--$2.3 million TIFA (development area #2) tax increment revenue and refunding bonds, series 2002.
In addition, Fitch assigns a 'B-' implied ULTGO rating with a Rating Watch Negative to the city of Pontiac.
SECURITY
The bonds are limited obligations of the TIFA payable solely from tax increment revenues collected in the development area. There is a funded debt service reserve to the IRS standard.
KEY RATING DRIVERS
SPECULATIVE GRADE ULTGO RISK FACTORS: The 'B-' implied ULTGO rating reflects the city's poor financial performance, rooted in its lack of revenue-raising flexibility, high fixed cost structure, and weak economic profile. The authority of the state-imposed emergency manager (EM) to rein in certain costs is a credit positive; however, structural budgetary balance remains elusive.
TIF BONDS RELIANT ON CITY SUBSIDY: The 'CCC' rating on the TIFA bonds reflects the city's demonstrated willingness to subsidize debt service on the bonds, whose pledged revenues provide insufficient support, which the city believes it is obligated to continue under the terms of Act 4.
POTENTIAL INFUSION OF RESOURCES: The Rating Watch Negative indicates a likelihood that Fitch will downgrade the ratings absent successful execution of an agreement with Oakland County to monetize the excess capacity at its regional wastewater treatment plant. This transaction would relieve near-term negative pressure on the ratings by providing funds to repay debt and restore, at least temporarily, general fund balance to positive levels.
MINIMAL TAX INCREMENT: Due to severe tax base declines tax increment revenue has dropped to levels far below annual debt service on the TIFA bonds. Further tax base declines are expected.
CONTINUED CITY SUBSIDIZATION: The rating relies solely on the city's continued willingness and ability to subsidize debt service from general resources.
WHAT COULD TRIGGER A RATING ACTION
FAILURE TO COMPLETE PLANNED WASTEWATER TRANSACTION: Should the transaction with the county to monetize excess wastewater treatment capacity not close within the next few months as expected, the ratings will likely be downgraded.
CREDIT PROFILE
INCREMENT INSUFFICIENT TO SUPPORT DEBT SERVICE
Primary support for the bonds is derived from the city's continued willingness to subsidize debt service, given the limited support from pledged revenues. The TIFA #2 base value totals $121.7 million and total taxable value equaled $152.7 million as of fiscal 2012, generating a very low incremental to base value ratio of 20%. Taxable property values decreased 80% in fiscal 2012 from the year prior largely due to a successful General Motors Corporation (GM) tax appeal.
The city projects further tax base declines will completely eliminate the incremental value in the near term. Meaningful tax base recovery is unlikely in the near or medium term, given the depths of the real estate downturn, and the projection of continued tax base erosion for the next several years.
Further thwarting the self-sufficiency of the debt is the passive nature of the tax rate. The aggregate property tax rate within the district is set by the cumulative rates of all the overlapping municipalities and may be adjusted at their sole discretion. Therefore, the city has no direct control over the tax rate.
WEAK TAX COLLECTIONS
Citywide property tax collections have hovered around 75% for the past two years. As with all local entities within Oakland County, the city is made whole via the county revolving delinquent tax fund. There is a charge back to the city after two years for uncollected taxes and the county may decide to terminate the revolving fund at any time.
STATE OVERSIGHT
Fitch believes Pontiac will continue to struggle economically and financially as it works to transition away from its traditionally manufacturing-based roots. Following multiple years of weak financial performance, the state appointed an emergency manager (EM) in March of 2009. The EM is employed by the state to re-establish structural integrity and eliminate the accumulative deficit within 5 years with authority over labor negotiations, hiring, spending, and most other financial concerns. Turnover is a concern, as the city was assigned its third EM in three years, in September 2011. Fitch notes the current EM has used his oversight to implement systemic expenditure changes that are necessary for long term fiscal stability.
Pontiac has demonstrated extremely weak financial performance for most of the past decade. After issuing $21 million deficit bonds in 2006 to reduce its cumulative general fund deficit, the city generated operating deficits for next two subsequent years. While the city generated general fund operating surpluses after transfers for fiscal 2009 and 2010, the fiscal 2010 surplus (1.7% of spending) was achieved with several nonrecurring revenues, and ended the fiscal year with a negative $4.1 million balance (negative 10.1% of spending).
FUNDAMENTAL EXPENDITURE CHANGES
The EM employed extraordinary expenditure reduction methods beginning in fiscal 2011, including outsourcing policing responsibilities to Oakland County, privatizing several governmental functions and dramatically reducing staff. As a result of the expenditure reductions coupled with the omission of certain payments, the city generated a $4.6 million general fund operating surplus after transfers (14% of spending) and ended fiscal 2011 with a $554,732 balance or 2% of expenditures and transfers out. The positive ending general fund balance was the first since fiscal 2002. The operating results were partially achieved by omitting a $4.0 million pension and benefits payment and a $1.9 million property tax refund to General Motors Corporation.
