Fitch Rates Midland, TX's COs 'AAA'; Outlook Stable

AUSTIN, Texas--()--Fitch Ratings has assigned a 'AAA' rating to the following Midland, TX obligations:

--$28.2 million tax and limited pledge revenue certificates of obligation (COs), series 2016.

The obligations are expected to be sold via negotiation the week of Sept. 12. Proceeds will fund the construction and equipment of new convention center facilities.

Fitch currently rates Midland's Long-Term Issuer Default Rating (IDR) and its $119.5 million outstanding limited tax debt 'AAA'.

The Rating Outlook is Stable.

SECURITY

The COs are payable from a property tax limited to $2.50 per $100 of taxable value and are additionally secured by a de minimis pledge of net utility system revenues, not to exceed $2,500.

KEY RATING DRIVERS

The 'AAA' rating reflects the city's robust financial cushion, expenditure flexibility, revenue-raising capability, and low long-term liability burden.

Economic Resource Base

The city is the county seat for Midland County (general obligation bonds rated 'AAA' by Fitch) and is the main service center for the Permian Basin in west Texas. The city's 2015 estimated population of 132,950 is 25% higher than 10 years prior.

Revenue Framework: 'aaa' factor assessment

The city of Midland has realized strong 10-year revenue growth and maintains sizable ad valorem tax rate capacity. The 'aaa' assessment incorporates the local economy's energy concentration and associated revenue base volatility in addition to the long-term viability of the U.S. energy industry.

Expenditure Framework: 'aa' factor assessment

Solid expenditure flexibility results from strong workforce control and moderately low carrying costs. Fitch expects expenditures to grow in line with revenues but notes adjustments to spending may be necessary in the case of revenue volatility.

Long-Term Liability Burden: 'aaa' factor assessment

The city typically cash-funds capital needs, resulting in a low debt burden. Pensions are well funded, and near-term tax-supported capital needs are modest.

Operating Performance: 'aaa' factor assessment

Fitch expects the city to demonstrate an exceptionally strong degree of gap closing ability and financial resilience during an economic downturn based on its healthy reserves, strong expenditure flexibility and high independent revenue raising ability.

RATING SENSITIVITIES

Spending Flexibility: The rating is sensitive to management's ability to adjust spending in light of volatile revenues.

CREDIT PROFILE

The Permian Basin is one of the country's oldest and largest oil and gas reservoirs; however, real oil, gas and other mineral values comprised less than 2% of the city's fiscal 2016 taxable assessed value (TAV) since most exploration and production occurs outside of city boundaries. The well documented energy sector decline that began in 2014 has significantly affected the Permian Basin area. Rig counts have fallen sharply since 2014 from a peak of 568 to 196 as of August 2016, yet the Permian Basin still accounts for almost half of the nation's rig count.

The top 10 taxpayers make up a moderate 7.5% of the tax base but industry concentration is evident with seven of the top 10 in oil and gas. Major employers are in education, medical, energy/mining, and governmental sectors.

Revenue Framework

The revenue base is dominated by a voter-approved local sales tax at about 40% of total general fund revenues and property taxes at one-third, followed by franchise fees at 13%.

Over the last decade general fund revenues have grown at a compound annual growth rate (CAGR) of 5.8%, in excess of both U.S. economic performance and CPI. Sales tax revenues more than doubled over this time period due to the precipitous increase in the price of crude oil, driving a boom in exploration and production and associated services. Council developed a strategic plan to use sales tax funds in excess of a certain amount (one-third of general fund revenues) for non-recurring uses, one time capital improvements, or to enhance fund balance reserves in order to maintain a minimum of 30% in reserves (slightly above the 25% formal fund balance policy level).

The precipitous decline in energy prices produced a significant contraction in sales tax revenues; fiscal 2016 year-to-date results show a roughly 20% decline compared to a year ago, to levels that are more consistent with 2013 trends. In contrast, the residential portion of the tax base has proven resilient through the downturn, driving an overall increase in certified values for fiscal 2017 through new properties and increasing home sale prices. Fitch's 'aaa' assessment incorporates the exposure of the city's revenues, particularly sales tax revenues, to the energy sector.

Strong sales tax revenue growth has allowed the city to reduce its ad valorem tax rate from $0.642 per $100 TAV in fiscal 2006 to $0.3805 in fiscal 2016, providing ample capacity below the statutory cap of $2.50. If a proposed tax rate results in an 8% year-over-year levy increase (based on the prior year's values), the rate increase may be subject to election if petitioned by voters. Management typically adopts an effective tax rate plus 3%.

