Loading...
2018-125 CO Bond Sale and Rating ReportsDate: September 14, 2018 Report No. 2018-125 INFORMAL STAFF REPORT TO MAYOR AND CITY COUNCIL SUBJECT: City’s most recent competitive bond sale of Certificates of Obligation (COs) accompanied by the bond rating reports from Fitch Ratings (Fitch) and Standard & Poor’s (S&P). BACKGROUND: The purpose of this report is to provide the City Council with the rating agency reports from Fitch Ratings (Fitch) and Standard & Poor’s (S&P) as well as details on the sale of COs, Series 2018A authorized on September 11, 2018. DISCUSSION: In the weeks preceding the current bond sale City staff and the City’s Financial Advisor, First Southwest Company, completed questionnaires submitted by the rating agency analysts requesting updated financial information for the City. Both agencies, S&P and Fitch, assigned a rating of ‘AA+’ to the City’s upcoming bond sale. This is the second highest rating offered by either rating agency. There is no change to either rating and both indicated a stable rating outlook for the City. For your review, staff has attached rating reports from S&P and Fitch (Attachment 1) and a ratings chart (Attachment 2) for all three rating agencies. On September 12, 2018, the City along with its financial advisor conducted a competitive sale of $29,545,000 in principal amount of COs. The delivery date of the funds to the City will be September 28, 2018. The participating underwriting firms were: Robert W. Baird & Co., Inc.; Citigroup Global Markets Inc.; Fidelity Capital Markets; UMB Bank, N.A.; Bank of America Merrill Lynch; and FTN Financial Capital Markets. The COs were awarded to Robert W. Baird & Co., Inc. as the lowest true interest cost bidder. The COs will fund the general government projects approved by the City Council on August 7, 2018. The bond sale met all of the following required parameters listed below: 1) The maximum principal amount of bonds shall not exceed $31,810,000; 2) Final stated maturity of February 15, 2038; 3) Maximum net effective interest rate of 3.75% 4) The sale must occur prior to March 11, 2019. The all-in true interest cost for the COs is 3.315%, which factors in the cost of issuance. Please do not hesitate to contact me if you have any questions. ATTACHMENT: 1. S&P and Fitch Credit Rating Report Date: September 14, 2018 Report No. 2018-125 2. Ratings Chart STAFF CONTACT: Antonio Puente, Jr., Director of Finance (940)-349-7283 Antonio.Puente@cityofdenton.com Summary: Denton, Texas; General Obligation Primary Credit Analyst: Daniel P Pulter, Centennial (1) 303-721-4646; Daniel.Pulter@spglobal.com Secondary Contact: Randy T Layman, Centennial + 1 (303) 721 4109; randy.layman@spglobal.com Table Of Contents Rationale Outlook Related Research WWW.STANDARDANDPOORS.COM/RATINGSDIRECT AUGUST 30, 2018 1 Summary: Denton, Texas; General Obligation Credit Profile US$29.6 mil certs of oblig ser 2018A dtd 09/01/2018 due 02/15/2038 Long Term Rating AA+/Stable New Rationale S&P Global Ratings assigned its 'AA+' long-term rating to the city of Denton, Texas' series 2018A certificates of obligation. At the same time, S&P Global Ratings affirmed its 'AA+' rating on the city's general obligation (GO) debt outstanding. The outlook is stable. The series 2018A certificates, in addition to previously issued certificates, are secured by the city's direct and continuing ad valorem tax, as well as a limited pledge (not to exceed $1,000) of surplus net revenues of the utility system. Despite the de minimis revenue pledge, we rate the certificates based on the city's GO pledge, which we consider stronger. Based on the application of our criteria, titled "Issue Credit Ratings Linked To U.S. Public Finance Obligors’ Creditworthiness" (published Jan. 22, 2018, on RatingsDirect), we do not differentiate between the city's limited-tax GO debt and its general creditworthiness, since the ad valorem tax is not derived from a measurably narrower tax base and there are no limitations on the fungibility of resources. We understand that proceeds from the sale of the bonds will be used to finance street, municipal service center, municipal airport, fire station, and police department improvements. The 'AA+' rating reflects our opinion of the city's: • Strong economy, with access to a broad and diverse metropolitan statistical area (MSA) and a local stabilizing institutional influence; • Very strong management, with strong financial policies and practices under our Financial Management Assessment methodology; • Strong budgetary performance, with operating surpluses in the general fund and at the total governmental fund level in fiscal 2017; • Very strong budgetary flexibility, with an available fund balance in fiscal 2017 of 32% of operating expenditures; • Very strong liquidity, with total government available cash at 1.8x total governmental fund expenditures and 12.7x governmental debt service, and access to external liquidity we consider strong; • Weak debt and contingent liability position, with debt service carrying charges at 14% of expenditures and net direct debt that is 114.6% of total governmental fund revenue; and • Strong institutional framework score. WWW.STANDARDANDPOORS.COM/RATINGSDIRECT AUGUST 30, 2018 2 Strong economy We consider Denton's economy strong. The city, with an estimated population of 131,388, is located in Denton County in the Dallas-Fort Worth-Arlington MSA, which we consider to be broad and diverse. The city also benefits, in our