NEW YORK--(BUSINESS WIRE)--Fitch Ratings affirms the following Battle Creek, Michigan (the city) bonds:
--Implied unlimited tax general obligation bonds (ULTGO) rating at 'AA';
--$14.2 million LTGO bonds, series 2013 at 'AA';
--$5.4 million LTGO refunding bonds, series 2011 at 'AA';
--$3.7 million LTGO downtown development refunding bonds, series 2013 at 'AA':
--$32.2 million LTGO Battle Creek downtown development bonds, series 2008 at 'AA';
--$5.7 million LTGO Battle Creek Tax Increment Finance Authority bonds, series 2009 and 2010 at 'AA';
--$4.1 million LTGO Battle Creek Building Authority bonds, series 2008 at 'AA'.
The Rating Outlook is Stable.
All LTGO bonds are ultimately payable from the city's pledge of its full faith and credit and its ad valorem tax, subject to charter, statutory and constitutional limitations. The downtown development bonds and the tax increment finance authority bonds are payable in the first instance by a pledge of tax increment revenue. The building authority bonds are backed by lease payments from the city to the authority. The obligation to make the rental payments is not subject to appropriation, set-off or abatement for any cause, and carries the city's LTGO pledge.
KEY RATING DRIVERS
BREAK-EVEN FINANCIAL PERFORMANCE: The city has steadily posted modest increases in reserves as a percentage of spending over the past few years, despite mixed operating margins. Liquidity metrics have improved over the period, as demonstrated by augmented quick ratios.
PROACTIVE, PRUDENT MANAGEMENT: Management employs extensive financial and capital planning tools. Fitch expects management to continue expenditure controls and to maintain acceptable financial margins, given the continued susceptibility of the city's financial performance to economic cyclicality and the importance of income tax to the city's revenue base.
ABOVE-AVERAGE TAX BASE CONCENTRATION: The city's top 10 taxpayers represent over one-quarter of the tax base. The top three taxpayers, Kellogg Company, Denso Manufacturing, and Kraft Foods Inc., equal nearly one-fifth of the total taxable assessed value (TAV).
BELOW-AVERAGE SOCIOECONOMIC PROFILE: Unemployment rates remain above, and city income levels well below, state and national levels.
MANAGEABLE DEBT AND PENSIONS: The city's debt profile is moderate and benefits from a practice of pay-as-you-go capital investment, rapid amortization of debt, and modest future borrowing needs. Pension funding levels vary from below average to adequately funded, and the city consistently contributes the full annual requirement; carrying costs are moderate.
EXPOSURE TO TAX INCREMENT SHORTFALLS: The city's tax increment revenues currently cover debt service; however, coverage is thin and has declined for the downtown development authority (DDA) and may require general fund support in the future. General fund support beyond a moderate level would pressure the rating.
LTGO RATING ON PAR WITH IMPLIED ULTGO: The LTGO bonds are rated on par with the implied ULTGO rating on the basis of the city's solid general fund reserves and a margin of taxing capacity under statutory limits.
FINANCIAL & ECONOMIC RISKS: The rating is sensitive to financial performance and economic factors, especially risks from the inherently cyclical revenue base.
Battle Creek is located in south central Michigan roughly 42 miles southwest of Lansing and is best known as the historic capital of breakfast food production. City population has been relatively stable at around 52,000 over the past three decades, although there have been marginal declines since the 2000 census.
CYCLICAL, MANUFACTURING BASED ECONOMY
Manufacturing, especially in the food services industries, underlies the city's economy. The city's tax base reflects this concentration, with the top 10 taxpayers accounting for a high 18% of total TAV. Kellogg Company (Issuer Default Rating 'BBB+'; Negative Outlook) has a large presence in the community, serving as both the city's largest taxpayer at 9% of TAV for 2014 and the largest employer with 2,500 employees.
Other top employers include auto parts maker Denso Manufacturing Michigan Inc., which further contributes to the cyclical nature of the local economy, as well as medical services firms and government sector employers, which provide some measure of stability. Additional job growth is likely over the near term given the pace of private investment over the past few years and expectations for further economic expansion.
The city's 5% September 2015 unemployment rate is just slightly above that of the state and the nation, at 4.7% and 4.9%, respectively, in contrast to historical trends of local unemployment notably above the broader indices. City wealth levels are below average, with median household income levels at 68% of the state average.
Battle Creek's TAV has declined 12% since its peak in fiscal 2010; recent declines have been moderate, with a 1.8% decline in fiscal 2012 and a 3.6% decline for fiscal 2013, approximately a third of which was driven by tax appeal adjustments. City officials project modest TAV growth in the near future, pointing to gains from recent expansions by its top taxpayers. Property tax collections stayed strong through the recession and remain above 99%.
EXPOSURE TO TAX INCREMENT SHORTFALLS; MIXED COVERAGE
The city's tax increment districts (TIFA and DDA) are highly concentrated by leading taxpayers and have had valuation fluctuations over the past five years. The bonds also carry the additional security of the city's LTGO pledge. Historically, the districts have generated sufficient annual property tax increment and state business tax reimbursement revenues to support their annual debt service payments without additional city funding. Fiscal 2015 tax increment district debt service coverage for TIFA was strong at more than 3.7x, consistent with historical results. In contrast, the DDA's debt service coverage was very thin at 1.1x for the DDA's $4.6 million payment (representing 11% of general fund spending).
