Fitch Affirms Cleveland, OH's General Obligation Bonds and IDR at 'A+'; Outlook Revised to Stable

NEW YORK--()--Fitch Ratings has affirmed the 'A+' rating on the following Cleveland, OH bonds:

--$29,270,000, series 2007A;

--$1,570,000, series 2007B;

--$20,155,000, series 2007C;

--$8,410,000, series 2008A;

--$37,890,000, series 2009A.

In addition, Fitch has affirmed the city of Cleveland's Issuer Default Rating (IDR) at 'A+'.

The Rating Outlook has been revised to Stable from Positive.

SECURITY

The bonds are unvoted general obligations of the city payable by ad valorem property taxes within the 10-mill property tax limitation and municipal income taxes pledged under the city's general bond ordinance. The city may also use any available funds (state disbursements, interest earnings, all nontax revenues) for debt service.

KEY RATING DRIVERS

The city's 'A+' IDR reflects a below-average revenue framework that is offset by solid expenditure controls, a moderate long-term liability burden, and strong gap-closing capacity. Fitch believes that the city's financial operations would be more challenged in a downturn than is the case for higher rating levels, but expects the city to maintain some reserves throughout an economic cycle and recover financial flexibility as conditions improve. The revision to the Stable Rating Outlook from Positive reflects implementation of Fitch's revised criteria for U.S. state and local governments, which was released on April 18, 2016. Under the revised criteria, Fitch expects that the city will maintain strong gap-closing capacity in an economic downturn, although financial operations may be challenged.

Economic Resource Base

The city is located in northeastern Ohio on the southern shore of Lake Erie and is the county seat of Cuyahoga County ('AA+' IDR/Outlook Stable). The city's population declined a significant 17% from 2000 to 2010, but the decline has slowed, with an estimated 2015 population of 388,072, 2% down from 2010.

Revenue Framework: 'bbb' factor assessment

Fitch expects the city's revenue growth to be stagnant, remaining at a rate below the rate of inflation. The city has no independent legal ability to raise revenue.

Expenditure Framework: 'a' factor assessment

The city's expenditures are likely to grow at a rate above natural revenue growth, due to the low expectations for revenue prospects. Flexibility is supported by moderate costs for servicing debt and other long-term liabilities.

Long-Term Liability Burden: 'aa' factor assessment

Cleveland's long-term liability burden including pension liabilities and overall debt is moderate relative to personal income.

Operating Performance: 'a' factor assessment

The city has strong gap closing capacity, balancing its lack of control over revenues with solid reserve levels and expenditure controls.

RATING SENSITIVITIES

Maintenance of Reserves: The 'A+' IDR and GO rating is sensitive to any material change in Fitch's expectations for available reserve levels that would affect the city's ability to maintain flexibility in an economic downturn.

CREDIT PROFILE

The city's economy has transformed from manufacturing to the more stable health and education sectors. The city's weak socioeconomic profile is characterized by a declining population, below average income levels, and high poverty rate. Unemployment rates are consistently above state and national levels. As one of Ohio's largest metropolitan areas, Cleveland benefits from a measure of scale and diversity. The Cleveland Clinic is the largest private employer. Other large employers include University Hospitals of Cleveland, MetroHealth System, KeyCorp, and Case Western Reserve University.

Assessed valuation declined a moderate 5.2% from 2009 to 2013 but has recorded small increases in subsequent years. Fitch expects assessed value to remain stable to modestly increasing given ongoing commercial development and some moderation from high foreclosures. Demolition of distressed properties has decreased, but property tax collections continue to be very weak, with a total collection rate of only 89% in 2015. The city's financial operations are somewhat insulated from assessed value declines and poor collections as only a small portion of general fund revenue is derived from property taxes, but they are an indication of economic weakness.

Revenue Framework

The city's revenue comes largely from income taxes, which made up 63% of FY 2015 general fund revenue. The remainder is comprised of charges for services, other miscellaneous revenue, and a comparatively small amount of property taxes (7%).

