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2019-127 Moody's Investors Service RatingDate: June 14, 2019 Report No. 2019-127 INFORMAL STAFF REPORT TO MAYOR AND CITY COUNCIL SUBJECT: Moody’s Investors Service rating upgrade for outstanding general obligation debt. BACKGROUND: The purpose of this report is to inform the City Council of a rating upgrade by Moody’s Investors Service (Moody’s) for the City of Denton’s outstanding general obligation debt. On May 29, 2019, staff participated in a surveillance rating conference call with Moody’s regarding the City’s outstanding general obligation debt. DISCUSSION: On June 13, 2019, the City received a notice from Moody’s that our bond rating was upgraded from an ‘Aa2’ to ‘Aa1’ rating on outstanding general obligation debt. This is the second highest rating offered by this agency. The major reason for the upgrade is a rapidly expanding tax base which support’s the city’s healthy and stable financial profile. The rating indicated some of Denton’s other strengths are institutional presence of the universities, population growth, and low unemployment. Also identified in the rating is the City’s continual maintenance of the fund balance, which is well above the budgeted expenditure target, and strong financial and capital planning. The upgraded rating from Moody’s is now comparable to the ratings from S&P and Fitch. For your review, staff has attached the Credit Opinion report and a rating chart for all three rating agencies which includes Moody’s. ATTACHMENT: 1. Moody’s Press Release 2. Moody’s Credit Opinion Report 3. Ratings Chart STAFF CONTACT: David Gaines, Director of Finance (940)-349-8260 David.Gaines@cityofdenton.com Rating Action: Moody's upgrades to Aa1 City of Denton, TX's issuer and GOLT ratings 13 Jun 2019 New York, June 13, 2019 -- Moody's Investors Service has upgraded to Aa1 from Aa2 the City of Denton, TX's issuer rating and general obligation limited tax (GOLT) rating. The upgrade affects $98.1 million in rated debt outstanding. RATINGS RATIONALE The upgrade to Aa1 for the issuer rating reflects the city's large and rapidly expanding tax base, which supports the city's healthy and remarkably stable financial profile. The rating further reflects several universities that help to anchor the city's local economy. Additionally, the rating considers the city's elevated fixed costs and overall debt burdens which are higher than similarly rated peers, even though a majority is supported by enterprise operations The Aa1 GOLT rating is the same as the issuer rating, reflecting ample available taxing headroom of over 500%, which offsets the lack of full faith and credit pledge and inability to override the statutory cap. RATING OUTLOOK Moody's does not generally assign outlooks to local governments with this amount of debt outstanding. FACTORS THAT COULD LEAD TO AN UPGRADE - Continued tax base expansion coupled with higher resident incomes - Material and sustained increases to financial reserves FACTORS THAT COULD LEAD TO A DOWNGRADE - Large debt issuance absent tax base growth - Trend of deficit operations that impair financial reserves - Inability of utility funds to service currently self-supporting debt LEGAL SECURITY The outstanding bonds and certificates constitute direct obligations of the city, payable from a direct annual ad valorem tax levied, within limits prescribed by law, on all taxable property within the city. PROFILE The City of Denton is located in, and is the county seat of, Denton County, Texas (Aaa stable). The city covers approximately 97.411 square miles and serves a population of approximately 129,635 as of 2019. The city is approximately 38 miles northwest of Dallas (A1 stable) and 36 miles northeast of Fort Worth (Aa3 stable). Denton is the site of the nation's first underground control center of the Office of Emergency Planning and Office of Civil and Defense Mobilization. The city is also home to major universities, the University of North Texas System (Aa2 stable) and Texas Woman's University (Aa3 stable). METHODOLOGY The principal methodology used in these ratings was US Local Government General Obligation Debt published in December 2016. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology. REGULATORY DISCLOSURES For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com. Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review. Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating. Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating. Samantha Krouse Lead Analyst Regional PFG Dallas Moody's Investors Service, Inc. Plaza Of The Americas 600 North Pearl St. Suite 2165 Dallas 75201 US JOURNALISTS: 1 212 553 0376 Client Service: 1 212 553 1653 Adebola Kushimo Additional Contact Regional PFG Dallas JOURNALISTS: 1 212 553 0376 Client Service: 1 212 553 1653 Releasing Office: Moody's Investors Service, Inc. 250 Greenwich Street New York, NY 10007 U.S.A JOURNALISTS: 1 212 553 0376 Client Service: 1 212 553 1653 © 2019 Moody’s Corporation, Moody’s Investors Service, Inc., Moody’s Analytics, Inc. and/or their licensors and affiliates (collectively, “MOODY’S”). All rights reserved. CREDIT RATINGS ISSUED BY MOODY'S INVESTORS SERVICE, INC. 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U.S. PUBLIC FINANCE CREDIT OPINION 14 June 2019 Contacts Sam Krouse +1.214.979.6842 Associate Lead Analyst sam.krouse@moodys.com Adebola Kushimo +1.214.979.6847 VP-Senior Analyst adebola.kushimo@moodys.com CLIENT SERVICES Americas 1-212-553-1653 Asia Pacific 852-3551-3077 Japan 81-3-5408-4100 EMEA 44-20-7772-5454 Denton (City of) TX Update following upgrade of issuer rating and GOLT to Aa1 Summary The City of Denton, TX (Aa1) benefits from a large and rapidly expanding tax base, which support’s the city’s healthy and remarkably stable financial profile. The city is also home to several universities that help to anchor the local economy. A majority of the city’s total general obligation backed debt is supported by enterprise operations, which lowers the city’s net direct debt obligation. However, debt levels remain elevated compare to peers and the city's credit profile is challenged by its elevated fixed costs and overall debt burdens, which somewhat temper overall flexibility. On June 12, we upgraded the city's issuer rating and outstanding general obligation limited tax debt (GOLT) to Aa1. Credit strengths »Large and expanding tax base »Institutional presence of several universities »Healthy and stable financial management Credit challenges »Elevated fixed costs »Elevated overall net debt Rating outlook Moody's does not generally assign outlooks to local government issuers with this amount of debt outstanding. Factors that could lead to an upgrade »Continued tax base expansion coupled with higher resident incomes »Material and sustained increases to financial reserves Factors that could lead to a downgrade »Large debt issuance absent tax base growth »Trend of deficit operations that impair financial reserves MOODY'S INVESTORS SERVICE U.S. PUBLIC FINANCE Key indicators Exhibit 1 Denton (City of) TX 2014 2015 2016 2017 2018 Economy/Tax Base Total Full Value ($000)$6,979,224 $7,797,178 $8,463,147 $9,172,250 $10,936,140 Population 122,742 125,734 128,421 131,097 127,093 Full Value Per Capita $56,861 $62,013 $65,902 $69,965 $86,048 Median Family Income (% of US Median)102.8%102.8%102.7%105.1%105.1% Finances Operating Revenue ($000)$104,983 $112,200 $120,751 $130,703 $135,204 Fund Balance ($000)$30,565 $32,157 $33,063 $37,180 $35,847 Cash Balance ($000)$28,421 $29,585 $28,723 $31,219 $30,608 Fund Balance as a % of Revenues 29.1%28.7%27.4%28.4%26.5% Cash Balance as a % of Revenues 27.1%26.4%23.8%23.9%22.6% Debt/Pensions Net Direct Debt ($000)$120,989 $138,688 $145,799 $168,051 $208,852 3-Year Average of Moody's ANPL ($000)$158,150 $178,939 $191,181 $213,677 $226,060 Net Direct Debt / Full Value (%)1.7%1.8%1.7%1.8%1.9% Net Direct Debt / Operating Revenues (x)1.2x 1.2x 1.2x 1.3x 1.5x Moody's - adjusted Net Pension Liability (3-yr average) to Full Value (%)2.3%2.3%2.3%2.3%2.1% Moody's - adjusted Net Pension Liability (3-yr average) to Revenues (x)1.5x 1.6x 1.6x 1.6x 1.7x The city's operating funds include the general and debt service fund Source: Denton's Certified Annual Financial Reports, US Census Bureau Profile The City of Denton is located in, and is the county seat of, Denton County, Texas (Aaa stable). The City covers approximately 97.411 square miles and serves a population of approximately 129,635 