Bonds

Cleveland heads into the market on upgrade tailwinds

Cleveland heads into the market this week with an upgrade helped along by its decision to tap surpluses to bolster reserve levels.

Moody’s Investors Service raised the city’s rating to Aa3 from A1 while S&P Global Ratings affirmed its AA-plus. Both assign a stable outlook.
Moody’s action recognizes a “strengthening of fund balance and liquidity,” analysts said. “Reserves are expected to remain very healthy across city operations given an influx of federal aid and conservative budgeting of revenue and expenses.”

 “This change means that the city’s future borrowing costs should go down and that we will be better able to expand our investor base,” said Ahmed Abonamah, the city’s chief of finance.

 “This change means that the city’s future borrowing costs should go down and that we will be better able to expand our investor base,” said Ahmed Abonamah, the city’s chief of finance.

The city plans to sell $49 million of general obligation debt on Wednesday.

Proceeds will finance various capital projects and equipment purchases like city vehicles while capital projects include construction, renovations, and improvement to city facilities, parks, and streets and sidewalks.

KeyBanc Capital Markets is senior manager with four other firms acting as co-managers. Phoenix Capital Markets LLP and Government Capital Management LLC are acting as advisors and Squire Patton Boggs LLP is bond counsel. The deal is the first issue under Mayor Justin Bibb who took office earlier this year.

The city closed out 2021 with a fund balance of more than $300 million, up 59% from the prior year, as it tapped $109 million from its share of first allocation of federal COVID-19 pandemic relief in the American Rescue Plan to make up for lost revenue.

Above-average leverage from debt and post-retirement benefit liabilities weigh on the rating. A pronounced contraction of the city’s economy and tax base including material declines to income tax collections or recurring operating deficits resulting in a narrowing of fund balance or liquidity could drive a downgrade. The city covers about 80 square miles in Cuyahoga County along the shores of Lake Erie in northeast Ohio with about 373,000 residents.

The upgrade impacts $387 million of general obligation limited tax debt, $399 million of subordinate lien income-tax-backed bonds that are rated at the same level and $55 million of non-tax revenue bonds that were raised to A1 from A2.

Income tax receipts, a primary source of revenue at 60% of the general fund, are on the upswing performing 9% better than budgeted so far this year and could hit $500 million. The city held the projection for 2022 steady at the 2021 level of $430 million due to uncertainty over refund requests that could be sought from remote workers when filing their 2021 tax returns and the lingering pandemic effects.

With stronger collection new in hand and the ability to use a portion of its $512 million of federal COVID-19 ARPA relief to make up for lost revenues, the city took steps that helped make a case for the Moody’s upgrade with a $20 infusion into its rainy day reserve bringing it to $65 million, or about 10% of city revenues. Past annual rainy day deposits typically were around $4 million to $8 million.

The city also established a new $90 million payroll reserve fund. It serves as a cushion in the next economic downturn that would give the city flexibility to avoid deep service cuts and layoffs.

The City Council signed off on the actions earlier this month.

“We felt based on actual results that we had an opportunity to put money away to ensure the city’s long-term fiscal health,” Abonamah said.

The city tapped ARPA for eligible expenses on one-time public safety, public health, and housing spending as well as revenue recovery freeing up other funds that contributed to the surpluses.  A total of $109 million went to revenue recovery in 2021.

Most of the funding is aimed at one-time maneuvers aimed at avoiding adding to the city’s structural imbalance.

The pandemic left a structural hole in the city’s books that amounts to $62 million in the current budget. The city expects to chip away at it based on revenue projections but the mismatch will remain and serves a key challenge going forward. “The goal is to get back to a point of having as structurally balanced budget” during the mayor’s term, Abonamah said.

The city is eyeing its fee structures that haven’t been revamped in 20 years as a means to raise revenue while also assessing the expense side with a review of the city’s organizational and administrative structure.

S&P rates the city’s GO bonds, which enjoy a first-lien pledge of the city’s 2.5% income tax, at AA-plus and its subordinate-lien income tax bonds and unrestricted income tax bonds AA. 

“The AA-plus rating on the series 2022 GO bonds and the city’s first-lien pledge of income taxes is two notches higher than the obligor’s creditworthiness, reflecting our view that the pledged revenue and the flow of funds are sufficiently removed from the city’s control so as to substantially mitigate operating risk,” S&P said.

The impact of remote work on income tax collections remains a risk that could strain future budgets, but it is clouded. State legislation in 2020 allowed Ohio cities that year to continue collecting income taxes from workers living outside the city who were working remotely.

“Management will likely have to continue to navigate the impact of telecommuters and population loss on the city’s tax base and how it affects the budget, particularly once ARP funds are no longer available,” S&P noted.

On environmental, social, and governance issues, S&P said: “We believe that the city’s environmental and governance factors are neutral; Cleveland continues to take steps to mitigate exposure to cyber-security threats, and despite its location along Lake Erie, the city is not overexposed to extreme weather events or long-term changes in climate trends, in our view.”

Abonamah, 39, returned to Ohio, which he considers home to take the job as the city’s top finance officer in the new administration earlier this year. 

While he was born in Chicago, his family later landed in Akron and Abonamah received a law degree from Case Western Reserve University School of Law in Cleveland. He relocated with his wife to Washington, D.C., in 2012 and took a position at Squire Patton Boggs where he was a public finance associate in the Public and Infrastructure Group.

In 2016, he joined the Securities and Exchange Commission starting out as an attorney-adviser in the SEC’s Office of Municipal Securities. In 2017, he became senior counsel to the director of the Office of Municipal Securities and then was named deputy director in 2019. In 2020, he was named the acting director of the SEC’s Office of Credit Ratings and was formally named the director in November 2021.

He applied to work in the new administration and earlier this year Bibb offered him the chief of finance position.

“This is my hometown and I have a lot of affection for the city. That’s one of the reasons when the mayor offered me the job I took the opportunity to come home,” Abonamah said.

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