News Column

Fitch Rates New York City's (NY) $900MM GOs 'AA'; Outlook Stable

August 8, 2014

NEW YORK--(BUSINESS WIRE)-- Fitch Ratings assigns an 'AA' rating to the following New York City, NY general obligation (GO) bonds:

--Approximately $900 million fiscal 2015 series A and B, consisting of $700 million in series A and $200 million in series B.

In addition, Fitch affirms the 'AA' rating on the city's approximately $41.9 billion in outstanding GO bonds.

The Rating Outlook is Stable.

The series 2015 bonds are expected to be priced via negotiation on Aug. 13. Proceeds will refund outstanding GO bonds and pay costs of issuance.

SECURITY

The bonds are general obligations of the city secured by a pledge of the city's full faith and credit and the levy by the city of ad valorem taxes (without limit as to rate or amount) on all real property within the city subject to taxation. The city is not subject to New York State's property tax cap.

KEY RATING DRIVERS

SOLID ECONOMIC UNDERPINNINGS: The city has a broad economic base and serves a unique role as a national and international center for commerce, culture, and tourism. Recession-related job declines have been well under comparable national averages and job recovery has been strong, although the unemployment rate remains elevated.

HIGHLY EFFECTIVE BUDGET MANAGEMENT: The city's sound approach to budget development features reasonable revenue and expenditure forecasting, proactive budget monitoring, and effective actions to eliminate projected deficits.

LABOR SETTLEMENTS REDUCE UNCERTAINTY: Recently ratified agreements with several bargaining units reduce uncertainty about the resolution of long-expired labor agreements. Fitch believes the overall package represents a sizeable but manageable funding need, although some uncertainty remains regarding still-unsettled contracts.

HIGH & GROWING LONG-TERM LIABILITIES: Fitch anticipates a continued high debt burden given the city's significant capital commitments and expected future tax-supported issuance. Post-employment liabilities are also high. However, Fitch expects the combined burden on the budget of long-term liabilities will remain fairly stable.

DIVERSE BUT CYCLICAL REVENUE: Economically sensitive revenues, including personal income, business, and sales tax, comprise a sizable share of the city's budget and are highly vulnerable to variability in the financial services industry. Recent performance shows a trend of sound growth with some year-to-year variability.

RATING SENSITIVITIES

PRUDENT BUDGET MANAGEMENT: The rating is sensitive to the city's ability to keep out-year budget imbalances contained in light of limited spending flexibility. Evidence that the newly-higher gaps are the beginning of a trend, rather than a one-time adjustment, would likely result in negative rating action.

LONG-TERM LIABILITY CONTAINMENT: Fitch is increasingly concerned about the city's large and growing long-term liability burden. Growth in the budget burden associated with these liabilities would reduce overall financial flexibility and negatively affect the rating.

CREDIT PROFILE

RECENT TRENDS REINFORCE EXPECTATION FOR CONTINUED BUDGET BALANCE

The key credit strength underpinning Fitch's 'AA' rating is the city's tight budget monitoring and control as demonstrated by its ability to achieve consistent balance and manage out-year gaps. Regular reviews by various external financial oversight entities enhance the city's own internal analysis which includes monthly reporting and three detailed budget and four-year financial plan updates annually. Nascent gaps are dealt with quickly, and year-end results tend to be very close to break-even, with positive variation from budget.

Fiscal 2014 revenues (on an unaudited basis) were a sizable 7.4% above the level forecast in June 2013, due largely to a surge in real estate transaction-related tax revenue, receipt of federal disaster recovery funding, and underestimated personal income tax revenue. Expenditures show a similar increase, reflecting an increase in prepayments of subsequent year expenditures; the retention of $1 billion in, and further allocation to, the OPEB trust that had previously been planned for use in the current fiscal year; and costs related to the recent and expected labor settlements. Consistent with prior results, the fiscal year is expected to end in balance.