Fitch anticipates the potential for a decline in TAV in the next couple of years depending on the direction of oil prices and energy sector trends. The 'aaa' revenue framework assessment incorporates Fitch's expectation that the city will raise the tax rate to maintain sound revenue growth during the downside of economic and energy cycles.

Expenditure Framework

The city's largest spending area is public safety, which makes up a bit less than half of general fund spending. Spending growth in that area has trended in line with overall general fund expenditure growth.

The pace of spending on operating functions is likely to remain in line with revenue growth. Fitch does not anticipate pressure on service levels given the city's maturity.

The city exercises considerable expenditure flexibility through significant control of workforce costs and moderately low carrying costs. Fiscal 2015 carrying costs were 11.9% of governmental spending and principal amortization is swift.

Long-Term Liability Burden

The city's long-term liability burden is estimated by Fitch at a very low 3% of personal income due to high wealth and low debt. This sale is funding the construction of a new convention center in downtown Midland and will be financed in part with monies held in the hotel-motel fund ($12 million); the remainder will be paid from the hotel occupancy tax ($31 million). This revenue stream provides maximum annual debt service of 3x using projected fiscal 2016 hotel occupancy tax receipts, and is restricted by law for economic development use. After the $12 million contribution to the project, the hotel-motel fund balance will still be in excess of 2x annual debt service. Other capital plans are focused on street projects that are being funded with monies that are already set aside.

The city participates in the Texas Municipal Retirement System (TMRS), an agent multiple-employer defined benefit plan. Additionally, the city pays into the Firemen's Relief and Retirement Fund, a single-employer defined benefit pension plan.

Under GASB Statement 68, the city reports a fiscal 2015 TMRS net pension liability (NPL) of $27.8 million, with fiduciary assets covering 90% of total pension liabilities at the plan's 7% investment return assumption and based on a Dec. 31, 2014 valuation date. The city reports a fiscal 2015 Firemen's NPL of $41.8 million, with fiduciary assets covering 60% of total pension liabilities at a 7% return assumption (adjusted by Fitch as a substitute for the plan rate of 8%). The Firemen's valuation date is Dec. 31, 2013. The NPL of both plans represents less than 1% of personal income.

Operating Performance

The city historically has maintained robust reserve levels, and has continued to do so during both the 2007-2009 recession (which was relatively mild in the region) and the current energy sector downturn. The city is expected to manage through periods of economic weakness while preserving a superior level of fundamental financial flexibility. General fund reserves are well above the city's reserve policy, a level that withstands the moderate economic downturn stress evaluated using the Fitch Analytical Sensitivity Tool (FAST).

The city practices conservative budgeting and has implemented cost savings initiatives when necessary. For the current fiscal year management has cut $2.8 million from general fund spending to counter the decline in sales tax revenues. Operationally, management plans to end the year break-even, but may use up to $2.1 million in reserves for one-time projects. Fiscal 2015 unrestricted fund balance stood at $71 million or a very high 64% of expenditures, providing ample cushion in the event of further revenue contraction.

The proposed fiscal 2017 budget maintains operational balance, assumes further reduction in sales tax revenues and includes an increase in funding for street improvements.

Additional information is available at 'www.fitchratings.com'.

In addition to the sources of information identified in Fitch's 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

Additional Disclosures

Solicitation Status
https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1010791

Endorsement Policy
https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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Contacts

Fitch Ratings
Primary Analyst:
Leslie Cook, +1-512-215-3740
Associate Director
Fitch Ratings, Inc.
111 Congress Avenue
Austin, TX 78701
or
Secondary Analyst:
Shane Sellstrom, +1-512-215-3727
Associate Director
or
Committee Chairperson:
Michael Rinaldi, +1-212-908-0833
Senior Director
or
Media Relations:
Elizabeth Fogerty, +1-212-908-0526
New York
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst:
Leslie Cook, +1-512-215-3740
Associate Director
Fitch Ratings, Inc.
111 Congress Avenue
Austin, TX 78701
or
Secondary Analyst:
Shane Sellstrom, +1-512-215-3727
Associate Director
or
Committee Chairperson:
Michael Rinaldi, +1-212-908-0833
Senior Director
or
Media Relations:
Elizabeth Fogerty, +1-212-908-0526
New York
elizabeth.fogerty@fitchratings.com