Fitch Affirms Cleveland, OH’s General Obligation Bonds at ‘A+’; Outlook Revised to Positive
By Business Wire News
Fitch Ratings has affirmed the following Cleveland, Ohio’s (the city) limited tax general obligation (LTGO) bonds:
–$795,000, series 2004 at ‘A+’;
–$7,555,000, series 2005A at ‘A+’;
–$31,225,000, series 2007A at ‘A+’;
–$1,640,000, series 2007B at ‘A+’;
–$20,284,000, series 2007C at ‘A+’;
–$8,690,000, series 2008A at ‘A+’;
–$41,650,000, series 2009A at ‘A+’.
The Rating Outlook has been revised to Positive from Stable.
The bonds are unvoted general obligations of the city secured by ad valorem property taxes within the 10-mill property tax limitation and municipal income taxes pledged under the city’s general bond ordinance. The city may also use any available funds (state disbursements, interest earnings, all non-tax revenues) for debt service.
KEY RATING DRIVERS
REVISED OUTLOOK: The Positive Outlook reflects improved financial operations and the resultant increase in reserves to healthy levels.
RELIANCE ON INCOME TAX: The city’s finances are reliant on economically sensitive income tax revenues which have experienced strong growth over the last few years, but historically have fluctuated with economic cycles leaving the city vulnerable during downturns.
SLOWLY RECOVERING ECONOMY: The city’s economy has transformed from manufacturing to the more stable and strong health and education sectors. The recovery from the recession has been slow but economic development is notable with several significant projects recently completed and others under construction.
WEAK SOCIOECONOMIC PROFILE: The city’s weak socioeconomic profile is characterized by a declining population, below-average income levels, and elevated high poverty rate. Unemployment rates are trending lower but are still above state and national levels.
MANAGEABLE DEBT PROFILE: Debt ratios are moderate to high. Positively, debt amortization is rapid, and carrying costs associated with debt service, pension contributions, and other post-employment benefit (OPEB) payments are manageable.
MAINTENANCE OF RESERVES: The rating could move into the ‘AA’ category over the near term if the city continues to demonstrate maintenance of healthy operations and reserves.
The city is located in northeastern Ohio on the southern shore of Lake Erie and is the county seat of Cuyahoga County (LTGOs rated ‘AA+’; Outlook Stable). The city’s population declined a significant 17% from 2000 to 2010, but the decline has slowed with an estimated 2013 population of 390,113, a 1.7% decline from 2010.
INCOME TAX RELIANT; INCREASING RESERVES
Economically sensitive income tax revenues are the largest source of general fund revenues at approximately 60%. The recession adversely impacted income taxes but receipts have rebounded over the last few years due to the economic recovery, increasing by 4.6%, 5.3% and 3.5% in 2011, 2012 and 2013, respectively.
Property taxes represent a small portion of general fund revenues – about 6.5%. In 2013 property taxes declined by 9.2% as a result of decreases in both residential and commercial property valuations after a 2012 reappraisal. The property tax base is slightly concentrated with the top ten taxpayers comprising 14.4% of assessed valuation. The city charter provides that the maximum total tax rate that may be levied without a vote for current operating expenses is 8.35 mills. The city is currently at that limit. The city has no voted tax levies and none are contemplated as income tax revenues are sufficient to support operations.
The city has recorded general fund surpluses after transfers for four consecutive years (2010-2013). In 2013 (year-end Dec. 31), the surplus was $18 million (3.7% of general fund spending) compared to a $20.2 million (4.2% of spending) surplus in 2012. The unrestricted general fund balance at Dec. 31, 2013 totaled a healthy 18.4% of general fund spending compared to 10.7% and 14.8%, respectively in 2011 and 2012. Established by city ordinance, the rainy day fund, which is part of the unassigned general fund, is required to total 2% of general fund expenditures with a goal of 5%. In 2013 the city added $5 million to the rainy day fund, bringing the total to $18.6 million, or about 4% of 2013 general fund expenditures. No additions were budgeted for in 2014 or 2015 but the city expects to reach its 5% goal in three years.
Projected 2014 results (budgetary basis) show continued positive trends with general fund receipts of $515.2 million, $21.4 million above budget. The increase was partially due to non-recurring items including a worker’s compensation refund and land sales. Income taxes were down slightly from the prior year. Expenditures totaled $517 million, $24 million below budget. Ending general fund cash balance was $49.6 million, similar to the prior year. Audited 2014 GAAP financials are not yet available but management projects on a GAAP basis the ending general fund balance will increase by $8 million.
