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2018-062 Informal Staff Report on CO & GO Bond Ratings ReportsDate: May 18, 2018 Report No. 2018-062 INFORMAL STAFF REPORT TO MAYOR AND CITY COUNCIL SUBJECT: Bond credit ratings for the upcoming General Obligation (GO) and Certificates of Obligation (CO) bond sales. BACKGROUND: The purpose of this report is to provide the City Council notice of recent bond credit ratings from Fitch Ratings (Fitch) and Standard & Poor’s (S&P) for the upcoming GO and CO bond sales. The City Council is scheduled to consider adoption of bond ordinances to authorize the bond sales on May 22, 2018. DISCUSSION: On April 30th and May 2nd, staff and the City’s financial advisor, First Southwest Company, participated in conference calls with analysts from Fitch and S&P to discuss the City’s financials and upcoming GO and CO bond sales. As a result of these conference calls, and a review of financial information, both S&P and Fitch assigned a rating of ‘AA+’ to the City’s upcoming bond sales. This is the second highest rating offered by either rating agency. There is no change to either rating from the prior year and both indicated a stable rating outlook for the City. For your review, staff has attached the rating reports and a ratings chart for all three rating agencies which includes Moody’s. Moody’s has not rated the City for the upcoming bond sales. On April 10, 2018, the Audit/Finance Committee received a presentation on the City’s FY 2017- 18 Adopted CIP, planned bond sales and the Notice of Intention ordinance to issue COs. The Audit/Finance Committee unanimously recommended approval to forward the upcoming bond issuance to the City Council for consideration. On April 17, 2018, the City Council adopted Ordinance No. 18-621 directing the publication of a Notice of Intention to issue COs. The City Council is scheduled to consider adoption of bond ordinaces to authorize the bond sales on May 22, 2018. Please do not hesitate to contact me if you have any questions. ATTACHMENT: Fitch and S&P Credit Rating Reports Ratings Chart STAFF CONTACT: Antonio Puente, Jr., Director of Finance (940)-349-7283 Antonio.Puente@cityofdenton.com Public Finance www.fitchratings.com May 18, 2018 Tax-Supported / U.S.A. Denton, Texas New Issue Report New Issue Summary Sale Date: May 24 via competitive sale. Series: $19,155,000 General Obligation (GO) Bonds, Series 2018, and $9,630,000 Certificates of Obligation (CO), Series 2018. Purpose: GO bond proceeds will be used to finance various street, stormwater drainage and park improvements. Proceeds from the COs will be used for vehicle acquisitions and facility improvements. Security: An annual property tax levy, limited to $2.50 per $100 of taxable assessed valuation (TAV). Analytical Conclusion The 'AA+' IDR and GO bond rating reflect exceptionally strong operating performance, supported by strong revenue growth prospects, ample revenue-raising capacity and sound expenditure flexibility. The rating also incorporates the expectation for a moderate, but slightly elevated, long-term liability burden. Economic Resource Base: With a population of about 133,000, Denton is located at the northern end of the Dallas-Fort Worth (DFW) metro area. The local economy features institutes of higher education, a regionally prominent medical sector and a strong warehousing and manufacturing base, leveraging the city's multimodal transportation network. Key Rating Drivers Revenue Framework: 'aaa' Fitch Ratings expects Denton's diverse and expanding tax base to continue to grow at a pace in excess of U.S. GDP over the medium term. Strong revenue-raising capacity is supported by a tax rate well below the statutory cap. Expenditure Framework: 'aa' The city's pace of spending is aligned with revenue growth. Discretion with respect to workforce and other operating costs provides the city with flexibility to address future uncertainties, including economic slowdowns. Carrying costs do not pressure the budget; however, debt issuance for capital needs is expected to keep carrying costs somewhat elevated. Long-Term Liability Burden: 'a' Currently at 19.6% of estimated personal income, Fitch expects the city's long-term liabilities to place a slightly elevated, but still moderate, burden on the resource base over time, considering likely debt issuance plans to address regional growth needs. The city's net pension liability burden contributes a modest amount to its long-term liability burden. Operating Performance: 'aaa' Fitch anticipates Denton would maintain strong financial flexibility in an economic downturn based on relatively stable revenues and sound expenditure flexibility. The city consistently maintains a solid financial cushion. Ratings Long-Term Issuer Default Rating AA+ New Issues $19,155,000 General Obligation Bonds, Series 2018 AA+ $9,630,000 Certificates of Obligation, Series 2018 AA+ Outstanding Debt Certificates of Obligation AA+ General Obligation Bonds AA+ Rating Outlook Stable Analysts Emmanuelle Lawrence +1 512 215-3740 emmanuelle.lawrence@fitchratings.com Jose Acosta +1 512 