U.S. PUBLIC FINANCE SECTOR IN-DEPTH 18 JUNE 2015 ANALYST CONTACTS Tiphany Lee-Allen 212-553-4772 Analyst tiphany.lee-allen@moodys.com Julie Beglin 212-553-4648 VP-Sr Credit Officer/Manager julie.beglin@moodys.com Naomi Richman 212-553-0014 MD-Public Finance naomi.richman@moodys.com Local Government Virginia's Hampton Roads Region Responds to Flood Risk The Hampton Roads region in southeastern Virginia (Aaa stable), which includes Virginia Beach (Aaa stable) and Norfolk (Aa2) as its largest cities, is at risk of flooding by virtue of its geography. Flooding risk from inland rainfall, storm surges, and high tides challenge the region due to its location at the confluence of the Atlantic Ocean, Chesapeake Bay, and the James and York rivers. Land use planning, building codes, risk planning and preventative investments have thus far prevented any significant credit impact from flooding, but continued development coupled with sinking land, and recurring strong storms, will require further capital investment and effective planning to mitigate negative credit effects on the Hampton Roads coastal municipalities. » The region faces significant flooding risks associated with weather-related and tidal flooding, exacerbated by intensive development. Damage costs from a future severe storm and flooding event could far exceed $10 billion, according to a planning report by the Hampton Roads Planning District Commission. Gradual sea level rise would worsen flooding in low-lying areas, and require rebuilding storm sewer infrastructure. Given the region's extensive military ports, the Department of Defense is doing planning for various sea-level rise scenarios over the next 20 to 50 years.1 » Land use planning, building codes, and capital investment in infrastructure all play a role in mitigating future credit risks. Planning mitigates vulnerability to storms and flooding, and can enable continued private sector development and property tax revenue. Annual spending for stormwater management in the near term reduces the need to spend larger amounts later. Hampton (Aa1) has spent nearly $30 million on flood control over the last three years. However, cost forecasts indicate a potential need for greater investment by local governments across the region. » Conservative financial management and economic strengths benefit the region's municipalities. Despite flooding risk, credit quality within the region remains generally stable. This largely reflects a strong economic base anchored by the region's concentrated military presence and port activity, together with broadly conservative financial operations across the individual local governments. » Regional coordination at the state and federal level will lessen the cost burden for local governments. The concentration of military installations and contiguous cities in Hampton Roads suggest that coordination of planning, development and infrastructure investment will reap the strongest benefits and minimize credit impact for municipalities. MOODY'S INVESTORS SERVICE U.S. PUBLIC FINANCE Region faces significant risks from storm and tidal flooding Water is the lifeblood of the Hampton Roads region, home to a major Northeast commercial port and the world's largest naval base. Access to good harbors and water transportation is both the economic foundation as well as recurring threat to the Hampton Roads region. The region is susceptible to flooding from both the ocean and inland rivers, and its low-lying areas are also vulnerable to stormdriven tidal surges. When combined with sinking land and recurring strong storms, any rise in sea level will require further capital investment and effective planning to lessen the odds of negative credit effects on the Hampton Roads coastal municipalities. Hampton Roads Benefits from Military Presence, Port Activity and Tourism The Hampton Roads region benefits from a substantial military presence, commercial port operations, and a growing tourism business. Norfolk is home to the world's largest naval base with 46,000 active-duty personnel and 21,000 civilians. Other major installations include Langley Air Force Base, Fort Eustis, Fort Story and two National Aeronautics and Space Agency (NASA) facilities. Department of Defense (DOD) accounts for 40% of regional economic activity and increased by 5.6% annually from 2000 to its peak in 2012. Spending is expected to total $18.7 billion in 2015, marking a 3% decline from peak 2012 levels. 