Fitch Ratings has assigned a ‘AA-‘ rating to the following city of Milwaukee, WI obligations:
–$120 million general obligation refunding promissory notes, series 2020 R9.
The Rating Outlook is Negative.
Proceeds of the notes will be used to refund the $120 million outstanding principal amount of the tax-exempt general obligation promissory notes, series 2020 R3, which were issued to finance fiscal requirements of the city. The city expects to take advantage of current low interest rates to fix out the short-term notes over a ten-year period and reduce annual cash flow borrowing needs going forward. The obligations will be sold via competitive sale on Oct. 29, 2020.
SECURITY
The notes are general obligations of the city, payable from taxes levied on all taxable property within the city, without rate or amount limitations.
ANALYTICAL CONCLUSION
The ‘AA-‘ rating reflects the city’s moderate long-term liability burden, stagnant revenue growth prospects, and adequate expenditure flexibility. The rating also reflects the city’s very strong financial resilience, although this has eroded over the past several years. Fitch believes the city’s financial flexibility is bolstered by the public debt-amortization fund (PDAF) that mitigates to a degree the impact of the recent draws on reserves. The Negative Outlook is due to the low available reserve levels incorporating the PDAF, and the continued appropriation of a portion of the city’s tax-stabilization fund for operations, albeit at smaller levels than recent years. The inability to implement a plan to rebuild reserves once recovery from the pandemic-related recession takes hold may result in a downgrade.
ECONOMIC RESOURCE BASE
Milwaukee serves as the economic engine for the surrounding region and has a diverse economic and employment base. However, wealth levels are generally below average and a relatively large proportion of the population is below the poverty level. The local economy maintains a reduced but still above-average reliance on manufacturing that in the past created vulnerabilities to recessionary employment shifts. The city’s population has been stagnant since the 2010 census and the labor force steadily declined over the past five years.
KEY RATING DRIVERS
REVENUE FRAMEWORK:
Fitch expects the city’s two largest sources of revenue, state aid and property taxes, to remain stagnant or grow below the level of inflation. The city’s independent legal ability to raise revenues is constrained by state law. The vulnerability to state fiscal conditions is offset to a degree by the city’s ability to independently increase non-tax revenue sources.
EXPENDITURE FRAMEWORK:
Fitch believes the city’s flexibility of main expenditure items is adequate. Carrying costs for long-term liabilities claim a large and growing percentage of the governmental fund spending given the expectation for increasing pension contributions. The city operates within a fairly flexible labor environment. On average, the natural pace of spending growth is likely to be above that of revenue growth over time.
LONG-TERM LIABILITY BURDEN:
Milwaukee’s long-term liabilities are a moderate burden on the city’s resource base. The city participates in a well-funded pension plan. Future capital needs are manageable and debt is rapidly repaid.
OPERATING PERFORMANCE:
While the stability of the city’s revenue streams makes the city’s finances less vulnerable to decline in economic downturns, the city has been drawing on reserves to fund operations for the last three years, reducing its financial resilience cushion. The availability of the PDAF only partially offsets this concern.
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade:
–Implementation of a plan to rebuild reserves could lead to a revision of the Outlook to Stable;
–A fundamental improvement in the city’s economy that notably improves growth prospects for revenues;
–While unlikely in the medium term, a sustained increase in available general fund reserve levels providing what Fitch considers improved financial flexibility.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
–Failure by the city to stabilize and subsequently begin to bolster its reserve levels in the next fiscal year;
–A lowering of the city’s Issuer Default Rating (IDR) below ‘AA-‘ could result in a downgrade to the RAN rating if coverage of principal is not consistent with the current ‘F1+’ rating.
BEST/WORST CASE RATING SCENARIO
International scale credit ratings of Sovereigns, Public Finance and Infrastructure issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of three notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from ‘AAA’ to ‘D’. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit [https://www.fitchratings.com/site/re/10111579].
