July 29, 2016 - 12:54 PM EDT
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Fitch Rates Jacksonville, FL's Special Revenue Bonds 'AA-'; Outlook Stable

Fitch Ratings has assigned a 'AA-' rating to the following bonds to be issued by the city of Jacksonville, Florida:

--$89,885,000 special revenue refunding bonds, series 2016A;

--$57,475,000 special revenue refunding bonds, series 2016B.

The bonds will be sold via negotiation on or about Aug. 9. Proceeds will refund several series of outstanding bonds for debt service savings and to refinance on a long-term basis $24 million of outstanding commercial paper.

Fitch also affirms the following Jacksonville ratings:

--Issuer Default Rating (IDR) at 'AA';

--$985 million in special revenue bonds at 'AA-'.

SECURITY

The special revenue bonds are backed by the city's covenant to budget and appropriate non-ad valorem (NAV) revenues sufficient to pay debt service. The NAV covenant shall be cumulative to the extent not paid and shall continue until such non-ad valorem revenues or other legally available funds are sufficient to make all such required payments under the bond resolution.

KEY RATING DRIVERS

The 'AA' IDR reflects Fitch's expectation that the city will continue to demonstrate a prudent level of fiscal management, contributing to generally stable financial results and adherence to formal reserve policies that Fitch views as an integral part of the city's overall financial resiliency. The rating also reflects Fitch's view that the city will continue to make efforts to moderate the impact of its pension liability on the annual budget. The 'AA-' rating on the special obligation bonds is one notch below the IDR as the bonds are not general obligations but viewed as an ongoing and enforceable obligation of the city payable from a broad base of resources.

Economic Resource Base

Jacksonville is the most populous city in the state of Florida and the anchor of the northeast Florida economy. The regional economy has grown at a steady pace and is adequately diverse, but there is some concentration to the federal government owing to the presence of several naval installations. Unemployment tends to track closely to the state, and resident income levels are moderately below average.

Revenue Framework: 'aa' factor assessment

Fitch believes general fund revenues are likely to grow at a slow pace consistent with historical patterns that are generally in line with inflation absent policy action. The city retains a significant margin within existing statutory tax rate limits, which lessens risk to revenue volatility in periods of economic downturn.

Expenditure Framework: 'bbb' factor assessment

Fitch view the city's expenditure flexibility as limited given its very high cost of servicing debt and retiree benefits (over 30% of governmental spending). Furthermore, the city continues to operate with a considerably smaller workforce than prior to the recession, constraining its ability to lower spending without meaningful reductions to service.

Long-Term Liability Burden: 'aa' factor assessment

The city's debt and unfunded pension liabilities measure 16% of personal income, which Fitch views as moderate. Declining levels of debt have been offset by a rising net pension liability (NPL). The city's capital program appears manageable, and the city contends it is continuing to meet necessary infrastructure investment.

Operating Performance: 'aaa' factor assessment

The city's financial performance remained fairly stable during the last recession due to a variety of revenue and expenditure policy actions. Reserves remain compliant with formal policies and contribute to an exceptionally strong level of financial flexibility when considered in the context of the city's revenue raising powers and limited spending flexibility.

RATING SENSITIVITIES

Liability Burden Constrains Rating: Fitch believes the IDR will likely remain constrained by the high cost of servicing the city's long-term debt and unfunded pension liabilities despite recent some recent favorable developments that may alleviate the pension burden over time.

CREDIT PROFILE

The city serves as the focal point of the Jacksonville metropolitan statistical area (MSA), which has an estimated population of 1.4 million residents and ranks as the 42nd largest regional economy in the U.S. The economy is anchored by the trade, transportation, and utilities sector (21% of employment), professional and business services (15%), education and health care (15%) and leisure and hospitality (13%). Key infrastructure and economic assets within the MSA include the Port of Jacksonville, the Jacksonville Jaguars franchise of the National Football League, and three naval installations with a collective military and civilian employment of more than 41,000. The most prominent of these facilities, Naval Station Mayport, is the third largest naval facility in the nation. Mayport will homeport the first of eight new combat ships later in 2016, and the Navy's continuing investment in the base would appear to lessen risk over the short term to federal cuts in military spending.

The Jacksonville economy also has a notable concentration of jobs in financial service and insurance firms including Bank of America (8,000), Florida Blue (6,500), and Citi (4,000). The operations of these firms are largely comprised of administrative and call centers, which tend to exhibit lower wages relative to the broader sectors they represent. Resident incomes slightly lag the state norm while median home values are about 30% below the statewide figure reported by Zillow Group.

