We've spent a significant amount of time here discussing the City Council's controversial and divided decision to reduce the fund balance level to 11.1% of the budget in the coming fiscal year, down from the 12% floor that the City has set as a policy.
At the time, the debate in elected officialdom revolved around whether a change in this critical benchmark would cause Durham's much-vaunted AAA bond rating to fall to a lower level, thus costing the city more in interest costs.
As Ray Gronberg wrote in Saturday's H-S, all three bond rating agencies have in fact re-affirmed Durham's AAA rating status -- Fitch via a press release on Friday, S&P and Moody's via verbal statements to the city in advance of a written release.
The news is for now a vindication of the strategy proposed by Mayor Bell, and supported by Councilman Farad Ali in a crucial swing vote: namely, that experience shows that Durham departments typically don't spend all their allocated funds, and that the fund balance at fiscal year's end will typically meet or exceed the floor level set.
Meaning for this year that, even with an 11.1% fund balance budgeted, the Council majority expects that the fund balance level will still meet the 12% floor.
First, the good news from the Fitch report:
The 'AAA' rating is based on the city's strong economic fundamentals coupled with excellent growth prospects, as well as historically sound financial performance and planning. Employment and job growth in the city are strong, bolstered by development in and around Research Triangle Park (RTP). Further economic growth is driven by the city's efforts to revitalize its downtown with several public/private development projects that should support continued expansion of the overall economy and tax base....
The city plays an integral role in the area economy and benefits from its proximity to Research Triangle Park (RTP). Although unemployment rates have not returned to the very low levels registered in the late 1990s, they remain below state and national levels, declining to 3.6% on average in 2007 from 3.8% in 2006. The city's higher education and health care sectors provide employment stability, which compensates for the impact of economic cycles on other business activity in the city and the adjacent RTP. Additional indicators of economic strength include a significant 11.8% increase in the city's population since the 2000 census and healthy labor force and job growth since 2004.
Bottom line: Durham's economic strengths and growth are seen as positives by the rating agencies -- not surprising, since after all, the bond rating speaks to the ability of a city to repay its obligations, something that's easier to do when you have population growth and development that grow the tax base. (Fitch also calls out the 28%+ growth in the tax base thanks to the recent revaluation.)
The rating agency also hits the nail on the head relative to Durham's double-barreled economic strength, highlighting both the economic dynamism of RTP's employment centers and the recession-resistant university and health care sectors.
What does Fitch have to say about the fund balance level? They're not silent on the issue, and in fact call out the City's expectation that the 12% floor will still be met -- meaning the city will need to follow the line of assumptions above that actual spending will be less than budgeted.
Financial management and operations continue to be fundamentally sound. Reserve levels have strengthened after significant draws on the general fund balance in fiscal years 2001 and 2002. The undesignated fund balance at the close of fiscal 2007 of $20.2 million equaled 12.9% of adjusted appropriations above the city council's policy floor of 12% of adjusted budgeted appropriations (excluding debt service and transfers out). City officials expect reserve levels to remain in compliance with the 12% policy floor for fiscal year 2008.
Note that Fitch doesn't speak to the fiscal year 2009 budget (which was just passed), but it's clear that the rating agencies like Durham to hit the mark it's set for the fund balance.
In conversations with BCR, Councilman Ali has raised an interesting point: the Council doesn't look at the budget once a year, but has the chance to review spending on an ongoing basis. Ali pointed out that this is actually, on the face of things, an argument for maintaining conservative controls on the City Manager's spending authority -- that is, to allow elected officials to make sure that spending trends appropriately, and to curtail new spending if the City is running over target.
(We wouldn't expect this to be a done debate. While new City Manager Tom Bonfield is certain to inherit the same financial controls and limits as Patrick Baker has had, we'd expect to see the Brown-Catotti-Woodard wing on Council make a fresh play at setting these limits to levels more comparable with other municipalities when possible.)
Fitch's press release turns to the level of debt that Durham's taken on -- an item that draws a strong review, though also a reminder of the ceiling of ambition the city faces with more borrowing in the near term:
Direct debt levels are low, and payout is well above average, with 66% of GO bonds and COPs retired within 10 years. The six-year CIP for fiscal years 2008-2014 totals a sizable $1.3 billion. Funding sources for roughly $480 million of the plan have not been identified and thus, not all projects included in the plan are expected to be funded during the current plan horizon. Fitch anticipates that debt levels will remain moderate despite growing capital needs given strong tax base and population growth, manageable plans for future debt issuance and the extended period over which CIP projects will be funded.
We've talked about this challenge of debt before; expect some hard conversations in the years to come as city leaders debate which projects should be maintained and which should get postponed.
Fitch did raise two concerns, formally, about the city's overall qualification for the AAA rating:
The city reports that it and 14 of its employees have been named as defendants in three lawsuits filed in connection with the 2006 Duke University lacrosse rape case. The financial exposure cannot be quantified at this time and Fitch will continue to monitor the situation....
Wealth levels are below those typically seen for an 'AAA' rating.
With these two caveats aside, it's a pretty strong rating of Durham's financial strategy.
Left unsaid in this release, of course, is one point of worry that the Brown-Catotti-Woodard wing raised during the budget debate: the overall macroeconomic climate, and the impact that rising foreclosures or decreased tax collection rates could have on Durham's financial health. (Durham's tax collection rate is one of the highest in the state, at over 98% -- a number that may be hard to maintain with more homeowners falling behind or defaulting on their obligations.)
Diane Catotti signaled in the H-S article that she hasn't changed her mind on what strategy the Council should have followed; we doubt Brown or Woodard have, either.
Still, as with the lacrosse case outcome, the only thing to do at this point is to wait and see whether there's any effect of such broader financial trends on the bottom line. The Moody's report, the H-S notes, may contain a formal mention of the change in rating policy, something we'll watch for in the coming days.
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