Fitch Affirms Naugatuck, Connecticut's GOs at 'AA'; Outlook Stable

NEW YORK--(BUSINESS WIRE)--

Fitch Ratings has affirmed its 'AA' rating on the following Naugatuck, Connecticut (the borough) outstanding general obligation (GO) bonds as follows:

--Approximately $2.2 million GO bonds, series 2002;

--Approximately $40.4 million GO pension bonds, series 2003.

In addition, Fitch affirms the following ratings:

--Approximately $2.2 million wastewater system certificates of participation (COPs), series 2002 at 'AA-';

--Approximately $15.9 million incinerator facilities COPs, series 2002A at 'A+'.

The Rating Outlook is Stable.

SECURITY

GO bonds are secured by the borough's full faith and credit and unlimited taxing power.

COPs are secured by lease payments made by the borough equal to debt service, subject to annual appropriation. The series 2002 and 2002A COPs are additionally and respectively secured by a leasehold security interest in certain capital improvements to the borough's sewage and wastewater system and sludge incinerator facility. Each series of COPs is secured by a cash funded debt service reserve fund.

KEY RATING DRIVERS

SOLID FINANCES AND CONSISTENT BUDGET PERFORMANCE: Finances are well managed and budgeting is very conservative, resulting in consistently positive operations and strong unrestricted fund balance levels.

ECONOMIC PRESSURES PERSIST: Housing market conditions remain weak in the borough but continue to slowly improve. Labor force, employment, and population have experienced declines over the past several years, and commercial and residential development is relatively stagnant.

TAXPAYER SENTIMENT WANES: Fitch believes a recent negative voter referendum, although it failed to achieve sufficient turnout to be effected, indicates taxpayer resistance to further increases to already high tax rates.

MANAGEABLE LONG-TERM LIABILITIES: The borough's debt levels are moderate and its pensions are well funded. Debt levels will increase over the next two to four years as the borough issues bonds for school construction, but Fitch expects the overall debt burden to remain manageable. Fitch views efforts to pre-fund other post-employment benefits (OPEB) liabilities favorably.

RISK OF NON-APPROPRIATION: The lease ratings are based on the overall credit quality of the borough, the ultimate obligor. The distinction in the ratings on the COPs reflects Fitch's belief that the wastewater treatment plant provides more of an essential service to the borough than the incinerator, as the borough has other options for disposal of treated waste.

RATING SENSITIVITIES

ECONOMIC STRESSES: The borough's somewhat high tax burden and pressured economy could constrain general budget flexibility in the near term. Indications that continued economic weaknesses are reducing financial flexibility could result in a change in the Outlook or rating.

CREDIT PROFILE

The borough of Naugatuck is located about 24 miles northeast of Bridgeport. Population in the borough as of 2012 was 31,774.

STRONG FINANCIAL PROFILE

Unaudited results for fiscal 2013 show the borough finishing the fiscal year with a nearly $788,000 addition to unrestricted fund balance, despite budgeting for an $895,000 deficit. This performance represents at least the eighth consecutive fiscal period of positive budget variance, indicating conservative budgeting practices. Fiscal year end 2013 unrestricted general fund balance is projected to be $13.1 million, or a healthy 12.3% of spending. As part of its 2013 budget process, the borough's board raised the minimum required reserve level from 5% to 8%, which Fitch views favorably.

The borough's fiscal 2014 budget shows a $935k use of general fund balance. If the deficit were to occur in this amount, unrestricted general fund balance would be reduced to $12.3 million, or a still healthy 11.1% of spending. However, given the borough's strong, consistent history of conservative budgeting practices, Fitch does not anticipate this deficit to materialize.

LOCAL ECONOMY REMAINS WEAK

The borough continues to feel the aftereffects of the most recent recession. The local housing market has been recovering slowly, but remains depressed. Regional housing starts and median home price in the borough have both been slowly making gains, but remain well below pre-recession levels. The borough's $700 million mixed-use downtown improvement project, Renaissance Place, which was introduced prior to the recession, was canceled during fiscal 2013. The borough owns the site and has received multiple offers for new, albeit smaller, mixed-use projects. The borough hopes a new developer will have construction underway at the site by mid- to late- 2014.

