itch Upgrades Worcester, MA's GO Bonds to 'AA'; Outlook Stable

NEW YORK--()--Fitch Ratings has assigned a 'AA' rating to the following general obligation (GO) bonds for the city of Worcester, Massachusetts (the city):

--$57,740,000 GO municipal purpose loan of 2016 bonds, series A;

--$14,525,000 GO refunding bonds, series 2016B;

--$19,915,000 GO refunding bonds, series 2016C.

The bonds are scheduled to sell competitively on December 1. Proceeds of the series A bonds will be used for various municipal purposes; series B bond proceeds will be used to refund the city's series 2008A bonds; and series C bonds will be used to advance refund a portion the city's outstanding series 2009 bonds.

In addition, Fitch has upgraded to 'AA' from 'AA-' the following city ratings:

--Approximately $573 million of outstanding GO bonds

--The city's Issuer Default Rating (IDR)

The Rating Outlook is Stable

SECURITY

The bonds are a general obligation of the city and are backed by its full faith and credit and a property tax levy that is limited by state statute

KEY RATING DRIVERS

The upgrade of the IDR and GO rating to 'AA' from 'AA-' reflects a combination of Worcester's sustained improvement in its financial profile over the past several years buoyed by tax base growth and maintenance of excess levy capacity as well as the application of Fitch Ratings' revised criteria for U.S. state and local governments (released in April 2016).

Fitch's expects the city of Worcester to maintain solid financial flexibility throughout economic cycles, consistent with a recent history of sound operating performance and adequate reserves. The city's strong financial profile reflects positive revenue growth prospects from an improving property tax base, manageable expenditure growth and a demonstrated ability to reduce expenditures during economic downturns. Fitch expects long-term liabilities for debt and pensions to remain moderate based on manageable capital needs and a practice of fully funding its annual required pension contributions. Other post-employment benefits (OPEB) are elevated but the city continues to manage growth in these costs through health insurance plan changes and additional funding above pay-as-you-go amounts.

Economic Resource Base

Worcester is located roughly 40 miles west of Boston and serves as the economic hub of central Massachusetts. The city's estimated population of 184,815 is up 2.6% since 2010 and 7% since 2000. The city benefits from the presence of well-established higher education and healthcare institutions, attracting ancillary businesses and providing stability to the economy.

Revenue Framework: 'aa' factor assessment

Fitch expects Worcester to realize continued healthy revenue growth based on anticipated increases in its tax base due to new development underway and planned for the future. General fund revenue growth for the 10 year period of 2005 - 2015 has exceeded both U.S. GDP and CPI for the same period, reflecting moderate tax base growth and tax levy increases. The city's independent legal ability to raise revenues is somewhat constrained by the state's Proposition 2.5% law.

Expenditure Framework: 'aa' factor assessment

Fitch expects the natural pace of spending growth to be in line with to slightly above revenue growth over time. Carrying costs for long-term liabilities claim a moderate proportion of governmental spending. The city has demonstrated the flexibility and willingness to cut spending during economic downturns.

Long-Term Liability Burden: 'aa' factor assessment

Fitch expects Worcester's long term liability burden to remain moderate based on a manageable capital plan, a history of full funding of its pension contributions and rapid principal amortization. Debt and unfunded net pension liabilities are estimated to represent a moderate 15% of personal income. OPEB liabilities are elevated at an estimated 13% of personal income but the city continues to actively manage these future costs.

Operating Performance: 'aaa' factor assessment

The city's steady revenue growth combined with prudent fiscal policies and conservative budgeting practices has led to consistently positive operating results for the past seven years through fiscal 2016. Fitch considers the city's gap-closing capacity to be sound based on its high level of inherent budget flexibility in the form of adequate spending control and revenue-raising ability. Fitch expects management to continue to maintain financial flexibility to withstand a future economic downturn.

