NEW YORK--(BUSINESS WIRE)--Fitch Ratings has downgraded the Issuer Default Rating (IDR) of the City of St. Louis, MO to 'A-' from 'AA-' and downgraded the rating of the lease revenue bonds issued through the city's Municipal Finance Corporation to 'BBB+' from 'A+' as part of the same rating action.
The rating action affects the following securities, which are also downgraded to 'BBB+' from 'A+' :
--$125.67 million (Pension Funding Project) leasehold revenue refunding bonds (taxable), series 2007;
--$6.5 million (Pension Funding Project) leasehold revenue refunding bonds (taxable), series 2008A;
--$21.425 million Juvenile Detention Center leasehold revenue bonds, series 2008B.
The Rating Outlook is Stable.
Leasehold revenue improvement bonds issued by the St. Louis Municipal Finance Corporation are backed by a pledge of annual appropriations of city general revenues to pay debt service on the bonds. In the case of the series 2007 and 2008A leasehold revenue bonds issued to fund a portion of the city's pension obligations, the city has covenanted to use proceeds from its half-cent public safety sales tax as dedicated revenues to pay debt service on the bonds, in addition to the annual appropriation pledge. The 2007 and 2008A leasehold revenue bonds are also backed by a pledge of essential city assets such as fire stations. The bonds are rated one notch below the city's IDR, reflecting the slightly higher degree of optionality associated with payment of appropriation debt.
KEY RATING DRIVERS
Fitch's rating action reflects a combination of negative credit trends and the application of Fitch's revised criteria for U.S. tax-supported ratings released on April 18, 2016. St. Louis's persistently narrow reserves well into an economic recovery, coupled with the absence of a plan to restore general fund reserves to levels consistent with the city's policy targets, have reduced Fitch's assessment of the city's financial flexibility under the revised criteria.
Assuming the U.S. economy was to enter a moderate economic downturn in the next one-to-two years, Fitch expects that the city would implement gap-closing measures likely to include a combination of capital deferments and workforce adjustments. Fitch believes these measures would likely be insufficient to prevent general fund balances from entering negative territory in the short term. We also expect that further actions by management would be needed to restore reserves to minimal levels following a period of mild fiscal distress. During prior downturns, management has raised municipal service fees and charges by ordinance to generate additional revenues, and has successfully sought voter approval on several occasions to institute new taxes and service fees.
The city's ability to defer capital spending and reduce headcount is limited, however, given that St. Louis already has a large backlog of deferred capital projects accumulated during the prior recession, some of which the city views as critical. The city could be confronted with the unpalatable choice of going to voters to request either tax increases or significant debt issuance to pay for needed capital improvements; alternatively, the city may decide that continued deferral of critical capital projects is preferable to higher leverage, voter-approved tax increases, or headcount reductions that reduce services to levels the city administration views as unacceptable.
Economic Resource Base
St. Louis' broad and diverse economic base acts as the central hub for a multi-county region that extends across the Mississippi River into western Illinois and into neighboring Missouri counties. The city's major employers and institutional anchors provide a measure of economic stability, and the city's downtown is the region's largest employment center. The city's population grows by an estimated 36% during working hours due to sizable numbers of commuters entering St. Louis from adjacent counties and from Illinois. Non-residents working in the city contribute to the local earnings tax. St. Louis contains pockets of severe poverty (the overall poverty rate is close to 30%, almost double the national rate) and wealth and income levels are well below U.S. and state averages.
St. Louis' growing healthcare and higher education sectors are its main growth drivers, but result in a slow-growth tax revenue profile given that these institutions are property-tax-exempt. Recent policy initiatives have made extensive use of tax incentives to spur redevelopment, making it difficult for government to fully capture new ratables in the near term. Until incentives begin to expire, policymakers will have to endure the revenue time lag until revitalized properties are added to the taxable base. The prevalence of tax increment financing is having less of an effect on sales taxes, which have shown healthy growth since 2013, than it has on property taxes, which have demonstrated weaker growth but account for a smaller proportion of general fund revenues.
Revenue Framework: 'bbb' factor assessment
Revenue growth has been sluggish over the past decade - roughly in line with the U.S. rate of inflation, but well below U.S. GDP. The city's ability to raise revenues independently is constrained by state constitutional provisions that require the approval of the majority of voters for most tax increases.