DDA debt service payments escalate over the intermediate term, and flat increment revenues would provide about 0.9x coverage. The city has the ability under current law to further restructure DDA bonds through 2018, providing a degree flexibility to respond to a personal property tax phase-out that Michigan voters approved in 2014. The current rating incorporates the expectation of thin coverage and possible modest general fund support. An ongoing draw upon the general fund to support DDA debt service could pressure the rating.
BREAK-EVEN FINANCIAL PERFORMANCE
The city's revenue profile is diverse. Property and income tax each have historically accounted for a little over a third of general fund revenues, and there is less dependence on revenue sources outside the city's control. The city has a 0.7142-mill (6.7%) margin available under its Headlee roll-back limit for operations, which would generate an additional $700,000 or 1.6% of fiscal 2014 revenues. Had the city used this additional taxing margin, operations would have been roughly balanced over the past four years.
The city posted positive results in fiscal 2014 with a $480,000 surplus (1.1% of spending). For the preceding five years, the city had ended with annual surpluses and deficits within a narrow range of 2% of spending. City officials project similar fluctuations in the near term. Preliminary fiscal 2015 results indicate that favorable budgetary variances will limit the use of fund balance to less than $150,000, about half of the original appropriation. In contrast, the fiscal 2016 budget does not include a fund balance appropriation. Management reports that to date fiscal 2016 results have outpaced those of fiscal 2015 on a year-over-year basis.
Generally consistent operations suggest that the city's efforts to right-size its spending base over the past few years with salary and benefits concessions and headcount reductions have been successful. Fitch will continue to monitor ongoing operations, as management's ability to match expenditures with recurring revenues is a key credit consideration, especially given the importance of an elastic income tax to the city's revenue base.
Although total fund balance fluctuated throughout over the past few years, the unrestricted fund balance consistently grew. At the end of fiscal 2014, the city's unrestricted fund balance was $7.5 million or an adequate 17.8% of spending, comfortably in excess of management's policy target of 8%.
General fund liquidity has improved over the past several years, as demonstrated by a doubling of the cash and investments listed in the audit and a commensurate increase in the quick ratio. Even when less, general fund cash has not been a concern given that ample cash was held in other funds as part of the city's pooled cash operations.
MODERATE, RAPIDLY AMORTIZING DEBT
Total city debt levels are moderate to high at $3,283 per capita or 5.3% of market value. More than 50% of the total debt outstanding is from local school districts. Overall carrying costs, including tax-increment debt service, pension ARC and other post-employment benefits (OPEB) payments, are manageable at 21% of fiscal 2014 governmental expenditures; carrying costs would increase by 1% if the OPEB ARC were fully funded.
Amortization remains rapid with 85% of outstanding principal paid in 10 years. The city currently is re-examining and prioritizing the capital needs that are included in the $194 million fiscal 2016-2021 tax- and revenue-supported capital improvement program.
The city provides employment benefits to its public safety staff through a single-employer defined benefit pension plan, which was adequately funded at 79.1% as of June 30, 2014. The plan assumes a 7% rate of return. The city additionally participates in a state-run agent multi-employer plan which was 68% funded as of Dec. 31, 2014 or a somewhat weaker 61.7% assuming an estimated 7% rate of return. The city consistently funds its full actuarial required contribution.
The city has contributed increasing amounts to its OPEB obligation over the past few years, reaching 53% of the annual requirement in fiscal 2013 and 71% in fiscal 2014. The funded ratio of the plan improved to 9.8% at the time of the June 2013 actuarial valuation, up from 2.8% funded in 2009. The 2013 OPEB UAAL was $37.5 million or 1.1% of 2014 market value, a reduction from $52.4 million or 1.6% of market value in 2009.
Additional information is available at 'www.fitchratings.com'.
Fitch recently published an exposure draft of state and local government tax-supported criteria (Exposure Draft: U.S. Tax-Supported Rating Criteria, dated Sept. 10, 2015). The draft includes a number of proposed revisions to existing criteria. If applied in the proposed form, Fitch estimates the revised criteria would result in changes to fewer than 10% of existing tax-supported ratings. Fitch expects that final criteria will be approved and published by Jan. 20, 2016. Once approved, the criteria will be applied immediately to any new issue and surveillance rating review. Fitch anticipates the criteria to be applied to all ratings that fall under the criteria within a 12-month period from the final approval date.
In addition to the sources of information identified in the applicable criteria specified below, this action was informed by information from CreditScope, IHS Global Insight, and Zillow Group.
Exposure Draft: U.S. Tax-Supported Rating Criteria (pub. 10 Sep 2015)
Tax-Supported Rating Criteria (pub. 14 Aug 2012)
U.S. Local Government Tax-Supported Rating Criteria (pub. 14 Aug 2012)
Dodd-Frank Rating Information Disclosure Form