During the course of routine surveillance, Fitch Ratings downgrades the following rating:
--$$24.01 million Milwaukee Redevelopment Authority taxable pension funding bonds, 2003 series C (the bonds) downgraded to 'AA-' from 'AA'.
The Rating Outlook is revised to Stable from Negative.
RATING RATIONALE:
--While the bonds are not an obligation of the city of Milwaukee, given a high degree of interconnectedness between the Milwaukee Public Schools (MPS) and the city, the recent downgrade of the city's general obligations to 'AA+' from 'AAA' contributed to the downgrade of the authority's bonds.
--The debt structure of these and parity obligations presents above-average risk given that the series C bonds are capital appreciation bonds with long-dated maturities and another series has swap exposure.
--School district finances have shown relative stability given continuing enrollment declines and the weak local economy.
KEY RATING DRIVERS:
--The ability of MPS to manage expenditures and retain adequate reserve levels despite a challenging revenue environment will be key to long-term credit quality.
--Maintenance of an above average rating by the city, whose long-term credit quality is contingent upon stabilization of the local economy, as evidenced by a return to positive employment and tax base trends.
--A specially-created state-aid intercept agreement could enhance these bonds' credit quality if the state's own GO rating (currently 'AA', Outlook Stable), improved.
SECURITY:
The bonds are secured by semi-annual loan payments made by Milwaukee Public Schools according to the Loan Agreement between the city of Milwaukee and Milwaukee Public Schools, pursuant to the Trust Indenture. Bonds are additionally secured by a state-aid intercept mechanism, wherein a deficiency in debt service would trigger a diversion of state aid, the amount and timing of which would be sufficient to prevent a default.
CREDIT SUMMARY:
The 2003 series C bonds were issued to fund a portion of the MPS unfunded pension liability to the Wisconsin Retirement System. While the bonds are not a general obligation of the city of Milwaukee, the city's credit quality is relevant to the rating, due to the high degree of interconnectedness between MPS and the city. According to state statute, MPS functions effectively as a department of the city, and the city acts as custodian of MPS' funds. This interconnectedness is generally a credit positive; however, the recent downgrade of the city of Milwaukee's general obligation bonds to 'AA+' from 'AAA', weakens these bonds' credit profile.
MPS is governed by the Milwaukee Board of School Directors (MBSD), but the city levies and collects the taxes necessary to support the separately adopted MBSD budget. The school system's service area is coterminous with the city. MPS independently provides elementary and secondary education and independently controls the budget but lacks authority to issue debt directly, so the city issues on MPS's behalf, including cash flow notes to help smooth MPS' cash flow throughout the year.
While MPS has made progress in containing expenditures, it remains challenged to meet its rapidly growing special education needs in an environment of declining state aid, waning enrollment, and a contracting tax base. State equalization aid accounts for a high proportion of MPS revenues. In FY2009, state aid amounted to 55% of General Fund expenditures, down from 64% in FY2008. The decline in state aid was offset by an increase in federal aid in FY 2009. Operating deficits in FY 2008 and FY 2009 reduced General Fund balance to 8.4% of General Fund expenditures at the end of fiscal 2009 from 8.8% at the end of fiscal 2008; unreserved General Fund balance amounted to 3.5% of expenditures in FY 2009. Preliminary FY 2010 results point to a minimal drawdown, which was equal to the amount budgeted. The FY 2011 budget includes the elimination of 682 positions, equivalent to a sizable 6.4% of the workforce. The reduction is to be accomplished through a combination of transfers of employees to vacant positions, attrition and layoffs. Additionally, MPS expects to benefit from recently negotiated provisions for health care premium sharing, which is expected to generate $30 million annualized savings commencing in FY 2012. Officials expect to end the FY 2011 year with a $2.4 million drawdown of general fund balance.
The bonds are additionally secured by a state aid intercept mechanism, crafted especially for the bonds, although this mechanism currently does not provide rating enhancement as the rating on the program would be no higher than the bonds' current rating. Regardless of whether MPS has appropriated the loan payment or not, the city makes the loan payments on Jan. 1 and Aug. 1 from money on deposit in the school operations fund. If 45 days prior to the scheduled state aid disbursement which immediately precedes the debt service date, the required money is not on deposit, the trustee will notify MPS, the state Department of Public Instruction (DPI) and the state Department of Administration (DOA) of the deficiency. DPI will then divert that amount to the trustee, on the regularly scheduled state aid payment date, to avoid a payment default on the bonds. Since the state aid amounts are subject to biannual appropriation by the state of Wisconsin (GOs currently rated AA, Stable Outlook), an improvement in the state's credit quality or a change in the amount of state aid appropriated for MPS could change the credit profile for the bonds.
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, LoanPerformance, Inc., IHS Global Insight, City of Milwaukee, Milwaukee Public Schools.
Related Research:
'Tax-Supported Rating Criteria', dated Aug. 16, 2010.
'U.S. Local Government Tax-Supported Rating Criteria', dated Oct. 8, 2010.
For information on Build America Bonds, visit 'www.fitchratings.com/BABs'.
Applicable Criteria and Related Research:
Tax-Supported Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=548605
U.S. Local Government Tax-Supported Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=564566
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