Expenditure Framework: 'a' factor assessment
Expenditures are expected to rise faster than the rate of inflation and make the achievement of structural balance challenging. The city's ability to control costs is supported by state labor laws that empower municipalities to impose unilateral terms if the collective bargaining process breaks down, although this power has been eroded somewhat by recent court decisions.
Long-Term Liability Burden: 'aa' factor assessment
The city's combined debt and unfunded pension liabilities are moderate, equaling 15% of personal income. Pension funded levels are adequate and likely to improve in the near term due to reforms of the firefighters' pension system that the city may extend to its other retirement systems.
Operating Performance: 'bbb' factor assessment
Fiscal operations since 2010 have been uneven. As of fiscal 2015 audited, general fund operations had concluded with deficits in four out of the five prior fiscal years on a GAAP basis. Liquidity remains adequate, but management has been unable to rebuild reserves during a period of economic expansion. More positively, the city has pressed on with an ambitious pension reform agenda and has largely been keeping up with its required pension contributions. Conversely, a pattern of deferred capital funding has led to a sizable backlog of capital projects. The city has utilized a longstanding policy of applying a portion of any general fund surpluses to rebuild reserves. Presently, the policy is to divide the surplus 50%-50% between the general fund and capital fund reserves. The city is revising this policy so that 100% of general fund surpluses will allocated to rebuild reserves in future.
The rating of St. Louis is sensitive to declines in general fund reserves that result in negative reserves for more than two or three fiscal years, to sharp reductions in liquidity, or to a prolonged economic downturn that depresses taxable values and tax revenue growth. St. Louis is also sensitive to the revenue shock that could occur if the city's earnings tax, its largest source of general fund revenue at 32% in fiscal 2015, fails to be re-approved by voters. The next re-approval vote will not take place until April 2021, however, giving the city ample time to contemplate contingencies.
Policymakers are focused on revitalizing the city's tax and economic base. Their strategy has been to use a combination of tax incentives, rezoning, and tax increment financing vehicles to draw private investment into the city. Since 2010, the city reports that private developers have invested approximately $500 million in new projects - most of them in the city's downtown. These projects have added new private-housing units and expanded residence halls at the city's universities, and led to the construction of new business parks. Ambitious projects such as CORTEX aim to increase the city's number of technology startups. These developments appear to be having an impact: the population of the 17 neighborhoods making up the city's central corridor grew by 11% from 2000-2013, whereas the overall population fell by 9% from 2000-2010 and by another 1% from 2010 to 2015 (estimated).
St. Louis' unemployment rate has historically trended higher than those of the U.S. and Missouri, but the differentials have narrowed since 2013; St. Louis' March 2016 unemployment rate was 5.5% compared to 5.1% for the U.S. and 4.8% for the state. For 2015, the city's average unemployment rate was 6.1% compared to 5.3% for the U.S. and 5% for the state. Growth in the city's labor force has been positive, albeit slow, with only 2,500 additions between first quarter 2012 (1Q12) and 1Q16. With a population of almost 320,000, St. Louis is the home to nine Fortune 500 companies including Anheuser Busch, Express Scripts, Wells Fargo and Monsanto, and strong institutional anchors, including Washington University and BJC Healthcare. These entities have acted as an economic and employment stabilizer during past recessions.
St. Louis' revenue framework fits into the 'bbb' category given a diverse, but slow-growing revenue base that has expanded at roughly the rate of inflation for the past decade, coupled with the city's limited legal ability to raise taxes without voter approval, in common with other Missouri municipalities. General fund revenues are derived from the local earnings tax (33%), franchise tax (11%), public safety sales tax (11%), fees for service (12%), property tax (9%), and a payroll tax (8%), among others.
Historical revenue growth has been roughly in line with inflation, but below U.S. GDP growth. We believe this pattern is likely to persist, with some modest risks to the downside given the city's multi-decade pattern of population loss, sluggish growth in assessed values (AVs) and the large number of new developments that are being spurred on by tax incentives that will take time to translate into new tax revenues. An increase in college-educated younger residents moving into the city's downtown could potentially accelerate the revenue growth trend in the medium term if earnings taxes are boosted by the participation of highly-educated millennials in the labor force.
Management's ability to raise tax revenues is constrained by constitutional limitations that apply throughout the state of Missouri. These limitations require elected leaders to seek direct voter approval to raise taxes above an annual limit via a local referendum.
