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REVENUE DEBT Global Credit Research - 04 Dec 2009
SENIOR AND SUBORDINATE RATINGS APPLY TO $19.6 MILLION AND $541.2 MILLION OF OUTSTANDING PARITY DEBT, RESPECTIVELY County OH Opinion NEW YORK, Dec 4, 2009 -- Moody's has affirmed a Aa3 rating on Hamilton County's (OH) $19.6 million of outstanding Sales Tax Revenue Bonds (Senior Lien) and an A2 rating on the County's $541.2 million of Subordinate Sales Tax Revenue Bonds. The high grade Aa3 rating on senior lien bonds (Series 1998A), reflects extremely strong debt service coverage that is expected throughout the life of the bonds and A2 rating on the subordinate lien bonds reflects the narrower, yet still satisfactory projected coverage of both senior and subordinate obligations combined. Both ratings are based on strong legal protections, including direct flow of funds to the senior and subordinate trustees for bond repayment and a satisfactory additional bonds test, offsetting the challenges posed by lagging sales tax revenue growth trends. All outstanding senior and subordinate lien bonds are secured by a pledge of gross sales tax revenues generated by a 1/2% sales tax approved by voters in 1996. No additional parity debt is expected to be issued at this time. SALES TAX REVENUE BONDS SUPPORTED BY HALF CENT SALES TAX Moody's believes that the county's sales tax revenues, which have stagnated in the current decade and are declining due to the recession, will continue to face challenges as regional retail growth is increasingly located in the suburban counties. Moody's believes that the county's tax base, anchored by the City of Cincinnati (general obligation rated Aa1/stable outlook) and benefiting from several corporate employers as well as higher education and government, will grow steadily over the long term. However, Moody's does not anticipate sales tax growth to return to historic levels, based on changing growth patterns and redevelopment challenges in the downtown core, which should continue to pressure county revenue growth. The Cincinnati region has exhibited the impacts of the recent downturn, with unemployment increasing to 8.9% as of September 2009, which is still lower than the state and US for the same period (9.7% and 9.5%, respectively). Resident incomes exceed state levels, with median family and per capita income at 107% and 115% of the state and a healthy full value per capita exceeding $73,000. Prior to 2000, sales tax growth trends were extremely strong, averaging 7.4% annually in the preceding three decades, compared to a 1.4% average annual growth rate since 1998. With the impact of the recession, FY2008 collections declined by 1.3%, followed by a sizeable 6.9% decline projected for FY2009. The county has revised projections accordingly and is planning ahead for escalating annual debt service, assuming a 3.4% additional decline for FY2010, and no growth thereafter. On March 19, 1996, 61% of Hamilton County voters approved an increase to 1% from 0.5% in the county permissive sales tax to provide funding for the construction of two new stadiums for the area's two professional sports franchises - the Cincinnati Bengals and Cincinnati Reds. The resultant total county sales tax rate is 6 1/2%, reflecting revenues going to both the county and state. According to a resolution passed by the county, the commissioners intend to use 70% of the augmented sales tax revenues to fund the aforementioned projects and use the remaining 30% to provide local property tax relief. Despite this plan, should sales tax revenues fall below expected levels, bond holders will have priority over other competing needs (reflecting the gross pledge). The approved sales tax may also be used for other purposes, including additional riverfront-related capital projects and early retirement of sales tax debt. In addition to applying 30% of the sales tax to a property tax roll back, the county has also entered into contractual agreements that are to be funded with sales tax revenues. COVERAGE LEVELS HIGH FOR SENIOR LIEN BONDS, AND ADEQUATE FOR TOTAL MADS
Notwithstanding the non-debt service expenditure pressure on the ½% dedicated sales tax, Moody's believes that total debt service coverage, including senior and subordinate debt will remain healthy, exceeding two times over the near term, but may decrease if current sales tax decline trends continue. Conservatively assuming no growth in sales tax from FY2009 collections over the next 25 years, coverage would drop to a narrow 1.05 times when maximum annual debt service is reached in 2027. Debt service does increase over time, scheduled to match an assumed 3% annual growth rate in sales tax revenues. Projected senior debt service coverage is much stronger, at a stable 65 times from FY2010, with debt service remaining a level $935,000 through FY2023, and then dropping to approximately 11 times for the remaining four years of debt service. Moody's Aa3 rating on the senior lien bonds incorporates these coverage levels but also factors in the county's commitment, as provided in the Subordinate Indenture, to not issue any additional debt nor extend the maturity of outstanding senior lien bonds. Moody's A2 rating on the subordinate lien bonds reflects not only the lower coverage levels on the subordinate debt, relative to the senior lien, but also the ability of the county to issue additional debt under the 1.15 times additional bonds test under the Subordinate Indenture. While current collection trends do not