215-3726 jose.acosta@fitchratings.com Public Finance Denton, Texas 2 May 18, 2018 Rating Sensitivities Liability Burden: The rating assumes that liability levels will remain generally consistent with current levels, placing a slightly elevated, but moderate, burden on the resource base. Credit Profile Denton's location at the convergence of Interstate 35 East and Interstate 35 West and ready access to air and rail transportation have contributed to its strong warehousing and manufacturing base. The city is home to sizable distribution centers such as Target, Aldi, Fastenal and WinCo. Its diverse manufacturers include Safran, Flowers Baking Company, TetraPak and Peterbilt Motors. Denton is also known for its institutions of higher education (University of North Texas and Texas Woman's University) and regionally prominent medical sector. The city's growing healthcare facilities serve North Texas and Southern Oklahoma. These institutions include Columbia Medical Center Denton, Texas Health Presbyterian Hospital, and The Heart Hospital Baylor Denton. Current TAV, at $10.3 billion, represents about a 13% increase over the previous year. The city's management typically budgets for an annual 4% TAV increase; however, for the past several years TAV growth has exceeded budget projections. Additional development is reported across the city's commercial, industrial and residential property base. The city's ample developable land positions it well for ongoing solid growth over the medium-to-long term. Revenue Framework Taxes, including property and sales taxes, account for the bulk of the city's operating revenues. Based on fiscal 2017 audited results, tax receipts accounted for 74% of general fund revenues. The 4.1% CAGR of Denton's general fund revenues over the 10 years ended in fiscal 2017 reflects growth in excess of U.S. GDP, driven by rapid TAV growth and mirroring the expanding regional economy. Fitch expects ongoing revenue strength based on growth in the city's diverse local economy. The city of Denton's fiscal 2018 tax rate of 63.8 cents per $100 of TAV provides 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. Expenditure Framework Based on audited results, public safety accounted for 57.6% of fiscal 2017 general fund spending. The pace of spending is likely to remain at the level of revenue growth based on the expected moderate pace of population growth and the ongoing strength of revenues, incorporating a diverse tax base and robust sales tax along the city's transportation corridors. The city maintains flexibility with respect to headcount and salary arrangements and through the discretionary nature of its pay-as-you-go capital spending program as well as its annual contributions to funding street improvements. Carrying costs represent 21% of governmental spending and reflects a 10-year debt amortization rate of 58%. The city has a sizable multiyear capital improvement program and has plans to issue additional debt over the near term. As such, we anticipate carrying costs to remain around 20%. Rating History (IDR) Rating Action Outlook/ Watch Date AA+ Affirmed Stable 5/11/18 AA+ Assigned Stable 3/19/12 Related Research Fitch Rates Denton, TX's $124MM GOs and COs 'AA+'; Outlook Stable (May 2018) Related Criteria U.S. Public Finance Tax-Supported Rating Criteria (April 2018) Public Finance Denton, Texas 3 May 18, 2018 Long-Term Liability Burden Fitch expects Denton's long-term liabilities, currently 19.6% of personal income, to rise to somewhat elevated, but still moderate, levels (slightly over 20%) over the medium-term horizon based on the impact of regional growth on direct and overlapping issuances. Overlapping debt makes up the bulk of the burden. Denton's fiscal 2017 five-year capital improvement plan includes about $130 million of general government needs between fiscal 2017 and fiscal 2021, somewhat above the scheduled debt to be retired over the same period. The city has roughly $34 million of remaining GO bond authorization. At this time, the city has tentative plans to approach voters of additional bonding authority over the next 24–36 months. The city's pensions are provided through the Texas Municipal Retirement System, an agent multiple-employer defined-benefit plan, and the Denton Firemen's Relief and Retirement Fund, a single-employer plan. Under GASB Statement 68, the city reports a fiscal 2016 net pension liability (NPL) of $105.2 million for both plans combined, with fiduciary assets covering 80.3% of total pension liabilities at the plans’ 6.75% investment return assumption. Using a more conservative 6% investment return assumption, the ratio of assets to liability declines to 72.5%, and the NPL rises to $162 million. Operating Performance Fitch expects Denton to maintain the highest gap-closing capacity through an economic downturn. For details, see Scenario Analysis, page 4. Over the past 18 months, Denton updated its reserve policy to include a 5% resiliency (25% combined total) reserve component to safeguard against unexpected financial circumstances or economic downturns. The city's financial