City of Cambridge Bond Ratings - 2013

February 25, 2013
To the Honorable, the City Council:

I am pleased to inform you that the City of Cambridge retains the rare distinction of being one of 37 municipalities in the United States with three AAA ratings from the nation's three major credit rating agencies.  The City has received AAA ratings from Moody's Investors Service, Standard & Poor's and Fitch Ratings every year since 1999.

These ratings are in conjunction with the City's sale of $65.3 million in General Obligation bonds, which took place on February 19, 2013 to finance such capital projects as King Elementary School Renovations, Sewer Reconstruction, Old Police Station Renovations, Improvements to the Harvard Square Tunnel, Open Space Improvements, Acquisition of a Fire Ladder Truck and Pumper, Building Improvements, and Street and Sidewalk Improvements at Kendall Square.

In addition, Standard & Poor's reaffirmed its "strong" Financial Management Assessment (FMA) of the City.   An FMA of "strong" indicates that practices are strong, well embedded and likely sustainable. The strong rating indicates that the government maintains most best practices deemed critical to supporting credit quality and that these are well embedded in the government's daily operations and practices. Formal policies support many of these activities, adding to the likelihood that these practices will continue into the future and transcend changes in the operating environment or personnel.  

Based on this ongoing recognition from the rating agencies, especially during these challenging economic times for municipalities, the City Council can be justly proud of its sound fiscal policies.

I have attached the final rating opinions of Fitch Ratings, Moody's Investors Service and Standard & Poor's Corporation.  Listed below are highlights from the Fitch, Moody's and Standard & Poor's credit reports.

Fitch Ratings

Key Rating Drivers
Exceptional Financial Management: Management's conservative budgeting practices and prudent use of reserves has helped keep tax levy increases at moderate levels while the city faces growing employee-related costs.

Above-Average Reserve and Liquidity Levels: The city's positive financial profile is characterized by large reserves and ample liquidity. Additionally, the city's levy margin continues to grow favorably to the highest level in the city's history.

Economic Diversity Promotes Stability: The stable presence of higher education, healthcare, biotechnology, and life sciences industries supports the well-diversified economy with low unemployment and above-average wealth levels.

New Development Continues: Ongoing development within the city is projected to promote growth in assessed value, providing the city with tax levy flexibility for operations and debt service.

Moderate Debt Levels: Debt levels are moderate and expected to remain manageable, aided by the city's rapid amortization rate.

Credit Profile
Cambridge is located in Middlesex County across the Charles River from the city of Boston and is an important economic component for the Boston metropolitan area and Massachusetts as a whole. The city benefits from the presence of both Harvard University and Massachusetts Institute of Technology These institutions are the city's top two employers with a combined workforce of 19,000. The city continues to experience employment expansion amongst companies in the biotechnology and life and sciences sector. Leading biotech companies, including Novartis, Biogen Idec, Vertex, Pfizer Millennium and Genzyme, employ more than 8,500 Cambridge workers. Several major software and internet companies have recently established research and development operations in Cambridge including Microsoft, Google, and VMware. Cambridge continues to be recognized for its high level of venture capital investment totaling $305 million during the third quarter of 2012, as new ventures are attracted to Cambridge's highly skilled workforce, urban setting and proximity to cutting edge companies and research institutions.

The city's well-diversified economy is characterized by a low November 2012 unemployment rate of 3.8%. Numerous economic development projects are under way or in the planning stages and include expansions to existing corporate facilities and new offices or labs.

Exceptional financial management and planning are demonstrated by the city's strong financial position. The city continues to strategically use general fund reserves, including debt stabilization funds, to keep tax levies at moderate levels. Reserve levels remain strong. 

Conservative revenue projections and lower than estimated expenses helped overcome the use of reserves, which has typically been the city's experience. The city has historically maintained an unreserved fund balance well in excess of the city's fund balance policy requiring an unreserved general fund balance equal to at least 15% of the ensuing year's budgeted revenues.

Cambridge's $116 million of certified free cash for fiscal 2012 (up from $102 million in fiscal 2011) is the largest amount in the city's history. Fitch Ratings also notes that Cambridge's substantial $104 million of excess levy capacity under Proposition 2½ (up from $102.6 million) provides the city with significant financial flexibility.

Moody's Investors Service

Summary Rating Rationale
The Aaa rating reflects the city's large, diverse and stable tax base, which is anchored by world renowned higher education institutions and a growing research and development sector. 

Also incorporated into the Aaa rating are a healthy financial position which has remained historically stable, management's consistently conservative approach to budgeting and expenditure management and a favorable debt profile supported by healthy enterprise systems. 

Strengths

• Large and diverse tax base anchored by stable universities
• Robust financial position guided by sound management policies
• Very ample excess levy capacity under Proposition 2½
• Very well managed debt profile

 Challenges

• Significant long-term liabilities for pensions and OPEB
• High regional costs of living and doing business

Highlights

COMMERCIAL DEVELOPMENT SPURS MODEST TAX BASE GROWTH
Cambridge's economy benefits from the presence of Harvard University (rated Aaa/stable outlook) and the Massachusetts Institute of Technology (MIT, rated Aaa/stable outlook) -- which together enroll 27,940 students and provide employment for almost 19,000 full-time equivalent positions -- and the related vibrant biotechnology, pharmaceutical and life sciences employment base. Together these institutions comprise 42% of the jobs provided by the city's top 25 employers while building permits issued to the universities historically represent a significant portion of the city's annual activity. Cambridge's assessed value has remained strong during the economic downturn and lagging recovery, largely due to the ongoing expansion of the city's commercial sector. New development continues in the city, as evidenced by improving building permit activity. Fiscal 2012 building permit valuations totaled approximately $1.1 billion, resulting in $15.9 million in revenue to the city. This represents a significant increase over 2011 permit valuations of $503.2 million, and is largely a result of several large scale commercial developments primarily located in Harvard Square and Kendall Square districts. 