view, from a stabilizing institutional influence. The city has a projected per capita effective buying income of 90.3% of the national level and per capita market value of $78,638. Overall, the city's market value grew by 13.3% over the past year to $10.3 billion in 2018. The county unemployment rate was 3.3% in 2017. Spanning an area of roughly 90 square miles, the city of Denton is located 35 miles north of Dallas and Fort Worth at the convergence of East and West Interstate 35. The local economy--largely based in retail, manufacturing, distribution, education, and health care--has grown in tandem with the robust geographic and economic expansion within the Dallas-Fort Worth metroplex in recent years. As home to both the University of North Texas and Texas Women's University, the city also benefits from a stabilizing institutional presence, in our view. Primary employers in fiscal 2017 were represented by the University of North Texas (with 8,738 employees), Denton Independent School District (4,417), Peterbilt Motors (2,314), and the Denton State Supported Living Center (1,700). We consider the local tax base very diverse, as the top 10 taxpayers constitute only 6.1% of taxable AV in fiscal 2018. Taxable AV itself has demonstrated steady year-over-year growth since fiscal 2014, and management expects this trend to continue at a rate near 4% annually in line with ongoing development. Both residential and commercial development have contributed to strong AV growth in recent years. Following a year of strong commercial development in fiscal 2017, in which multiple retail enterprises opened or began construction, city officials anticipate that commercial development will remain strong in the near term, with an assortment of new manufacturing and distribution, retail, hotel, and restaurant employers coming online. Among forthcoming projects are investments in electric utility infrastructure--expected to strengthen the city's cold storage industry footprint--as well as expansion to the local airport. Officials also report that construction has recently begun on a handful of new retail store fronts. Residential development likewise continues to represent a reliable source of taxable value growth for Denton, with multiple new subdivisions and multifamily housing complexes in various stages of development. Very strong management We view the city's management as very strong, with strong financial policies and practices under our Financial Management Assessment methodology, indicating financial practices are strong, well embedded, and likely sustainable. Key policies and practices include: • Conservative revenue and expenditure assumptions when compiling the annual budget, which typically allows for favorable budget variance by fiscal year-end; • Budget amendments that, if needed, can be made by the council, which is informed quarterly about how the budget is developing via budget-to-actual reports; • Formal debt management and investment policies are reviewed annually, with quarterly investment reporting to the city council; • An annually updated long-range capital improvement plan and multiyear financial forecast; and • A formal policy to maintain a minimum unassigned fund balance in the general fund equal to 20% of budgeted WWW.STANDARDANDPOORS.COM/RATINGSDIRECT AUGUST 30, 2018 3 Summary: Denton, Texas; General Obligation expenditures, and an additional 5% resiliency reserve (25% combined total) may be maintained to safeguard against unusual financial circumstances or economic downturns. Strong budgetary performance Denton's budgetary performance is strong in our opinion. The city had operating surpluses of 3.4% of expenditures in the general fund and of 11.6% across all governmental funds in fiscal 2017. In assessing the city's budgetary performance, we made adjustments for recurring transfers out of the general fund, and for expenditures toward one-time capital projects across total governmental funds with the use of debt proceeds. Denton has historically produced strong budgetary performance results, largely due to conservative budgeting practices in which deficit or balanced budgets are adopted and year-end results regularly exceed expectations. This was the case in fiscal 2017, when the city originally budgeted for a $99,000 drawdown in the general fund following transfers, but finished with a surplus of more than $3.3 million due in part to higher-than-expected sales tax revenues, and significant personnel savings in the public safety and parks and recreation departments. Property taxes represented 40% of general fund revenues throughout the year, with sales taxes (33%) and franchise fees (12%) constituting the next largest revenue sources. While franchise fees have remained stable in recent years, both property taxes and sales tax collections have demonstrated strong year-over-year growth, and officials expect these trends to continue in tandem with both residential and commercial expansion. The city once again budgeted for break-even general fund operations in fiscal 2018, and management reports that revenues and expenditures are trending ahead of expectations thus far, owing to persisting strength in sales tax collections. Despite earmarking $2.7 million in unassigned fund balance for additional capital expenditures related to park and traffic signal improvements, year-to-date projections indicate that the city will instead finish the year with a drawdown of approximately $44,000. And while the