RATING SENSITIVITIES

Financial Performance: The IDR and GO rating are sensitive to changes in financial performance over time, material changes in the city's long term liabilities, and their impact on financial flexibility.

CREDIT PROFILE

Worcester is the second largest city in Massachusetts and New England by population and is located roughly 40 miles from Boston, MA and Providence, RI. The presence of 10 higher education and several major healthcare institutions provides stability to the local economy. The full-time student population is estimated at over 30,000 and is comprised in part by the College of Holy Cross, Clark University, Assumption College, UMass Medical School, and Worcester Polytechnic. UMass Memorial Health Care is the largest employer followed by UMass Medical School, Reliant Medical Group and Saint Vincent Hospital.

Significant economic development efforts in the last several years have led to increased investment in the city and continue to attract new business ventures and residential projects. The city's numerous projects in various stages of development are adding to the revitalization of downtown. The largest of these are the $565 million multi-phased mixed-use CitySquare project and $100 million expansion of the city's rail terminal, increasing freight rail options to the city and express train service to Boston. Two new major hotel projects are underway and follow the recent completion of a new Hampton Inn. Rehabilitation projects have successfully provided new office, retail and residential development, spurring additional investment and interests in future development from developers.

The city's unemployment rate declined to 4.1% in September 2016, down from 6.1% a year prior. The city's wealth levels have historically been below state and national averages, partially due to the large student presence.

Revenue Framework

Intergovernmental revenues, primarily for education, represent roughly 49% of fiscal 2016 budgeted revenues. Property and motor vehicle excise taxes make up the bulk of the remaining operating revenues at 48% of budgeted revenues.

The city's taxable assessed value (TAV) of $11.2 billion grew marginally by a total of 3.3% over the past three years, but city officials are reporting an estimated 9% growth in TAV for fiscal year 2017. The fiscal 2017 value is subject to state certification. Fitch believes prospects for future moderate growth over the near term are reasonable given ongoing development city-wide.

Pursuant to state law, Proposition 2 1/2 limits the city's ability to levy property taxes by a "levy ceiling", an absolute cap on the level of property taxation, set at 2.5% of the overall property tax valuation (primary limit), and a levy limit which restricts the annual growth in taxation to a 2.5% increase over the previous year's levy plus the value of new growth (secondary limit). Taxation in excess of the levy limit (plus any new growth) requires voter approval.

Management has typically levied below the ceiling each year. Any excess in levy capacity is carried forward and available for use at any time. For fiscal 2016, the city levied $6.1 million below the secondary limit, the additional amount that may be levied without voter approval. The city's fiscal 2017 budget included a levy below the levy limit and the excess capacity with respect to the secondary levy limit is estimated to grow by $3 million to $9.1 million. Fitch expects the city to retain the financial flexibility that this cushion affords going forward based on management's history of conservative budgeting practices and no material declines in the tax base.

Expenditure Framework

The bulk of general fund expenses are associated with education (44%) followed by employee benefits, public safety and public works.

General fund expenditure growth has historically been in line with to slightly above revenue growth and the city has flexibility to reduce expenditures if necessary. Growth is expected by Fitch to continue at this same pace.

Pension contributions comprise only 5% of governmental expenses but will likely increase over time due to a sizable and growing net pension liability and a potential gradual reduction of the investment rate of return over time (currently 7.5%). Carrying costs for debt service, pensions and actual OPEB contributions were a moderate 18% of fiscal 2015 governmental spending when netting out enterprise fund contributions for pensions. Fitch expects carrying costs to remain close to these levels going forward.

Long-Term Liability Burden

Long term liabilities for debt and unfunded pension liabilities are moderate at around 15% of estimated personal income and are expected to grow marginally based on pension funded levels and manageable debt plans. The city's principal amortization rate is rapid at 67% over 10 years. Outstanding debt accounts for roughly half of the metric.

