Milwaukee takes rating hit ahead of school note sale

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Milwaukee heads into the market next month to borrow on behalf of its public school district after being stung by its second downgrade this year.

City Comptroller Martin Matson’s office will sell competitively $180 million of school revenue anticipation notes on Oct. 3 to smooth out the district’s cash flow needs as it awaits state aid payments.

Ahead of the sale, Fitch Ratings lowered the city’s issuer default rating to AA-minus from AA.

The action “reflects Fitch's view that the city's financial flexibility has weakened due to the expectation for growing pension contributions and recent declines in reserves, including a larger than anticipated draw in 2018. Fitch believes that the city continues to have very strong gap-closing capacity, moderate long-term liabilities and limited revenue growth prospects,” analysts wrote.

S&P Global Ratings affirmed the city’s AA-minus rating. It cut the rating by one notch in the spring due to “weak budgetary performance, as demonstrated by its recent trend of general fund deficits, and corresponding decline in reserves.”

Last year’s budget relied on $19 million in reserves. The 2019 budget assumes a $16 million deficit that relies on the use of reserves. Fitch warned three years of reserve drawdowns will hurt the city’s position to manage through an economic downturn.

Matson and his finance team that include public debt specialist Richard Li and special assistant Joshua Benson have been frustrated by the downgrades and expressed disappointment in the latest given that the reserves were built up with healthcare and other savings and the subsequent drawdowns were planned. The city, home to about 600,000 residents, remains at targeted reserve levels.

Like its spring deal, the city is also posting all deal documents earlier than in the past to give the market time to absorb all financial information.

“We were given a downgrade for executing on our plan. It’s unfortunate but as the city moves forward and remains fiscally conservative and pays off debt early that fund balance will bounce back,” Matson said, adding that his team’s hope is that the city can win upgrades in the coming years.

Pension costs will also pressure the budget and at a larger clip as the fund lowered its assumed rate of return to 7% from 8%. The city hopes to show rating agencies that its planning will allow the budget to absorb rising pension costs. A cushion for those costs is also in place through a $30 million pension reserve. The city has a net pension liability of $586 million, which increased due to actuarial changes. The system is 90% funded.

Fitch does acknowledge the city’s historical ability to balance its budgets. “The city has demonstrated its willingness and ability to limit expenditures to maintain budget targets,” analysts wrote.

The downgrades highlight the revenue struggles of Wisconsin municipalities. Fitch said it expects the city's two largest sources of revenue, state aid and property taxes, to remain stagnant or grow below the level of inflation.

School notes are backed by a pledge of state aid payments and all district fund revenues for the 2019-20 fiscal year that are due and not yet paid to the city. Interest repayment is also backed by a pledge of surplus revenues of the city’s debt service fund.

Moody’s Investors Service earlier this month highlighted statewide revenue challenges in a special commentary titled “Slow Economic Expansion and Property Tax Caps Will Constrain Wisconsin Cities' Revenue Growth.” Moody’s downgraded the city one notch last year to A1. The city has not asked Moody’s to rate new deals for several years.

Milwaukee County leaders joined by local state lawmakers and representatives from 19 local municipal officials including Milwaukee Mayor Tom Barrett are pressing for state support to put a 1% sales tax hike on the ballot. If approved, $160 million in new annual revenue raised could go to finance infrastructure, services, and ease the property tax burden.

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Ratings Primary bond market School bonds City of Milwaukee, WI Wisconsin