CURRENT DEVELOPMENTS
Sectorwide Coronavirus Implications
The ongoing coronavirus pandemic and related government containment measures have created an uncertain environment for U.S. state and local governments and related entities. Our ratings are forward-looking in nature; as such, Fitch will monitor the severity and duration of the budgetary impact on state and local governments and incorporate revised expectations for future performance and assessment of key risks.
While the initial phase of economic recovery has been faster than expected, GDP in the U.S. is projected to remain below its 4Q19 level until at least 4Q21. In its baseline scenario, Fitch assumes continued strong GDP growth in 3Q20 followed by a slower recovery trajectory from 4Q20 onward amid persisting social distancing behavior and restrictions, high unemployment and a further pullback in private-sector investment.
Additional details, including key assumptions and implications of the baseline scenario and a downside scenario, are described in the report entitled, “Fitch Ratings Coronavirus Scenarios: Baseline and Downside Cases — Update” (https://www.fitchratings.com/research/sovereigns/fitch-ratings-coronavirus-scenarios-baseline-downside-cases-update-08-09-2020), published Sept. 8, 2020 on www.fitchratings.com.
Milwaukee Coronavirus Impact
The city projects a $30 million (around 4% of general fund revenues) shortfall in fiscal 2020 (Dec. 31 fiscal year end) across a variety of its revenue streams, including charges for services, parking meters, and fees for permits and inspections. In response, the city has taken several steps to balance the budget, including furloughs, moving some eligible expenses in health care and public safety to be funded by Coronavirus Aid, Relief, and Economic Security (CARES) Act funding, and holding some positions vacant. While these actions may enable management to fill potential revenue shortfalls, the city may not be able to replenish the entire $10 million appropriation of the tax-stabilization fund, which is part of the general fund. At this time, the city does not expect a mid-year cut in state shared revenue.
The city entered the fiscal 2021 budgeting process with a $60 million budget gap. Management has balanced the proposed budget through a combination of expenditure reductions and revenue enhancements. These include 120 police officer positions eliminated through attrition ($8.5 million in savings), one fire station eliminated ($1.9 million), a new fee for street lighting (10.5 million), an increase in the vehicle registration fee ($3.2 million), and an increase in the tax levy by 2.8% ($8.2 million). The city also has proposed appropriating $6.5 million of its tax stabilization fund, lower than the $10 million in fiscal 2020.
CREDIT PROFILE
Milwaukee is the largest city in the state of Wisconsin, encompassing a 97-square mile area located adjacent to Lake Michigan, 90 miles north of Chicago. The city’s population of around 590,000 has slightly declined since the 2010 census.
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REVENUE FRAMEWORK
The city remains dependent on state shared revenue for approximately 40% of its general fund revenues, making its finances somewhat vulnerable to the state’s fiscal condition (Wisconsin’s IDR is AA+/Stable). The city’s second-largest source of revenue is its property tax at about 31%.
The historical rate-adjusted revenue growth trend has been positive on a nominal basis, but has not kept pace with inflation. Milwaukee is a well-developed urban center, so expectations for future growth are largely redevelopment-related. While continued revenue growth below the rate of inflation can be expected, the revenue stream has not demonstrated particularly vulnerability to decline in previous economic downturns. Management does not expect that stated shared revenue will be cut mid-year in fiscal 2020.
Wisconsin municipalities are subject to statutory property tax revenue-raising limitations, which generally allow for growth in the operating levy only for net new construction added to the tax base. The city maintains a modest margin beneath its limit and retains the ability to raise fees and charges. These amounts are sufficient to address the potential revenue decline in a typical recession identified in Fitch’s Analytical Stress Test (FAST) model.
EXPENDITURE FRAMEWORK
Public safety is the city’s largest responsibility at 42% of total spending, followed by general government at 39% and public works at around 14% of 2019 general fund spending.