The city's fiscal 2015 budget totals $77 billion net of prepayments, nearly unchanged from fiscal 2014 spending. The budget includes an increase in the general reserve to $750 million (about 1% of spending, which Fitch does not consider significant) from $40 million in fiscal 2014. At least two of the city's fiscal monitors (the Independent Budget Office and the New York City Comptroller) have commented that they believe the city's out-year revenue estimates, which incorporate 2-3% annual increases, are conservative.

LOW RESERVES MITIGATED BY STRUCTURAL PREPAYMENTS

The city's inability to carry a meaningful fund balance somewhat limits financial flexibility. Management consistently offsets this constraint by using accumulated surpluses to prepay debt service and other expenses in subsequent years. Fitch expects the city to retain at least a modicum of accumulated surplus and continue the practice of prepaying out-year expenses. A marked change in this long-standing approach would be viewed negatively by Fitch.

The city accumulated an $8 billion surplus to roll forward prior to the economic downturn, with several consecutive years of operating surpluses. Between fiscal years 2009 and 2012, annual operating deficits eroded the amounts available for future years' budgets. Fiscal 2013 reversed the trend, showing a moderate operating surplus. Fiscal 2014 shows a small operating deficit of $855 million, in part due to an accounting treatment that required recognition in that year of $1.8 billion in labor settlement costs that are payable to future year retirees.

FORWARD TREND IN OUT-YEAR GAPS IS KEY

Fitch expected labor settlements to result in a moderate increase in out-year budget gaps, and therefore views the gaps that have emerged as a neutral credit factor. They are still fairly low relative to spending on a historical basis, but the trend from this point will be a key determinant in rating trajectory. Fitch's expectation is that out-year gaps will continue to be moderate and addressed on an annual basis. Evidence of a trend of increasing gaps relative to spending would lead to negative rating pressure.

The financial plan includes out-year gaps growing to 3.7% of budget in fiscal 2018, still well below levels at the time the fiscal 2012 budget was presented of 6 - 7% of spending. As expected, the increased gaps result from the city's inclusion of the cost of the labor settlement with the United Federation of Teachers (UFT) and application of the same costs (except for retroactive payments for 2009 and 2010) to the city's other bargaining units. The contracts settled to date remove a significant uncertainty from the city's budget. Settlements consistent with the UFT agreement have been ratified with two additional unions (Local 199 SEIU and the New York State Nurses Association) and a tentative settlement has been reached with a third (District Council 37). Talks with other unions are reportedly ongoing.

LABOR SETTLEMENT COSTS MODERATE BUT NOT ALL FUNDED IN FINANCIAL PLAN PERIOD

Salary increase rates in the labor settlements are fairly modest, but the impact on the budget is nonetheless notable. The city estimates the gross cost, if most UFT contract terms are extended to all employees, at $17.8 billion. Management anticipates that the use of reserves and negotiated healthcare savings will reduce the overall budget impact to $8 billion.

The UFT contract restructures 4% salary increases for both 2009 and 2010 as annual 2% increases in fiscal 2015 - 2018, and includes increases of 1% in each of 2013 - 2015, 1.5% in 2016, 2.5% in 2017, and 3% in 2018. All increases are effective May 1. Retroactive payments will be made as lump sums on Oct. 1 of 2015 and 2017 (12.5% each), and 2019 - 2021 (25% each). UFT members who leave but do not retire prior to the end of this period will not receive the full retroactive payment. Payments to those expected to retire through 2018 were recognized as an expense in fiscal 2014.

Estimated costs assume 5% annual attrition through fiscal 2018 and 2.5% thereafter. The lump sums amount to $7 billion in total, of which about $4.2 billion (60%) in gross costs is deferred beyond the current financial plan period. Fitch views the postponement of payment of salaries earned a decade earlier to be a sign of the strain that even the moderate percentage increase puts on the city's budget.

If the same salary increases (net of the retroactive component, which many of the city's other bargaining units have already received), are applied to other bargaining units, the city calculates the gross cost for all unions to be $13.6 billion through fiscal 2018. Netting out pre-existing reserves of $4.5 billion, including the $1 billion healthcare stabilization fund and a $3.5 billion collective bargaining reserve, the total impact during the financial plan period would be $9.1 billion.