as of 2019. The city is approximately 38 miles northwest of Dallas (A1 stable) and 36 miles northeast of Fort Worth (Aa3 stable). Denton is the site of the nation's first underground control center of the Office of Emergency Planning and Office of Civil and Defense Mobilization. The city is also home to major universities, the University of North Texas (Aa2 stable) and Texas Woman’s University (Aa3 stable). Detailed credit considerations Economy and tax base: large economy with institutional presence Denton's economy will continue to expand more rapidly than peers given ongoing large commercial and residential developments. The city is located strategically between two major job centers at 38 miles northwest of Dallas (A1 stable) and 36 miles northeast of Fort Worth (Aa3 stable) which has prompted steady migration inflow. After increasing in population by 40.8% between the 2000 and 2010 census, the city has grown another 14.3% to 129,635 in 2019 according to city estimates. This growth has prompted ongoing residential construction including a new 6,000 acre master planned residential development, while the city's favorable location and low cost of living has lured commercial development including two warehousing and distribution centers with a total investment of an estimated $85.6 million. The city's $11.4 billion tax base has grown at an average annual rate of 10.4% and is likely to continue this rapid growth pattern despite the city's conservative estimate of 4%, which is used for budgetary purposes. The city is home to both the University of North Texas (Aa2 stable) and Texas Woman's University (Aa3 stable) which provides regional stability and enrolls over 51,000 at the Denton campuses, or a sizeable 39.6% of the city's total population. Denton is the site of the nation's first underground control center of the Office of Emergency Planning and Office of Civil and Defense Mobilization for the Federal Emergency Management Agency (FEMA) and continues to be a major employer in the city. Resident income indices are diluted due to the large institutional and governmental presence yet still equal 105.1% of the US. The city also enjoys a tight and annually expanding labor force, with unemployment at a low 2.4% as of April 2019, compared to the state unemployment rate of 3% and the national rate of 3.3%. This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on www.moodys.com for the most updated credit rating action information and rating history. 2 14 June 2019 Denton (City of) TX: Update following upgrade of issuer rating and GOLT to Aa1 MOODY'S INVESTORS SERVICE U.S. PUBLIC FINANCE Finances and economy: healthy and stable finances The city's financial profile will remain healthy supported by a long standing history of stability and management's commitment to prudent fiscal practices. The city has been able to maintain a general fund balance between 26-31% of revenues over the past ten years due to strong budgetary practices, including conservative assumptions for tax base growth. Additionally, the city codified a minimum 20% unassigned fund balance policy, which is enhanced by an extra 5% resiliency reserve for a 25% combined total to safeguard against unusual financial circumstances and downturns. In fiscal 2018 (ending 9/30), the city's general fund ran a deficit of $1.4 million mainly due to a budgeted $1.4 million in one time public safety enhancements including a new medic unit at Fire Station 4 and an expansion of the Taser system at the police department. The city's general fund balance remained a healthy $30.3 million, or 26.7% of general fund revenues. Inclusive of the debt service funds, the city's operating fund balance was a $35.8 million, or 26.5% of operating revenues. Fiscal 2019 will likely close near balanced operations despite a budgeted $1.5 million drop in general fund balance. The city is expecting a $3.5 million decrease in sales tax receipts compared to budget because a significant tax payer has recorded a sharp decline in collections, for which management is balancing with additional general fund savings. The city is also projecting $500,000 in economic development savings by year end. The estimated year end results as of the most recent budget presentation in