Fitch Upgrades Tallahassee, FL's Capital Bonds and IDR to 'AA+'; Outlook Stable

NEW YORK--()--Fitch Ratings has upgraded the following city of Tallahassee, FL obligations:

--$81 million outstanding capital bonds, series 2012 and 2014, to 'AA+' from 'AA';

--Issuer Default Rating (IDR) to 'AA+' from 'AA'.

The Rating Outlook is Stable.

SECURITY

The bonds are backed by the city's share of the local government half cent sales tax, state guaranteed entitlement revenues, public service tax revenues and the local communications services tax revenues.

KEY RATING DRIVERS

The upgrade to the city's IDR reflects a combination of positive credit trends and application of Fitch's revised criteria for U.S. state and local governments, released on April 18, 2016, which incorporate a more focused consideration of the adequacy of an issuer's reserves and the use of scenario analysis in the rating process. The capital bond rating is capped at the IDR. Tallahassee's 'AA+' IDR reflects its strong fiscal track record and combination of high reserves and budget flexibility that result in an exceptionally strong capacity to manage through economic downturns. The city's economy benefits from the stability of government and higher education but such sectors have not supported strong revenue growth over time. Long-term liabilities related to debt and pensions are expected to remain low.

Economic Resource Base

The city is located in the north central portion of the state within the Florida panhandle. It serves as the state capital and the county seat of Leon County. The city's economy is dominated by government and higher education providing depth and stability. The city's population, currently estimated at 189,907, has experienced solid growth over the past five years of 4.7% and 24% since 2000.

Revenue Framework: 'aa' factor assessment

Natural revenue growth has been slow for the 10-year period through 2014 as general fund revenues trended below GDP and inflation for that period. Fitch expects continued slow but improved growth as the economy has shown signs of a rebound with the tax base and non-ad valorem revenues experiencing recent growth. Management has significant property tax revenue raising capabilities under the 10 mill property tax millage cap.

Expenditure Framework: 'aa' factor assessment

Fitch expects that the city's overall spending needs will be in line or slightly exceed natural revenue growth. Expenses have been recently controlled due to local pension reform efforts and future debt costs should remain manageable. Fixed costs are moderate and not expected by Fitch to change materially.

Long-Term Liability Burden: 'aaa' factor assessment

The city's liability burden for debt and pensions is low as a percentage of personal income and is expected to remain low based on manageable debt plans and well-funded pension plans.

Operating Performance: 'aaa' factor assessment

Conservative budgeting practices and an increase in annual transfers of revenues from enterprise funds have provided for sound financial results over an extended period. Fitch expects the city to maintain a level of financial reserves and budget flexibility that more than adequately addresses risks commensurate with a moderate economic downturn.

RATING SENSITIVITIES

Financial Management Practices: Fitch expects ratings stability in the absence of a shift in management practices and/or policy and resultant weakening of the city's long-term operating profile.

Dedicated Tax Coverage Levels: The capital revenue bond rating is sensitive to changes in the level of pledged revenues over time compared to maximum annual debt service as well as to changes in the city's IDR.

CREDIT PROFILE

The capital city is home to two large universities, Florida State University and Florida Agricultural and Mechanical University (Florida A&M). The presence of these institutions, along with state governmental offices, provides a stable base for the economy. A new Veterans Administration Health Clinic scheduled to open in October and an estimated $250 million expansion at the Tallahassee Memorial Hospital for a new surgical center are supporting growth in the city's healthcare sector. Tax base values exhibited moderate losses from 2009 through 2014 but have experienced growth in fiscal 2015 and 2016 of 4.6% and 4% respectively. Wealth levels have historically trended below state and national averages and are somewhat skewed due to the high student population.

Revenue Framework

The city's primary revenue sources are property taxes, excise taxes and revenue transfers from the city's utility funds. General fund revenues, excluding utility transfers, have been relatively flat the past five fiscal years reflective of a flat tax rate, moderate declines in the tax base and moderate increases in excise taxes.

Officials have offset property tax declines with tight spending controls and an increase in transfers in from its utility funds. In fiscal 2015, transfers from the utility funds to the general fund totaled $41.7 million or 30% of combined general fund revenues and transfers in. The transfers help offset reduced property tax revenues as over half of the city's tax base is exempt from property taxes.

The largest transfer is from the electric fund which approximated $28.8 million or 20% of combined revenues. In fiscal 2013, officials changed the methodology for determining electric utility transfers from a fixed percent of revenue basis to a fixed amount of $23.9 million to be adjusted by the change in the consumer price index (CPI). Fitch rates the city's energy system revenue bonds, backed by electric and gas system revenues, 'AA-' with a Stable Outlook.

Fitch expects natural revenue growth to continue to be slow over the long term, but recent tax base growth will help support growth in expenditures and offset budgeted flat utility transfers.

The city's tax rate of 4.2 mills is viewed by Fitch to be low and leaves substantial capacity under the maximum statutory 10 mill limit. The city had maintained it tax rate at 3.7 mills for the fiscal year period of 2010-2015 while it benefitted from increases in annual utility transfers and modest annual growth in excise taxes.

Expenditure Framework

Tallahassee's spending is primarily related to public safety and services. The city has the ability to reduce certain service related costs and employee contracts are not overly restrictive.

Fitch expects the city's overall spending needs will increase in the future at a pace slightly above natural revenue growth. The city has taken steps to rein in future post-retirement cost growth. In 2012, the city's police and fire unions agreed to increased employee contributions to their pension plan and the city established a plan D for its general employees' pension plan for newly hired employees. Plan D has a higher retirement age threshold and increases the age for the first cost of living adjustment among other changes made in benefits. The city capped its retiree health insurance subsidy at a dollar amount rather than as a percentage of the premium helping control the growth in OPEB costs.