allow for additional leveraging of the 1/2% sales tax, the county continues to explore development opportunities and could utilize the sales tax if collections were to improve significantly going forward. STRONG LEGAL PROVISIONS INCLUDE DIRECT TRUSTEE RECEIPT OF COLLECTED REVENUES AND FUNDING OF DEBT SERVICE PRIOR TO ADDITIONAL OBLIGATIONS Moody's believes that the legal provisions laid out by the indentures are critical to the strength of both securities, particularly given the unexpected lagging of growth trends in the pledged revenue, and the additional expenditures to which the county has dedicated, but not pledged, these revenues. The 0.5% sales tax is collected by the State's Treasury and then remitted monthly directly to the senior trustee (Bank of NY - Senior unsecured rated Aaa/Stable) to pay debt service on the 1998 bonds and then transferred to the subordinate trustee (Huntington National Bank - Senior unsecured rated Baa1/Negative). The subordinate trustee is legally restricted from releasing funds to the county for any other purposes until all monthly debt service coverage requirements are met. The debt service reserve is funded at the lesser of one-half maximum annual debt service requirement or 1.25 times average annual debt service and is sized at a total of $24 million for all outstanding senior and subordinate bonds. The entire reserve is currently fulfilled with a surety policy from Ambac. The trust indenture requires that any surety provider be rated by at least two major rating agencies that also rate the bonds. Ambac did have its rating withdrawn by one of the rating agencies this past year and county officials are exploring replacement options. The Trustee has yet to notify the county of the deficiency, but once it does, the county will have 90 days to cure. After that, if the deficiency is not otherwise cured, a cash funding requirement will be triggered, requiring the county to fill the reserve with four equal annual payments. Moody's believes that the county's efforts to pre-empt the 90 day notification to cure are important, particularly in preventing a trigger of the cash funding requirement, which could pose challenges to liquidity. The reserve requirement is low relative to reserves established for most sales tax revenue bonds nationwide but is mitigated somewhat by the Subordinate Indenture requirement that a sales tax stabilization fund (STSF) balance be maintained at 10% of the highest year's dedicated 0.5% sales tax collections. The stabilization fund is currently sized at $6.6 million and is expected to be replenished to that level by year-end, following a draw in August 2009 to support non-debt service payments, as described in the following section. Additional legislation enacted in November 1996 eliminated the ability of residents or county commissioners to petition, repeal, or reduce the sales tax if any revenue bonds are outstanding insuring ongoing collections. Further, the inclusion of such a provision in the Subordinate Indenture enhances bond holder comfort that any legislative change will not affect the payment source for the bonds. GROWTH IN ADDITIONAL EXPENSES TO WHICH SALES TAX REVENUES ARE PLEDGED DO NOT PRESSURE SALES TAX REVENUE DEBT, BUT MAY CHALLENGE GENERAL COUNTY OPERATIONS After debt service on the senior lien and subordinate lien sales tax debt is paid, the Trustee releases remaining sales tax revenue to the county. This portion of the sales tax is currently dedicated, but not legally pledged, to additional expenses, including property tax rollbacks, real estate taxes on stadium land, contractual payments to support operations at the Cincinnati Reds' Great American Baseball Stadium and the Cincinnati Bengals football stadium operations, and a payment in lieu of taxes to the Cincinnati City School District (general obligation rated Aa3/stable outlook) for the baseball and football stadiums. Moody's
School District (general obligation rated Aa3/stable outlook) for the baseball and football stadiums. Moody's notes that while these additional obligations do not have a security claim on sales tax revenues, continued stagnation in this revenue stream could pressure the county's general operations as it would be required to seek alternate revenues to meet these contractual obligations. Evidencing the pressures of these dedicated outflows, the county had to tap into the $6.6 million Sales Tax Stabilization Fund in August 2009. While projections of improved sales tax collections in the fourth quarter will allow the county to replenish the $5.5 million draw by January 15, 2010, as required by bond documents, FY2010 poses much more significant pressures. As established through a promise to voters during the 1996 authorization for the rate increase, 30% of the revenues generated from the 1/2% sales tax continue to be dedicated to property tax relief, subject to annual resolution approval by the county board. The Board of Commissioners has consistently approved the 30% offset to property taxes each year, including for the upcoming FY2010 tax year, or a $17.4 million offset to property taxes. Projected FY2010 cash flows are extremely narrow, with initial projections estimating an accumulated net $6 million shortfall at year end. After debt service is paid, just under $30 million would be available for the county's other obligations. For FY2010, these expenditures are estimated to total over $36 million. Moody's notes that the county attempted to address expected lagging revenues by restructuring