April shows a $14,000 general fund surplus. Though the fiscal 2020 budget will not be passed for several months, preliminary proposals indicate a modest $1.3 million general fund deficit for one-time personnel related expenditures. LIQUIDITY The city's cash and investment position has historically remained strong near total reserve levels. The general fund cash position in fiscal 2018 totaled $25.1 million, or 22.2% of revenues, with slight variance in fund balance mainly due to $7.8 million in property taxes receivable versus $4.1 million in accounts payable. Including the debt service fund, the operating funds cash position was also healthy at $30.6 million, 22.6% of revenues. Debt and pensions: elevated debt with utility system support, elevated fixed costs The city's net direct debt burden will remain manageable despite additional debt plans given the support of the city's utility systems of a large portion of GOLT debt. In total, the city has $751.6 million in general obligation backed debt, though only $212.9 million is paid through ad valorem taxes as the city's various utility systems support roughly 72% of total GOLT debt outstanding. Net of self-supporting debt, the direct debt burden is reduced to 1.9% of fiscal 2019 full value. The city plans to issue $21 million of debt for infrastructure needs in the second quarter of 2020 and may go to voters for $190 million of authorization in November 2019. DEBT STRUCTURE All of the city's debt is fixed rate and matures in 2049. Payout of principal is average at 58% paid in 10 years. DEBT-RELATED DERIVATIVES All of the city's debt is fixed rate, and the city is not party to any derivative agreements. PENSIONS AND OPEB Budgetary pressures due to the city's participation in defined benefit pension plans are expected to remain manageable in the near term. The city participates in two defined benefit pension plans; a multi-employer agent plan administered by the Texas Municipal Retirement System and the single-employer Denton Fireman's Relief and Retirement Plan. The city's pension contribution for the two plans in fiscal 2018 was $12.1 million, net of payments made by other funds, which was above the “tread water” indicator of $10.7 million. Moody's “tread water” indicator calculates the amount at which the pension contribution would need to be to prevent the unfunded liability from growing, under reported assumptions. Moody’s adjusted net pension liability (ANPL) for the city in fiscal 2018, under our methodology for adjusting reported pension data, is $256.2 million, or a moderate 1.9 times operating revenues. Moody’s ANPL reflects certain adjustments we make to improve comparability of reported pension liabilities. The adjustments are not intended to replace the district’s reported liability information, but to improve comparability with other rated entities. 3 14 June 2019 Denton (City of) TX: Update following upgrade of issuer rating and GOLT to Aa1 MOODY'S INVESTORS SERVICE U.S. PUBLIC FINANCE The city does offer Other Post-Employment Benefits (OPEB) on a pay go basis to cover retiree medical, dental, and vision care, and payments in fiscal 2018 totaled $899,000. The city's net OPEB liability as of fiscal 2018 reporting between the three plans was $42.9 million, or 0.31 times net operating revenues. Management and governance: strong institutional framework Denton's management team has exhibited good governance through its continual maintenance of fund balances well above the 20-25% of budgeted expenditure target. Management's financial policies include a requirement for any budgeted drawdown to be for one-time projects. The city also undergoes multi-year financial and capital planning. The City operates under the Council/Manager form of government where the Mayor and six Councilmembers are elected for staggered two-year terms. Texas Cities have an Institutional Framework score of “Aa”, which is strong. The sector's major revenue sources (property taxes and sales taxes) account for about a third of revenues each and are subject to a cap; the remaining third is derived from other fees and is not subject to a cap. Property taxes, are subject to a statutory cap of $25 per $1,000 of assessed values, with no more than $15 allocated for