The city practices conservative budgeting and typically budgets use of cash balance, with actual results proving much better. The 2015 general fund budget reduces revenues by 4% and increases expenditures by 4.9%. Income tax receipts are relatively flat. Consistent with prior years, the budget assumes the use of nearly all of the $49.6 million balance carried over from 2014 with a budgeted year end 2015 balance of $1.8 million. Given management’s history of prudent financial management, Fitch expects the 2015 year-end balance to significantly exceed budget with the city continuing to maintain adequate reserve levels.
DIVERSE ECONOMY; WEAK SOCIOECONOMIC PROFILE
As one of Ohio’s largest metropolitan areas, Cleveland benefits from a measure of scale and diversity. Over the last two decades, the city has diversified its economy from dependency on manufacturing towards the more stable education and health care sectors. The Cleveland Clinic is the largest private employer with approximately 31,000 employees, providing stability. Other large employers include University Hospitals of Cleveland (12,719), MetroHealth System (5,396), KeyCorp (4,955) and Case Western Reserve University (4,543).
Despite diversification, and characteristic of an urban population, the city continues to struggle with above average unemployment rates and weak socioeconomic indicators. For December 2014, the city recorded an unemployment rate of 7.8%, higher than the 4.7% and 5.4% for the state and nation, respectively. A drop in the rate from 9.4% in December 2013 was due to employment growth of 1.3% outpacing a small decline of 0.5% in the labor force. City income levels, as measured on a 2013 per capita income basis, are well below state and U.S. levels at 65% and 60%, respectively. The city’s poverty rate remains high at more than double state and national levels.
Assessed valuation declined a moderate 5.2% from 2009 to 2012 but has recorded small increases since 2013. Fitch expects assessed value to remain stable to modestly increasing given the ongoing commercial development and some moderation from high foreclosures. Demolition of distressed properties (there were over 7,857 from 2006-2014) has decreased, but property tax collections continue to be very weak, with a total collection rate of only 89% in 2014. The city’s financial operations are somewhat insulated from assessed value declines and poor collections as only a small portion of general fund revenue is derived from property taxes but they are an indication of economic weakness.
Economic development is a key focus of Cuyahoga County management and the city has benefited from this strategy. The new $465 million convention center/medical mart (renamed the Global Center for Health and Innovation; the “Center”), located in the city, opened in July 2013, enhancing the city’s healthcare sector. The Center hosted 113 events in 2013 and 152 events in 2014, and will host the 2016 Republican National Convention. An adjacent 600-room Hilton hotel is currently being constructed and is set to open in the summer of 2016. Additionally, the first phase (office/residential) of the $272 million Flats East Bank mixed use project located in an industrial area of the city along the Cuyahoga River has opened and is 92% occupied. The 2nd phase (residential/retail/entertainment) will be completed in 2015.
MANAGEABLE DEBT PROFILE
The city’s debt profile is mixed with a moderate $2,255 debt per capita and an elevated 6.28% of market value. Fitch expects debt levels to remain fairly stable as amortization is above-average with 65% of debt retired within ten years. The city is required to use one-ninth of income tax receipts (restricted income taxes) solely for capital improvements or debt service on obligations issued for capital improvements. In 2013, after payment of debt service, approximately $21.9 million was available for capital projects. Currently the city has no capacity to issue GO debt.
The city participates in and continues to make 100% of its annual statutorily required contributions to multiple-employer, cost-sharing state plans to fund both pension and other post-employment benefits. The largest, the Ohio Public Employees Retirement System, reported a funded ratio of 80.9% as of Dec. 31, 2013. Using Fitch’s more conservative 7% rate of return, the estimated funded ratio is 73%. Carrying costs for debt service, pension and OPEB are manageable at 18.5% of government fund expenditures.
Additional information is available at ‘www.fitchratings.com‘
In addition to the sources of information identified in the Tax-Supported Rating Criteria, this action was additionally informed by information from Creditscope, University Financial Associates, S&P/Case-Shiller Home Price Index, IHS Global Insight, Zillow.com National Association of Realtors and Financial Advisor.
Applicable Criteria and Related Research:
–‘Tax-Supported Rating Criteria'(Aug. 14, 2012);
–‘U.S. Local Government Tax-Supported Rating Criteria'(Aug. 14, 2012).
Applicable Criteria and Related Research:
Tax-Supported Rating Criteria
U.S. Local Government Tax-Supported Rating Criteria
Karen Wagner, +1-212-908-0230
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
Brendan Scher, +1-212-908-0686
Amy Laskey, +1-212-908-0568
Elizabeth Fogerty, New York, +1-212-908-0526