Revenue Framework

Property taxes fund roughly 50% of the city's $1 billion general fund budget. The next largest revenue stream for the general fund is an annual contribution from the Jacksonville Electric Authority (JEA) at about 11% of total revenue. The JEA contribution is outlined in an interlocal agreement between the city and the JEA that was recently extended through fiscal 2021. The agreement establishes a funding floor at the current year level and annual increases in the contribution amount of at least 1%. The JEA is a component unit of the city whose governing body is appointed by the mayor and budget subject to approval by the city.

Utility taxes and the city's share of the statewide local government half-cent sales tax (LGST) each represent about 9% of general fund revenue. Utility taxes are based on the sale of water, electric, and natural gas within the city and the LGST distributions are based on sales tax activity within the city and the ratio of incorporated to unincorporated population (there are no incorporated municipalities within the joint Duval County/Jacksonville government).

Fitch believes general fund revenues are likely to grow in line with the level of inflation. The 10-year historical general fund revenue CAGR of 3% reflects a variety of policy actions that served to alleviate the impact of the recession and housing market crisis on its fiscal condition.

The city has ample legal revenue raising authority. As a joint city-county Jacksonville is subject to a statutory property tax cap of 20 mills. The adopted tax rate for fiscal 2016 was 11.44 mills. Fitch estimates the city could generate roughly $380 million in additional revenue through an increase in the property tax rate to the maximum legal rate, the equivalent of nearly 40% of the total general fund budget. Fitch views favorably the fact that the city has demonstrated a willingness to increase revenues during prior periods of economic stress to help stabilize its financial position.

Annual changes in the property tax rate are determined using a roll-back or revenue neutral rate, which is then adjusted for changes in the Florida per capita personal income. However, this limitation may be overridden by vote of the county governing body. The city also has the ability to increase various license and permit revenues and service charges that make up a smaller but still notable portion of its revenue base.

Expenditure Framework

Jacksonville provides a broad range of governmental activities, but spending is led by the operation of the sheriff's office and fire and rescue, which account for roughly 60% of the general fund budget.

General fund spending has increased at a higher pace than revenue in recent years despite the aforementioned policy actions taken by the city during and subsequent to the recession. Fitch would expect this trend to continue absent stabilization of the city's pension costs, which reached $254 million in fiscal 2015 compared to $125 million in fiscal 2011. The city estimates its pension cost at $280 million in the next fiscal year (see below for more on the city's pension reform efforts).

Credit concerns center on Jacksonville's very high cost of funding debt service and annual contributions for pension and retiree health benefits, which generally diminish financial flexibility and the availability of resources for other spending needs. In fiscal 2015 the city paid close to $450 million in total for these expenses or the equivalent of 32% of total governmental fund spending.

The city engages in collective bargaining with various labor groups representing general employees, police, fire, and correction officers. All six of the city's unions are operating under expired contracts but have reportedly agreed to postpone negotiations until the pension surtax referendum. Under Florida law if an impasse is declared both parties are required to engage in a non-binding mediation process following which the governing body of the local government may ultimately impose contract terms for the year. Fitch believes the city and its organized labor groups have shared a generally cooperative relationship, illustrated by agreed upon wage reductions during the recession and more recent reform of the city's Police and Fire Pension Fund (PFPF).

From a practical perspective Fitch believes flexibility around personnel spending may be somewhat constrained as the size of the citywide workforce (7,109 in fiscal 2016) is about 14% lower than pre-recession budgets. The proposed fiscal 2017 budget aims to add close to 100 workers government wide with the majority in the general fund for public safety.

Pension Reform Update

The city reached an agreement in 2015 with the PFPF pursuant to which it subscribed to making additional annual payments above the actuarially determined contribution to accelerate the amortization of the NPL (the PFPF is the largest of the city's three defined benefit pension plans with a Fitch-adjusted NPL of $1.8 billion or 5% of personal income). The 2015 agreement did not specify a funding source for the additional pension contributions to be made by the city. The city subsequently proposed a plan that was adopted by the 2016 state legislature that allows for the extension of the Better Jacksonville Plan (BJP) one-half cent local option sales tax for the explicit purpose of paying down the city's pension liability (the pension surtax). The pension surtax is subject to approval by voter referendum scheduled for August 30. If approved the pension surtax would commence on the date of the expiration of the BJP surtax on Dec. 31, 2030 for a period of up to 30 years or until the city's pension plans are fully funded, whichever comes first.

