Fitch Affirms Cleburne, TX's Ltd Tax Bonds & Downgrades Sales Tax Bonds on Criteria Change

AUSTIN, Texas--()--Fitch Ratings has affirmed the following Cleburne, TX obligations at 'AA-':

--Issuer Default Rating (IDR);

--$32.4 million combination tax and revenue refunding bonds, series 2013;

--$8.1 million combination tax and revenue certificates of obligation (COs), series 2013;

--$11 million general obligation (GO) refunding bonds, series 2008, 2010, and 2011;

--$24.9 million taxable GO bonds, series 2016.

In addition, Fitch has downgraded $13.4 million of outstanding Cleburne 4B Economic Development Corporation sales tax revenue bonds to 'A' from 'A+'.

The Rating Outlook is Stable.

SECURITY

The GOs, revenue bonds, and COs are payable from a property tax limited to $2.50 per $100 of taxable value. The revenue bonds and COs are additionally secured by a de minimis pledge of net utility system revenues not to exceed $1,000.

The 4B corporation sales tax revenue bonds are secured by a first lien on a 1/2 cent sales tax levied and collected city-wide for the purposes of the corporation.

KEY RATING DRIVERS

The 'AA-' IDR, revenue bonds, COs, and GOs reflects the city's robust financial cushion, moderate fixed-costs supporting solid expenditure flexibility and manageable long-term liability burden.

The downgrade to 'A' on the sales tax revenue bonds reflects the application of Fitch's revised criteria for U.S. state and local governments, which was released on April 18, 2016, and a more focused consideration of historical pledged revenue volatility and lenient covenants.

Economic Resource Base

Cleburne is located 30 miles south of Fort Worth within the Barnett Shale natural gas play. It is the seat of Johnson County ('AA+'/Outlook Stable). The city's population growth has lagged the larger Dallas-Fort Worth (DFW) metroplex, holding steady at roughly 30,000 for the last decade.

Revenue Framework: 'aa' factor assessment

The city of Cleburne has realized strong revenue growth over the past 10 years, partly as a result of tax rate increases to offset declines in value. The city still holds ample independent legal ability to raise revenues. The 'aa' assessment incorporates the local economy's energy concentration and associated revenue-base volatility.

Expenditure Framework: 'aa' factor assessment

Solid expenditure flexibility results from strong workforce control and moderate carrying costs. Fitch expects expenditures to grow in line with revenues, but notes that debt service spending will increase materially as the city begins to pay principal and interest on recently issued debt.

Long-Term Liability Burden: 'aa' factor assessment

The long-term liability burden remains moderate relative to the resource base despite a recent issuance to fund the construction of a minor-league baseball stadium. Fitch expects the burden to remain moderate given modest tax-supported capital needs and a low net pension liability.

Operating Performance: 'aaa' factor assessment

Fitch expects the city to demonstrate a high degree of gap closing ability and financial resilience during an economic downturn based on its healthy reserves, strong expenditure flexibility and high independent revenue-raising capacity.

RATING SENSITIVITIES

Contingent Risks: The rating could be pressured if general fund revenues are required to support the voter-approved baseball stadium in a manner that dilutes its financial position or flexibility.

Sales Tax Leverage: Fitch does not expect the city to leverage pledged revenues to the ABT based on use of residual revenues for operations of capital projects. However, should revenues be leveraged to the ABT, the bonds would likely be downgraded.

CREDIT PROFILE

The city lies over the Barnett Shale play, one of the largest natural gas fields in the U.S. Weakness in valuations across the residential, commercial, and industrial sectors has been the result of decreased drilling activity due to depressed natural gas prices since 2009. Taxpayer concentration remains elevated with the top 10 taxpayers making up 21% of taxable assessed value (TAV) but has come down from a high 32% in 2009 due to declining valuations of oil/gas firms. The top taxpayer group is now diversified with construction, engineering, retail, chemical and utility industry presence.

Potential for mid-term growth in the local economy is tied to the city's proximity to the large DFW job market, as well as the effectiveness of the economic development initiatives currently underway. Access to the metroplex has been enhanced by the completion of a major arterial highway that provides a direct link to Fort Worth. The DFW employment base is extensive and the region is outperforming the nation in post-recession job, income, and population growth.

Revenue Framework

Property taxes, charges for services, and sales and franchise taxes are the predominant revenue sources for the general fund.

City officials have addressed declining revenue trends by raising the tax rate, resulting in general fund revenue growth of a compound annual growth rate (CAGR) of 4%, in excess of both U.S. economic performance and CPI over the 10 years through 2014. Sales tax performance was particularly weak post-recession, declining by a compound annual average of 6% from 2008-2013. Fiscal 2014 collections were strong at 10% over the prior year only to soften once again in the most recent results. Management prudently assumes no growth in the sales tax revenue stream for planning purposes given past volatility.

After a period of incremental increases, the city's ad valorem tax rate will hold steady for the fourth consecutive year at $0.804 per $100 TAV in fiscal 2017, providing ample capacity below the statutory cap of $2.50. If a proposed tax rate results in an 8% year-over-year levy increase (based on the prior year's values), the rate increase may be subject to election if petitioned by voters.

Expenditure Framework

The city's largest spending area is public safety that makes up slightly less than half of the general fund budget. Spending growth in that area has trended in line with general fund expenditures, and Fitch believes it will continue to do so.

Fitch does not anticipate pressure on service levels given the city's stable population.

The city maintains adequate expenditure flexibility through strong control of workforce costs and moderate carrying costs. Fiscal 2015 carrying costs were 18.2% but are expected to rise to over 20% when the city begins paying debt service on recently issued debt.

