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Rating Update:

MOODY'S DOWNGRADES THE CITY OF WAUKEGAN'S (IL) UNDERLYING GO RATING TO A2 FROM A1 AND REMOVES THE NEGATIVE OUTLOOK

22 Jun 2011

A2 RATING APPLIES TO $100.2 MILLION IN OUTSTANDING GO DEBT

Municipality
IL

Opinion

NEW YORK, Jun 22, 2011 -- Moody's Investors Service has downgraded to A2 from A1 the underlying rating on the City of Waukegan's (IL) general obligation unlimited tax debt. The A2 rating applies to $100.2 million of outstanding general obligation debt.

SUMMARY RATINGS RATIONALE

The outstanding bonds are secured by the city's general obligation unlimited tax pledge. The downgrade to the A2 rating reflects the city's narrowed General Fund reserves; pressured financial operations with significant amounts of underfunded liabilities; a sizable tax base located between Chicago (rated Aa3/stable) and Milwaukee (Aa1/negative); and above average debt burden.

STRENGTHS

- Revenue generating flexibility afforded by Illinois Home Rule status

- Available access to additional employment centers in the Chicago and Milwaukee metro areas

CHALLENGES

- Narrow General Fund reserve levels pressured by negative variances between revenues and expenditures

- Continual reliance on unrestricted reserves from Enterprise Funds to balance operations

- Significantly underfunded liabilities in police and fire pensions, and Safety and Risk Management Fund

Detailed Credit Discussion

PRESSURED FINANCIAL OPERATIONS DESPITE ADDITIONAL FLEXIBILITY DERIVED FROM HOME RULE STATUS

We expect the city to remain fiscally pressured, despite recent and ongoing expenditure reductions and the revenue raising flexibility provided to Illinois home rule communities. The recent deterioration of the city's financial position has come primarily from negative variances in economically sensitive revenues during the economic downturn, expenditure levels which were not in line with those revenues, and the failure of management to apply the correct accounting standards to some of the city's sizable liabilities. While we believe that management has implemented adjustments to address the expenditure and accounting issues, it is still unclear how the city will respond to stagnating revenues as the broader economy continues to recover.

The city has experienced five consecutive operating deficits, deteriorating its once healthy General Fund reserves. Recently, unexpected expenses and lower than budgeted revenues have led to significantly larger General Fund deficits than anticipated by management. While management's unaudited estimates for fiscal 2009 expected a General Fund operating deficit of $675,000, audited figures depicted a more significant deficit of $4.3 million. Economically sensitive revenues experienced significant negative variations, including the city's sales tax and income tax revenues which were $1 million and $1.1 million below budget, respectively. Additionally, the city did not include police and fire department pension contributions ($2.9 and $2.4 million, respectively) in the fiscal 2009 budget which contributed to the deficit figure. The General Fund ended fiscal 2009 with a GAAP balance of $8.1 million, or a relatively healthy 13.5% of operating revenues. In fiscal 2010 management again underestimated the city's operating deficit, experiencing a $7.8 million drop in General Fund reserves. Fiscal 2010 saw similar trends as fiscal 2009 as several budgeted revenue streams underperformed and police and fire department pension contributions were once again omitted in the city's budget ($3.3 million and $2.4 million, respectively). Several revenue streams which experienced negative variances included income taxes, state and federal grants, utility taxes and fines and forfeitures which came under budget by $3.8 million, $1.2 million, $600,000 and $1.5 million, respectively. Despite the continued reliance on transfers from the city's Working Cash and Enterprise Funds, the General Fund ended fiscal 2010 with an extremely narrow GAAP balance of $105,000, or 0.2% of operating revenues. Unrestricted General Fund reserves were in a deficit position reflecting the lack of liquidity in the city's main operating fund.

Several other city funds held deficit positions at the conclusion of fiscal 2010. Chief among them is the city's Safety and Risk Management Fund which holds a $29.5 million deficit balance. Management notes that the substantial deficit increase from fiscal 2008, when the fund had a $6.9 million deficit, was primarily driven by a $10 million wrongful imprisonment claim, an estimated $10 million in prior claims that had not been appropriately addressed, and current work-related claims incurred over the past two fiscal years. A significant portion of the liability is currently tied up in litigation, and management notes that plans to address the deficit position are currently evolving. Positively, management expects a $2 million to $3 million operating surplus in fiscal 2011, achieved by conservatively budgeting revenues and aggressively cutting expenditures, primarily in the areas of personnel and benefits. The city actively reduced General Fund personnel by a sizable 187 positions, or 30% in fiscal 2011, with an additional 73 positions expected for elimination in fiscal 2012. Favorably, management reports additional liquidity available in the city's Working Cash and Water and Sewer funds which remain available to the General Fund if needed to balance operations. Management's ability to accurately budget revenues and expenditures and achieve positive variances going forward will be critical in maintaining the city's current credit profile. Additional draws on reserves could result in a credit profile that is inconsistent with the A2 rating.