In addition to voter approval the pension surtax is further subject to the closure of at least one of the city's three current defined benefit pension plans and a requirement that each employee who is a member of a closed plan contributes 10% of salary to the plan. These provisions would be subject to collective bargaining. The 2015 pension agreement with police and fire did not address the closure of the PFPF to new hires, but it did increase the contribution rate for new hires to 10% effectively immediately and for current members upon restoration of a 2% wage reduction agreed to in 2010.

The dedication of a revenue stream to amortize the NPL would be viewed by Fitch as a positive, as the actuarial recognition of this revenue stream would have the effect of lowering the city's actuarially determined contribution. The BJP sales tax generated a considerable $78 million in fiscal 2015 (roughly 30% of the current year's actuarially determined pension cost) and has increased at a CAGR of 2.3% since fiscal 2004. The state law authorizing the pension surtax further stipulates that the amortization period of any affected pension plan(s) reset to 30 years immediately (the effective amortization dates of the city plans currently range from 21-25 years). Re-amortizing the pension plans would lower the city's annual pension contribution by roughly $50 million in the near term at the expense of higher contributions in future years which would align with the collection of the pension surtax.

Long-Term Liability Burden

Jacksonville's long-term liabilities are estimated by Fitch at $5.5 billion or a moderate 16% of personal income. The long-term liability estimate includes $2.5 billion of overall net debt and a Fitch-adjusted NPL of $3 billion. The Fitch-adjusted NPL has increased close to 20% since fiscal 2011. The total NPL is expected to remain fairly stable over the next 10 years then steadily decline and reach full funding by fiscal 2046 based on an actuarial analysis conducted by Milliman. The Milliman analysis assumes a phased-in increase in the employee contribution rate to 10% through fiscal 2018, 7.0% to 7.5% investment rates of return, and the re-amortization of the pension plans to 30 years, among other factors. The Milliman analysis does not recognize any benefit to an effective pension surtax revenue stream.

The city has reduced the rate of new money borrowing resulting in a reduction in direct debt outstanding of $635 million or 23% since fiscal 2011. The proposed general government capital program for fiscal 2017-2021 nears $330 million; the program will largely be debt financed but closely match the amount of outstanding principal scheduled to amortize in the five-year period.

Operating Performance

Fitch believes the city maintains an exceptionally strong capacity to manage challenges associated with an economic downturn and that the city will continue to take actions necessary to maintain compliance with formal reserve policies. The city is required to maintain a separate emergency and operating reserve each equal to 5% to 7% of spending; on a combined basis the reserve policies amount to a level Fitch views as sufficient in a downturn for a 'aaa' assessment.

The assessment also considers scenario-estimated changes in revenue and a budget flexibility profile of 'midrange' which reflects a combination of the city's high independent revenue raising powers relative to potential cyclical revenue declines and limited expenditure flexibility largely driven by a high cost of carry for debt and retiree benefits.

Management of the city's operating budget remains a credit positive. The city produced positive operating margins (after transfers) throughout the recession largely through the enactment of various revenue enhancements and spending reduction measures and despite the challenge of meeting escalating pension costs.

Post-recession the city has increased the general fund's unrestricted reserve position to $173 million or 16.8% of spending at fiscal year-end 2015. The city has adopted a structurally balanced budget for fiscal 2016; management reports a favorable revenue variance of $10-14 million based on year-to-date results through March 31 (six months into the fiscal year) and expenditures that are tracking below budget consistent with prior year actual results. The proposed budget for fiscal 2017 submitted by the mayor is also balanced without the use of existing reserves.

Additional information is available at 'www.fitchratings.com'.

In addition to the sources of information identified in Fitch's applicable criteria specified below, this action was informed by information from Lumesis and InvestorTools.

Applicable Criteria

U.S. Tax-Supported Rating Criteria (pub. 18 Apr 2016)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=879478

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1009719

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1009719

Endorsement Policy

https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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Fitch Ratings
Primary Analyst
Michael Rinaldi
Senior Director
+1-212-908-0833
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Larry Levitz
Director
+1-212-908-9174
or
Committee Chairperson
Amy Laskey
Managing Director
+1-212-908-0568
or
Media Relations
Elizabeth Fogerty, +1 212-908-0526
[email protected]


Source: Business Wire (July 29, 2016 - 12:54 PM EDT)

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