Fitch Ratings lifted Cleveland's issuer rating into the double-A category over its growing reserves and income tax collections despite the impact of remote work tax refunds.
Fitch rates just a small piece of the city's general obligation debt but it's now on par with Moody's Investors Service and S&P Global Ratings in rating the city in the double-A category although S&P rates the city's GOs that also carry a first lien pledge of the city's 2.5% income tax at AA-plus. Moody's rates the general obligation bonds at Aa3
The upgrade "is driven by sustained improvements in the city's income tax collections and the city's superior gap-closing capacity," Fitch said. "The AA-minus rating also incorporates the city's elevated but still moderate long-term liability burden, strong reserve levels, and solid expenditure controls."
"I think this is the result of the good financial practices some which we continued from the prior administration while implementing others, like augmenting our reserves and making the policy choice not to use ARPA for day-to-day operations," said Ahmed Abonamah, the city's chief of finance.
The city's next GO sale for roughly $60 million is expected later this summer and the city recently closed a request for proposals to establish a pool of underwriters for the credit. One question posed to broker-dealers was on rating agency strategies so no decisions have been finalized on what rating agencies would be asked to rate the deal. Moody's and S&P rated last year's sale.
The city has water and pollution control deals in the works, but the timing isn't set and with a $2 billion master facilities plan at Cleveland Hopkins International Airport, significant issuance is expected in the coming years as existing debt is paid down, Abonamah said.
While the Northeastern Ohio city on the southern shore of Lake Erie serves as the county seat of Cuyahoga County has struggled with population losses — an 8.9% drop to 362,000 from 2010 through 2022 — and manufacturing employment declines, its "economy has rebalanced toward the more stable health and education sectors in recent years," Fitch said.
The Cleveland Clinic is the largest private employer with University Hospitals of Cleveland, MetroHealth System, KeyCorp, and Case Western Reserve University close behind.
Strong income tax collections and the use of the city's share of $512 million in federal COVID-19 American Rescue Plan Act funding drove a net operating surplus of $111 million, equal to 17% of spending, in 2021, that brought the city's unrestricted fund balance to $322 million, or 49% of spending. The city closed 2022 with an anticipated $252 million surplus, $37 million net of the ARPA allocation.
The city tapped $109 million and $215 million in ARPA funding in fiscal 2021 and fiscal 2022, respectively, to replace lost revenues.
The city held $135 million or 25% of spending in reserve for 2021 and 2022 as it built up the funds with ARPA dollars available to make up for lost revenue. The city also established a special payroll reserve fund that will serve as a cushion in the next economic downturn, giving the city flexibility to avoid deep service cuts and layoffs.
The 2023 budget is structurally balanced without any ARPA funds and projects ending the fiscal year with a modest net operating surplus, Fitch said.
"As the city spends down excess levels of general fund reserves, Fitch expects that management will continue to maintain a requisite level of fund balance to manage well through economic downturns while maintaining a high level of fundamental financial flexibility," analysts said.
The city's income tax revenues continue to grow despite the state's commuter refund law that has driven up income tax refund requests by 50% year-over-year. Rising wages and employment levels have helped offset the impact of remote work.
In fiscal 2021, net income tax collections in the general fund exceeded pre-pandemic levels by 2%, and management estimates general fund net income tax collections were 3% higher in fiscal 2022.
The city levies a 2.5% income tax on gross salaries and wages earned by residents and nonresidents and on net business profits attributable to business conducted within the city. Residents employed outside Cleveland have their income tax liability to the city reduced by a credit equal to 100% of the tax paid to the municipality where they are employed.
The income tax growth has eased worries for the city. "It's a much less dire picture of the future than we were fearing at this point last year," Abonamah said. "Inflation did help us as a ballast against the increased refund activity" and while growth will moderate, declines are no longer a top worry.
Structurally balancing the books marks a high point for Abonamah as it was a key goal when he joined Mayor Justin Bibb's administration. "That was my laser focus — to do everything we could without resorting to any tricks to balance the budget structurally and we were able to do that by relying on conservative growth" and trimming 250 vacant positions that didn't harm services.
While the 2023 budget doesn't make a deposit in reserves — that currently stand at about $155 million between the $90 million in its special payroll reserve and $65 million in a rainy-day fund — if the city ends the year on a high fiscal note it could make a deposit, Abonamah said.
Income taxes account for about 57% of general fund revenues while property taxes account for only 5% of general fund revenues.
While the city needs voter approval to raise property taxes, it does have authority to raise various charges, fees, and other locally controlled revenues if needed.
Debt levels weigh on the rating. Fitch calculates the ratio of both Ohio Public Employees Retirement System's and Ohio Police and Fire Pension Fund's assets to liabilities to be 67%, assuming a 6% discount rate.