From 2007 through the fall of 2012, Cambridge has added approximately 898,000 square feet of commercial space, with several additional projects under construction. City officials report that over 6.3 million additional square feet of space, primarily slated for biotechnology research and development, is in various stages of construction, or is already completed, in the city's economic development districts. Cambridge's commercial vacancy rate compares favorably to metro Boston.

Incorporating a 3.8% population increase since 2000, the city's equalized value per capita is a robust $253,325 in fiscal 2013; despite the tax exempt status of nearly one-third of the tax base.

HEALTHY FINANCIAL POSITION CHARACTERIZED BY AMPLE RESERVE LEVELS AND PROACTIVE MANAGEMENT
Cambridge is expected to maintain a healthy financial position in the near term, although stabilization funds earmarked for debt service are expected to be depleted over the next several years. The city continues to benefit from ample financial flexibility and robust reserve levels, which position it to absorb an extended period of flat or declining state aid and sluggish local revenue growth. Cambridge's management team maintains formally adopted fiscal policies for its annual budgeting. Steady revenue streams, generated by its substantial and stable tax base, provide flexibility to address budgetary challenges.

AFFORDABLE DEBT BURDEN WITH MANAGEABLE CAPITAL NEEDS
Cambridge's debt obligations will remain affordable given a sizeable level of self-supporting debt and a rapid principal retirement schedule.

Self-supporting water and sewer system debt as well as the city's pay-as-you-go funding plan, budgeted at approximately $5 million annually, also contribute to Cambridge's favorable debt ratios. Direct debt is retired at an average pace of 81.2% within ten years.  

Outlook
The stable outlook reflects Moody's expectation that Cambridge will maintain a healthy financial position, given its strong reserve levels and history of balanced operations. Moody's also expects that the city will continue to improve funding ratios for pension and OPEB while maintaining a conservative approach to budgeting and expenditure management.

Standard & Poor's Corporation

Rationale
Standard & Poor's Ratings Services has assigned its 'AAA' long-term rating to Cambridge, Mass.' Series 2013 general obligation (GO) bonds and affirmed its 'AAA' long-term rating on the city's GO parity debt. The outlook is stable.

The ratings reflect our opinion of the city's: 

• Strong and dynamic local economy, anchored by Harvard University and Massachusetts Institute of Technology(MIT), as well as biotechnology and high-tech firms;
• Above-average wealth and income factors, including an extremely strong market value per capita;
• Very strong financial position, despite general fund decreases in fiscals 2010 and 2011, coupled with an experienced management team and strong management policies; and
• Low debt burden and manageable capital plan.

Standard & Poor's considers Cambridge's financial management practices "strong" under its Financial Management Assessment methodology, indicating practices are strong, well embedded, and likely sustainable. 

Outlook
The stable outlook reflects Cambridge's very strong financial position, experienced management team and strong financial management policies and practices. We do not expect to change the rating within the two-year outlook period as we expect the city's strong and resilient local economy and property tax base will continue to provide sound revenue to support the city's financial position. 

Economy: Diverse With Multiple Large Employers
The city remains an employment center: In 2011, the city was host to one job for every city resident. Cambridge is home to a concentrated cluster of world-recognized biotechnology and pharmaceutical firms that are attracted by the concentration of intellectual capital at Harvard; MIT; and the Whitehead Institute, a research and development think tank. Private biotechnology firms account for six of the city's 25 leading employers.

Finances
The total and available general fund balances both increased in fiscal 2012 due to a combination of both revenue and expenditure surpluses. A $27.0 million increase in the available general fund balance brought it to $126.7 million or 28.7% of operating expenditures. The total fund balance was $163.2 million or 37% of expenditures.

The fiscal 2013 budget increased by 2.9% from the prior budget, and the tax levy increased by 6.0%. The budget appropriates $9.0 million of free cash (general fund balance), which was reserved in the fiscal year-end 2012 balance sheet, along with some funds from non-general fund reserves. The city has agreements with eight of its 10 collective bargaining units; the teachers and firefighters contracts are still being negotiated, but management expects the settled contracts will be manageable. Cambridge's five-year financial forecast projects continued free cash appropriations of $8 million to $9 million, along with reductions from various stabilization reserve funds in line with the plans when those funds were established. The city's reserve policy requires at least a 15% general fund balance. 

Debt, Pensions, and Other Postemployment Benefits
Following this issuance, the city will have $68.5 million of authorized unissued debt remaining. We expect that the city's additional debt burden should remain moderate.

As of Jan. 1, 2012, the city's unfunded pension actuarial accrued liability increased to $237.8 million. The city recently pushed the full pension funding date back to 2029 from 2013, due to investment losses. Officials indicate that once the city fully funds the pension liability, it may dedicate the former pension funding to making payments for the other postemployment benefits (OPEB) liability, but they have not yet made a decision on this funding issue.

As of June 30, 2012, the unfunded OPEB actuarial accrued liability was $611.1 million. The city currently funds its OPEB on a pay-as-you-go basis, with a fiscal 2012 contribution of $22.5 million, or 5.1% of general fund expenditures. The city established an OPEB trust fund in December 2009 and made a $1.0 million contribution in fiscal 2013, and officials expect a $2.0 million contribution for fiscal 2014.

Very truly yours,
Robert W. Healy
City Manager