News Column

Fitch Affirms Various Kalamazoo, MI Ratings; Outlook Negative

May 2, 2014

NEW YORK--(BUSINESS WIRE)-- Fitch Ratings affirms the following Kalamazoo, Michigan (the city) ratings:

--Implied unlimited tax general obligation (ULTGO) bond rating at 'AA';

--$15.27 million capital improvement limited tax general obligation (LTGO) bonds at 'AA-';

--$1.7 million downtown development LTGO bonds at 'AA-';

--$21.6 million Kalamazoo Building Authority LTGO bonds at 'AA-'.

The Rating Outlook remains Negative.

SECURITY

The LTGO building authority and downtown development bonds all carry the city's full faith and credit and its ad valorem tax, subject to constitutional, charter and statutory limitations.

KEY RATING DRIVERS

OUTLOOK REMAINS NEGATIVE: The Negative Outlook reflects the city's continued challenges in restoring and maintaining structural balance in the face of tax base deterioration, lower state revenues, own-source revenue limitations, and forward spending pressures.

LTGO RATING DIFFERENTIAL: The rating differential between the implied ULGO rating and the LTGO bonds reflects the city's limited financial flexibility and the lack of available taxing margin for operations.

REGIONAL CENTER; BELOW AVERAGE INDICES: The local economy remains highly dependent on manufacturing but is stabilized by the presence of higher education and healthcare. Per capita wealth levels are below average and the local unemployment rate is above average.

MODEST DEBT BURDEN; OVERFUNDED PENSIONS: The debt burden is modest, principal amortization is rapid, and future debt requirements appear manageable. The city's pension plan is over-funded, but its other post-employment benefit (OPEB) obligation is sizable.

RATING SENSITIVITIES

RETURN TO STRUCTURAL BALANCE: The ratings and Outlook are sensitive to the city achieving structural balance, as evidenced by its ability to stabilize the unrestricted general fund balance without resorting to non-recurring means.

CREDIT PROFILE

Kalamazoo is located in the southwestern quarter of Michigan'sLower Peninsula, approximately 50 miles south of Grand Rapids. The city has experienced marginal population loss over the past decade, to an estimated 74,588 in 2011.

UNEVEN FINANCIAL PERFORMANCE; STRUCTURAL IMBALANCE

The city's financial performance has been uneven historically, although adequate reserves still remain. Recent years have shown operating deficits predominantly. Fitch believes the city's ability to control spending is key to maintaining its current cushion as its revenue base is somewhat limited. The city's fiscal 2011 revenue composition includes 58% from property taxes and 17% from intergovernmental sources. The city is currently levying at its tax cap, and has no immediate plans to seek a voter override which would free up additional taxing capacity.

In 2012 and 2013, the city implemented cost efficiencies and a 'strategic alignment plan,' which resulted in an overall headcount reduction of 12% through 2013, in an attempt to align its spending base with new, lowered revenues. Management estimates it has realized approximately $5.2 million in ongoing savings from personnel changes.

Performance in 2012 beat budget, reducing use of fund balance to $1.9 million from the budgeted $2.5 million. Unrestricted fund balance declined to $7.1 million or 13.1% of spending. Management estimates that 2013's financial performance beat budget and resulted in an approximate $900,000 draw on fund balance, verses $1.65 million budgeted. This performance left the city's general fund with a $6.7 million total fund balance representing 12.5% of 2013 spending. Fitch estimates ending unrestricted fund balance will be approximately 11.4% of spending, based on the city's historic relationship between restrictions and total fund balance.

Fitch estimates that the city's structural gap is approximately $1.2 million assuming cash-funding of capital, forward funding of the city's OPEB liability and continuation of hold-harmless payments to the city's pensions fund for early retirements. The budget includes a $4.4 million one-time contribution from the city's insurance fund. The insurance fund transfer is a result of accumulated savings in the insurance fund and the city has changed its cost-allocation model going forward. The structural gap is lower than in year prior, which includes more conservative budgeting and no longer contains speculative revenues.

The city has effectively managed down its annual liquidity borrowing from $6 million in 2009 (11% of revenues) to a moderate $3 million in 2013 (6% of revenues), reflecting the city's efforts to improve its operating position.

The city's financial forecast is balanced but relies on unidentified spending cuts that ultimately rise to $5.6 million by fiscal 2019, and maintains the city's total fund balance (budget basis) at its 13% target. The forecasts incorporate the additional costs of holding the pension fund harmless from upfront costs associated with its early retirement program.

