Summary: Bay City, Michigan; General Obligation Primary Credit Analyst: Benjamin D Gallovic, Chicago (312) 233-7070; benjamin.gallovic@standardandpoors.com Secondary Contact: Helen Samuelson, Chicago (1) 312-233-7011; helen.samuelson@standardandpoors.com Table Of Contents Rationale Outlook Related Criteria And Research WWW.STANDARDANDPOORS.COM/RATINGSDIRECT SEPTEMBER 9, 2015 1
Summary: Bay City, Michigan; General Obligation Credit Profile US$6.63 mil 2015 cap imp & rfdg bnds (ltd tax GO) due 10/01/2025 Long Term Rating A+/Negative New Rationale Standard & Poor's Ratings Services revised its outlook to negative from stable and affirmed its 'A+' long-term rating and underlying rating (SPUR) on Bay City, Mich.'s general obligation (GO) bonds based on our view of the city's elevated debt service, pension, and other-post employment benefit (OPEB) costs, which are approaching 50% of the city's total governmental fund expenditures, and which we believe could continue to put pressure on the city's budget. At the same time, we assigned our 'A+' long-term rating to the city's series 2015 limited-tax GO capital improvement and refunding bonds. The city's limited-tax full faith and credit GO pledge secures the series 2015 bonds. Despite that the city is at the legal tax limit, we believe it possesses the financial stability necessary to sustain ratings on the limited-tax bonds equal to an unlimited-tax pledge. Officials will use bond proceeds to finance various capital improvements in its Downtown Development Authority district, as well as to current refund the city's series 2004 and 2005 limited-tax GO bonds for interest cost savings. Two of the city's bond issues that we rate have multiple revenue pledges. A pledge of the city's limited-tax GO ultimately secures its series 2013 and 2014 tax increment bonds. The city is also pledging tax increment revenue, but we rate the bonds based on the GO pledge, which we view as the stronger pledge. The 'A+' rating reflects our assessment of the following factors for the city, specifically its: Very weak economy, with projected per capita effective buying income (EBI) at 71.6% of the national level and market value per capita of $33,734; Strong management, with "good" financial policies and practices under our Financial Management Assessment (FMA) methodology; Strong budgetary performance, with operating results that we expect could improve in the near term relative to fiscal 2014, which closed with an operating deficit in the general fund but a slight operating surplus at the total governmental fund level; Strong budgetary flexibility, with an available fund balance that we expect will decrease in the near term from its fiscal 2014 level of 16% of operating expenditures; Very strong liquidity, with total government available cash of 144.0% of total governmental fund expenditures and 16.6x governmental debt service, and access to external liquidity we consider strong; Very weak debt and contingent liability position, with debt service carrying charges of 8.7% of expenditures and net direct debt that is 102.0% of total governmental fund revenue, as well as a large pension and OPEB liability; and Strong institutional framework score. WWW.STANDARDANDPOORS.COM/RATINGSDIRECT SEPTEMBER 9, 2015 2
Very weak economy We consider Bay City's economy very weak. The city, with an estimated population of 34,191, is located in Bay County. The city has a projected per capita EBI of 71.6% of the national level and per capita market value of $33,734. Overall, the city's market value grew by 1.5% over the past year to $1.2 billion in 2016. The county unemployment rate was 7.1% in 2014. Bay City, the seat of Bay County, is on Saginaw Bay, with frontage property along the Saginaw River. The largest employers in the city include the area hospital with 1,960 employees, the Bay City Public Schools (956), the county (526), and a General Motors Powertrain facility (365). According to management, local employers have been stable in the past year. Management also reports that the city continues to undergo development in its downtown area, including Uptown Bay City, a mixed-use project along the Saginaw River. Based on this new development as well as general economic recovery within the city, we anticipate that market value will remain stable. Strong management We view the city's management as strong, with "good" financial policies and practices under our FMA methodology, indicating financial practices exist in most areas, but that governance officials might not formalize or monitor all of them on a regular basis. Management uses historical data when formulating revenue and expenditure assumptions. The city commission receives a monthly financial report with budget-to-actual results, and the budget can be amended as needed. The city does not engage in formal long-term financial forecasting. However, the city does maintain a six-year rolling capital improvement plan, which identifies cost estimates and funding sources. The city has its own investment policy, and reports investment holdings monthly to the commission. The city lacks a formal debt policy, but has a formal reserve policy to maintain the general fund balance