Fitch Ratings - Austin - 07 Aug 2020: Fitch Ratings has assigned a 'AA' rating to the following obligations of the city of Huntsville, Texas:
--$20.62 million GO bonds, series 2020;
--$3.23 million combination tax and revenue certificates of obligation (COs), series 2020.
Both series will be sold via competitive bid on August 18. GO bond proceeds will be used to construct, renovate, and equip certain city services facilities; CO proceeds will finance improvements to various parks and recreation facilities and the city's animal shelter.
Fitch has also affirmed its 'AA' on the following ratings of the city:
--Long-Term Issuer Default Rating (IDR);
--approximately $27 million in outstanding GO bonds and COs;
The Rating Outlook is Stable.
The GO bonds and COs are backed by a limited ad valorem tax pledge, not to exceed $2.50 per $100 TAV. The COs are further payable from a limited pledge of the surplus revenues of the city's waterworks and sewer system, not to exceed $1,000.
The 'AA' Issuer Default Rating (IDR) and limited tax bond rating reflect the city's highest level of demonstrated and anticipated operating financial resilience through a typical economic cycle. Fitch believes post-pandemic operating revenue growth prospects are strong and the city's revenue-raising ability satisfactory--in light of moderately high expected revenue volatility. The city retains sound expenditure flexibility and carrying costs are expected to remain moderate. Fitch expects the liability burden to remain low.
ECONOMIC RESOURCE BASE
Huntsville, located approximately 70 miles north of Houston, is the county seat of Walker County. The economic resource base is largely based on the city's role as long-standing home of the Texas prison system headquarters (Texas Department of Criminal Justice or TDCJ) that includes seven state prisons. The city is also home to Sam Houston State University (SHSU), with more than 21,000 students. The city's 2019 population is estimated at about 42,200, reflective of a healthy pace of growth since 2010 that was slightly above the nation's but below the state's rate of growth.
KEY RATING DRIVERS
Revenue Framework: 'aa'
Fitch expects steady economic expansion will drive post-pandemic operating revenues at or above U.S. GDP, in line with historical trends. This expectation is balanced against the city's diminished independent legal ability to increase ad valorem revenues as a result of recently approved state legislation. Fitch views the city's revenue-raising ability as satisfactory relative to its moderately elevated expected revenue volatility.
Expenditure Framework: 'aa'
Growth in spending is likely to remain in line with revenue gains. Substantial expenditure flexibility is derived from workforce related spending control, periodic pay-go capital spending, and moderate fixed carrying costs.
Long-Term Liability Burden: 'aaa'
Fitch expects the long-term liability burden will increase as a result of growth-driven infrastructure needs but remain in the current low range. Future regional capital and debt needs should remain aligned with growth in the area's resource base.
Operating Performance: 'aaa'
A solid revenue framework, sound expenditure control, and a strong reserve cushion relative to expected revenue volatility position the city well to maintain the highest level of financial resilience through the current economic downturn as well as future business cycles.
Factors that could, individually or collectively, lead to a positive rating action/upgrade:
--A marked, sustained strengthening in the expenditure flexibility assessment, driven by a substantial decline in carrying costs.
Factors that could, individually or collectively, lead to a negative rating action/downgrade:
--An economic contraction extending well into the 2H20 or beyond, consistent with Fitch's coronavirus downside scenario, which triggers sustained, and deeper than expected, tax revenue losses and materially erodes the city's gap-closing capacity;
--A material deterioration of the city's strong revenue growth prospects;
--A sizeable increase in direct and/or overlapping debt levels that weakens the Long-Term Liability assessment.
BEST/WORST CASE RATING SCENARIO
International scale credit ratings of Sovereigns, Public Finance and Infrastructure issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of three notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit [https://www.fitchratings.com/site/re/10111579].
The ongoing coronavirus pandemic and related government containment measures worldwide create an uncertain global environment for U.S. state and local governments and related entities in the near term. While the city's most recently available fiscal and economic data may not fully reflect impairment, material changes in revenues and expenditures are occurring across the country and likely to worsen in the coming weeks and months as economic activity suffers and public health spending increases. Fitch's ratings are forward-looking in nature, and Fitch will monitor developments in state and local governments as a result of the virus outbreak as it relates to severity and duration, and incorporate revised expectations for future performance and assessment of key risks.
In its baseline scenario, Fitch assumes sharp economic contractions to hit major economies in 2H20 at a speed and depth that is unprecedented since World War II. Sequential recovery is projected to begin from 3Q20 onward as the health crisis subsides after a short but severe global recession. GDP is projected to remain below its 4Q19 level until mid-2022. Additional details, including key assumptions and implications of the baseline scenario and a downside scenario, are described in the report entitled, "Fitch Ratings Coronavirus Scenarios: Baseline and Downside Cases - Update" (https://www.fitchratings.com/site/re/10120570), published April 29, 2020 on www.fitchratings.com.
