Fitch Rates Annapolis, MD's $16MM GO Bonds 'AA+'; Outlook Stable

NEW YORK--()--Fitch Ratings has assigned a 'AA+' rating to the following Annapolis, Maryland (the city) general obligation (GO) bonds:

--$9,500,000 public improvement bonds, 2016 series A;

--$6,755,000 public improvement refunding bonds, 2016 series B.

The bonds are scheduled to sell competitively on December 6. Proceeds of the bonds will be used to finance certain projects of the city and to refund certain outstanding city general obligation bonds for debt service savings.

In addition, Fitch has affirmed the following ratings:

--Approximately $61 million outstanding city GO bonds at 'AA+';

--the city's Issuer Default Rating (IDR) at 'AA+'.

The Rating Outlook is Stable.

SECURITY

The full faith, credit, and taxing power of the city are pledged for the payment of debt service.

KEY RATING DRIVERS

Fitch expects Annapolis to maintain a high level of financial flexibility throughout economic cycles, consistent with a recent history of improved operating performance and sound 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 despite some anticipated growth in the unfunded pension liability.

Economic Resource Base

Annapolis is the capital of Maryland and is located approximately 25 miles from both Baltimore and Washington, D.C. The city's 2015 population is estimated at 39,474, which is up 3% since 2010.

Revenue Framework: 'aaa' factor assessment

The city derives the bulk of its revenues from property taxes and there is no legal limit on the tax rate or levy. General fund revenues have exceeded both GDP and CPI levels over the ten year period from 2005 - 2015, reflective of tax base growth and periodic increases in tax rates and charges.

Expenditure Framework: 'aa' factor assessment

Fitch expects expenditure growth to be in line with to slightly above natural revenue growth in the absence of policy action. Total carrying costs for debt service, required pension payments and OPEB pay-as-you-go are moderate at 19% of governmental spending. These costs are likely to increase due to less than full funding of the city's pension ARC, but Fitch expects the city's expenditure flexibility to remain solid.

Long-Term Liability Burden: 'aa' factor assessment

The combined burden of long-term debt and unfunded pension liabilities is at the low end of the moderate range as a percentage of personal income. Fitch expects the liability burden to remain moderate even with potential new overlapping debt to be issued by the county over time. The city's direct debt amortization is rapid.

Operating Performance: 'aa' factor assessment

The city's financial resilience has improved notably following the Great Recession. During the period of economic downturn the city drew down reserves and reduced spending. Implementation of financial policies in the recovery has led to positive operating performance the past few years and the city's gap-closing capacity is exceptionally strong.

RATING SENSITIVITIES

FINANCIAL PERFORMANCE: Fitch expects operating results to remain relatively stable and that the city will maintain a strong level of financial resilience, gradual improvement in reaching full funding of its city administered pension, and improvement in its enterprise fund operations. Results contrary to this expectation could pressure the rating.

CREDIT PROFILE

The city is the capital of Maryland and the county seat of Anne Arundel County (IDR: 'AA+'/ Stable Outlook). The local economy is anchored by federal, state, and local government employment (approximately 25% of labor force), with added depth from tourism and maritime industries due to the city's location on the Chesapeake Bay. While government centers and the United States Naval Academy generate significant year-round visitation, the marinas and the historic district attract leisure travelers from around the region. Resident wealth levels are above-average and the low unemployment rate is consistently below state and national averages, reflecting the stable employment environment. Market value per capita is high at an estimated $167,000.

Revenue Framework

The city derives approximately 65% of its revenues from property taxes. The city also receives its share of income taxes from the state and it levies and collects a hotel and motel tax within the city (11% and 7% of projected fiscal 2016 revenues, respectively). Annual increases in property tax revenues have resulted from a combination of tax base growth and the timing of tax rate increases.

The city's general fund revenues have grown faster than the rate of GDP and inflation for the 10-year period 2005 to 2015. Fitch expects future natural revenue growth to moderate but exceed inflation based on recent trends. A modest level of new residential and commercial redevelopment is underway, which will contribute to future tax base growth.

The city is not subject to any legal limitation on its property tax rate or levy.

Assessed value was $6.2 billion for fiscal 2015 and is estimated to increase to $6.6 billion for fiscal 2017, which is close to its peak value in fiscal 2012. Revaluations are performed over a rolling three-year reassessment cycle and if there is an increase it is phased in over three years. If there is a decline, it is reflected in the first year.

Expenditure Framework

The city's largest spending area is public safety, making up about 60% of general fund spending in fiscal 2015, followed by general government and public works.

As with most local governments, Fitch expects spending growth will be near to slightly ahead of natural revenue growth, requiring ongoing budget management.