2 The Port of Virginia is the secondlargest port on the East Coast by cargo volume, according to the latest American Association of Port Authorities data. The Virginia Port Authority (senior revenue-backed debt Aa3 stable) operates the port terminals. Tourism is also a pillar of the Hampton Roads economy. Tourists spent nearly $1.3 billion in Virginia Beach in 2014 and tourism-related revenues in Virginia Beach have increased an average of 5% annually since 2010. Exhibit 1 shows the locations of the region's assets. Exhibit 1 Hampton Roads Is Home to World's Largest Naval Base and Second-Largest US East Coast Port Source: Moody's Investors Service This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on www.moodys.com for the most updated credit rating action information and rating history. 2 18 JUNE 2015 LOCAL GOVERNMENT: VIRGINIA'S HAMPTON ROADS REGION RESPONDS TO FLOOD RISK MOODY'S INVESTORS SERVICE U.S. PUBLIC FINANCE Urbanization and development can exacerbate flooding risks, and contribute to stormwater drainage flows. Last year, for example, storms combining high tides and severe rainfall left some drivers stranded in Norfolk, Portsmouth (Aa2 stable) and Virginia Beach. In some cases, land use and planning decisions have exacerbated the risks for flood-prone areas. For example, flooding has caused shutdowns of Norfolk’s $318 million light rail system several times since it opened in 2011; the system was built at sea level and thus is particularly vulnerable. Gradual increases in sea level would over time worsen the flooding risks in the region, particularly for lowlying areas and direct waterfront facilities. Eventually, this might require such investments as rebuilding of sanitary and storm sewer outfalls and other related sewer works, and the elevation of roadways or use of floodgates in low-lying areas. In the meantime, land use planning and building code measures can mitigate risks. Given the extensive naval operations in the region and the problem of recurrent flooding, the US Department of Defense (DOD) is undertaking contingency planning and examining scenarios should long-term sea rise continue or accelerate.3 Extreme sea rise would be very costly here, as it would be for many other places along the US coast. At the same time, we note that military installations in the area already at or close to sea level, such as Fort Story, have undergone recent expansion. Similarly, Virginia Beach has permitted some 500 residential projects along its waterfront in the past year. Stormwater and flood control management require both hard and soft investment to mitigate risk Coastal Virginia municipalities are broadly engaged in measures to prevent serious effects from recurrent weather and tidal-related flooding, as well as the more severe possibility of major ocean storm damage and heavy tidal surge. While capital investment for major works may be required, including floodgates or elevating roadways, flood resiliency can be effectively achieved with many “soft” measures that are both regulatory and physical. This includes land use planning to restrict development in sensitive areas; the stringent application of building codes requiring that any new structures in flood-prone areas be elevated; minimizing runoff through the use of pavers or other permeable surfaces for parking; and the incorporation of natural features such as swales and ponds into the stormwater runoff and impoundment system. At the same time, annual spending for basic maintenance of flood control works is critical, so that the physical system of a municipality is in good working order at all times. Land use zoning and development plans reduce risk to the local economy The region's extensive waterfront areas, although obviously most vulnerable to flooding risks, continue to be major drivers of economic growth and tax-base valuation in each community. Residential waterfront locations may be desirable for many reasons, but they inevitably come with some risk. Flood risks could drive housing values down in flood-prone neighborhoods, negatively impacting property values and ultimately a municipality's tax revenue. Property taxes account for the majority of municipalities' operating revenues in the Hampton Roads region. While the lingering effects of the recession must be taken into account, the value of housing permits in the region decreased by 7% in 2014, falling 43% below peak values in 2005.4 In Virginia Beach, 59.8 out of the nearly 310 square miles are susceptible to flooding over the next 100 years due, in large part, to low-lying land.(see Exhibit 2). 