Fitch believes that the decision to forward fund the OPEB liability and continued cash-funding of capital at a healthy level (5% of general fund spending in 2012) provides an important measure of expenditure flexibility. Absent organic growth in revenue Fitch thinks that the city will remain challenged to achieve consistent positive margins given its limited revenue flexibility.

TAX BASE DECLINES MODERATE

The city's tax base declines have moderated, with a small 0.2% loss in 2014 signaling possible stabilization. Nevertheless, the tax base has declined an aggregate 14.7% since 2008, pressuring operations as the city is at its maximum operating rate. The city is projecting minimal tax base growth for 2015 and after, which could widen the structural gap if not realized.

REGIONAL CENTER; BELOW-AVERAGE SOCIOECONOMIC INDICATORS

The city is a regional economic and population center for south-west Michigan. Pfizer Corp. has a major presence within the city, serving as both the largest taxpayer (5.6% of total assessed value) and a significant employer (4,000 personnel). Other major employers include Borgess Medical Center (4,642), Western Michigan University (2,817), and Bronson Healthcare Group (3,729 employees). The city's economy is further stabilized by Kalamazoo College and Kalamazoo Community College. Approximately 40% of the city's property is tax exempt. While the regional economy has experienced some diversification in recent years, employment within the manufacturing sector remains elevated as compared with the national average.

Socioeconomic indicators are below average, with per capita income levels at 72% and 65% of the state and national averages, respectively, although these may be marginally skewed by a large student population. The city's education levels are above average, with 34% holding a bachelor's degree, compared with 28% for the nation. The individual poverty rate is well above average at 242% of the national.

Unemployment is elevated at 8.6 as of December 2013, down from the year prior (9.2%), but above the state (7.7%) and national (6.5%) averages. Positively, growth in local employment outpaced labor force gains over the prior 12 months.

MODEST LONG-TERM OBLIGATIONS

The overall debt burden is slightly above average at 5.1% of market value or $2,169 per capita. Principal amortization is rapid with 77% of debt retired within 10 years. The five-year capital improvement plan contemplates issuing a manageable $11.6 million in general obligation debt.

The city provides employment benefits through a single-employer defined benefit pension plan that was overfunded at 120% in 2012 or an estimated 113% using Fitch's 7% investment return assumption. The city continues to make contributions to the fund to hold it harmless for actuarial changes due to its early retirement incentive program.

The city funds its OPEB obligation on a pay-go basis, with a payment of $6.8 million in 2012 representing 46.2% of the OPEB ARC. As of the latest funding calculation (December 2011), the OPEB unfunded actuarial accrued liability totaled $190 million or a high 5.9% of 2013 market value, which was significantly reduced from the prior actuarial valuation due to negotiated OPEB modifications for new hires.

The city's carrying costs for debt service, pension, and OPEB was moderate at 20% of governmental fund spending.

LTGO PLEDGE; DEBT REPAID FROM NON-GF SOURCES

The building authority bonds are secured by cash rentals under the lease between the authority and the city. The cash rentals constitute the city's full faith and credit and its ad valorem tax, subject to constitutional, charter and statutory limitations. Payment under the lease is not subject to annual appropriation nor setoff or abatement for any cause. Therefore, the rating is on par with the city's LTGO rating.

The downtown development bonds carry the city's LTGO pledge but are also secured by a pledge of tax increment revenues generated within the development area. Tax increment revenues are the intended source of repayment and provide at least sum sufficient debt service coverage, however, Fitch's rating is based upon the strength of the city's LTGO pledge.

Additional information is available at www.fitchratings.com.

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, and Zillow.

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:

Tax-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=686015

U.S. Local Government Tax-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=685314

Additional Disclosure

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE WWW.FITCHRATINGS.COM. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.



Fitch Ratings

Primary Analyst:

Stephen Friday, +1-212-908-0384

Associate Director

Fitch Ratings, Inc.

33 Whitehall Street

New York, NY 10004

or

Secondary Analyst:

Bernhard Fischer, +1-212-908-9167

Director

or

Committee Chairperson:

Arlene Bohner, +1-212-908-0554

Senior Director

or

Media Relations:

Elizabeth Fogerty, +1-212-908-0526

elizabeth.fogerty@fitchratings.com

Source: Fitch Ratings


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