Carrying costs for debt, governmental supported pensions and OPEB pay-as-you-go is moderate at 17% of fiscal 2015 spending. Pensions and debt each account for 7% of spending. The city operates within a fairly flexible workforce environment which supports the ability to control labor costs, if necessary.

Long-Term Liability Burden

Long term liabilities for debt and unfunded pensions represent a low 5.7% of personal income. Debt levels account for the bulk of the metric as pension funds are well funded. General government debt consists primarily of revenue bonds secured by or payable from non-ad valorem revenues and a small amount of capital leases. Debt levels are not expected to change materially and principal amortization of governmental debt is rapid at 71% within 10 years.

The city's pension plan includes both defined contribution and defined benefit components. The combined net ratio of assets to liabilities is an estimated 79% using Fitch's 7% investment rate of return. In 2012, officials reduced benefits for employees hired after April 2013 and this is expected to limit growth in the liability. The city contributes 100% of its actuarially determined contributions.

OPEB provided to retirees include health insurance and prescription drug coverage. City subsidies to retirees have been capped at fiscal 2010 levels with employees responsible for all costs above that amount, limiting the city's future liabilities.

Operating Performance

Fitch expects Tallahassee to maintain financial resilience throughout the economic cycle. The city has built a sound reserve cushion through a combination of expenditure reductions and increases in utility transfers. While reserves would likely decline in a moderate recession scenario, Fitch expects that management would address the shortfall through an increase in revenues and expenditure management as it has done in the past.

To offset slow to declining growth in revenues following the great recession the city eliminated more than 150 positions, reduced or kept salaries flat, and implemented furloughs and other actions. Officials balanced property tax declines with increased transfers from its utility funds.

Future transfers in from the city's utilities fund are projected by management to remain stable as the tax base has begun to experience growth and management has implemented a reorganization projected to result in a reduction in annual general fund expenditures of approximately $1.1 million.

Fiscal 2015 general fund operating results were positive with a $2.5 million net operating surplus after transfers on a GAAP basis. Positive expenditure variances and conservative budget estimates have contributed to these results. This is the city's seventh consecutive year of a net operating surplus. Reserves improved to $28.9 million, equivalent to a healthy 20.4% of spending.

The city maintains a deficiencies fund, as part of the general fund reserves, for unforeseen expenditures and emergencies, targeted at two months of general government operating spending (approximately $24 million). After previously falling well below the target, the city has aggressively replenished its reserves, which now exceed the targeted level.

The fiscal 2016 budget included a half mill increase in the tax levy to 4.2 mills to help fund an additional 18 new police officers and to help reduce dependence on increases in utility transfers to fund the budget. While a portion of the deficiencies fund of $2.1 million was included in the budget, the aforementioned reorganization and continued conservative budget practices are projected by management to negate the need for any use of these funds during fiscal 2016.

Capital Bonds Dedicated Revenue Stream Details

The rating on the capital bonds is capped at the city's IDR. Fitch does not view the pledged revenues as special revenues under section 902(2)(B) of the bankruptcy code, which defines 'special excise taxes imposed on particular activities or transactions' as special revenues.

Fitch expects pledged revenue growth to be in line with inflation given projected increases in population and a general improvement in the city's overall economy. Pledged revenues had a 15-year CAGR of 1.6% for the period 2000-2015.

The variety of revenue sources tends to cushion revenue volatility, enhanced somewhat by the fixed state guaranteed entitlement fund distributions of $1.25 million per annum. Despite a weak additional bonds test (ABT) of pledged revenues equaling at least 1.25x MADS, additional issuance is more effectively restricted by the city's need of pledged revenues in excess of debt service to fund general operations.

To evaluate the sensitivity of the dedicated revenue stream to cyclical decline, Fitch considers both the revenue sensitivity results (using the same 1% decline in national GDP scenario that supports assessments in the IDR framework) and the largest decline in revenues over the period covered by the revenue sensitivity analysis. Based on the city's 15-year pledged revenue history, Fitch's analytical sensitivity tool (FAST) generates a -1.1% scenario decline in pledged revenues. The largest actual cumulative decline in historical revenues is a 2.8% decline in fiscal years 2009-2010.

The revenue stream performs strongly when subjected to Fitch's stress analysis. Assuming issuance up to the 1.25x ABT, well below actual current coverage, the structure could tolerate a 18% drop in pledged revenues, or 18 times the scenario results and almost 7x the largest actual revenue declines in the review period.

Fiscal 2015 pledged revenues of $35 million are up 1.8% over fiscal 2014 revenues and cover combined senior bonds and subordinate series 2009 bonds MADS (2021) by 3.2x. Based on MADS of $11 million, the capital revenue bonds could tolerate a 68% drop in revenues, 62 times the scenario results and 23 times the largest actual revenue decline in the review period.

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

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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
Larry Levitz
Director
+1-212-908-9174
or
Committee Chairperson
Arlene Bohner
Senior Director
+1-212-908-0554
or
Media Relations:
Hannah James, +1 646-582-4947
hannah.james@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
Larry Levitz
Director
+1-212-908-9174
or
Committee Chairperson
Arlene Bohner
Senior Director
+1-212-908-0554
or
Media Relations:
Hannah James, +1 646-582-4947
hannah.james@fitchratings.com