As is the case with other cities, Huntsville has experienced the effects of coronavirus mitigation and the related economic shutdown. The governor directed a gradual reopening of the state's economy in late April, but the subsequent pace of economic traction remains conditioned on the still-evolving nature of the pandemic in Texas. Amid rising levels of coronavirus cases throughout Texas recently, Governor Abbott mandated a pause in reopening further businesses and a return to certain social distancing measures, such as the reduction of maximum service capacity at restaurants and the closure of bars.
Coronavirus - City Budgetary Update
Pre-pandemic, fiscal 2020 (FYE September 30) city sales tax performance was trending positively compared to budget. Management reports receipts for March through May were either modestly negative or ahead of the same month in fiscal 2019; they cite the presence of Texas Department of Criminal Justice facilities as a major contributor to the city's generally stable economic profile. Management currently anticipates fiscal 2020 sales tax revenues will outperform the $8.8 million originally budgeted by roughly $700,000. This gain is partly due to the expiration of an economic incentive agreement with a local company. Sales taxes are the primary general fund revenue source, contributing more than 45% of the fiscal 2019 total.
The city projects fiscal 2020 general fund results to include a decline in fund balance of roughly $900,000 (3% of spending and transfers out). This projection is less than the originally budgeted drawdown of $1.7 million. The budget included contributions to a number of one-time capital projects and staff compensation increases (primarily police). Reserves should remain healthy and comfortably above the city's 25% fund balance policy minimum; fiscal 2019 ended with an unrestricted general fund balance of nearly $14.5 million or roughly 55% of spending and transfers out.
The city reportedly has received 20% or approximately $460,000 of its $2.3 million Coronavirus Aid, Relief and Economic Security (CARES) Act allocation from the state. Management reports spending related to the coronavirus has been manageable to date; the city has applied roughly $90,000 to eligible pandemic response outlays in both the general fund and other city funds, and expects to spend roughly $150,000 by fiscal year-end.
The local economic resource base is moderately concentrated in terms of its tax and employment base. In addition, the large number of university students residing in the area contributes to the lower than average local income levels. The city's unemployment rate at the end of 2019 remained slightly above that of the state and nation.
The top 10 taxpayers make up about 13% of the fiscal 2020 total taxable assessed value (TAV), the majority of which are various apartment complexes and other commercial properties. TAV generally has been trending positively, including a sharp 17.5% gain in fiscal 2020 to nearly $2.19 billion. The city continues to realize investment in multi-family housing and various retail/commercial projects, in addition to some job/facility expansion by existing local businesses. Fitch believes the generally stable local economy and a steadily growing population base support the prospect of further TAV gains.
The general fund relies heavily on sales taxes. Revenue from the 1.5% sales tax levy comprised approximately 46% or about $9.5 million of total operating revenue in fiscal 2019, followed by property taxes at 23%. With utility transfers of $6.6 million considered, the city's sales taxes contributed a somewhat lower portion (35%) of fiscal 2019 total operating revenue.
Once normal business activity resumes, Fitch expects gains in the city's population, tax base, and economic activity will yield strong revenue gains that continue to match or exceed U.S. GDP. The CAGR of city general fund revenues over the 10 years through fiscal 2019, adjusted for tax rate changes, was a strong 5.6%. Steady expansion of Sam Houston State University's student base and campus has contributed to the city's residential and retail/commercial expansion.
In 2019 the Texas legislature approved and the governor signed into law Senate Bill 2, which makes a number of changes to local governments' property tax rate setting process. Most notably, SB 2 will reduce the rollback tax rate (now the 'voter approval tax rate') to 3.5% from 8% for most local taxing units and require a ratification election (replacing the current petition process) if any local taxing unit exceeds its voter approval rate.
The tax rate limitation in SB2 excludes new additions to tax rolls and allows for banking of unused margin for up to three years. Considering this legislation, Fitch believes the city retains a satisfactory although diminished ability to independently raise revenues given moderately high expected revenue volatility. The governor's March 13 declaration of a statewide disaster triggered an SB 2 provision that gives cities and counties the option of using the previous 8% cap for at least two years.
The city's largest spending area is public safety, which comprised a below average 35% of fiscal 2019 general fund spending. General government (26%) and public works (23%) were the next largest spending categories.
Average spending growth is generally on par with revenues, a trend that Fitch expects to continue given expected increases in service demands as the population expands.