Prospects for natural revenue growth are weak. Fitch believes that future revenue growth is likely to be in line with historical revenue growth, lagging both CPI and GDP. The city projects income tax revenue to grow at 2% and for property taxes to grow at less than 2% annually.

The city is limited in its ability to legally raise revenue independently. The city charter provides that the maximum total tax rate that may be levied without a vote for current operating expenses is 8.35 mills. The city is currently at that limit. The city has no voted property tax levies and none are contemplated as income tax revenues are sufficient to support operations. Increases in the income tax require voter approval. The city is planning to have a ballot initiative in November that proposes increasing the income tax rate from 2% to 2.5%, which would bring in an additional $83 million in revenue.

Expenditure Framework

The city's largest expenditure item is public safety at 64% of FY 2015 general fund expenditures. The city also spent 16% on general government administration and 14% on public works expenditures.

Fitch expects that the city's natural pace of expenditure growth will be above the expected revenue growth rate. The largest drivers in the city's expenditure items include costs related to the labor force, which represents approximately 80% of city expenditures. These expenditures are expected to increase at a rate exceeding 2% annually. Additionally, the city is operating under a consent decree resulting from an investigation by the U.S. Department of Justice. The consent decree largely calls for changes in training of police recruits and experienced police officers and an independent monitor.

The city maintains a solid degree of expenditure flexibility. Carrying costs for debt service and retiree benefits are moderate at approximately 18% of governmental expenditures in FY 2015, and the city management has a solid degree of control over staffing levels and implementing workforce reductions.

Long-Term Liability Burden

The city's long-term liability burden is moderate, with debt and pension liabilities at 17% of personal income. Direct debt totals about $755 million, and overlapping debt about $182 million. Approximately 52% of the total $2.0 billion liability burden is in the form of unfunded pension liabilities, a more variable liability. The city is required to use one-ninth of income tax receipts (restricted income taxes) solely for capital improvements or debt service on obligations issued for capital improvements.

The city participates in the Ohio Public Employees Retirement System (OPERS), which is a cost-sharing, multiple employer defined benefit pension system, as well as the Ohio Police & Fire Pension Fund (OP&F), a cost-sharing multiple employer system. Fitch calculates the ratio of assets to liabilities to be 71% assuming a 7% discount rate.

Operating Performance

The city has maintained a strong level of available fund balance throughout the recession and subsequent recovery relative to potential revenue declines depicted by the Fitch Analytical Sensitivity Tool (FAST) in a moderate economic downturn. Fitch expects that available general fund and other operating fund reserves (16% of expenditures in fiscal 2015) would remain above the 'a' reserve safety margin level, even in an unaddressed moderate recessionary period, although the city would be required to use its expenditure flexibility to remain above its 5% reserve policy in times of economic stress.

The city has made efforts to maintain a solid level of available reserves in the recent economic recovery. The city had surpluses from FY 2010 through FY 2014 before a deficit in FY 2015 due to retroactive pay to several of its collective bargaining units. The city expects another draw on reserves in FY 2016 due to another retroactive payment, after which the city is expected to have between $70 million and $74 million in available reserves (approximately 15% of general fund expenditures).

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
Primary Analyst
Matthew Wong, +1-212-908-0548
Director
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Arlene Bohner, +1-212-908-0554
Senior Director
or
Committee Chairperson
Laura Porter, +1-212-908-0575
Managing Director
or
Media Relations
Elizabeth Fogerty, New York, +1-212-908-0526
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Matthew Wong, +1-212-908-0548
Director
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Arlene Bohner, +1-212-908-0554
Senior Director
or
Committee Chairperson
Laura Porter, +1-212-908-0575
Managing Director
or
Media Relations
Elizabeth Fogerty, New York, +1-212-908-0526
elizabeth.fogerty@fitchratings.com