiencing recent redevelopment. Manufacturing and healthcare anchor the local economy, with major employers showing stability throughout the recession. Overall tax base concentration is low with the top 10 taxpayers accounting for less than 6% of total TV.

The city's tax base is projected to grow by 1% in fiscal 2014 following four years of modest recessionary declines totaling 10% between fiscals 2009 and 2013. Management projects further TV gains of 2% in fiscal 2015 as per the city assessor's estimates. Fitch considers this expectation reasonable, given improved existing home prices according to Zillow, and increasing permit applications for new construction in recent years.

Local unemployment continues to outperform state and national averages, with the July 2014 unemployment rate of 5.2% below the rate of the prior year (5.6%), and well below the state (8.6%) and nation (6.5%). Resident wealth remains strong, with the city's per capita money income at 150% and 137% of state and national averages, respectively, and an individual poverty rate less than half of state and national levels.

STRONG FINANCIAL POSITION

Property taxes are the city's main revenue source, constituting approximately 59% of fiscal 2013 revenues across the general and public safety funds, which encompass the city's general government spending. Fiscal 2013 property tax revenue increased by a significant 42% over the prior year due to a new public safety millage approved by voters in November 2012. The city levied 3.475 mills of the 3.975-mill five-year authorization, which is subject to voter renewal in fiscal 2017. Fitch notes with some concern the renewal risk associated with the millage. The millage measure resulted in an operating surplus (after transfers) of $5.3 million, or a sizable 15.1% of general and public safety fund spending, reversing a budgeted draw of $2.8 million. Unrestricted reserves across these funds increased to $12.6 million, or 36% of spending.

State shared revenue (approximately 16% of general fund revenue), which declined significantly between fiscals 2001 and 2011, has grown modestly in recent years. The city has taken steps necessary to reverse state funding levels by complying with the state's Economic Vitality Incentive Program (EVIP), which provides funding for localities that implement shared services or other efficiencies. The city reports that they are in full compliance with the new EVIP provisions and received a modest increase in fiscal 2014 with another increase budgeted for fiscal 2015. Total state shared revenues are budgeted at approximately $5.1 million for fiscal 2015, remaining 30% below fiscal 2001 funding amounts.

The city budgeted balanced operations in fiscal 2014, without the use of reserves. Conservative revenue and expenditure forecasting drove an operating surplus (after transfers) of $4.2 million (unaudited), increasing the city's unrestricted fund balance to $13.7 million, or 38% of spending across the general and public safety funds.

The fiscal 2015 budget includes the use of approximately $1.7 million from reserves (4% of budgeted fiscal 2015 spending) across the general and public safety funds. The budget includes the full public safety millage of 3.975 mills and conservatively assumes modest tax revenue growth of 1% over fiscal 2014 and holds all other revenues flat. Management reports that revenues have tracked budget thus far and expenditures are modestly below budget to date.

The city will propose a ballot measure for public vote in November for a 2.5 mill, 10-year road millage to fund local street repairs and maintenance. If passed, the millage is anticipated to generate $5.5 million in additional revenues annually.

PENSION AND OPEB COSTS CREATE PRESSURE

Most full-time employees are covered under the city of Royal Oak Retirement System, a single-employer defined benefit plan. In fiscal 2013 the city paid the full annually required contribution (ARC) of $6.2 million, or a sizable 12% of fiscal 2013 governmental fund spending. The city will continue to face budgetary pressure from rising pension costs due to increasing salaries and the low funding level of the plan, estimated at 58% in fiscal 2013 based on the 7% investment rate of return used by Fitch.

Retiree healthcare is an even greater cost pressure than the city's pension. OPEB costs in fiscal 2013 equaled a high 15% of governmental fund spending, which did not meet the full ARC. The city's contribution slightly exceeded the ARC in fiscal 2014 at $10.9 million or a very high 19.4% of governmental fund spending. The unfunded OPEB liability of $113 million equals a sizable 2.4% of full value.

Carrying costs, including pension ARC, OPEB contributions and debt service, are high at 30% of fiscal 2013 governmental fund spending. Carrying costs are expected to increase further. Fitch expects the increased public safety millage to absorb at least some of the increased payment, but views reliance on a renewable levy to fund a fixed cost burden as a notable risk. Benefits changes have not materially offset the rising trend in pension and OPEB costs, as carrying cost have increased in each of the last three audited fiscal years.

MANAGEABLE DEBT LEVELS

The total debt burden is moderate at $2,103 per capita and 2.6% of full value in fiscal 2014. Amortization is rapid, with 83% of principal retired in 10 years. The city's five-year capital improvement plan (CIP) totals a reasonable $80.5 million. The debt burden is expected to remain manageable due to the city's limited future debt issuance plans, which are contingent on the passage of the road millage measure to fund street repairs.

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.

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

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Contacts

Fitch Ratings
Primary Analyst
George M. Stimola
Analyst
+1 212-908-0770
Fitch Ratings, Inc.
33 Whitehall St.
New York, NY 10004
or
Secondary Analyst
Karen Wagner
Director
+1 212-908-0230
or
Committee Chairperson
Amy Laskey
Managing Director
+1 212-908-0568
or
Media Relations
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
George M. Stimola
Analyst
+1 212-908-0770
Fitch Ratings, Inc.
33 Whitehall St.
New York, NY 10004
or
Secondary Analyst
Karen Wagner
Director
+1 212-908-0230
or
Committee Chairperson
Amy Laskey
Managing Director
+1 212-908-0568
or
Media Relations
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com