debt. Most cities are well under the cap, and on an annual basis can increase their property tax revenues by 8% on existing property without voter approval. Most cities are at the sales tax cap for operating purposes. Unpredictable revenue fluctuations tend to be minor, or under 5% annually. Across the sector, fixed and mandated costs are generally less than 25% of expenditures and are primarily debt service expenditures. Unpredictable expenditure fluctuations tend to be minor, under 5% annually. Rating methodology and scorecard factors The US Local Government General Obligation Debt methodology includes a scorecard, a tool providing a composite score of a local government’s credit profile based on the weighted factors we consider most important, universal and measurable, as well as possible notching factors dependent on individual credit strengths and weaknesses. Its purpose is not to determine the final rating, but rather to provide a standard platform from which to analyze and compare local government credits. 4 14 June 2019 Denton (City of) TX: Update following upgrade of issuer rating and GOLT to Aa1 MOODY'S INVESTORS SERVICE U.S. PUBLIC FINANCE Exhibit 2 Rating Factors Measure Score Economy/Tax Base (30%) [1] Tax Base Size: Full Value (in 000s)$11,427,569 Aa Full Value Per Capita $88,152 Aa Median Family Income (% of US Median)105.1%Aa Notching Factors:[2] Institutional Presence Up Finances (30%) Fund Balance as a % of Revenues 26.5%Aa 5-Year Dollar Change in Fund Balance as % of Revenues 4.1%A Cash Balance as a % of Revenues 22.6%Aa 5-Year Dollar Change in Cash Balance as % of Revenues 2.0%A Management (20%) Institutional Framework Aa Aa Operating History: 5-Year Average of Operating Revenues / Operating Expenditures 1.0x A Debt and Pensions (20%) Net Direct Debt / Full Value (%)1.9%A Net Direct Debt / Operating Revenues (x)1.6x A 3-Year Average of Moody's Adjusted Net Pension Liability / Full Value (%)2.0%Aa 3-Year Average of Moody's Adjusted Net Pension Liability / Operating Revenues (x)1.7x A Notching Factors:[2] Standardized Adjustments [3]: Unusually strong or weak security features: Secured by statute Up Scorecard-Indicated Outcome Aa1 Assigned Rating Aa1 [1] Economy measures are based on data from the most recent year available [2] Notching Factors are specifically defined in the US Local Government General Obligation Debt methodology dated December 16, 2016 [3] Standardized adjustments are outlined in the GO Methodology Scorecard Inputs Updated for 2019 publication Source: US Census Bureau, City of Denton's Certified Annual Financial Reports, official statements 5 14 June 2019 Denton (City of) TX: Update following upgrade of issuer rating and GOLT to Aa1 MOODY'S INVESTORS SERVICE U.S. PUBLIC FINANCE © 2019 Moody’s Corporation, Moody’s Investors Service, Inc., Moody’s Analytics, Inc. and/or their licensors and affiliates (collectively, “MOODY’S”). All rights reserved. CREDIT RATINGS ISSUED BY MOODY'S INVESTORS SERVICE, INC. AND ITS RATINGS AFFILIATES (“MIS”) ARE MOODY’S CURRENT OPINIONS OF THE RELATIVE FUTURE CREDIT RISK OF ENTITIES, CREDIT COMMITMENTS, OR DEBT OR DEBT-LIKE SECURITIES, AND MOODY’S PUBLICATIONS MAY INCLUDE MOODY’S CURRENT OPINIONS OF THE RELATIVE FUTURE CREDIT RISK OF ENTITIES, CREDIT COMMITMENTS, OR DEBT OR DEBT-LIKE SECURITIES. MOODY’S DEFINES CREDIT RISK AS THE RISK THAT AN ENTITY MAY NOT MEET ITS CONTRACTUAL FINANCIAL OBLIGATIONS AS THEY COME DUE AND ANY ESTIMATED FINANCIAL LOSS IN THE EVENT OF DEFAULT OR IMPAIRMENT. SEE MOODY’S RATING SYMBOLS AND DEFINITIONS PUBLICATION FOR INFORMATION ON THE TYPES OF CONTRACTUAL FINANCIAL OBLIGATIONS ADDRESSED BY MOODY’S RATINGS. CREDIT RATINGS DO NOT ADDRESS ANY OTHER RISK, INCLUDING BUT NOT LIMITED TO: LIQUIDITY RISK, MARKET VALUE RISK, OR PRICE VOLATILITY. 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REPORT NUMBER 1179654 6 14 June 2019 Denton (City of) TX: Update following upgrade of issuer rating and GOLT to Aa1 MOODY'S INVESTORS SERVICE U.S. PUBLIC FINANCE CLIENT SERVICES Americas 1-212-553-1653 Asia Pacific 852-3551-3077 Japan 81-3-5408-4100 EMEA 44-20-7772-5454 7 14 June 2019 Denton (City of) TX: Update following upgrade of issuer rating and GOLT to Aa1 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).