Fitch Rates Naugatuck, CT's GO Bonds 'AA'; Outlook Stable
--$8,000,000 general obligation (GO) bonds issue of 2016.
In addition, Fitch affirms the following ratings at 'AA':
--$48.2 million outstanding GO bonds;
--Issuer Default Rating (IDR).
The Rating Outlook is Stable.
The bonds are expected to be sold via competitive sale on October 13. Proceeds will be used to refund bond anticipation notes issued earlier in the calendar year.
SECURITY
The bonds are general obligations of the borough and are payable from the borough's full faith and credit and unlimited taxing authority.
KEY RATING DRIVERS
The 'AA' GO and IDR ratings reflect the borough's high level of financial resilience underscored by a combination of available reserves, revenue-raising authority, and expenditure flexibility that position it to withstand the challenges associated with a moderate economic downturn.
Economic Resource Base
Naugatuck encompasses a land area of 16.2 square miles in east central Connecticut along state route 8, approximately five miles south of Waterbury and within 35 miles of New Haven, Bridgeport, and Hartford. The borough's 2015 population is estimated at 31,538 and largely unchanged from the 1990 Census figure of 30,625.
Revenue Framework: 'aa' factor assessment
Ten-year general fund revenue growth has been strong but reflects consistent increases in the real property tax rate, as the pace of tax base expansion has been more moderate. Absent similar policy action Fitch would expect revenues to perform near the level of inflation.
Expenditure Framework: 'aa' factor assessment
Expenditure growth is expected to be in line with to marginally above revenue growth. Moderate carrying costs and yearly pay-go spending for capital provides solid expenditure flexibility.
Long-Term Liability Burden: 'aa' factor assessment
The combined long-term liability burden of debt and pension liabilities is moderate at roughly 10% of personal income. Limited additional debt plans and an average pace of outstanding debt amortization are expected to keep the liability burden stable.
Operating Performance: 'aaa' factor assessment
The borough consistently generated surplus operating results during the recession and subsequent economic recovery. Fitch believes the borough will manage an economic downturn with a combination of revenue raising, expenditure control, and moderate use of fund balance within prescribed policy limits, if necessary.
RATING SENSITIVITIES
Improved Revenue Performance: Continued expansion and diversification of the local economy supporting higher levels of natural revenue growth could lead to stronger credit quality.
Management Practices: The GO and IDR rating assume the borough will continue to demonstrate sound management practices; actions contrary to this expectation that weaken its long-term operating profile could pressure the rating.
CREDIT PROFILE
Naugatuck is a fairly mature community of roughly 31, 000 with average income characteristics relative to the national standard but somewhat below Connecticut norms. The borough's tax base reflects a good mix of residential (68%) and commercial/industrial (15%) properties, and there is no concentration among top 10 taxpayers. Leading industries represented among the largest taxpayers include utilities (CT Light & Power Co., CT Water Co., and Yankee Gas), retail (Wal-Mart) and health care (Genesis Health Ventures and Beacon Brook Health Center). There is some new construction activity evident including a hospital, retail, and expansion of the industrial park. Management expects to see gains in the upcoming revaluation, driven by new construction, significant renovations and upgrades to local facilities.
Revenue Framework
Property taxes are the main source of revenue for the borough making up nearly 62% of general fund revenues. State municipal aid accounts for the bulk of remaining general fund sources and is subject to periods of volatility linked to state budgetary pressures and policy action.
The city's tax base has grown at a pace of less than 2% for the 10-year period ending fiscal 2014. The most recent revaluation (effective fiscal 2014) reflected a 23% drop linked to post-recessionary housing and commercial property value decline. In the years following, the grand list has shown modest growth and the 2015 grand list (effective fiscal 2017) grew 1.7% over the year prior. Zillow forecasts home values to increase 1.9% in the next year. Fitch does not expect near-term tax base growth to outpace inflation but rather continue to expand at a pace consistent with historical levels.
The borough has independent legal ability to raise taxes without limit.
Expenditure Framework
The bulk of the borough's spending is related to education (56.5% of general fund expenditures) followed by public safety (9.3%). The borough is responsible for the provision of public education, the cost of which is funded by a combination of local contributions and state aid.
Fitch expects the natural pace of spending growth to match or marginally exceed revenue growth. The largely built-out community has shown population stability and there are few service demand pressures.
The borough maintains a solid level of expenditure flexibility. Carrying costs for debt service, pension and OPEB are moderate at 14% of fiscal 2015 governmental fund spending. Management has the legal ability to reduce non-public safety staff at any time if necessary. Union contracts are subject to arbitration but a decision may be rejected by a two-thirds vote by city council. A new arbitration panel would then be appointed by the state and their subsequent decisions are required to take into consideration the financial capability of the employer.
State legislation was passed last year imposing a 2.5% cap on local governments' general spending growth budgets beginning in fiscal 2018. The cap limits annual increases to 2.5% over the spending level for the previous fiscal year, or the rate of inflation, whichever is greater. The cap excludes expenditures for debt service, special education, court orders and arbitration awards. There is an exception for major disasters provided there is a presidential or gubernatorial declaration of emergency. Towns and cities that increase their general budget expenditures over the previous fiscal year by an amount that exceeds this cap receive a reduced municipal revenue sharing grant. The reduction is equal to 50 cents for every dollar the local government spends over the cap. Management expects to be able to keep expenditure growth within this cap based upon recent years' performance.
Long-Term Liability Burden
The combined long-term liability burden of debt and pension liabilities is estimated at 10% of personal income. Borough direct debt is the main driver of this metric. Fitch believes the borough's direct debt will remain fairly stable due to an average pace of principal amortization (53% within 10 years) and moderate additional capital needs and borrowing plans. The borough's only near-term borrowing plans are for approximately $8.5 million of debt related to incinerator upgrades during fiscal 2017.
The borough maintains three separate pension plans for general employees, police and fire. The borough's Fitch-adjusted net pension liability of $41.8 million is equivalent to 2.8% of personal income. The borough contributes above the ARC on all three plans. The pension plans are closed to new hires. The borough contributes modestly to an OPEB trust but mostly funds liabilities through pay-go. The borough's net OPEB liability is estimated at close to $140 million or a high 6.3% of market value. Fitch views OPEB liabilities as more flexible in many cases. Recently negotiated contracts increase health care contributions for members and should moderate this liability going forward.
Operating Performance
Fitch believes the borough is well-positioned to manage financial operations through an economic downturn. The borough's unlimited revenue-raising ability and solid expenditure flexibility provide it with exceptional gap-closing ability. Fitch expects the borough to manage fund balance in accordance with their policy (8% - 12% of general fund spending) which is sufficient for a 'aaa' level of financial resiliency considering low revenue volatility and managerial control.
The borough has prudently managed their budget through economic recovery, adding to fund balance in nearly every year. Fiscal 2016 will see a $2.6 million reduction in fund balance with over half relating to pay-go capital spending. An additional $1.2 million is a result of lost revenue from a now-settled dispute with Veolia Water North America (Veolia) regarding non-compliance at the borough's incinerator. The upcoming debt issuance will remedy the compliance issue. The settlement with Veolia will enable the borough to again begin receiving rent and profit-sharing payments from Veolia.
The fiscal 2017 budget includes a $3.3 million decrease in fund balance. A total of $1.7 million in fund balance use was dedicated for non-recurring capital expenses. The borough anticipates being able to offset the remainder of the budgeted draw from revenue received as part of the settlement with Veolia.
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