Local tax limitations are governed by the Hancock Amendment to the Missouri state constitution, which was enacted in 1980. The Hancock Amendment limits the ability of Missouri local governments to raise their property tax levy above the lower of 5% or the rate of inflation annually without recourse to a special election. The Hancock Amendment applies to all taxes levied by municipal governments but does not apply to non-tax fines, fees or charges for service. As such, St. Louis' sales and earnings tax rates are subject to the Amendment's constraints, while its fees and fines are not. The enactment of new taxes, which city leaders have campaigned for successfully in the past, requires a citywide vote. St. Louis is close to its annual property tax millage cap of 1.49 for operations. Its fiscal 2016 general operations rate is 1.4828, allowing for only a 0.5% property tax rate increase absent new AV growth.
Three of St. Louis' minor tax revenue streams have shown weak performance in the past several years or are expected to underperform in the near term: gaming, amusement, and natural gas taxes. In particular, the local gaming tax (about 1% of governmental revenues) underperformed budget by 5% in fiscal 2015 and has declined by 31% since 2011. The city also expects amusement and consumption taxes to decline by $4 million (less than 1% of general fund revenues) in fiscal 2017 as a result of the departure of the Rams football franchise to Los Angeles, CA. Amusement tax revenues have consistently declined since fiscal 2010, partly as a result of tax exemptions granted to the St. Louis Cardinals and St. Louis Blues sports franchises in conjunction with the development of new facilities. By contrast, most general fund tax revenues are growing modestly, with the earnings tax up 4.2% in fiscal 2016. The earnings tax must be re-authorized by voters every five years and would be phased out over a 10-year period if not re-authorized. The most recent vote was in April 2016 and residents voted in favor of retaining the tax by a margin of 72% to 28%.
Payroll makes up the largest share of government expenses at nearly 75% given the need to deliver services to 320,000 residents. Public safety represented 55% of general fund expenditures in fiscal 2015, while general government accounted for 19%, public works 8%, and debt service 7%. Carrying costs are above average at 23.6% of total governmental expenditures, with debt service accounting for 13.8%, pension contributions 8.5%, and actual OPEB contributions 1.3% in fiscal 2015. Though constrained on the revenue side by Missouri's constitution, state statutes governing municipal-labor relations tend to be supportive of management, as Missouri lacks binding arbitration. The city's power to adjust the size of its labor force is constrained more by service delivery concerns than by law.
Although revenues grew faster than expenditures (2.5% versus 1.7%) during the past five fiscal years, the city projects a growing structural imbalance in the coming decade absent corrective action, due primarily to expenditure growth that is projected to outpace revenues as the result of healthcare cost inflation, rising pension costs and needed infrastructure improvements. Management is contemplating a variety of cost reductions and efficiencies across multiple fronts while, at the same time, trying to improve existing revenue streams by enhancing collection procedures and conducting a thorough review of all non-tax fees and fines, which have historically grown at a rate less than inflation.
As mentioned above, carrying costs consumed a moderately high 23.6% of fiscal 2015 government spending given an elevated debt burden and significant contributions to fund municipal pensions. Fitch expects carrying costs to remain stable with modest near-term declines possible due to the city's recent Firemen's Retirement System reforms and the potential for reforms of the city's other retirement systems. A sharp rise in new debt issuance to fund capital would add to the city's fixed cost burden and could crowd out funding for operations.
Fitch regards St. Louis' control over employee headcount, wages, benefits and work rules to be moderate given the combination of a favorable statutory framework set against a practical need to maintain adequate service delivery in a city with high poverty levels and elevated social service needs. While management currently regards its staffing levels as sufficient to provide adequate service levels, significant force reductions would probably not be a realistic gap-closing approach during a recession given the need to avoid service cuts that could imperil residents' safety and health. Management describes labor relations as positive and contract terms as relatively flexible, allowing for periodic re-openers. Municipal strikes are prohibited under Missouri statute, and municipalities have the ability to impose contract terms unilaterally if unable to reach a resolution with their bargaining units following non-binding mediation.