The borough's local economy has historically been dominated by manufacturing but has recently started to diversify into healthcare and a larger retail presence. The borough also benefits from direct commuter rail and highway access to Waterbury and Bridgeport.

Wealth indicators in the borough are comparable to the surrounding New Haven region and the nation, and have been growing at a solid pace. Population in the borough has seen a very mild 1% decline since 2009. The borough's labor force and employment both also continue to see declines following steep losses during the recession, a trend that has reversed at the national level. The borough's unemployment rate has improved over the past several years due to continued employment loss, and was a high 9.6% in June, 2013.

MILLAGE RATE INCREASES, TAXPAYER SENTIMENT WANES

The borough's 2012 grand list, from which 2014 fiscal year property tax revenue is budgeted, was 23% lower than the 2011 grand list, attributable to a five-year statistical revaluation. The borough was able to adjust the millage rate, mitigating the net effect on the levy of the decline in the grand list. Going forward, the borough projects annual growth in the grand list of about 1%, which Fitch believes is reasonable given the slowly improving housing values.

Because of the millage rate adjustment above what is already considered high, the fiscal 2014 budget was petitioned by the voters and faced a referendum. The referendum failed when only 13.8% of the required 15% registered voters in the borough attended, but results would have been negative. While not uncommon to the state of Connecticut, this could present a practical limitation to any rate increases in the near term.

INCENTIVE TO MAKE LEASE PAYMENTS FOR COPS

The borough is party to a management contract for the Naugatuck Treatment Plant (the plant) as well as a 20-year operating lease for the incinerator with Veolia Corporation (Veolia), a subsidiary of Veolia Environment S.A. ('BBB+' Fitch IDR; Outlook Negative). Since 2009, rental payments from Veolia have equaled half the annual lease payments due by the borough under the lease, and the borough has been entitled to a portion of Veolia's operating profits. Although the plant continues not to generate sufficient profits to be shared with the borough, the borough has continuously budgeted each year for the full amount of debt service on the COPs and offsets these costs with rental payment proceeds from Veolia.

The plant's ability to achieve break-even operations in fiscal 2013 somewhat lessens Fitch's concern about the borough's incentive to continue to budget and appropriate for COP lease payments, and that the incentive will only increase if the facility gets closer to generating profits. Conversely, appropriation risk would be heightened if the project were to fail.

Fitch believes that the wastewater asset is a more essential asset for the borough than the incinerator facility since the borough could send its own sludge to another processor at a nominal cost if the merchant facility were to fail, whereas the Connecticut Department of Environmental Protection has identified the wastewater facility as crucial to serving regional needs.

MANAGEABLE LONG-TERM LIABILITIES

The borough's overall debt burden is manageable at $2,613 per capita and 3.7% of market value projected for fiscal 2014. Debt amortization is rapid at 68.3% retired in 10 years.

Naugatuck issued pension obligation bonds in 2003, which currently represents the majority of the borough's outstanding debt. This bonding and continued pension funding have resulted in the borough's two single-employer defined benefit plans being well funded. Further, six of the borough's seven unions have recently agreed to new hires entering a defined contribution plan, and the seventh is expected to transition to a similar plan soon, which should alleviate some of the borough's pension cost growth in the long term.

The borough anticipates borrowing $30 million in multiple issuances over the next two to four years for construction of a new high school. This borrowing is not anticipated to make the borough's debt burden less manageable because the issuance is expected to occur over several years, giving the borough enough time to amortize some existing debt. Capital needs outside of the school construction appear to be limited, and the borough has a convened capital planning committee, but the borough's lack of a formal capital improvement document raises concerns over whether the borough has fully anticipated their future capital needs.

The borough prudently established a trust fund for its OPEB obligation in 2010 and has contributed approximately $4.2 million towards its total $38.8 million liability to date. The borough's unfunded OPEB liability was about 1.7% of market value as of the most recent valuation. Total carrying costs, consisting of debt service and OPEB/pension contributions, represented an affordable 15.8% of governmental spending in fiscal 2012.

Additional information is available at 'www.fitchratings.com'.

In addition to the sources of information identified in Fitch's 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' (Aug. 14, 2012);

--'U.S. Local Government Tax-Supported Rating Criteria' (Aug. 14, 2012).

Applicable Criteria and Related Research:

Tax-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=686015

U.S. Local Government Tax-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=685314

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=803660

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