recently-adopted fiscal 2019 budget again prescribed a planned drawdown in fund balance, no potential sources of future budgetary pressure have been identified by management at this time. Consequently, we expect budgetary performance to remain strong in the near term. Very strong budgetary flexibility Denton's budgetary flexibility is very strong, in our view, with an available fund balance in fiscal 2017 of 32% of operating expenditures, or $31.8 million. The city has historically maintained very strong reserve levels, exceeding 28% operating expenditures in each of the past three fiscal years, and providing flexibility over its formal policy of 20%. Surplus results in fiscal 2017 allowed the city to grow unassigned fund balance by an additional $3.7 million, and despite budgeting for the use of $2.7 million in reserves for capital projects in fiscal 2018, outperformance in general fund revenues and expenditures may instead culminate in draw on fund balance of $44,000. While management indicates that fund balance may be used to cash finance future capital outlays in a similar manner, no immediate plans exist to materially draw on fund balance, or draw below the city's 20% policy level. Therefore, we expect budgetary flexibility to remain very strong in the near future. WWW.STANDARDANDPOORS.COM/RATINGSDIRECT AUGUST 30, 2018 4 Summary: Denton, Texas; General Obligation Very strong liquidity In our opinion, Denton's liquidity is very strong, with total government available cash at 1.8x total governmental fund expenditures and 12.7x governmental debt service in 2017. In our view, the city has strong access to external liquidity if necessary. Denton's strong access to external liquidity is demonstrated by its access to the market over the past two decades, which includes numerous GO-and revenue-backed bond issuances. It has historically maintained what we consider very strong cash balances, and despite our expectation for deficit operations in fiscal 2018, we do not believe its cash position will materially weaken in the near term. All of the city's investments comply with both Texas statutes and its own formal policy, and were held in treasuries, agencies, certificates of deposit, commercial paper, municipal bonds, and local government investment pools at the end of fiscal 2017, which we do not view as aggressive. Additionally, we have not identified contingent liabilities that could pose a material risk to liquidity. Therefore, we do not expect the city's liquidity position to deteriorate from its very strong position in the near term. Weak debt and contingent liability profile In our view, Denton's debt and contingent liability profile is weak. Total governmental fund debt service is 14.0% of total governmental fund expenditures, and net direct debt is 114.6% of total governmental fund revenue. Debt supported through the city's enterprise fund has been adjusted in our direct debt to revenue calculations. Using the city's total direct debt we estimate that about 53% of debt will be retired over the next 10 years, which we consider average. Management plans to issue about $46.3 million of additional tax-supported debt over the next two years. Despite the additional debt plans, we do not believe the city's key debt ratios will materially change our view of the debt profile. Denton's combined required pension and actual other postemployment benefits (OPEB) contributions totaled 12.6% of total governmental fund expenditures in 2017. The city made its full annual required pension contribution in 2017. The city participates in the Texas Municipal Retirement System (TMRS), which is administered by the State of Texas, and is the city's largest plan. Denton's required pension contribution is its actuarially determined contribution (ADC), which is calculated at the state level, based on an actuary study. Using updated reporting standards in accordance with Governmental Accounting Standards Board (GASB) Statement No. 68, the city's net pension liability was measured as of Dec. 31, 2016, and was $85.5 million. The TMRS plan maintained a funded level of 80.4%, using the plan's fiduciary net position as a percent of the total pension liability. TMRS calculates the ADC using a level percent of payroll amortization, assuming 3% annual growth, which means that contributions are deferred into the future with the idea that growth will enhance affordability. TMRS also amortizes using a layered 25-year offsetting approach. This means that each year there is an actuarial loss, a new base is created to be amortized over 25 years, which we consider long. However, for each actuarial gain, the largest loss is essentially reduced in size--decreasing overall contribution volatility. TMRS lists an equivalent single amortization period for Denton of 18.1 years for 2017. The city also participates in a single-employer, contributory, defined-benefit retirement plan, the Denton Firemans' Relief and Retirement Fund (FRRF)--established to provide pension benefits to full-time firefighters. The city recorded a net pension liability of $19.6 million as of Dec. 31, 2016, with a reported funded ratio of 79%. Contributions to FRRF are defined to be the same percent of payroll as those of TMRS, which equates to a calculated amortization length of WWW.STANDARDANDPOORS.COM/RATINGSDIRECT AUGUST 30, 2018 5 Summary: Denton, Texas; General Obligation 31 years; however, city officials indicated that a funding plan was recently adopted that will reduce this