at 15% of expenditures, which is based on cash flow and contingency needs. The policy also contains a replenishment requirement. The city was in compliance with the policy as of the end of fiscal 2014. Strong budgetary performance Bay City's budgetary performance is strong in our opinion. The city had deficit operating results in the general fund of 4.4% of expenditures, but a slight surplus result across all governmental funds of 1.2% in fiscal 2014. Our assessment accounts for our anticipation that budgetary results could improve from 2014 results in the near term. The 1.2% surplus across total governmental funds accounts for our removal of $910,000 in one-time expenditures related to the renovation of city hall, which was damaged by a fire in 2010. We also removed a one-time $386,000 transfer from the general fund to the public improvement fund, which was intended to cover costs for the city hall renovation. The city's general fund has been pressured in recent years as a result of reduction in property tax and state shared revenue, the city's two main revenue sources, as well as increases in pension and OPEB costs. In an effort to counteract these changes, the city has taken various actions, including eliminating positions, merging the police and fire departments, and reallocating indirect, pension, and OPEB costs among other funds. In our opinion, these adjustments should result in an improvement in the city's budgetary performance. WWW.STANDARDANDPOORS.COM/RATINGSDIRECT SEPTEMBER 9, 2015 3
Following several years of one-time training costs related to the consolidation of the police and fire departments, the city realized full savings from this merger, in the amount of $1.5 million, starting in fiscal 2015. The city's last amended budget for 2015 (ended June 30) depicted a $297,000 deficit in the general fund, but this was all due to another transfer to the public improvement fund for city hall restoration costs. Without this transfer, the budget would have been balanced. According to management, the city likely ended the year on target with the budget. Officials also expect to report break-even results across total governmental funds. The city's fiscal 2016 budget reflects another year of balanced operations in the general fund. The city expects to post a deficit across total governmental funds, but as a result of spending down reserves in the major and local streets funds for road projects. Therefore we don't view the projected deficit as structural deterioration. Based on stabilization in property tax and state shared revenue, as well as recent expenditure reductions, we anticipate that the city will maintain strong budgetary performance in fiscal 2017. Strong budgetary flexibility Bay City's budgetary flexibility is strong, in our view, with an available fund balance that we expect will decrease in the near term from its fiscal 2014 level of $3.16 million in total committed fund balance, with $296,923 earmarked for city hall restoration projects, leaving $2.8 million, or roughly 16% of fiscal 2014 expenditures. The city's available general fund balance is classified as "committed" for future general fund operations, to comply with the city's formal policy to maintain a minimum general fund balance equal to 15% of expenditures. The city budgeted the use of the $296,923 in fiscal 2015. According to management, the actual result may be better than budgeted. The city's 2016 budget is balanced without the use of reserves, so we anticipate that the city will maintain at least strong budgetary flexibility. Very strong liquidity In our opinion, Bay City's liquidity is very strong, with total government available cash of 144.0% of total governmental fund expenditures and 16.6x governmental debt service in 2014. In our view, the city has strong access to external liquidity if necessary. The city had $42.4 million in available cash and equivalents at the end of 2014. We believe the city has strong access to external liquidity, because it has issued various types of debt over the past 20 years. Based on management's projections, we believe the city will maintain very strong liquidity during the next two years. Management has confirmed that the city has no contingent liquidity risks from financial instruments with payment provisions that change on certain events. Very weak debt and contingent liability profile In our view, Bay City's debt and contingent liability profile is very weak. Total governmental fund debt service is 8.7% of total governmental fund expenditures, and net direct debt is 102.0% of total governmental fund revenue. Approximately $35 million of the city's GO-backed debt is self-supporting with revenue from the city's water and sewer funds, and therefore is not included in the city's net debt. It is our understanding that the city does not plan to issue additional debt during the next several years. The city has a loan with the U.S. Department of Housing and Urban Development in the amount of $1.6 million. It is a WWW.STANDARDANDPOORS.COM/RATINGSDIRECT SEPTEMBER 9, 2015 4
