Fitch Rates Evanston, IL's GOs 'AA+'; Affirms Outstanding Bonds

NEW YORK--()--Fitch Ratings has assigned a rating of 'AA+' to the following Evanston, IL general obligation (GO) bonds:

-- $14 million GO bonds, series 2016A;

-- $8 million GO refunding bonds, series 2016B.

In addition, Fitch has affirmed the following city ratings at 'AA+':

-- Long-Term Issuer Default Rating (IDR);

-- $136 million of GO bonds outstanding.

The Rating Outlook is Stable.

Proceeds of the series 2016A bonds will be used to finance capital improvements throughout the city outlined in the city's capital improvements plan, while the proceeds of the series 2016B bonds are being used to currently refund certain maturities of the city's series 2006 GO bonds.

The bonds will be sold via a competitive process on Sept. 7, 2016.

SECURITY

The bonds are backed by the city's full faith and credit pledge. Debt service will be paid from an ad valorem tax on all taxable property within the city, without limit as to rate or amount.

KEY RATING DRIVERS

The affirmation of Evanston's IDR and GO ratings at 'AA+' incorporates the city's strong independent revenue-raising ability, moderate long-term liability burden, and robust financial flexibility. The rating also incorporates Evanston's somewhat uneven general fund operating performance since the 2009 recession, which reflects a trade-off between management's desire to preserve service levels and increase annual pension contribution funding, while insulating residents from significant tax increases. The administration has kept up with necessary capital spending and improved its funding of annual pension contributions, but general fund reserves have declined, albeit to still-healthy levels.

Economic Resource Base

The city is contiguous with Chicago and is approximately 13 miles from downtown. The city's local economy is strong, anchored by Northwestern University, which employs about 5,000 people and educates approximately 10,000 students at its Evanston campus. Additionally, Northshore University Healthcare and St. Francis Hospital with approximately 3,700 and 1,200 employees, respectively, provide stability. Evanston's population is estimated at about 75,000.

Revenue Framework: 'aa' factor assessment

Fitch expects that the city's revenue growth pattern will continue to be slow, roughly even with inflation. The city's independent legal ability to raise revenue is exceptionally strong given its status as an Illinois home rule municipality.

Expenditure Framework: 'a' factor assessment

Fitch anticipates that the city's natural rate of expenditure growth will be above its revenue growth rate. The city retains an adequate level of expenditure flexibility pertaining to service delivery, headcount and capital spending, but fixed carrying costs for debt service and retiree benefits are somewhat elevated at approximately 24% of expenses.

Long-Term Liability Burden: 'aa' factor assessment

Evanston's long-term liability burden, inclusive of its net overall debt burden and unfunded pension liability, is very moderate compared to its resource base.

Operating Performance: 'aaa' factor assessment

The city maintains an exceptionally high level of gap-closing capacity, and Fitch believes that the city would manage successfully through a downturn while maintaining a high level of financial flexibility. Total available reserves, including unrestricted deposits held outside the general fund, equaled 22% of spending in fiscal 2015 - a healthy fiscal cushion, albeit lower than pre-recession levels.

RATING SENSITIVITIES

REVENUE GROWTH RATE: The rating is sensitive to the future rate of revenue growth. If the rate of general fund tax revenue growth over time is significantly lower than Fitch's expectations for growth close to the level of inflation, then this could lead to negative pressure on the rating.

FINANCIAL FLEXIBILITY: Failure to maintain an adequate level of financial flexibility could put negative pressure on the rating.

CREDIT PROFILE

The primarily residential community has a very strong socioeconomic profile as evidenced by high wealth and employment levels. Proximity to Chicago and Evanston's own diverse economy provides abundant employment opportunities. Residents are highly educated with 66% of the population attaining at least a bachelor's degree versus 30% nationally. The city's unemployment rate has historically been below those of the state and U.S.

Revenue Framework

Fitch expects slow, but steady revenue growth based on improving regional economic conditions and the city's ability to capture growth given its status as an Illinois home rule municipality.

Fitch believes that future revenue growth is likely to be slightly better than recent historical performance, which has been below the rate of inflation. According to the city's fiscal 2015 audited financial statements, general fund revenues are principally composed of property taxes, at 28% of budgeted revenues, as well as other local revenues. The latter include the 1% municipal share of state sales taxes and a 1% home rule sales tax; together, these local taxes account for 18% ($17 million) of general fund revenues. The city's share of state income taxes are also included in the general fund, and accounted for $19 million, or 19.7% of general fund revenues in fiscal 2015. Equalized property assessments are expected to increase modestly in fiscal 2016, reflecting increased economic activity including new construction. Sales taxes are also expected to increase by 1% to 2% given new retail development in the city, including two new grocery stores.

The city has significant ability to increase revenues given its status as a home rule municipality under the Illinois state constitution. There are no tax limits or requirement to conduct referenda to increase property taxes and other sources of local revenue, giving the city's elected leaders broad legal authority to raise revenues.

Expenditure Framework

Evanston's pace of expenditure growth has outstripped its growth in revenues since the 2009 recession, a trend that Fitch expects will continue. Budget management requires continuous actions by the city administration to limit annual draws on budgetary reserves. The city's general fund expenditures are concentrated largely on public safety, which accounted for 56% of spending in fiscal 2015. Other notable expenditure items are public works at 16% and general government and culture & recreation - both at 11% of spending.

Fitch believes that Evanston's expenditures are likely to grow more quickly than revenues over the next several years in the absence of management actions to limit budgetary growth, based on Fitch's expectation of a slow pace of revenue expansion. The majority of spending relates to contractual salaries and benefits, which consume nearly two thirds of budget. Labor costs are managed through four union contracts. Recently settled contracts included a 2.4% to 2.75% per annum wage increase across all bargaining units. Non-union staff received a 2% salary increase effective in fiscal 2016. Overall costs are estimated to have grown by 2.9% in fiscal 2016 due to the recent salary increases, as well as the hiring of some new employees.

