TEXT-Fitch affirms Douglas, Ariz, Muni Property Corp bonds at 'A'
Jan 25 - Fitch Ratings has taken the following rating actions on Douglas, Arizona Municipal Property Corporation (MPC, or the corporation) bonds: --$1.4 million excise tax revenue bonds affirmed at 'A'; In addition, Fitch affirms the city's implied general obligation (GO) rating at 'A'. The Rating Outlook is Stable. SECURITY The bonds are special obligations of the corporation payable from lease payments to be made by the city. The lease payments are secured by a pledge of and first lien on the city's excise taxes. The lease payments are unconditional obligations of the city and not subject to annual appropriation. SENSITIVITY/RATING DRIVERS EXCISE TAX-CENTERED ECONOMY: The city relies heavily on economically sensitive sales and excise tax revenues to fund government operations, although diversification within this source exists. Subsequent to a multi-year decline precipitated by the recession, economic recovery has largely stabilized state shared and local collections. STRONG COVERAGE: The 'A' rating on the excise tax revenue bonds reflects the general creditworthiness of the city and high coverage of maximum annual debt service (MADS) from pledged revenue. The rating also reflects the volatility associated with economic fluctuations inherent to many border communities and interdependency with the Mexican economy. NO RATING DISTINCTION: There is no rating distinction between the excise tax revenue bond and implied general obligation rating as excise tax revenues support the vast majority of general fund operations. Fitch caps most special tax bond ratings, including this excise tax bond rating, at the level of the GO rating. ADEQUATE RESERVES: The city's current unrestricted general fund balance is adequate in relation to spending and transfers out. However, material diminishment of reserve levels would be a credit concern given the city's considerable exposure to economically sensitive revenues. MODERATE DEBT / RISING TRAJECTORY: Overall debt in relation to market value is moderate, but expected to rise with anticipated new debt issuance to fund street improvements. Carrying costs, including annual debt service, pension and other post-employment (OPEB) contributions, are manageable. Growth in pension costs will likely continue for the foreseeable future given below-average funding levels of state pension programs to which the city contributes. BELOW-AVERAGE INCOME/WEALTH: Measures of income and wealth significantly lag state and national averages, although this is somewhat offset by a lower cost of living. WHAT COULD TRIGGER A RATING ACTION Recurring deficits, a material decline in fund balance coverage levels, or the inability to fund necessary capital improvements would place pressure on the current rating. CREDIT PROFILE The city of Douglas, with an estimated population of 20,000, is located 117 miles southeast of Tucson, Arizona on the border with Mexico. BINATIONAL COMMERCIAL MARKET The economy of Douglas is based primarily on tourism, government services, warehousing and manufacturing. The city serves as a commercial hub to approximately 160,000 residents of Cochise County and Aqua Prieta, Mexico, population approximately 125,000. The economies of Douglas and Aqua Prieta are interdependent, with up to 70% of the city's retail sales tax base attributed to Mexican nationals. Douglas also exports raw materials and components to Aqua Prieta's maquiladoras for assembly and transport back into the U.S. The city's economy has been dampened by a decline in cross-border traffic over the past decade. However, local officials have recently implemented improvements at the Port intended to expedite traffic flow pending a planned expansion in 2018. ECONOMICALLY SENSITIVE REVENUES Local sales taxes and state shared revenues contribute 38% and 34%, respectively, to fiscal 2012 general fund revenues, followed by charges and services and other taxes and fees. State shared revenues declined by 22% between fiscal 2009 and fiscal 2012 mirroring the recession and state-wide housing crises, during which time the city's local sales tax receipts (supported by the base 2.5% rate) lost only 9% of value. Gains in restaurant/bars, accommodation and construction taxable sales mitigated soft retail sales attributed by management to weakness in the Mexican economy and reduced cross-border shopping. Year-to-date trends support flat fiscal 2013 sales tax revenues, reflecting improvement in the Mexican economy, but a slower than expected rate of local construction activity. The fiscal 2013 improvement in state shared revenues, distributed with a two-year lag, represents the city's share of broad economic recovery underway throughout the state. STABLE EMPLOYMENT BASE Governmental, educational and health care employers supplement the city's retail/tourism and manufacturing/warehousing sectors, lending stability to the local economic base. Top employers include the Arizona Department of Corrections, Douglas USD, Cochise College, City of Douglas, Chiricahua Community Health Center, Southeast Arizona Medical Center and Cochise County. However, the prevalence of low wage rates contributes to median household income representing just 54% of fiscal 2011 state and 52% of U.S. levels. PRESSURE ON FINANCIAL MARGINS Several years of lower state shared revenues have reduced net margins despite savings in general government expenditures and deferred capital spending due to cost pressures which included rising public safety costs and an ongoing municipal golf course deficit (beginning in fiscal 2011). Fiscal 2012 break-even results, combined with a $1 million write-off pursuant to a prior period adjustment, reduced the fiscal 2012 year-end unrestricted general fund balance to $4.1 million (28.4% of general fund expenditures and transfers out). The city projects a fiscal 2013 net deficit of $250,000 as increased state shared revenues are offset by continuing public safety and new program costs, including a self-funded health insurance program and municipal transit program for which the city assumed management during the year. The transit system supports Mexican tourism and serves the city's elderly and student population. Although trends suggest a return to revenue growth, Fitch notes that prudent cost management will be required to achieve structural balance of the city's operating budget. MODERATE DEBT/STRONG COVERAGE Overall debt is moderate at 3.2% of market value. Direct debt amortization is rapid at 74.3% in 10 years. The city is considering issuing new debt (subject to voter approval) in the next couple of years to fund street improvements, which would elevate debt levels. Longer term, the city anticipates participating in a joint project with Mexico to expand the Douglas Port of Entry. The city pledges its excise taxes to bondholders of the MPC issued debt. High maximum annual debt service coverage of 10.8x reflects the use of pledged revenues as the city's primary operating source. RISING PENSION COSTS Douglas participates in the Arizona State Retirement System (ASRS), a cost sharing multiple-employer (CSME) plan governed by the state, and two agent multiple-employer (AME) plans for public safety and fire officials, the Public Safety Personnel Retirement System (PSPRS). Using Fitch's more conservative 7% rate of return, versus the plan's assumed 8.5% rate, funded ratios for the AME plans were low at an estimated combined 40.7% funded, as of June 30, 2011. Douglas consistently funds 100% of the pension actuarial required contribution (ARC) for the three plans in which it participates. The city funds OPEB on a pay-go basis. The city's carrying costs, including debt service, pension and OPEB contributions, represent a moderate 17% of fiscal 2012 governmental expenditures and transfers out, net of capital project spending. The city projects its share of ASRS and PSPRS retirement and OPEB contributions to increase over the next several years. 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, Zillow.com, National Association of Realtors, and the Municipal Advisory Council of Texas. Applicable Criteria and Related Research: --'Tax-Supported Rating Criteria' (Aug. 14, 2012); --'U.S. Local Government Tax-Supported Rating Criteria' (Aug. 14, 2012). Applicable Criteria and Related Research: U.S. Local Government Tax-Supported Rating Criteria Tax-Supported Rating Criteria