Fitch Affirms Hialeah, FL's IDR at 'A'; Outlook Negative

NEW YORK--()--Fitch Ratings has affirmed the following ratings of the City of Hialeah, Florida (the city):

--$25,000,000 special obligation taxable revenue bonds, series 2015A at 'A-';

--$21,145,000 special obligation refunding revenue bonds, series 2015B at 'A-';

--$37,265,000 outstanding Florida Municipal Loan Council (FMLC) refunding and improvement revenue bonds, series 2012A (City of Hialeah) at 'A-'.

--Issuer Default Rating (IDR) at 'A'.

The Rating Outlook remains Negative.

SECURITY

The special obligation bonds are payable from a pledge and lien on franchise fee revenues levied and collected by the city, pursuant to Ordinance No. 07-55, granting the electric franchise to Florida Power & Light Company (FPL), its successors and assigns, or any franchise or franchises granted in substitution. If franchise fee revenues are insufficient to fully pay annual debt service, the city covenants and agrees to budget and appropriate (CB&A) non-ad valorem revenues in an amount which is equal to the deficiency in the sinking fund for the applicable fiscal year to the credit of the sinking fund. Such CB&A shall be cumulative to the extent not paid and shall continue until all amounts payable under the ordinance have been paid. The amount available to be budgeted and appropriated to make debt service payments is subject to the obligation of the city to provide essential services.

The improvement revenue bonds are limited obligations of the FMLC, payable solely from loan payments made by the city to the FMLC in an amount equal to debt service. Pursuant to the loan agreement, the city covenants to annually budget and appropriate (CB&A), by amendment if necessary, an amount of non-ad valorem revenue sufficient to satisfy its loan payments.

KEY RATING DRIVERS

The city's 'A' IDR and Negative Outlook reflect weak financial operations including relying on one-time sources and deferring obligations to fill budget gaps. The Negative Outlook reflects Fitch's concerns about the city's use of the series 2015A bonds to fund annual pension contributions as a form of deficit financing and its ability to achieve sustainable structural balance.

Fitch's 'A-' rating on the special obligation bonds and the FMLC refunding and improvement revenue bonds are based on the CB&A of the city and are rated one notch below the IDR. Non-ad valorem revenues are ample relative to overall debt service backed by the CB&A and are diverse in nature. A one-notch distinction on the special obligation revenue bonds from the IDR reflects the inability to compel the city to generate non-ad valorem revenues sufficient to pay debt service and the prior payment requirements of essential government service costs.

The pledged franchise fee revenues of the special obligation bonds are currently required to be paid solely by one entity, Florida Power & Light Company (FP&L), pursuant to a franchise fee agreement between FP&L and the city. Fitch does not believe this pledge enhances credit quality beyond the level provided by the non-ad valorem covenant.

Economic Resource Base

Hialeah is located in Miami-Dade County immediately north of Miami International Airport. The city is the sixth largest in the state with an estimated 2015 population of 237,969, an increase of 5.6% since 2010.

Revenue Framework: 'a' factor assessment

The city's general fund revenues are expected to rebound slightly to increase with inflation following steep declines during and post-recession. The city retains significant room under the legal rate limit.

Expenditure Framework: 'bbb' factor assessment

The city's fixed carrying costs for debt service, pension and other-post employment benefits (OPEB) are elevated at about 27% of general fund spending. Fitch believes the city has a limited ability to make expenditure cuts at the level of preceding years without reducing core services.

Long-Term Liability Burden: 'aa' factor assessment

The long-term liability burden for debt and the net pension liability (NPL) is moderate at about 12% of personal income. The city acknowledges the NPL, while moderate, will continue to be a growing burden on the resource base without pension reform. The amortization rate of debt is slightly below average and there is no new money debt planned.

Operating Performance: 'bbb' factor assessment

Structural imbalance due to revenues not keeping pace with expenditures has eroded reserves and the city's gap-closing capacity. Fitch believes city's fund balance is in the 'bbb' assessment category based on the midrange budgetary flexibility and level of historical revenue volatility.

RATING SENSITIVITIES

BALANCED OPERATIONS: The rating is sensitive to the city's continued reliance on one-time measures and the use of deficit financing to support operations. Demonstrated progress during this period of economic recovery towards reaching structural balance, with recurring revenues meeting recurring expenses, is the key to maintenance of the current rating level. Performance contrary to this could lead to a downward rating pressure in the IDR.

CREDIT PROFILE

Hialeah is located within Miami-Dade County and has access to the county's broad and diverse labor market. Within city limits, the commercial sector consists of small businesses, specifically industrial, light manufacturing, and service related companies. The top 10 taxpayers make up a minimal 8.2% of fiscal 2015 taxable assessed value (TAV).

Wealth indicators are low with per capita personal income estimated at about half of the national level. The individual poverty rate at 25.8% is well above local, state, and national levels. Unemployment rates were elevated into the double digits during the recession, but have recovered significantly in recent years to within 1% to 2% of state and national levels.

Revenue Framework

About a third of the city's general fund revenue comes from property taxes and another 30% from utility fees and franchise taxes. The city's taxable assessed value (TAV) remains 30% below the pre-recession peak of fiscal 2009 after the housing market's drastic decline from 2008 - 2012; Zillow reports home values declined 50%.

The city's general fund revenue growth has lagged that of both U.S. GDP growth and inflation over the decade from 2005 - 2015. Prospects for the future are somewhat brighter and expected to at least track inflation as the housing market continues to recover and building permit growth leads to increases in TAV. The 2017 budget reflects a third year of solid TAV increases.