3 18 JUNE 2015 LOCAL GOVERNMENT: VIRGINIA'S HAMPTON ROADS REGION RESPONDS TO FLOOD RISK MOODY'S INVESTORS SERVICE U.S. PUBLIC FINANCE Exhibit 2 Virginia Beach Is Susceptible to Flooding in Hampton Roads Region Source: Virginia Institute of Marine Science, Recurring Flooding Study for Tidewater Virginia Much redevelopment in Virginia Beach continues to occur along its oceanfront. In 2013, the city strengthened a number of ordinances related to floodplain properties. Officials report a slowdown in the approval process to ensure proposed plans meet zoning requirements. Virginia Beach officials expect the city's hurricane protection wall, constructed nearly 20 years ago, to withstand a storm event over a 140-year period. As a result, officials report that the majority of the city's oceanfront development is not in a direct floodplain, which is why over 500 residential development projects took place along the city's waterfront in the last year. The permitting process for these projects is extensive and includes advising applicants of their exposure to flooding, along with recommending shoreline stabilization techniques. The Virginia Beach City Council approved $3 million in the 2015 budget to further study sea level and recurring flooding issues. Municipalities participating in the National Flood Insurance Program (NFIP) are encouraged to adopt a minimum freeboard standard of one foot. According to the Federal Emergency Management Agency (FEMA), freeboard is a factor of safety usually expressed in feet above a flood level. Communities are generally encouraged to exceed the NFIP standard. In the Hampton Roads region, many municipalities have gone that route to provide a greater level of protection from flooding and help prepare communities for rising sea levels. Currently, Chesapeake (Aa1) has one-and-a-half foot freeboard requirements (see Exhibit 3). Virginia Beach has a two-foot requirement, while Norfolk, Portsmouth and Hampton have three-foot requirements. 4 18 JUNE 2015 LOCAL GOVERNMENT: VIRGINIA'S HAMPTON ROADS REGION RESPONDS TO FLOOD RISK MOODY'S INVESTORS SERVICE U.S. PUBLIC FINANCE Exhibit 3 Hampton Roads Municipalities Exceed National Flood Insurance Program's (NFIP) Minimum Standard for Distance from Waterline to Base Level of a Property (aka Freeboard) Sources: Cities of Chesapeake, Portsmouth, Virginia Beach, Norfolk and Hampton Further, most Hampton Roads municipalities require that redevelopment projects, new construction and in some cases existing properties meet planning, zoning and building requirements including freeboard guidelines. With the majority of the area's roadways and key economic assets at or near sea level, new development in low-lying areas will continue to be a challenge. Municipalities that take rising sea levels into consideration in long-term planning and new construction are better positioned to maintain their economic vitality. Further, land use policies that consider areas most vulnerable to sea-level rise and recurrent flooding are crucial to credit strength. Capital investment in infrastructure is key to mitigating future debt burden risks The region's cities have also actively pursued direct capital projects. Virginia Beach has continued to take an active approach to flood resiliency, particularly along its ocean front. The city has completed $43 million in flood control projects over the past five years and plans to spend $135 million over the next 10 years on multiple stormwater management projects, including development of a flooding and sea level rise response plan by 2017. Additionally, Virginia Beach developed a sea wall at the oceanfront and has installed a number of storm water pump stations throughout the city. In Norfolk, annual capital investments have allowed the city to manage recent increases in expenses related to storm events without significantly increasing its debt profile. Over the last three years, Norfolk has undertaken a comprehensive approach to address resiliency, and most recently selected by the Rockefeller Foundation to compete in its 100 Resilient Cities Centennial Challenge. The city is investing $7 million annually for flood resiliency projects, which should help minimize long-term costs including a recently completed $2.4 million mitigation project to elevate a bridge near Fort Norfolk. Additionally, Norfolk instituted a $1 increase in residential stormwater rates in fiscal 2013 to help fund its ongoing flood control efforts. Norfolk's flood-related capital expenses would rise significantly if the city follows an action plan from Fugro Atlantic, a Dutch energy infrastructure firm. The city hired the firm to develop the plan, which calls for new floodgates, elevated roads and a retooled stormwater system. City officials report that this