flexibility is demonstrated by its practice of funding nonrecurring expenditures with favorable revenue performance and taking advantage of economic upturns to maintain its financial cushion. Public Finance Denton, Texas 4 May 18, 2018 Ver 22 Denton (TX) Scenario Analysis v. 2.0 2017/03/24 Analyst Interpretation of Scenario Results: Scenario Parameters:Year 1 Year 2 Year 3 GDP Assumption (% Change)(1.0%)0.5%2.0% Expenditure Assumption (% Change)2.0%2.0%2.0% Revenue Output (% Change)(1.0%)3.4%5.9% Inherent Budget Flexibility Revenues, Expenditures, and Fund Balance 2011 2012 2013 2014 2015 2016 2017 Year 1 Year 2 Year 3 Total Revenues 85,343 83,636 85,432 89,777 95,772 102,302 110,167 109,065 112,749 119,375 % Change in Revenues -(2.0%)2.1%5.1%6.7%6.8%7.7%(1.0%)3.4%5.9% Total Expenditures 82,039 80,834 84,701 88,608 92,523 97,686 100,561 102,572 104,623 106,716 % Change in Expenditures -(1.5%)4.8%4.6%4.4%5.6%2.9%2.0%2.0%2.0% Transfers In and Other Sources 111 167 140 85 118 171 288 169 175 185 Transfers Out and Other Uses 516 1,557 950 1,171 1,840 3,982 6,293 4,062 4,143 4,226 Net Transfers (405)(1,390)(810)(1,086)(1,722)(3,811)(6,005)(3,892)(3,968)(4,040) Bond Proceeds and Other One-Time Uses ---------- Net Operating Surplus(+)/Deficit(-) After Transfers 2,899 1,412 (79)83 1,527 805 3,601 2,601 4,158 8,618 Net Operating Surplus(+)/Deficit(-) (% of Expend. and Transfers Out)3.5%1.7%(0.1%)0.1%1.6%0.8%3.4%2.4%3.8%7.8% Unrestricted/Unreserved Fund Balance (General Fund)24,424 25,836 25,755 25,838 27,365 28,170 31,771 34,372 38,530 47,149 Other Available Funds (Analyst Input)---------- Combined Available Funds Balance (GF + Analyst Input)24,424 25,836 25,755 25,838 27,365 28,170 31,771 34,372 38,530 47,149 Combined Available Fund Bal. (% of Expend. and Transfers Out)29.6%31.4%30.1%28.8%29.0%27.7%29.7%31.5%35.4%42.5% Reserve Safety Margins Minimal Limited Midrange High Superior Reserve Safety Margin (aaa)16.0%8.0%5.0%3.0%2.0% Reserve Safety Margin (aa)12.0%6.0%4.0%2.5%2.0% Reserve Safety Margin (a)8.0%4.0%2.5%2.0%2.0% Reserve Safety Margin (bbb)3.0%2.0%2.0%2.0%2.0% Fitch expects Denton to maintain the highest gap closing capacity through an economic downturn. As demonstrated in Fitch's analytical sensitivity tool (FAST) 1% decline in GDP scenario, the city has a strong financial cushion to address a moderate economic downturn. Fitch expects the city would maintain an ample cushion given its high level of revenue raising capacity and adequate expenditure flexibility. The city completed fiscal 2017 with a $3.6 million operating surplus and $31.8 million in unrestricted reserves, which equates to 30% of spending. The fiscal 2017 surplus, per management, is largely due to higher-than- anticipated sales tax receipts. Denton projects similarly strong fiscal 2018 results based on brisk sales tax revenues. The city's five-year forecast reflects moderate revenue growth, with maintenance of reserves at a level consistent with the city's 20% of spending policy floor plus 5% resiliency reserve (25% combined total). Actuals Scenario Output Inherent Budget Flexibility 0.0% 5.0% 10.0% 15.0% 20.0% 25.0% 30.0% 35.0% 40.0% 45.0% 2011 2012 2013 2014 2015 2016 2017 Year 1 Year 2 Year 3 Reserve Safety Margin in an Unaddressed Stress Available Fund Balance bbb a aa aaa Actual Scenario Financial Resilience Subfactor Assessment: Notes: Scenario analysis represents an unaddressed stress on issuer finances. Fitch's downturn scenario assumes a -1.0% GDP decline in the first year, followed by 0.5% and 2.0% GDP growth in Years 2 and 3, respectively. Expenditures are assumed to grow at a 2.0% rate of inflation. Inherent budget flexibilityis the analyst's assessment of the issuer's ability to deal with fiscal stress through tax and spending policy choices, and determines the multiples used to calculate the reserve safety margin.For further details, please see Fitch's US Tax-Supported Rating Criteria. Hide Public Finance Denton, Texas 5 May 18, 2018 ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTPS://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEB SITE AT WWW.FITCHRATINGS.COM. PUBLISHED RATINGS, CRITERIA, AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE, AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE CODE OF CONDUCT SECTION OF THIS SITE. 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Classification Moody's S&P Fitch Meaning Aaa AAA AAA Prime Grade Aa1 AA+AA+ Aa2 AA AA High Grade Aa3 AA-AA- Investment Grade A1 A+A+ A2 A A Upper Medium Grade A3 A-A- Baa1 BBB+BBB+ Baa2 BBB BBB Lower Medium Grade Baa3 BBB-BBB- Ba1 BB+BB+ Ba2 BB BB Non-Investment Grade Speculative Ba3 BB-BB- B1 B+B+ B2 B B Highly Speculative B3 B-B- Junk Caa1 CCC+CCC+Substantial Risks Caa2 CCC CCC Extremely Speculative Caa3 CCC-CCC-In Default with Little Ca CC CC+Prospect of Recovery C CC CC-In Default D D D BOND RATING CHART Note: City's current ratings for all general obligation debt are: AA+ from S&P and Fitch. Moody's has not rated the City's new bonds since 2011 but maintains a surveillance rating of Aa2 for any outstanding general obligation debt (2011 and prior).