TAX BASE SITUATED BETWEEN CHICAGO AND MILWAUKEE

Despite the city's historically high local unemployment and relatively weak demographics, we believe growth in taxable valuation will continue over the long term aided by the relative health of the city's largest employers and long-term plans for extensive downtown and waterfront redevelopment efforts. Located 45 miles north of Chicago, Waukegan is the county seat of Lake County (Aaa). The local economy benefits from a small measure of stability provided by Lake County government, which employs approximately 2,800 in the city. The close proximity of Great Lakes Naval Station adds an additional facet of stability to the city and its businesses. Waukegan's sizable $4.9 billion tax base has demonstrated comfortable annual growth averaging 5.6% over the past five years. Growth is largely attributable to residential and commercial development in areas throughout the city, though appreciation has occurred in older neighborhoods of the city as well in recent years. While valuation increases have slowed due to the recession, these figures are expected to rebound in line with the rest of the region.

The city has begun efforts to target the downtown and waterfront areas for expansive redevelopment, both of which are long-term development goals. The city aims to integrate upper-end residential housing, public park space and retail/commercial property with pre-existing development in both of these areas. The city's unemployment rate at 11.9% as of April 2011 remains above the state-wide and national figures for the same month, at 8.6% and 8.7% respectively. Wealth indices are below state and national medians with per capita and median family income at 75.2% and 85.2% of state levels, respectively.

ABOVE AVERAGE DEBT BURDEN WITH AGGRESSIVE PAYOUT

The city's debt burden is expected to remain manageable due to continued tax base growth, albeit narrowing trends from non-property tax sources. The city's direct debt burden is above average at 2.1% of full value, while its overall debt burden is notably higher at 4.6% of full value, representing the significant amount of overlapping debt from school districts and other local government units. Favorably, the city's debt amortization is rapid as 85.9% of principal is retired within 10 years. Management anticipates pursuing refunding opportunities in the near-term if significant savings present themselves. All of the city's debt is fixed rate, and the city is not a party to any interest rate swap agreements

What Could Make The Rating Go Up

- The restoration of General Fund reserves to a level sufficient to provide adequate cushion to offset unforeseen negative budget variances across the city's operating funds.

- Significant growth in taxable valuation

What Could Make The Rating Go Down

- Negative variances in General Fund performance resulting in the further deterioration of the city's financial position

- Significant deterioration in the city's tax base and economy

- Inability to manage and reduce long-term liabilities

Key Statistics

2010 Population: 89,078 (1.4% increase since 2000)

2010 Full value: $4.93 billion (5.6% average annual increase since 2005)

Full value per capita: $54,420

2000 Per capita income (as % of state): 75.2%

2000 Median family income (as % of state): 85.2%

Fiscal 2010 General Fund (GAAP) balance: $105,000 (0.2% of General Fund revenues)

Net direct debt burden: 2.1%

Overall debt burden: 4.6%

Principal amortization (10 years): 85.9%

Outstanding general obligation debt: $100.2 million

The principal methodology used in this rating was General Obligation Bonds Issued by U.S. Local Governments published in October 2009.

REGULATORY DISCLOSURES

Information sources used to prepare the credit rating are the following: parties involved in the ratings, parties not involved in the ratings, public information.

Moody's Investors Service considers the quality of information available on the credit satisfactory for the purposes of assigning a credit rating.

Moody's adopts all necessary measures so that the information it uses in assigning a credit rating is of sufficient quality and from sources Moody's considers to be reliable including, when appropriate, independent third-party sources. However, Moody's is not an auditor and cannot in every instance independently verify or validate information received in the rating process.

Please see ratings tab on the issuer/entity page on Moodys.com for the last rating action and the rating history.

The date on which some Credit Ratings were first released goes back to a time before Moody's Investors Service's Credit Ratings were fully digitized and accurate data may not be available. Consequently, Moody's Investors Service provides a date that it believes is the most reliable and accurate based on the information that is available to it. Please see the ratings disclosure page on our website www.moodys.com for further information.

Please see the Credit Policy page on Moodys.com for the methodologies used in determining ratings, further information on the meaning of each rating category and the definition of default and recovery.

Analysts

Andrew T. Van Dyck Dobos
Analyst
Public Finance Group
Moody's Investors Service

Mark G. Lazarus
Backup Analyst
Public Finance Group
Moody's Investors Service

Edward Damutz
Senior Credit Officer
Public Finance Group
Moody's Investors Service

Contacts

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Research Clients: (212) 553-1653


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MOODY'S DOWNGRADES THE CITY OF WAUKEGAN'S (IL) UNDERLYING GO RATING TO A2 FROM A1 AND REMOVES THE NEGATIVE OUTLOOK
No Related Data.
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