Long-Term Liability Burden

The city's overall debt and net pension liability of $112.6 million represents a moderately low 12% of personal income, primarily composed of direct debt. Fitch does not anticipate a material change in the city's long-term liability profile in the intermediate term; management is in the process of finalizing a long-range infrastructure assessment yet reports that additional tax-supported debt will likely be minimal with the majority of general government needs addressed on a pay-as-you-go basis.

The city participates in the Texas Municipal Retirement System (TMRS), an agent multiple-employer defined benefit plan. Additionally, the city pays into the Firemen's Relief and Retirement Fund, a single-employer defined benefit pension plan.

Under GASB Statement 68, the city reports a fiscal 2015 TMRS net pension liability (NPL) of $17.8 million, with fiduciary assets covering 79% of total pension liabilities at the plan's 7% investment return assumption and based on a Dec. 31, 2014 valuation date. The city reports a fiscal 2015 Firemen's NPL of $10.2 million, with fiduciary assets covering 64% of total pension liabilities using an adjusted 7% investment return assumption. The Firemen's valuation date is Dec. 31, 2014. The combined NPL of both plans represents 3% of personal income. Other post-employment benefit (OPEB) requirements are modest and funded on a pay-as-you-go basis.

The 2016 general obligation bonds (sold earlier this year) were issued to fund a portion of the costs of construction of a baseball stadium. The stadium represents the city's contribution to a $100 million mixed-use project featuring retail and restaurants. The city has executed formal agreements with respect to the construction and operation of the stadium; the stadium is expected to be completed by late spring 2017.

The land acquisition and stadium construction was approved by voters by a wide margin in November 2015. Voters also approved an additional 1/2 cent sales tax levy that is allocated to the newly created Cleburne Type A Economic Development Corporation. While the bonds were issued as general obligations of the city, management plans to use the Type A 1/2 cent sales tax to pay principal and interest on the series 2016 bonds, as well as for maintenance of the ballpark once completed. Using the city's fiscal 2015 actual sales tax collections, the new 1/2 cent sales tax would generate approximately $2.8 million or 1.3x (times) maximum annual debt service (MADS) on the bonds.

Operating Performance

The city has maintained ample reserve levels and continued to do so during their most recent economic slowdown. The last two years of audited results included fund balance drawdowns after transfers, largely due to capital spending. Unrestricted reserves at fiscal 2015 year-end were $17.3 million (28.3% of spending). The city predicts the operating results for the fiscal year that ends Sept. 30 will be slightly better than the $1.7 million budgeted deficit. Despite the drawdowns, reserves are expected to provide a high level of fundamental financial flexibility during an economic downturn.

Management has been proactive in light of the recent downturn by making mid-year budget adjustments and deferring non-critical capital plans. The fiscal 2017 proposed budget includes plan changes to lower the city's TMRS contribution, equipment acquisition for street repair, additional firefighting personnel, and no increase in water or wastewater rates.

Sales and Use Tax Revenue Bonds

The sales tax revenue bonds are payable from a senior lien on the Cleburne 4B Economic Development Corporation's 1/2 cent sales tax levied on all transactions within the city. The 4B sales tax was approved by voters in 2001 in perpetuity to fund projects and support operations that exclusively benefit the city. Fitch believes that there are solid growth prospects for this revenue stream, driven primarily by economic development initiatives underway, but it will remain vulnerable to fluctuations in natural gas prices.

Sales tax revenues have been volatile given exposure to the energy sector by way of the Barnett Shale. The revenue stream has grown at a 5% CAGR since collections began in March of 2002 but have stagnated or declined since 2009 when natural gas prices began declining.

Debt service is mostly flat and MADS occurs in 2020. Current MADS coverage is strong at 2.3x, but the city could further leverage the revenue stream up to the lenient additional bonds test (ABT) of 1.25x MADS. Given the volatility of the revenue stream and use of residual revenues for operations of various economic development projects, Fitch believes management will continue to use conservative growth assumptions for capital planning and not leverage up to the ABT.

Fitch's stress analysis tests coverage levels using the largest actual revenue decline in the review period, which was 26% from 2008-2013 in Cleburne. Assuming issuance up to the ABT, pledged revenues would fall below 1x coverage in the case of a 26% decline in collections. The previous decline in sales tax revenues was exceptional in magnitude and would not likely be repeated to equal extent given the waning influence of energy prices on the local economy. In addition, Fitch expects the city to maintain a debt service coverage cushion in excess of the 1.25x ABT. If the city leverages to 1.25x MADS, the bonds would likely be downgraded given the historical pledged revenue volatility.

Fitch does not view the pledged sales taxes as special revenues under section 902(2)(B) of the bankruptcy code, which defines 'special excise taxes imposed on particular activities or transactions' as special revenues. Therefore, the rating would be capped by an Issuer Default Rating (IDR) of the city per Fitch's rating criteria.

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

In addition to the sources of information identified in Fitch's applicable criteria specified below, this action was informed by information from Lumesis, the Municipal Advisory Council of Texas, 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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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1012631

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Contacts

Fitch Ratings
Primary Analyst
Leslie Cook
Associate Director
+1-512-215-3740
Fitch Ratings, Inc.
111 Congress Avenue
Austin, TX 78701
or
Secondary Analyst
Rebecca Moses
Director
+1-512-215-3739
or
Committee Chairperson
Karen Ribble
Senior Director
+1-415-732-5611
or
Media Relations
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Leslie Cook
Associate Director
+1-512-215-3740
Fitch Ratings, Inc.
111 Congress Avenue
Austin, TX 78701
or
Secondary Analyst
Rebecca Moses
Director
+1-512-215-3739
or
Committee Chairperson
Karen Ribble
Senior Director
+1-415-732-5611
or
Media Relations
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com