The city has negotiated $3.4 billion in healthcare savings with bargaining units citywide that management expects will further reduce the net cost of the contracts during the financial plan period to $5.7 billion. Enforcement of the healthcare savings will be subject to arbitration, so the savings appear likely to be realized. However, a failure or delay in implementation could increase out-year gaps by up to $400 million in fiscal 2015, increasing to $1.3 billion in fiscal 2018. The benefit of any additional healthcare savings beyond the amount currently negotiated would be shared between the city and employees.

HIGHLY DETAILED ESTIMATES OF DIVERSE REVENUE MIX; RISKS REMAIN

The city benefits from a diversity of revenue sources, although many are subject to economic volatility. Fitch believes that the city's revenue estimates, based on a highly detailed and frequently-reviewed analysis are reasonable. The property tax is the largest source, at 27% of fiscal 2013 audited funds, followed by personal income tax at 14% and sales tax at 10%. Intergovernmental sources are primarily for education and social services programs and make up 28% of fiscal 2013 revenue.

Combined taxes make up 65% of total revenue. The city has a modest amount of room to increase the property tax levy under the cap. Real estate transaction taxes (real property transfer and mortgage recording) totaled a modest but increasing 2.6% of fiscal 2013 revenues.

Assessed value (AV) grew by a healthy 6.1% in fiscal 2015, following 5.7% growth in fiscal 2014. Current projections indicate 5.3%, 4.4% and 4.1% growth in fiscal years 2016 through 2018, respectively, as the pipeline of value increases to be phased in declines. The phase-in of value changes over five years evens out year-to-year volatility and enhances predictability.

Areas of revenue risk beyond forecast tax variations include state revenue shortfalls that could result in reduced aid to municipalities including New York City and federal actions that could result in reduced funding to the city. Recent budgets have included modest amounts of non-recurring revenue; Fitch would be concerned if such funding sources grew to be significant. The city also views the impact of the changing healthcare landscape on the operations of the Health and Hospitals Corp., to which the city now provides a modest operating subsidy and more sizable capital funding, to be an additional uncertainty.

Management estimates the gross cost to public sector facilities from Hurricane Sandy to be $5.1 billion. Of this amount, $1.8 billion will come from the operating budget and the rest from reimbursable capital spending. The city expects all costs to be reimbursed from non-city sources. The damage cost estimate does not include the cost of enhancements for future damage mitigation.

CARRYING COSTS EXPECTED TO REMAIN LARGE BUT MANAGEABLE

Fitch expects the carrying costs for debt service, pensions and OPEB to remain a stable burden on the budget despite the large capital and fringe benefit pressures. Fitch recognizes the city's conservative budgeting of debt service expense and views positively the city's ability to achieve sizable interest rate savings from debt refinancing over the last several years. Debt service consumes $5.6 billion, or a moderate 7.4% of fiscal 2014 unaudited spending. However, debt service is projected to increase to $7.8 billion (9.3% of total spending) by fiscal 2018. Management uses as a guideline a cap on debt service of 15% of city tax revenue. By this measure, debt service is projected to be about 11.6% for fiscal 2014, rising to nearly the cap at 14.4% by fiscal 2018. Principal amortization is slightly below average.

A more notable concern is spending on pension and other post-employment benefits (OPEB), which total $8.3 billion and $2.1 billion, respectively (a combined 13.9% of expenditures), in fiscal 2014. The city projects that following rapid escalation in pension costs (from $1.5 billion in fiscal 2002) that costs will grow slowly during the financial plan period. OPEB payments, while lower, grow more quickly and reflect funding on a pay-as-you-go basis.

While Fitch views favorably the increase to $2.3 billion in an OPEB trust fund, the amount does little to offset the liability, and could in future years be used to alleviate spending pressures. Carrying costs for debt service, pensions and OPEB were 21.3% of governmental spending in fiscal 2014, which Fitch considers to be in the moderate range.