Solid expenditure flexibility is aided by the city's strong legal control over its workforce related spending with the ability to adjust employee headcount and compensation. Moderate fixed carrying costs for debt service, pension, and OPEB also support the assessment (about 15% of governmental spending in fiscal 2019).
LONG-TERM LIABILITY BURDEN
The city's long-term liability burden is low at an estimated 8% of resident personal income. Steady increases in population and personal income have generally kept pace with recent city borrowings. The city's liability burden consists primarily of direct debt and the Fitch-adjusted net pension liability (NPL) (both approximately 40% of the total). The series 2020 GO bonds are the second installment of a $55 million 2016 bond authorization; less than $4 million will remain from that authorization after this sale. Principal amortization has slowed with recent borrowings; slightly more than 30% of tax-supported debt will amortize in 10 years following this sale. Management reports no planned near-term tax-supported borrowings following these offerings.
City employees participate in the Texas Municipal Retirement System (TMRS), a statewide, agent multiple-employer defined benefit plan. Under GASB 67 and 68, the city reported a fiscal 2019 NPL of approximately $22.7 million, with fiduciary assets covering about 75% of total pension liabilities based on the plan's 6.75% investment return assumption. Adjusting for Fitch's lower standard 6% investment return assumption, the aggregate NPL for the city's plan totaled about $31.7 million with fiduciary assets covering about 69% of total estimated pension liabilities.
The Fitch Analytical Stress Test (FAST) scenario analysis tool, which relates historical tax revenue volatility to GDP to support the assessment of operating performance under Fitch's criteria, has now been adjusted to reflect GDP parameters consistent with Fitch's global coronavirus forecast assumptions. FAST is not a forecast, but it represents Fitch's estimate of possible revenue behavior in a downturn, based on historical revenue performance.
Hence, actual revenue will vary from FAST results and Fitch expects the city will implement necessary corrective actions to offset them. FAST does provide a relative sense of the risk exposure of a particular local government compared to other U.S. local governments.
The city's unaddressed FAST results under both the coronavirus baseline and downside scenarios indicate pressure on the city's financial resilience in the medium-term, absent policy interventions. The 'aaa' operating performance assessment reflects Fitch's expectation that based on its capability and willingness to make spending cuts and its commitment to maintain a solid reserve cushion, the city will maintain the highest level of financial resilience through both the current economic contraction as well as through future business cycles.
City finances have historically been strong and stable. The city also periodically draws down reserves for pay-go capital investment. In line with operating exposure to economically sensitive sales taxes, general fund reserves are typically maintained at no less than the city's policy minimum of 25% of spending. Fitch's expectation that the city will continue to adhere to these policies is reinforced by recent financial performance and conservative budgeting.
A roughly $780,000 (or 3% of spending) fiscal 2019 net operating surplus boosted the city's unrestricted general fund reserve position to nearly $14.5 million or a robust 54% of spending at year-end. The year's performance was supported primarily by revenues outperforming budget. Management anticipates a roughly $900,000 drawdown of general fund reserves at fiscal 2020 year-end due to planned one-time capital outlays. This projection betters the original budgeted draw of $1.7 million, as favorable sales tax revenue performance (despite pandemic-induced economic pressures) and expenditure control successfully shrank the planned deficit.
In addition to the sources of information identified in Fitch's applicable criteria specified below, this action was informed by information from Lumesis.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
The highest level of ESG credit relevance, if present, is a score of 3. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity(ies), either due to their nature or to the way in which they are being managed by the entity(ies). For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.
View additional rating details
Additional information is available on www.fitchratings.com
Numbers in parentheses accompanying applicable model(s) contain hyperlinks to criteria providing description of model(s).
Copyright © 2020 by Fitch Ratings, Inc., Fitch Ratings Ltd. and its subsidiaries. 33 Whitehall Street, NY, NY 10004. Telephone: 1-800-753-4824, (212) 908-0500. Fax: (212) 480-4435. Reproduction or retransmission in whole or in part is prohibited except by permission. All rights reserved. In issuing and maintaining its ratings and in making other reports (in
The ratings above were solicited and assigned or maintained at the request of the rated entity/issuer or a related third party. Any exceptions follow below.
Fitch's approach to ratings endorsement so that ratings produced outside the EU may be used by regulated entities within the EU for regulatory purposes, pursuant to the terms of the EU Regulation with respect to credit rating agencies, can be found on the EU Regulatory Disclosures page. The endorsement status of all International ratings is provided within the entity summary page for each rated entity and in the transaction detail pages for all structured finance transactions on the Fitch website. These disclosures are updated on a daily basis.