and reducing some of these obligations through FY2009. However, the flexibility to continue delaying these payments is more limited. The county has not yet determined how it will address the projected shortfall in FY2010 and going forward. However, the Board of Commissioners believes it will be able to close the gap in FY2010, with a few adjustments to expenditures. According to a new resolution passed on December 2, 2009, the county will recognize a $5 million deferral of the school district PILOT from FY2010 to FY2011; utilize a portion of the Stabilization Fund for cash flow purposes, in accordance with the indenture; contribute $1.2 million from the General Fund through nonpersonnel and non-public safety reductions or the use of reserves above 5% of General Fund expenditures. Further, the commissioners have resolved to continue discussions with stakeholders as they determine a long-term plan for FY2011 and beyond. Cincinnati City Schools has passed a Resolution of Intent regarding the $5 million deferral and is in discussions with the county as to the details of the deferral, depending on the long-term plan set forth by the county and subject to the requirements of the district's trust indenture for its Certificates of Participation. Moody's believes that while the county's plan provides a short-term fix for the currently projected gap, we also recognize that negative variances will likely arise if sales tax revenues fall below currently projected figures, which reflect a reasonable 3.4% decline from 2009. However, if revenues to lag projections, additional adjustments may need to be made, potentially placing further pressure on the General Fund, which may in turn pressure the county's general obligation credit quality. DELAY IN RELEASE OF FY2004 THROUGH FY2006 AUDITS DUE TO REVIEW BY STATE AUDITOR POSES A MEASURE OF RISK, BUT FINAL IMPACT YET UNKNOWN The county released a disclosure statement on October 5, 2006 relating the delay in filing of its FY2004, FY2005, and FY2006 audits to independent audit reports from the State Auditor and the Ohio Department of Jobs and Family Services for the periods of July 1, 2000 through June 30, 2004 and July 1, 2001 through June 30, 2004, respectively, questioning accounting and management practices of the county's social service programs. A follow up release from the county on July 15, 2009 contained updates that ODJFS had released a Limited Review Report in May 2008 with preliminary quantification of findings. The release also indicated that the county had retained and independent forensic auditor to test the findings of the report released by ODJFS. The accounting practices relate to $2 billion of expenditures for various social service programs throughout the period in question, but the dollar amount subject to recovery has not yet been determined. The county has contracted for its own independent audit of the expenditures in question and is expected to present an investigation plan to the state by the end of the year. The state audit reports do not allege fraud or criminal conduct. Moody's recognizes that the potential outcome and findings for recovery may pose a challenge to the county and will evaluate eventual outcomes as they are determined in the context of the county's options to comply with and respond to those findings. METHODOLOGY USED AND MOST RECENT RATING ACTION The Hamilton County (OH) special tax revenue bond ratings were assigned by evaluating factors we believe are relevant to the credit profile of the issuer, such as i) the business risk and competitive position of the
are relevant to the credit profile of the issuer, such as i) the business risk and competitive position of the issuer versus others within its industry or sector, ii) the capital structure and financial risk of the issuer, iii) the projected performance of the issuer over the near to intermediate term, iv) the issuer's history of achieving consistent operating performance and meeting budget or financial plan goals, v) the debt service coverage provided by such revenue stream, vi) the legal structure that documents the revenue stream and the source of payment, and vii) the issuer's management and governance structure related to the payment. These attributes were compared against other issuers both within and outside of the issuer's core peer group and these special tax obligation bond ratings are believed to be comparable to ratings assigned to other issuers of similar credit risk. The last rating action for the Hamilton County, OH was on August 24, 2009 when the county's general obligation rating of Aa3 and Stable Outlook were affirmed. KEY STATISTICS: Hamilton County population (2000 census): 846,000 County sales tax supporting the bonds (first collections received 8/96): 1/2 % Sales tax collections (1/2%), 2008: $65.4 million Projected sales tax collections (1/2%), 2009: $60.9 million (6.9% decline) MADS Coverage, 2009 Sales Tax Revenues: Senior Lien: 10.9X Subordinate Lien: 1.28X Combined debt service: 1.07X Sales Tax Collections, Average Annual Growth (2005-2009): -0.8% Debt service reserve: lesser of one-half maximum annual debt service requirement or 1.25 times average annual debt service Hamilton County G.O. rating: Aa3/stable Analysts Henrietta Chang Analyst Public Finance Group Moody's Investors Service Rachel Cortez Backup Analyst Public Finance Group Moody's Investors Service Contacts Journalists: (212) 553-0376 Research Clients: (212) 553-1653
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