Fitch Downgrades Surprise Muni Property Corp, AZ's 2003 Excise Tax Revs to 'A+'; Outlook to Negative

AUSTIN, Texas--(BUSINESS WIRE)--

Fitch Ratings takes the following action on Surprise Municipal Property Corporation's (AZ) excise tax revenue bonds:

--$35.1 million excise tax revenue refunding bonds, series 2003 downgraded to 'A+' from 'AA-'.

Additionally, Fitch downgrades the city's implied unlimited tax general obligation rating to 'A+' from 'AA-'.

The Rating Outlook is revised to Negative from Stable.

KEY RATING DRIVERS:

REDUCED FINANCIAL FLEXIBILITY: The downgrade and Outlook revision reflect continued erosion of financial flexibility, as fiscal 2011 general fund reserves were again used to satisfy development fee and related obligations pursuant to the city's discovery of accounting errors dating back 10 years. Officials have communicated an intent to substantially rebuild reserves by fiscal year 2014 through cost management efforts.

FINANCIAL UNCERTAINTY: The negative rating action is also based on a fiscal 2011 audit opinion that is expected to be qualified due to uncertainty as to the impact on results of previous years' financial transactions. The city has retained accounting consultants to determine the financial impact of the development and intergovernmental transactions dating back to 2000. The study is expected to be complete within eight months.

HEALTHY DEBT SERVICE COVERAGE: Surprise maintains high debt service coverage on outstanding excise tax revenue bonds despite the downturn in economically sensitive pledged revenues. Adequate legal provisions further protect bondholders.

LOW DEBT BURDEN: Debt levels are low and amortization is rapid, reflecting the city's historically heavy reliance on development fees and internally generated funds for capital expenditures. Capital needs going forward are projected to be moderate while development fees have declined dramatically.

WHAT COULD TRIGGER A DOWNGRADE:

FURTHER DETERIORATION: Further erosion of reserves and financial flexibility likely will place additional pressure on the rating.

SECURITY:
The excise tax revenue bonds are payable from rental payments made by the city to the corporation, secured by a pledge of the city's excise taxes. Rental payments are not subject to annual appropriation.

CREDIT SUMMARY:

WEAKENED FINANCIAL POSITION
The city expects a fiscal 2011 qualified audit opinion based on incomplete information relating to the city's impact fee program and related development fee contracts. Adjustments made to correct known errors reduced the fiscal 2011 general fund balance to a meager $1.6 million (2.1% of spending), offsetting otherwise favorable financial performance reflecting strengthening revenues and cost reductions. Officials were unable to estimate the potential impact of further accounting adjustments on reported reserve levels.

The fiscal 2012 budget included further cost management efforts, and management anticipates positive operating results for fiscal 2012, aided by further improvement in local sales tax receipts and other revenues. City council has directed staff to implement additional spending reductions over the next two fiscal years, including staff beginning in fiscal 2013, with the objective of restoring operating reserves to target levels by fiscal year-end 2014.

The city's general fund balance has steadily declined since peaking at more than $90 million in fiscal 2007 (nearly 100% of spending). The drop was due largely to a combination of capital spending and accounting corrections made over the past several years to recognize the distinctions between general operating, capital and development fee funds. By the close of fiscal 2010, the unreserved general fund balance had declined to $7.0 million, or 9.9% of spending, which was below management's policy target of 60 days of spending or 16.7%.

STRONG DEBT SERVICE COVERAGE
Maximum annual debt service (MADS) coverage of excise tax bonds remains very strong at greater than 12 times (x) for fiscal 2010; by comparison, coverage at the fiscal 2007 revenue peak was 17x. Revenue collections in fiscal 2010 continued to reflect the strained economy, with excise taxes of $60.8 million at just 74% of the fiscal 2007 peak. Soon to be released fiscal 2011 financial results reflect similar coverage of about 12x, with pledged revenues totaling $59.3 million, down 3% from the previous year. The current fiscal 2012 projection is for a nearly 15% jump in pledged revenues, driven by gains in local sales tax revenues and state shared revenues.

Excise taxes include transaction privilege (sales) taxes, state-shared revenues (consisting of state-shared sales taxes and state revenue sharing), charges for services, permits and fees, and fines and forfeitures. Local sales taxes are the largest component of the pledged revenue stream, and they reversed a three-year decline with modest fiscal 2011 growth (up 1%); fiscal 2012 receipts are on pace for another gain, with collections up 11% through first six months of the year. Additionally, the projected 20% gains in state shared revenues for fiscal 2012 are due partly to the city's increased portion of revenues based on the city's 2010 census population gains. Legal provisions provide strong bondholder protections, including an additional bonds test of 3.0x MADS.

LOW DEBT BURDEN
Overall debt levels in Surprise are low ($1,562 per capita or 1.7% of market value), with all of the existing excise tax debt repaid within 10 years. The city's capital needs are modest at about $30 million through fiscal 2016. This total is much smaller than in prior years' plans due to more manageable growth projections. The city may issue a modest amount of new excise tax debt in the next several years, but has no immediate plans to return to voters for general obligation bond authorization after a 2009 referendum was rejected.

The city participates in two state-sponsored pension programs, the Arizona State Retirement System (ASRS) for nonpublic safety personnel and the Arizona Public Safety Personnel Retirement System (PSPRS) for public safety employees-both cost sharing, multiple employer plans. The city also participates in the PSPRS post retirement health plan. The combined annual required payment for the plans in fiscal 2010 represented a modest 7% of general fund expenditures. While contribution rates for both plans have increased recently, management expects modest near term relief from recent legislative action that shifted more of the contribution burden from participating governments to employees.

SLOW ECONOMIC RECOVERY
Surprise is located in Maricopa County roughly 20 miles northwest of downtown Phoenix. The city's 2010 census population of roughly 117,500 represents an almost quadrupling of the population since the 2000 census. However, the previous torrid pace of residential construction has reversed dramatically over the past number of years.

Housing starts declined from a peak of 7,700 in 2004 to just 290 in 2010. The reversal of the city's rapid growth is also reflected in secondary assessed value (SAV) changes. The SAV more than doubled from fiscal 2006-2009, before dropping to current levels, which represent about 65% of the peak. Fitch believes, given the weak housing market and the lag in assessments, that values may register additional, albeit smaller declines before leveling off.

Additional information is available at www.fitchratings.com. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.

In addition to the sources of information identified in the Tax-Supported Rating Criteria, this action was additionally informed by information from Creditscope, University Financial Associates, S&P/Case-Shiller Home Price Index, IHS Global Insight, National Association of Realtors.

Applicable Criteria and Related Research:
--'Tax-Supported Rating Criteria', dated Aug. 15, 2011;
--'U.S. Local Government Tax-Supported Rating Criteria', dated Aug. 15, 2011.

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=648898
U.S. Local Government Tax-Supported Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=648842

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