UNCERTAIN FINANCIAL STANDING
The positive general fund position is projected to reverse as several major revenue sources declined considerably in fiscal 2012. Taxable property tax values declined 21% resulting in a projected $3 million reduction in general fund property tax revenues coupled with a $2.1 million (20%) decline in state revenue sharing. Otherwise stated, the city lost $5.1 million or 23% of combined property tax and state aid compared to the year prior. Total general fund revenue declined $5.5 million (13%) for the year.
Despite expenditure reductions enacted by the EM, including the outsourcing of fire protection services to an adjacent township effective February 2012, consolidating 20 healthcare plans into one, and privatizing several additional municipal services, the city projects ending FY12 with an $8.9 million operating deficit, leaving an accumulated general fund deficit of $8.4 million.
The city has made significant strides in limiting operating expenditures. The regionalization and privatization of most municipal services has had or will have multiple benefits including the reduction of absolute cost, suppression of expenditure growth via fixed price contracts, and the elimination of ancillary costs such as liability insurance and litigation costs. Furthermore, the two-thirds reduction in the city's workforce, including the elimination of 118 public safety positions, will materially alter future retirement and OPEB obligations. Despite the progress made, the preliminary fiscal 2013 budget shows recurring expenditures still exceeding recurring revenues by approximately $5.9 million.
ASSET MONETIZATION WOULD RESTORE GENERAL FUND BALANCE
The agreement with Oakland County to monetize the excess capacity of the wastewater treatment plant is expected to generate $55 million for the city. Proceeds will be used to put money aside for water and wastewater system improvements ($5 million), retire revenue debt associated with the system ($5 million), retire the 2006 fiscal stabilization bonds ($16.3 million), retire 2006 tax increment finance authority/building authority bonds ($9.6 million), and to pay the property tax appeal refund due to General Motors ($2 million). The remaining $17.1 million will be deposited in the general fund, restoring the fund balance to a projected positive $4.7 million at the end of fiscal-year (FY) 2013. Absent the wastewater transaction, the general fund balance is projected to sink to a negative $14.3 million, or negative 40% of projected general fund spending.
Fitch believes that the magnitude of this accumulated deficit in combination with the large structural budget gap would be inconsistent with the current rating level. There are no plans to refund or redeem the Fitch-rated TIFA bonds prior to the stated maturity of 2022.
CHALLENGING ECONOMIC PROFILE
Pontiac has been adversely impacted by the decline of the auto industry where, at one point, GM employed 15,000 people and accounted for 25% of aggregate taxable property value. Employment declined to 3,000 after the closure of both its truck and assembly plants in 2009, and taxable value now accounts for less than 5%. While smaller local employers have remained relatively stable, all employment sectors have experienced persistent declines. Citywide unemployment rates have improved from 31% in October of 2009; however, rates are still troublesome at 21.6% in May 2012. The individual poverty rate is almost double the state average, and median household income equals 65% of the state mean. As to be expected with a distressed community, the current property tax collection rate is extremely low at 75%. Oakland County makes the city whole through its delinquent tax revolving fund; however, the city is liable for charge-backs for uncollectible amounts after two years.
MANAGEABLE LONG-TERM OBLIGATIONS
Overall debt levels are moderate, totaling $1,599 per capita and 4.7% of market value. Principal amortization is above average with 68% repaid within 10 years. The city provides pension benefits to its employees through a single-employer defined benefit pension plan. The city made half of its required contribution in FY 2010, and none of the FY 2011 or FY 2012 amounts. Both plans are currently over-funded. The city also provides OPEB benefits, which the city currently funds on a pay-as-you-go basis. As of June 2010, the OPEB unfunded actuarial accrued liability totaled $306 million or a high 15% of market value.
For additional information, see 'Fitch Affirms Pontiac, MI's Water and Sewer Revs at 'B-'; Outlook Revised to Stable' July 11, 2012.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
In addition to the sources of information identified in Fitch's 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, National Association of Realtors.
Applicable Criteria and Related Research:
--'Tax-Supported Rating Criteria' (Aug. 15, 2011);
--'U.S. Local Government Tax-Supported Rating Criteria' (Aug. 15, 2011).
Applicable Criteria and Related Research:
Tax-Supported Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=648898
U.S. Local Government Tax-Supported Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=648842
ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE '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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