fixed-rate loan, though the interest rates may vary from year to year. This represents only 5.2% of the city's net direct debt, so we do not view it as significant exposure to interest rate risk. In our opinion, Bay City's large pension and OPEB liability is a credit weakness. Bay City's combined pension and OPEB contributions totaled 34.4% of total governmental fund expenditures in 2014, with 15.4% representing contributions to pension obligations and 19.0% representing OPEB payments. The city made 124% of its pension annual required contribution (ARC) in 2014. The pension funded ratio is 68.5%. The city participates in two defined benefit pension plans, the largest of which is a multi-employer defined benefit plan administered by the Michigan Municipal Employees retirement System (MERS). In 2014, the city made its required contribution of $2.7 million and an additional contribution of $1.1 million to this plan. As of Dec. 31, 2013, the plan was 68.5% funded. Bay City also provides a single-employer defined benefit pension plan for police officers and firefighters. In 2014, the city made its annually required contribution of $1.8 million. As of June 30, 2014, the plan was 84.3% funded. Bay City also provides OPEB to city retirees who meet eligibility requirements through a single-employer defined benefit plan administered by the city. The city contributed $5.6 million to this plan for the year ended June 30, 2014. As of that date, the plan was 10.8% funded. Despite the large pension and OPEB obligation, we believe management has taken adequate steps to address the obligations. First, the city created a single-employer defined contribution pension plan, which is administered by MERS, for employees hired after 1997 (excluding police officers and firefighters). Given the predictable nature of these costs, we do not believe contributions to this plan will cause budgetary stress. In addition, the MERS defined benefit plan has been closed to new hires since 2000, and the city continues to overfund the ARC in an effort to improve the funded ratio. Finally, the city has made changes to its OPEB plan, including implementing a high-deductible health savings account for new hires as well as shifting more of the contributions to funds outside the general fund, including the city's enterprise funds. Through these changes, management anticipates that pension and OPEB costs will not significantly increase in future years. Although management has taken steps to manage pension and OPEB costs within its budget, we still view the city's total debt service, pension, and OPEB obligation as an ongoing credit concern given the relative size of these fixed costs compared with the city's budget. In 2014, the combined total governmental fund debt service, pension ARC, and OPEB contributions equated to 43.1% of total governmental fund expenditures, representing a 5.7 percentage point increase from 2013. Given the growing trend, we believe these fixed costs could continue to put pressure on the city's budget. If management is unable to contain future increases, and if annual costs reach a level exceeding 50% of expenditures, we would likely lower the rating. Strong institutional framework The institutional framework score for Michigan municipalities with a population of 4,000 to 600,000 is strong. Outlook The negative outlook reflects our view that the city's budget could continue to experience pressure given elevated debt service, pension, and OPEB costs, which are approaching 50% of expenditures. If these annual fixed costs continue to WWW.STANDARDANDPOORS.COM/RATINGSDIRECT SEPTEMBER 9, 2015 5
rise and, in our opinion, stress the budget, we would likely lower the rating. Conversely, if management's recent actions to control pension and OPEB costs are sufficient to stabilize or lower these annual costs, allowing the city to maintain balanced operations, we could revise the outlook to stable. Related Criteria And Research Related Criteria USPF Criteria: Local Government GO Ratings Methodology And Assumptions, Sept. 12, 2013 USPF Criteria: Financial Management Assessment, June 27, 2006 USPF Criteria: Debt Statement Analysis, Aug. 22, 2006 USPF Criteria: Limited-Tax GO Debt, Jan. 10, 2002 USPF Criteria: Methodology: Rating Approach To Obligations With Multiple Revenue Streams, Nov. 29, 2011 USPF Criteria: Assigning Issue Credit Ratings Of Operating Entities, May 20, 2015 Criteria: Use of CreditWatch And Outlooks, Sept. 14, 2009 Related Research S&P Public Finance Local GO Criteria: How We Adjust Data For Analytic Consistency, Sept. 12, 2013 Institutional Framework Overview: Michigan Local Governments Ratings Detail (As Of September 9, 2015) Bay City GO unltd tax st imp bnds ser 1991 due 06/01/1999-2016 2021 Unenhanced Rating A+(SPUR)/Negative Outlook Revised Bay City GO Unenhanced Rating A+(SPUR)/Negative Outlook Revised Bay City Brownfield Redev Auth, Michigan Bay City, Michigan Bay City Brownfield Redev Auth (Bay City) tax incre (BAM) Unenhanced Rating A+(SPUR)/Negative Outlook Revised Many issues are enhanced by bond insurance. Complete ratings information is available to subscribers of RatingsDirect at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column. WWW.STANDARDANDPOORS.COM/RATINGSDIRECT SEPTEMBER 9, 2015 6
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