August 8, 2013
Last week the City of Manchester saw its general obligation bond rating downgraded from Aa1 to Aa2; in layman’s terms it went from the second highest to the third highest ranking category affecting $193 million in outstanding general obligation (GO) debt. The bond rating agency Moody’s also downgraded the school facility revenue bonds to Aa3, affecting $77.3 million in outstanding bonds.
The long term outlook for the city’s debt was also changed from negative to stable, indicating that further downgrades are unlikely.
Many have blamed the recently enacted tax cap for the downgrade and Moody’s opinion does mention it, noting that “(t)he rating also incorporates the city’s currently satisfactory financial position, which has been pressured by the recent implementation of a local tax cap.”
But is the tax cap really to blame for the downgrade? The key to the rating downgrade is the size of the city’s reserve fund, which dropped below 20% of revenues due to the recession and the sluggish recovery’s impact on tax collections. While a tax cap can limit the ability of the city to rebuild those reserves, the real culprit is the Recreation Fund.
The Recreation Fund, which consists of McIntyre Ski Area (which has been leased to a private group since 2009), a pair of ice arenas, and a golf course, have been operating in deficit for several years, requiring the transfer of a total of $5.8 million from the city’s general fund, with the understanding that it be repaid. The Recreation Fund currently carries this amount on its balance sheet as ‘due to other funds’. Given the nature of the debt, Moody’s considers it very unlikely that the city will recoup this money from the Recreation Fund and therefore factored in the write off for the full amount against the General Fund reserves.
Of this write off, Moody’s notes, “while the liability to the General Fund is limited given the size of the fund, the adjustment to the fund balance nonetheless brings reserves to levels below the current rating category.”
This means that the downgrade would have happened with or without a tax cap in place. The write off of the Recreation Fund deficit, which reduced the city’s Reserve Fund below the threshold for holding onto the Aa1 rating, is solely to blame. Had the tax cap not been in place there is a possibility that the outlook may have been rated positive rather than stable, but that would purely be speculation. Of the factors that could increase the city’s rating, two are directly related to the pressures placed on the city by the Recreation Fund, with the third being sustained economic growth.
Furthering the point, the last rating given by Fitch, another bond rating agency, less than a year ago mentioned the tax cap as likely to limit budget flexibility but concluded that “the impact of the cap on the city’s creditworthiness is presently neutral”