DBRS Confirms the City of Toronto at AA, Stable Trend

DBRS Limited (DBRS) has today confirmed the Issuer Rating and long-term foreign and local currency Debentures of the City of Toronto (the City or Toronto) at AA. All trends are Stable. The ratings continue to be supported by the City’s large and dynamic economy, considerable base of liquidity and moderate debt burden. Constraining the ratings are significant and rising unfunded capital liabilities that are likely to place material upward pressure on the debt burden. The City’s fiscal management practices also constrain ratings improvement — namely, the use of unsustainable one-time measures and elevated reliance on more volatile funding sources such as the Municipal Land Transfer Tax (MLTT) to balance annual operating budgets. The outlook for debt has risen moderately since the time of the last review.

In 2015, Toronto posted a consolidated operating surplus of $1.2 billion and a DBRS-adjusted post–capital expenditures (capex) deficit of $839.0 million or 7.0% of total revenues. In 2016, the City is projected to post a modest net operating surplus of $35.3 million on a non-consolidated/pre-capex basis. Addressing persistent budget pressures remains challenging, as total tax levy increases in recent years have been below the rate of inflation and insufficient to close a growing structural divergence between revenue and expenditures. DBRS expects this trend to continue, with $731 million in budget pressure in 2017 to be addressed through a proposed cut of 2.6% to programs and agencies, a 2.0% tax increase and numerous one-time bridging strategies. Toronto has also fully budgeted MLTT revenues at 2016 all-time highs, a decision that exposes a greater share of revenue to the volatility of the housing market. However, DBRS is encouraged by recent reports on multi-year revenue strategies and asset optimization that have provided some clarity on the future direction of the City’s finances. In DBRS’s view, new revenue sources, including road tolling of expressways, could provide meaningful support to significant capital funding challenges. Nonetheless, DBRS believes that greater political willingness to utilize traditional revenue sources will likely also be necessary to more fully address the sustainability of operating budgets to avoid future service impacts.

RATING DRIVERS
The trends on the ratings are Stable, reflecting DBRS’s view that the debt outlook is manageable at the current rating level based on the funded 2016 to 2025 capital plan and a preliminary estimate of the City’s capital contributions for the SmartTrack transit proposal. As approximately $33 billion in unfunded capital investment and state-of-good-repair work is incrementally added to funded capital plans each year, upward revisions to the current outlook for debt and long-term capital liabilities (e.g., public-private partnerships) are likely. DBRS-adjusted tax-supported debt is estimated to rise to $6.9 billion, or roughly $2,300 per capita, by 2022, with tax-supported debt as a share of taxable assessment reaching 1.03%, which DBRS considers manageable for the ratings. Material upward revisions to the outlook may erode flexibility in the credit profile and place downward pressure on the ratings over time. Upward pressure on the ratings is highly unlikely given the scale of unfunded capital and the likely impact on future borrowing.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

The applicable methodology is Rating Canadian Municipal Governments, which can be found on our website under Methodologies.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

The rated entity did participate in the rating process. DBRS had access to the accounts and other relevant internal documents of the rated entity or its related entities.

The full report providing additional analytical detail is available by clicking on the link under Related Research at the right of the screen or by contacting us at info@dbrs.com.