The city's employees (excluding teachers) participate in the city-operated Worcester Contributory Retirement System. The estimated funding level using a 7% investment rate of return is 63% or an estimated $468 million (7% of personal income).

The city's unfunded other post-employment benefits (OPEB) liability totaled $861 million as of July 1, 2015, equal to an unusually high approximate 13% of personal income. This total is up $91 million from the 2013 valuation due primarily to changes in actuarial assumptions. OPEB contributions in fiscal 2015 totaled $24 million, or roughly 50% of the ARC.

The city has made efforts to manage the growth in its future OPEB liability through its policy that requires a portion of surplus revenues (or "free cash" as certified by the state director of accounts) be committed for OPEB. The city established a restricted OPEB account in fiscal 2011. The 2017 budget includes a modest $500,000 annual appropriation towards OPEB in addition to the planned free cash contribution of approximately $2.9 million. At fiscal year-end 2016, the projected balance restricted for OPEB liabilities was $8.8 million.

The city has successfully negotiated with the bulk of its bargaining groups for increases in employee deductibles, co-pays and changes in prescription coverage. Additionally, the city has reduced its provider costs. These and other plan changes are anticipated to control future healthcare costs and liabilities.

Operating Performance

Fitch expects the city will continue to maintain sound reserve levels throughout economic cycles given its historically stable revenue performance, high level of inherent budget flexibility, and demonstrated commitment to growing reserves for debt service, OPEB and operations. The city has experienced steady growth in revenues largely driven by consistent moderate increases in the property tax levy that have supported growth in expenditures and helped maintain a level of reserves above the level Fitch deems adequate to maintain an 'aaa' financial resilience assessment. The city's solid gap-closing capacity benefits from additional reserves, primarily consisting of debt stabilization funds, outside the general fund.

During the most recent downturn the city's reserves were substantially drawn down to support operations. Management has since demonstrated its ability to reduce spending through cost controls, staff reductions, and deferred hiring practices. Management also instituted policies to build up reserve levels to maintain a prudent level of financial flexibility to withstand future economic downturns. Given these changes Fitch does not believe the city will draw down on reserves to the same extent in the next downturn.

At fiscal-end 2015, the general fund experienced essentially break-even operations. Unrestricted general fund balance improved to $26.8 million or 5% of spending. External reserves for debt service and other uncommitted reserves raise reserves to around 9% of spending. The city has experienced surplus operating results since fiscal 2009 resulting in an increase in reserve levels over that time.

The fiscal 2016 budget of $599 million reflects increases in education costs as a result of a 5.3% increase in state aid due primarily to an increase in enrollment. The budget also included increases in debt service (5%), pension (2.1%) and health insurance (2.1%) costs. Preliminary results show a net operating surplus of $8.3 million reflective in part from higher than budgeted building permit fees, meal and hotel taxes, and motor vehicle excise taxes. Unrestricted general fund balance is projected to increase closer to 6% of spending. Reserves outside the general fund are expected to decline modestly.

The fiscal 2017 budget of $614 million includes $3.8 million in additional state and city funding for education. Other cost drivers were for debt service, employee related benefit and public safety additions. Revenue estimates continue to be conservatively budgeted at below fiscal 2016 actuals for almost all categories. The budget includes a nominal operating surplus of $0.95 million.

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
Kevin Dolan
Director
+1-212-908-0538
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Parker Montgomery
Analyst
+1-212-908-0356
or
Committee Chairperson
Amy Laskey
Managing Director
+1-212-908-0568
or
Media Relations:
Elizabeth Fogerty, New York, +1 212-908-0526
Email: elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Kevin Dolan
Director
+1-212-908-0538
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Parker Montgomery
Analyst
+1-212-908-0356
or
Committee Chairperson
Amy Laskey
Managing Director
+1-212-908-0568
or
Media Relations:
Elizabeth Fogerty, New York, +1 212-908-0526
Email: elizabeth.fogerty@fitchratings.com