In Fitch's view, the city has adequate expenditure flexibility, as it retains a tolerable measure of control over service delivery and headcount and the ability to scale back pay-go capital. However, carrying costs consisting of annual pension contributions, debt service, and retiree healthcare payments consume nearly 25% of budget; these somewhat elevated fixed costs limit the city's expenditure flexibility.

The administration's ability to control personnel costs is constrained by labor contracts that largely determine workplace rules, work hours and employee salaries. In most cases, Evanston's contracts with its four employee bargaining units (two police, one fire, and one general) are subject to binding arbitration. The city has 819 full-time employees, which is down slightly from 860 employees in 2008. The city reduced its workforce by 10% during the recession, and has since restored many positions. The city budgets a contingency each year for revenue underperformance; the fiscal 2016 contingency figure was a $1.5 million cost reduction built into the 2016 budget. The administration is raising its contingency plan level to a cut of 4% of spending across all departments in fiscal 2017 if revenues significantly underperform and, in particular, if receipt of the city's share of state income taxes is delayed due to fiscal pressures at the state level. Fitch believes this expenditure reduction target is achievable.

Long-Term Liability Burden

Evanston's long-term liability burden is moderate when compared to the size of its economic resource base. Combined debt and pension liabilities equaled 10.8% of personal income in fiscal 2015, which is at the lower end of Fitch's 'aa' range for such assessments. The direct debt burden is not expected to grow in the medium term, as the city plans to issue new debt in amounts approximately equal to the principal amount of bonds maturing each year. Amortization is rapid with 72% of bonds maturing within 10 years.

The city participates in three public pension plans: two single-payer plans established by the city for its police and fire employees and a state-sponsored plan for most other employees. Although the police and fire plans are single-employer plans, benefits and employee and employer contribution rates are established by state statutes. As of Dec. 31, 2014, both the city's police and fire pension plans remained severely underfunded with assets-to-liabilities ratios of 53% and 47%, respectively, using a 6.75% discount rate. As of Dec. 31, 2015, the state-sponsored plan, the Illinois Municipal Retirement Fund, was much better funded at 92% using a 7.5% rate of return; using Fitch's slightly more conservative 7% discount rate assumption, the plan's assets equaled 87% of liabilities. Taken as a whole, the city's adjusted aggregate unfunded actuarial liability for all three plans totaled $198 million in fiscal 2015, 35% of the city's total liability burden.

Management has been proactive about addressing its unfunded pension liability. It has consistently exceeded the minimum employer contribution amounts, and recently exceeded its actuarially required contribution (ARC) payments. It has also revised its discount rate assumptions downward to make them more conservative.

Evanston's other-post employment benefits (OPEB) liability is exceedingly modest at $15.8 million, equal to a slender 0.3% of personal income.

Operating Performance

Fitch believes Evanston's financial flexibility to be exceptionally strong given still-healthy available reserves despite a series of recent drawdowns. Evanston retains adequate control over expenditures, and would likely use a combination of cost reductions and revenue-raising measures to close a recession-driven budget gap. Unrestricted general fund reserves constituted just below 10% of general fund expenditures at fiscal year-end 2015; however, the city maintains significant available funds outside of the general fund in its parking enterprise and economic development funds. These moneys bring overall available reserves to 22.4% of general fund expenditures for fiscal 2015, and afford Evanston additional financial flexibility. Fitch believes the city would, in all likelihood, maintain reserves at a level consistent with a 'aaa' assessment for fiscal flexibility under a moderate stress scenario.

The city has a general fund balance policy that requires minimum fund balances of 16.6% of general fund expenditures. If reserves fall below that level, the city is required to budget a surplus and if the fund balance goes above 20%, the city must budget a deficit. Fitch notes that the city was below its own policy target at year-end fiscal 2015, despite adopting its target that same year. The administration budgeted a surplus for fiscal 2016 in order to increase reserves to the minimum required level.

Fitch's FAST model output for Evanston generates a revenue output change of -4.6% under the moderate stress scenario of a 1% decline in US GDP. In Fitch's view, Evanston's unusual general fund revenue fluctuations in fiscal 2012 and 2015 - which were caused primarily by fund accounting changes and the reclassification of certain revenues - in all likelihood bias the model output, yielding a much higher estimate of the city's natural revenue volatility than that which is actually borne out by a study of the city's historical tax receipts. Fitch expects that the city's actual revenue volatility would be below the -4.6% figure generated by FAST.

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

In addition to the sources of information identified in the applicable criteria specified below, this action was informed by information from Lumesis and InvestorTools.

Applicable Criteria

U.S. Tax-Supported Rating Criteria (pub. 18 Apr 2016)
https://www.fitchratings.com/site/re/879478

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Contacts

Fitch Ratings, Inc.
Primary Analyst
Michael D'Arcy, +1-212-908-0662
Director
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Shannon McCue, +1-212-908-0593
Director
or
Committee Chairperson
Laura Porter, +1-212-908-0575
Managing Director
or
Media Relations, New York
Hannah James, +1-646-582-4947
hannah.james@fitchratings.com

Contacts

Fitch Ratings, Inc.
Primary Analyst
Michael D'Arcy, +1-212-908-0662
Director
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Shannon McCue, +1-212-908-0593
Director
or
Committee Chairperson
Laura Porter, +1-212-908-0575
Managing Director
or
Media Relations, New York
Hannah James, +1-646-582-4947
hannah.james@fitchratings.com