Fitch believes cost pressures associated with pensions will continue. As of the most recent actuarial valuation date of June 30, 2011, pension funded ratios were weak at an aggregate of 60.7%, and the unfunded liability was a large $72 billion. The city uses an expected investment return rate of 7%. The city's actuary projects the aggregate funded ratio will increase to 67% by fiscal 2018. Fitch would be concerned if pension payments increased more than anticipated or unfunded liabilities grew measurably. Fitch views favorably the city's decision to implement GASB 68 for fiscal 2014, and does not anticipate that this change will result in rating action.

The unfunded actuarial accrued liability for OPEB is a very high $69.3 billion as of June 30, 2013, and the net OPEB obligation is even higher at $92.5 billion. Efforts to reduce the liability appear to be limited to the afore-mentioned contractual healthcare savings.

HIGH AND RISING DEBT IS A CREDIT CONCERN

Debt metrics are expected to remain high but stable relative to the city's vast tax base. Fitch-calculated net tax-supported debt including Transitional Finance Authority (TFA) future tax secured bonds equals approximately $9,233 per capita, and 8.6% of fiscal 2014 full value. If unfunded pension and OPEB obligations were included, the long-term obligation burden would more than triple.

The city's capital commitments are extensive, totaling $46.1 billion for fiscal 2014-2018, including $9.2 billion for self-supporting water and sewer projects and $12.7 billion for education (of which roughly half are expected to be paid with state aid). Fitch does not expect significant deviation in the overall size of the plan or debt needs, but believes adequate funding for aging infrastructure and expansion initiatives in the context of already-high debt levels will continue to be a challenge.

ECONOMY HAS INHERENT STRENGTHS BUT NOT WITHOUT CHALLENGES

Fitch considers the city's unique economic profile, which centers on its singular identity as an international center for numerous industries and major tourist destination, to be a credit strength. The character of the New York City economy has contributed to its relative employment stability during the recession and ability to regain by March 2012 the number of private sector jobs that existed prior to the recession. Population, which grew modestly during the first decade of the century, has increased 2.8% since 2010.

The city's tourism sector is performing exceptionally well, attracting a record 54 million visitors in 2013, the fourth record year in a row. The city estimates that continued strong visitor-related spending and moderate economic growth yielded sales tax growth of 5.3% in fiscal 2014, after 5.5% growth in fiscal 2013.

The economic profile of the city also benefits from good wealth levels; per capita personal income is 130% of the U.S. and market value per capita is over $100,000. Both per capita money income and median household income have grown more rapidly over the last five years than either the state's or nation's. However, the above-average individual poverty rate of 19.4% in 2011, compared to 14.3% for the U.S., indicates significant income disparity.

The local economy (and operating budget) is strongly linked to the financial sector, which accounts for approximately 11% of total employment but 30% of earnings. Financial activities employment declined 0.4% in 2013, and the high-earning securities and commodities component of the sector dropped 2.2% jobs following a 1.6% decline in 2012.

However, overall resident employment increased by 1.7% in 2013, with employment growth, similar to income levels, exceeding the state and nation. The unemployment rate decreased to a still-high 8.7% in 2013 from 9.4% in 2012. Recent data show continued improvement; the June 2014 city unemployment rate (not seasonally adjusted) was 7.7%, down from 8.9% a year prior, with 3.4% employment growth. However, the most recent rate is still well above the state and federal averages.

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, CoreLogic Case-Shiller Home Price Index, and Global Insight.

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

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=848254

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

Amy Laskey, +1 212-908-0568

Managing Director

Fitch Ratings, Inc.

33 Whitehall Street

New York, NY 10004

or

Secondary Analyst

Bernhard Fischer, +1 212-908-9167

Director

or

Committee Chairperson

Jessalynn Moro, +1 212-908-0608

Managing Director

or

Media Relations:

Elizabeth Fogerty, +1 212-908-0526

elizabeth.fogerty@fitchratings.com

Source: Fitch Ratings


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