Property taxes are subject to a statutory limit of 10 mills. The city's rate is well below the cap at 6.3 mills adopted for fiscal 2016. Fitch estimates that an increase of the levy to the maximum legal rate would generate roughly $26 million in additional revenue, the equivalent of nearly 20% of the total general fund budget.

Annual changes in the property tax rate are determined using a roll-back or revenue neutral rate, which is then adjusted for changes in the Florida per capita personal income. However, this limitation may be overridden by vote of the county governing body. The city also has the ability to increase various license and permit revenues and service charges that make up a smaller but still notable portion of its revenue base.

Expenditure Framework

The city's main general fund expenditure is for public safety, which makes up nearly 70% of the spending.

Fitch expects the city's natural pace of spending will increase ahead of revenues due to the slow pace of revenue growth and expectations for benefit costs to rise.

Fixed carrying costs for debt service, actuarially required pension contributions, and OPEB actual payments are a high 27% of total governmental spending in fiscal 2015. The pension contribution on its own was 15% of spending and, absent reform, is expected to grow significantly in the next several years due to a combination of the plan's poor investment returns and actuarial assumptions changes required by the state.

The city engages in collective bargaining with three labor groups representing general employees, police and fire. The city council retains the ability to impose labor terms and maintains control over headcount. From a practical perspective Fitch believes that flexibility around personnel spending may be somewhat constrained as the size of the citywide workforce has already decreased significantly; headcount is down over 30% from pre-recession peak levels.

Long-Term Liability Burden

The city's long-term liability burden is about 12% of personal income including pension and debt. Direct debt is a minor portion of the long-term liability burden as the majority of debt is overlapping debt of Miami-Dade County and the school district. The city is paying down 45% of existing debt within 10 years and has no plans to issue debt. Reported capital needs are minimal, though the city does not create a formal capital improvement program.

A growing portion of the city's liability burden is associated with the defined benefit pension plans. The primary plan is the Public Employees Retirement system (PERS) plan and a secondary plan is for a small number of certain elected officials. The NPL for the plans as of Oct. 1, 2010 was $164 million, but as of Sept. 30, 2015 the NPL has grown to $237 million under the plans' 8% investment rate of return. On a combined Fitch-adjusted basis at a 7% rate of return the PERS plan assets cover only 64% of liability. Management continues to seek pension reform from its employees in the current round of contract negotiations to help control growing costs and provide potential budget relief for the city. Effective April 1, 2012, new non-public safety employees participate in a defined contribution plan, but other assumption changes including the open amortization and the payroll growth assumption have caused the liability to continue to increase.

The city offers other post-employment benefits (OPEB) to its retirees and makes pay-as-you-go contributions. As of the last valuation report on Oct. 1, 2013, the unfunded liability of $307 million represented about 5% of personal income.

Operating Performance

Considerable tax base declines coupled with a determination to maintain or lower existing tax rates during the recession resulted in significant use of reserves over the last decade. The city implemented spending controls during the recession by reducing headcount and cutting capital spending, but the rapidity of the revenue erosion exceeded the city's ability to maintain structural balance. The city also began budgeting the underfunding of pensions and relying on one-time revenue including a large asset sale from the solid waste system that produced the fiscal 2014 surplus. Otherwise, the city spent down fund balance in six of the last seven audited fiscal years 2009 to 2015. Fitch believes the current level of reserves includes one-time measures not available to management to address a future economic downturn and is consistent with a 'bbb' financial resilience assessment.

In fiscal 2016, in a form of deficit financing, the city issued pension obligation bonds and used the proceeds to pay the actuarially determined contribution (ADC) for pension benefits for the year. Additional bond proceeds of $7 million were reserved in the general fund for future pension costs. Management estimates that absent the bond proceeds retained in the general fund, the fiscal 2016 year-end fund balance would decrease due to a $2-3 million operating deficit. In recent years the city has used short-term borrowing to make full pension ADC payments and nearly eliminated paygo capital spending in order to continue to hold property taxes flat. Management has raised some other fees including business fees and zoning fees.

The fiscal 2017 budget includes a stable property tax rate at 6.3 mills on TAV that increased a strong 8.6% over the year to $8.5 billion generating an additional $4 million in budgeted revenues. The budget includes cost controls by adding to recent reductions in headcount, though ultimately appropriates $3.2 million of reserves from those earmarked to pay increased pension contributions. Management highlights the importance of continued pension reform in the ongoing labor negotiations in all three of the city's employee bargaining unions whose contracts expired in fiscal 2016 in order to meet projected annual increases in the pension ADC. About $575 thousand in capital spending was included in the budget, primarily for software and computer equipment.

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
Parker Montgomery
Analyst
+1-212-908-0356
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Kevin Dolan
Director
+1-212-908-0538
or
Committee Chairperson
Karen Krop
Senior Director
+1-212-908-0661
or
Media Relations:
Elizabeth Fogerty, New York, +1 212-908-0526
Email: elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Parker Montgomery
Analyst
+1-212-908-0356
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Kevin Dolan
Director
+1-212-908-0538
or
Committee Chairperson
Karen Krop
Senior Director
+1-212-908-0661
or
Media Relations:
Elizabeth Fogerty, New York, +1 212-908-0526
Email: elizabeth.fogerty@fitchratings.com