The pace of spending growth, absent policy actions, is likely to be moderately above growth in revenues, given the expected slow-growth environment for revenue and inflationary expenditure pressures. The city had relatively large unexpected medical costs in its self-insured health care fund in both 2018 and 2019, which led to consecutive draws on reserves. While these unanticipated costs are unlikely to be repeated on a regular basis, their occurrence illustrates the city’s narrow operating environment, with stagnant revenue growth limiting the margin for expenditure increases. Management reports that 2020 medical costs are tracking under budget, largely due to employees opting not to undertake elective medical procedures.
Milwaukee’s expenditure flexibility is adequate. The 2011 Wisconsin Act 10 enhances the city’s ability to control spending by restricting collective bargaining rights of public employees and granting public employers significant flexibility over labor costs for nonpublic safety workers. Carrying costs are elevated at around 27% of governmental expenditures. While Fitch views positively the reduction in the investment rate of return for the city’s pension plan to 7.5% from 8.0%, effective in 2023, resulting increased annual contributions will claim a growing portion of overall spending.
LONG-TERM LIABILITY BURDEN
The combined debt and pension burden is moderate at around 16% of personal income and is composed primarily of the city’s Fitch-adjusted net pension liability (60% of the total) followed by direct debt (23%). Amortization is rapid, with around 91% of principal retired in 10 years, and the city has manageable capital needs and debt plans. The PDAF has a balance of around $49 million, or around 5% of outstanding debt in 2019, which is governed by state statute and the city commission. It is funded from a portion of the city’s interest earnings. The city may use up to 40% of the balance to retire debt each year, but typically appropriates an amount approximating investment earnings for this purpose. Fitch does not consider the PDAF as an offset to the city’s long-term liability burden.
The city participates in the Employees’ Retirement System of the City of Milwaukee, which in 2019 had a ratio of assets to liabilities of 66% when adjusted by Fitch to reflect a 6% investment rate of return. The recently approved decrease in the investment rate of return will increase the reported liabilities, but should not materially affect the Fitch-adjusted metric. The city also records a fairly large other post-employment benefit (OPEB) liability equal to around 6% of personal income.
OPERATING PERFORMANCE
Milwaukee’s revenue history has generally been stable, but the city operates under a framework that inhibits its ability to accumulate general fund reserves. All operating surpluses are required to be reserved and budgeted for use in future fiscal years. The city experiences net operating deficits in years when officials appropriate larger amounts of prior-year surpluses. After consecutive moderate operating deficits in 2016 and 2017, the city had larger than expected operating deficits and draws on reserves in both 2018 and 2019 due to the unexpected medical costs and a lag in some of its fee collections.
Fitch considers the city’s PDAF as a source of additional financial flexibility, with the city essentially able to transfer up to approximately $40 million of notes to the general fund for operating purposes. The city would have to issue notes that could then be purchased by the PDAF as an investment and canceled by the city commissioners. Given the reliability and stability of the revenue stream, the city’s midrange level of budgetary flexibility, and the additional flexibility provided by the PDAF, Fitch expects the city’s gap-closing capacity to continue to be very strong despite recent draws. However, failure to begin to implement a plan to bolster available general fund reserves once the economic recovery begins could lead to a rating downgrade.
The decline in reserves over the past four years has left the city more vulnerable in the current economic downturn. The city typically appropriates a portion of its tax stabilization fund (TSF), which is part of the general fund, to the operating budget. The city lowered its TSF appropriation to $10 million in its 2020 budget from the $16 million it appropriated in the 2019 budget and $19 million in 2018. Management expects to appropriate a smaller $6.5 million in fiscal 2021 and to eliminate the appropriation after that. The balance in the TSF at the beginning of fiscal 2020 was around $24 million and would be only about $8 million at the end of fiscal 2021 if appropriated amounts are used as planned.
DATE OF RELEVANT COMMITTEE
08 September 2020
In addition to the sources of information identified in Fitch’s applicable criteria specified below, this action was informed by information from Lumesis.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG CONSIDERATIONS
Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of ‘3’. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch’s ESG Relevance Scores, visit www.fitchratings.com/esg.