would require a total investment of $1 billion in the coming decades, including $600 million to replace current infrastructure. In part, the funds are needed to make homes and businesses more resilient to any major sea level rise. The city has not decided on a course of action regarding adoption of the action plan. While conducting studies related to flood resiliency is valuable to the planning process, municipalities able to follow through with investment will be better positioned to deal with challenges. In Hampton, $11.5 million in projects were identified in a Tidal Floodplain Study and Protection Plan initiated by the city and presented to the City Council in 2014. The plan includes the installation of storm 5 18 JUNE 2015 LOCAL GOVERNMENT: VIRGINIA'S HAMPTON ROADS REGION RESPONDS TO FLOOD RISK MOODY'S INVESTORS SERVICE U.S. PUBLIC FINANCE gates at high-impact locations and the elevation of roadways. The city's staff has begun to incorporate the projects into the fiscal 2016-20 capital improvement plan, but the City Council will need to make final decisions on funding levels in future years. Hampton has spent $28.7 million on flood mitigation over the last three years, including resiliency studies, construction of stormwater retention ponds, drainage maintenance projects, and installing breakwaters. The city's 2016 budget includes $100,000 for staff consultants to further prepare for rising sea levels. Hampton reports no significant unexpected budgetary expenses as a result of flood events in the last few fiscal years. Overall expenses for flood prevention measures, coupled with unexpected costs for storm cleanup, can pressure budgets already impacted by rising fixed costs and education spending, the largest budgetary expense for most Virginia cities. On average, fixed costs such as debt service, the annual required contribution (ARC) for employee retirement systems, and the pay-as-you-go portion of retiree health benefits typically make up between 16% and 30% of a Hampton Roads municipality's budget (see Exhibit 4). Debt service, which increases with additional capital borrowing, is often the largest fixed-cost component. If fixed costs comprise 30% or more of a locality’s budget, that government does not have much flexibility to add in a significant further increase in debt service to fund flood control capital work without pressuring its operating budget. Exhibit 4 Fixed Costs Limit Available Funds for Flood Control in Hampton Roads Region Note: ARC stands for annual required contribution for pensions expenses. OPEB stands for Other Post-Employment Benefits, mostly retiree health benefits. Source: 2014 CAFRs Conservative financial management and economic strengths benefit region's municipalities Even with their flooding risks, municipalities in the Hampton Roads region have relatively high credit ratings, reflecting the overall strong economic base anchored by the region's concentrated military presence and port activity, together with broadly conservative financial operations across the individual local governments. These cities generally possess more than adequate financial flexibility to manage their fixed costs and support the day-to-day functions of government. For example, even though Virginia Beach's available reserves fall below the national median, the city benefits greatly from a large and diverse $50 billion tax base stabilized by the presence of the tourism industry and military bases. Officials are also committed to raising revenues to maintain financial flexibility, and to this end, the city's 2016 budget includes a 6-cent real estate tax increase. Additionally, city management proactively monitors revenues and expenditures on a monthly basis and has historically made adjustments to revenue and expenditure projections throughout the fiscal year. Flooding risks jeopardize reserve levels However, the threat of increased flooding could materially impact budgets in the future and lead to draws on reserves. Exhibit 5 shows available reserves as a percentage of operating revenues at multiple Hampton Roads’ local governments. Many of the regions' 6 18 JUNE 2015 LOCAL GOVERNMENT: VIRGINIA'S HAMPTON ROADS REGION RESPONDS TO FLOOD RISK MOODY'S INVESTORS SERVICE U.S. PUBLIC FINANCE municipalities have available fund balance levels below the national 2013 median, but we view the current reserve levels as satisfactory at their respective rating levels, given conservative budget management of each locality and the strong revenue-raising flexibility and expenditure control among Virginia local governments. Virginia cities have an