term to 25 years. While we do not anticipate short-term fixed-cost pressure resulting from the city's pension obligations, the amortization methodology contains potential for unanticipated escalation in our view. However, we anticipate that any near-term increases should be manageable given the city's strong financial position and budgetary performance. As part of its OPEB, the city also provides defined-benefit group term life insurance through the supplemental death benefits fund (SDBF), administered by TMRS, which it funds on a pay-as-you-go basis and to which it contributed $152,556 in fiscal 2017. Furthermore, retiree health care is provided by the city, which is also funded on a pay-as-you-go basis; the city contributed $524,589 toward the plan in fiscal 2017. Although the city's combined pension and OPEB costs represented a high 12.6% of fiscal 2017 adjusted total governmental fund expenditures, we view these charges as somewhat skewed because funds generated from the city's ownership and operations of an electric utility system are used to offset the retiree costs of the system's employees. Most of Denton's comparable peer cities, by contrast, do not benefit from such an arrangement. When adjusting for retiree costs attributed to utility funds, combined pension and OPEB costs for governmental funds equate to a more manageable 9.2% of adjusted fiscal 2017 expenditures. Strong institutional framework The institutional framework score for Texas municipalities is strong. Outlook The stable outlook reflects our view of the city's stable economy within the broad and diverse Dallas-Fort Worth-Arlington MSA, its very strong flexibility and liquidity, and very strong management practices and policies. It also reflects our expectation that the city's debt profile will remain elevated corresponding with anticipated growth and planned future debt issuances. Consequently, we do not expect to change the rating within the two-year outlook period. Upside scenario We could raise the rating if continued economic expansion results in improved wealth and income indicators, compared to those of peers, or if the city's overall debt profile were to improve while strong financial performance is maintained. Downside scenario We could lower the rating if the city's financial performance deteriorates--potentially stemming from fixed-cost pressure resulting from growing pension-related liabilities--leading to sustained and significant drawdowns in reserves. Related Research • S&P Public Finance Local GO Criteria: How We Adjust Data For Analytic Consistency, Sept. 12, 2013 • Incorporating GASB 67 And 68: Evaluating Pension/OPEB Obligations Under Standard & Poor's U.S. Local WWW.STANDARDANDPOORS.COM/RATINGSDIRECT AUGUST 30, 2018 6 Summary: Denton, Texas; General Obligation Government GO Criteria, Sept. 2, 2015 Ratings Detail (As Of August 30, 2018) Denton GO Long Term Rating AA+/Stable Affirmed Denton GO Long Term Rating AA+/Stable Affirmed Denton GO Long Term Rating AA+/Stable Affirmed Denton GO Long Term Rating AA+/Stable Affirmed Denton GO Long Term Rating AA+/Stable Affirmed Denton GO Long Term Rating AA+/Stable Affirmed Denton GO Long Term Rating AA+/Stable Affirmed Denton GO Long Term Rating AA+/Stable Affirmed Denton GO Long Term Rating AA+/Stable Affirmed Denton GO Long Term Rating AA+/Stable Affirmed Denton GO Long Term Rating AA+/Stable Affirmed Denton GO Unenhanced Rating AA+(SPUR)/Stable Affirmed Many issues are enhanced by bond insurance. Certain terms used in this report, particularly certain adjectives used to express our view on rating relevant factors, have specific meanings ascribed to them in our criteria, and should therefore be read in conjunction with such criteria. Please see Ratings Criteria at www.standardandpoors.com for further information. Complete ratings information is available to subscribers of RatingsDirect at www.capitaliq.com. All ratings affected by this rating action can be found on S&P Global Ratings' public website at www.standardandpoors.com. Use the Ratings search box located in the left column. WWW.STANDARDANDPOORS.COM/RATINGSDIRECT AUGUST 30, 2018 7 Summary: Denton, Texas; General Obligation WWW.STANDARDANDPOORS.COM/RATINGSDIRECT AUGUST 30, 2018 8 STANDARD & POOR’S, S&P and RATINGSDIRECT are registered trademarks of Standard & Poor’s Financial Services LLC. S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, www.standardandpoors.com (free of charge), and www.ratingsdirect.com and www.globalcreditportal.com (subscription), and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at www.standardandpoors.com/usratingsfees. S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain non-public information received in connection with each analytical process. To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw or suspend such acknowledgment at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof. Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P’s opinions, analyses and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment and experience of the user, its management, employees, advisors and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. Rating- related publications may be published for a variety of reasons that are not necessarily dependent on action by rating committees, including, but not limited to, the publication of a periodic update on a credit rating and related analyses. No content (including ratings, credit-related analyses and data, valuations, model, software or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor’s Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an “as is” basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT’S FUNCTIONING WILL BE UNINTERRUPTED OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages. Copyright © 2018 by Standard & Poor’s Financial Services LLC. All rights reserved. Public Finance www.fitchratings.com September 6, 2018 Tax-Supported / U.S.A. Denton, Texas New Issue Report New Issue Summary Sale Date: Week of Sept. 10, 2018. Series: Certificates of Obligation, Series 2018A. Purpose: To finance various street improvements, municipal airport upgrades and the construction of a new municipal service center. Security: An annual property tax levy, limited to $2.50 per $100 of taxable assessed valuation. Analytical Conclusion The 'AA+' Issuer Default Rating (IDR) and GO bond rating reflect exceptionally strong operating performance, supported by solid revenue growth prospects, ample revenue-raising capacity and sound expenditure flexibility. The ratings also reflect the expected, continued, 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 metropolitan 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 multi-modal 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. 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 issuances for capital needs are expected to keep carrying costs somewhat elevated. Long-Term Liability Burden: 'a' Currently at 21% of estimated personal income, long-term liabilities place a slightly elevated, but still moderate, burden on the resource base over time, considering likely debt issuance to address regional growth needs. The city's net pension liability (NPL) 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. Rating Sensitivities Liability Burden: The ratings assume that liability levels will remain generally consistent with current levels, placing a slightly elevated, but moderate, burden on the resource base. Ratings Long-Term Issuer Default Rating AA+ New Issue $29,600,000 Certificates of Obligation, Series 2018A 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 September 6, 2018 Credit Profile Denton's location at the convergence of Interstates 35 East and 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 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. Denton's fiscal 2018 tax rate of $0.638 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 58% 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 growth 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 reflect a 10-year debt amortization rate of 55%. The city has a sizable multiyear capital improvement program and plans to issue additional debt over the near term. As such, we anticipate carrying costs to remain at about 20%. Moreover, the city's pension accounts for almost one-half of carrying costs, and other post-employment benefits costs are minimal. Long-Term Liability Burden Fitch expects Denton's long-term liabilities, currently 21% of personal income, to remain elevated but in the moderate range based on growth in both debt and personal income. Overlapping debt makes up the bulk of the city's long-term liability burden. Denton's five-year capital improvement plan includes about $130 million of general government needs between fiscal 2017 and fiscal 2021, somewhat above the debt scheduled to be retired Rating History (IDR) Rating Action Outlook/ Watch Date AA+ Affirmed Stable 8/28/18 AA+ Assigned Stable 3/19/12 Related Research Fitch Rates Denton, TX's $29.6MM COs 'AA+'; Outlook Stable (August 2018) Related Criteria U.S. Public Finance Tax-Supported Rating Criteria (April 2018) Public Finance Denton, Texas 3 September 6, 2018 over the same period. The city has roughly $34 million of remaining GO authorization. The city has tentative plans to approach voters for additional bonding authority over the next 24 to 36 months. In addition to general government needs, Denton's near-term enterprise priorities include the 220 MW quick-start Denton Energy Center to support the city's transition to reliance on a greater amount of renewable energy. 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 NPL of $105 million for both plans combined, with fiduciary assets covering 80% 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 73% 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 the 5% resiliency reserve component to safeguard against unexpected financial circumstances or economic downturns. The city's financial flexibility is demonstrated by its practice of funding non-recurring expenditures with favorable revenue performance and taking advantage of economic upturns to maintain its financial cushion. Public Finance Denton, Texas 4 September 6, 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), which depicts a 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. According to management, the fiscal 2017 surplus is largely due to higher-than-anticipated property and 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 a 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 flexibility is 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. Public Finance Denton, Texas 5 September 6, 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. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE. Copyright © 2018 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 (including forecast information), Fitch relies on factual information it receives from issuers and underwriters and from other sources Fitch believes to be credible. Fitch conducts a reasonable investigation of the factual information relied upon by it in accordance with its ratings methodology, and obtains reasonable verification of that information from independent sources, to the extent such sources are available for a given security or in a given jurisdiction. The manner of Fitch’s factual investigation and the scope of the third-party verification it obtains will vary depending on the nature of the rated security and its issuer, the requirements and practices in the jurisdiction in which the rated security is offered and sold and/or the issuer is located, the availability and nature of relevant public information, access to the management of the issuer and its advisers, the availability of pre-existing third-party verifications such as audit reports, agreed-upon procedures letters, appraisals, actuarial reports, engineering reports, legal opinions and other reports provided by third parties, the availability of independent and competent third-party verification sources with respect to the particular security or in the particular jurisdiction of the issuer, and a variety of other factors. Users of Fitch’s ratings and reports should understand that neither an enhanced factual investigation nor any third-party verification can ensure that all of the information Fitch relies on in connection with a rating or a report will be accurate and complete. Ultimately, the issuer and its advisers are responsible for the accuracy of the information they provide to Fitch and to the market in offering documents and other reports. In issuing its ratings and its reports, Fitch must rely on the work of experts, including independent auditors with respect to financial statements and attorneys with respect to legal and tax matters. Further, ratings and forecasts of financial and other information are inherently forward-looking and embody assumptions and predictions about future events that by their nature cannot be verified as facts. As a result, despite any verification of current facts, ratings and forecasts can be affected by future events or conditions that were not anticipated at the time a rating or forecast was issued or affirmed. The information in this report is provided “as is” without any representation or warranty of any kind, and Fitch does not represent or warrant that the report or any of its contents will meet any of the requirements of a recipient of the report. A Fitch rating is an opinion as to the creditworthiness of a security. This opinion and reports made by Fitch are based on established criteria and methodologies that Fitch is continuously evaluating and updating. Therefore, ratings and reports are the collective work product of Fitch and no individual, or group of individuals, is solely responsible for a rating or a report. The rating does not address the risk of loss due to risks other than credit risk, unless such risk is specifically mentioned. Fitch is not engaged in the offer or sale of any security. All Fitch reports have shared authorship. Individuals identified in a Fitch report were involved in, but are not solely responsible for, the opinions stated therein. The individuals are named for contact purposes only. A report providing a Fitch rating is neither a prospectus nor a substitute for the information assembled, verified and presented to investors by the issuer and its agents in connection with the sale of the securities. Ratings may be changed or withdrawn at any time for any reason in the sole discretion of Fitch. Fitch does not provide investment advice of any sort. Ratings are not a recommendation to buy, sell, or hold any security. Ratings do not comment on the adequacy of market price, the suitability of any security for a particular investor, or the tax-exempt nature or taxability of payments made in respect to any security. Fitch receives fees from issuers, insurers, guarantors, other obligors, and underwriters for rating securities. Such fees generally vary from US$1,000 to US$750,000 (or the applicable currency equivalent) per issue. In certain cases, Fitch will rate all or a number of issues issued by a particular issuer, or insured or guaranteed by a particular insurer or guarantor, for a single annual fee. Such fees are expected to vary from US$10,000 to US$1,500,000 (or the applicable currency equivalent). The assignment, publication, or dissemination of a rating by Fitch shall not constitute a consent by Fitch to use its name as an expert in connection with any registration statement filed under the United States securities laws, the Financial Services and Markets Act of 2000 of the United Kingdom, or the securities laws of any particular jurisdiction. Due to the relative efficiency of electronic publishing and distribution, Fitch research may be available to electronic subscribers up to three days earlier than to print subscribers. For Australia, New Zealand, Taiwan and South Korea only: Fitch Australia Pty Ltd holds an Australian financial services license (AFS license no. 337123) which authorizes it to provide credit ratings to wholesale clients only. Credit ratings information published by Fitch is not intended to be used by persons who are retail clients within the meaning of the Corporations Act 2001. 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. 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 CCC CC- In Default DDD 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).