The city maintains adequate expenditure flexibility. The majority of the city's employees are represented through unions and collective bargaining agreements. The city engaged in an interest-based bargaining process with all of its unions and approved four year contracts which expire June 30, 2017. Moderate salary increases were approved along with changes to pension and health insurance programs to control growth in these future liabilities. Management has the right to make reductions in staff if necessary.

Carrying costs for debt service, actuarially calculated annual required pension contributions, and OPEB spending are moderate at 19% of fiscal 2015 governmental spending. Debt service represented 8% of government spending and should remain stable or decline marginally going forward based on the rapid pace of principal payout (63% of tax supported debt over ten years) and manageable borrowing needs. Pension costs represented 8% of governmental spending but will likely increase moderately as the city has had a practice of under-funding its actuarially required contributions (ARC) for its city-administered police and fire plan.

Long-Term Liability Burden

Long-term liabilities for debt and unfunded pensions represent a moderate 12% of personal income. Fitch expects liability levels to remain moderate given the city's manageable borrowing plans. Fitch anticipates growth in the pension liability due to the practice of underfunding the ARC, although gradual improvement up to the full required amount is anticipated by management over time. City policy restricts annual tax-supported debt service costs to no greater than 12% of the general fund spending (currently 9%) and tax-supported debt not to exceed 3% of taxable assessed value (currently estimated at 1.3%).

The city administers a single-employer defined benefit pension plan for police and fire employees (city plan) and all general employees are part of the state retirement plan (the State Retirement and Pension System of Maryland). The Fitch estimated combined unfunded liability for both plans is around $44 million or a low 0.7% of estimated fiscal 2016 taxable value.

The city plan was overfunded prior to the recession. Investment losses in the downturn lowered the funded ratio to a current Fitch estimated 85%. The city was slow to absorb the larger ARC, and after several years of suspending its pension contributions to the police and fire pension plan, the city contributed 3% of the ARC in fiscal 2012 followed by an increase to 38% of the ARC in fiscal 2014. For fiscal 2015, the city paid 76% of its $3.2 million ARC. The city plans to increase employer and employee contributions gradually until full ARC funding is achieved over time; as such, the unfunded liability is likely to grow, although Fitch expects it to remain low.

The city's unfunded OPEB liability was a low $45.6 million and was 5% funded as of June 30, 2015.

Operating Performance

Fitch expects the city will continue to maintain strong financial resilience throughout economic cycles given its superior inherent budget flexibility in the form of revenue and spending control and the limited economic sensitivity of its revenue base, supplemented by high reserves. The city has a demonstrated commitment to restoring reserves to within its policy level of 10% of governmental spending during periods of recovery.

The city has experienced steady growth in revenues largely driven by moderate increases in the property tax rate, intergovernmental revenues and tax base growth. This revenue growth, combined with cost controls as well as partial pension funding deferrals, has helped increase reserves to very high levels.

At fiscal-end 2015, the general fund experienced a net operating surplus after transfers and net of bond proceeds of $1.4 million. Factoring in the $0.8 million underfunding of actuarially required pension contributions, results were slightly lower. The increase in the unrestricted general fund balance to $32.3 million from $14.5 million represents mostly a reclassification of both restricted capital funds and the amounts due to other funds in the general fund in fiscal 2015. The unrestricted general fund balance is a very large 48% of spending.

The city's general fund provides annual operating subsidies to the Transit Fund, operated as an enterprise fund of the city. The general fund subsidies are supported in part from transfers received from the city's parking fund. Transfers to the Transit fund equaled $2.5 million in 2015 (4% of spending) which is down from $3.6 million in 2014. Such amounts are projected by management to continue to decrease as management institutes changes to operations to reduce expenditures.

Three of the city's enterprise funds: Transit Fund, Dock Fund and Market Fund, have historically not been self-supporting and have accumulated operating deficits. Such deficits have resulted in a recording of accumulated amounts due to the general fund for prior subsidies. The amount owed to the general fund totals approximately $10.4 million as of fiscal-end 2015 (15% of spending).

Management took actions to reduce expenditures during the Great Recession but revenue growth was slow to rebound, resulting in a drawdown of reserves, short-term cash flow borrowing and a deferral of pension contributions. Fiscal policy for a budgetary reserve was instituted, property taxes were increased modestly and management was able to restore reserves to robust levels.

Management is projecting a moderate surplus for fiscal 2016 reflecting conservative estimates of intergovernmental revenues and tax collections. The city's fiscal 2017 general fund budget of $71.4 million is up 4% from the prior year's budget and includes conservative revenue estimates and modest increases in departmental and debt service spending. The tax rate was kept flat and the tax base was estimated to increase by 3.7% resulting in new revenue growth.

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
Laura Porter
Managing Director
+1-212-908-0575
or
Media Relations
Elizabeth Fogerty, +1 212-908-0526
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
Laura Porter
Managing Director
+1-212-908-0575
or
Media Relations
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com