Long-Term Liability Burden
St. Louis' long-term liability burden, as calculated by Fitch, is a moderate 15% of personal income, which we expect to remain stable for the near term. St. Louis reported $946 million of long-term governmental debt outstanding as of June 30, 2015. An added $440 million of bonds issued by various overlapping municipalities result in an overall debt burden of $1.4 billion, equal to 8% of market value and 11% of residents' combined personal income. Upon closer examination, one-third of St. Louis's 'direct' debt ($340 million) consists of tax increment financing (TIF) bonds issued to support various redevelopment projects. Debt service is supported by incremental property tax revenues generated by the related projects, rather than by the city's overall tax base. Fitch regards the TIF bonds as a form of overlapping debt and does not include them in its direct debt calculation for St. Louis.
The two main securities under which the city issues debt are its general obligation unlimited tax security, of which only $23 million of bonds remain outstanding, and its leasehold revenue improvement bond security, under which $435 million of debt is outstanding. The city does not require voter approval for leasehold revenue bonds; approval of two-thirds of voters is required for GO bonds. In April 2016, voters approved $25 million of new GO debt to fund long-overdue capital improvements to city streets, bridges and buildings.
The city operates four defined benefit pension plans for police, fire and general municipal employees. The legacy defined benefit plan for firefighters, the Firemen's Retirement System, was closed to new members as of Feb. 1, 2013, with all accrued benefits going forward to be paid from the newer Firefighters' Retirement Plan created as part of the reforms. The total pension liability of the four plans equals $2.2 billion with an unfunded actuarial accrued liability estimated at $503 million under Fitch's assumptions, which include a 7% annual rate of return on assets. Fitch calculates the aggregate funded ratio of the plans to be a relatively healthy 79%.
The city's narrow reserve cushion could be severely stressed by an unaddressed, moderate economic decline; there is a high likelihood that general fund reserves could be depleted altogether and move into negative territory in the absence of significant management action. Fitch regards St. Louis' budgetary flexibility as limited given the restrictive revenue-raising framework under which the city and other Missouri municipalities operate. The constrained ability to raise revenues is offset, to some degree, by a degree of control over expenditures that Fitch views as adequate given an ability to defer capital and furlough or lay off employees and adjust compensation by fiat. These factors result in limited gap-closing capacity that might not be sufficient to restore adequate financial flexibility. Even if flexibility is restored, we anticipate that this could take two to three fiscal years, following a period of distressed (and likely negative) general fund reserves.
St. Louis's budget management during the current economic expansion has been characterized by a difficult set of trade-offs: balancing the desire to restore services cut during the Great Recession while maintaining affordable staffing, set against an official policy of keeping unrestricted general fund reserves at no less than 5% of revenues, while at the same time addressing critical infrastructure needs. In general, the city has been more successful at restoring and maintaining services than fiscal reserves. Unrestricted general fund reserves finished fiscal 2015 at $11.4 million, equal to a narrow 2.2% of revenues and well below the city's own 5% target. The city has $10.7 million of additional available reserves held outside of the general fund that provide some degree of added flexibility. Taken together, the city's $22 million of available reserves equaled 4.2% of general fund revenues in fiscal 2015.
The city has also deferred significant amounts of capital spending in recent years. The city's long-range financial plan identifies a $324 million backlog of unfunded capital projects including $115 million categorized as 'critical'. Positively, the city has improved its pension funding contributions in recent years and contributed more than the actuarially required amount in fiscal 2015. This assures that the unfunded liability will stay manageable and not become a source of added pressure on the budget.
St. Louis' general fund operations yielded a series of mild operating deficits in five out of the last seven fiscal years, inclusive of the 2008-09 recession. Fiscal 2014's $22 million general fund deficit, which was something of an outlier, resulted primarily from the combination of police-related expenses into the general fund (and other governmental funds). The general fund concluded fiscal 2015 with a $7 million draw on reserves driven by above-budget police overtime costs and by a $10 million decline in general fund revenues. Management expects fiscal 2016 to conclude with balanced operations and no draw on reserves. The city's fiscal 2017 budget is set to grow by $19 million, or 3.7%, above the prior year's, although more than half ($10 million) of the increase is due to an additional pay period that occurs once every 11 years. Net of the extra pay period, which the city plans to fund using reserves restricted specifically for that purpose, the general fund budget will grow by only 1.6% in fiscal 2017, in line with expenditure growth and below the present rate of inflation.
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.
U.S. Tax-Supported Rating Criteria (pub. 18 Apr 2016)
Dodd-Frank Rating Information Disclosure Form