institutional framework score of “Aaa,” or very strong. Cities rely primarily on property taxes to support operations, providing high revenue-raising flexibility as property tax rates are not limited. Expenditures, which are primarily for education, are predictable and municipalities have the ability to reduce expenditures if necessary. Exhibit 5 Available Reserves Provide Hampton Roads Communities Adequate Financial Flexibility for Flood Events, Though Budgetary Pressure Remains Source: 2014 comprehensive annual financial reports (CAFRs) General government operating expenses, leverage for flood prevention measures, and unexpected costs for storm cleanup can pressure budgets and lead to declines in a municipality's available reserves and overall financial flexibility. Thus, the Hampton Roads’ municipalities, and all US local governments exposed to flooding risk, face difficult decisions in determining the right balance needed for flood mitigation work at the cost of lower operating flexibility and increased debt, and for waterfront development at the cost of putting additional assets at risk. In our bond ratings, we will continue to review these factors through our existing methodologies. Our general obligation bond methodology puts a 30% weight on a local government’s tax base and demographics, another 30% for finances, 20% for management and 20% for debt and pension leverage. Flood mitigation risk is a matter for regional cooperation When multiple municipalities occupy the same peninsula and surround the same harbor, coordinating flood control works, land use planning, and flood-related building codes can be effective. In the case of the Hampton Roads region, that coordination should extend to the concentration of military and related federal government institutions that control much of the land area here. A regional approach to flood resiliency is likely the most effective way to lessen the possibility of severe credit implications for the region's municipalities. Substantial costs to fund flood control infrastructure by one city, for example, could easily be undone by inadequate mitigation by a neighboring town. A regional approach is also warranted given the national economic and strategic importance of the area's port and military installations, along with its transportation infrastructure, such as the Chesapeake Bay Bridge-Tunnel. The Commonwealth of Virginia has taken steps in this direction with a pilot project aimed at coordinating efforts at the local, state and federal level, including the Department of Defense, and has established other task forces relating to sea level and recurring coastal flooding. Recent legislation in the Virginia General Assembly also acknowledged benefits in treating Hampton Roads as a region when considering sustainable, effective and affordable flood control. Though the bill failed, it was the state's first attempt at a comprehensive approach to managing continued flooding in the region. Local universities and other government agencies are also contributing to a regional approach through coordinated research. 7 18 JUNE 2015 LOCAL GOVERNMENT: VIRGINIA'S HAMPTON ROADS REGION RESPONDS TO FLOOD RISK MOODY'S INVESTORS SERVICE U.S. PUBLIC FINANCE Moody's Related Research » US Federal Disaster Aid Is Critical for State and Local Governments » Moody's Research on Environmental Risks and Developments To access any of these reports, click on the entry above. Note that these references are current as of the date of publication of this report and that more recent reports may be available. All research may not be available to all clients. 8 18 JUNE 2015 LOCAL GOVERNMENT: VIRGINIA'S HAMPTON ROADS REGION RESPONDS TO FLOOD RISK MOODY'S INVESTORS SERVICE U.S. PUBLIC FINANCE Endnotes 1 US Department of Defense 2014 Climate Change Adaptation Roadmap 2 Regional Economic Forecast, Old Dominion University 3 US Department of Defense 2014 Climate Change Adaptation Roadmap 4 Regional Economic Forecast, Old Dominion University 9 18 JUNE 2015 LOCAL GOVERNMENT: VIRGINIA'S HAMPTON ROADS REGION RESPONDS TO FLOOD RISK MOODY'S INVESTORS SERVICE U.S. PUBLIC FINANCE © 2015 Moody’s Corporation, Moody’s Investors Service, Inc., Moody’s Analytics, Inc. and/or their licensors and affiliates (collectively, “MOODY’S”). All rights reserved. CREDIT RATINGS ISSUED BY MOODY'S INVESTORS SERVICE, INC. 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MJKK or MSFJ (as applicable) hereby disclose that most issuers of debt securities (including corporate and municipal bonds, debentures, notes and commercial paper) and preferred stock rated by MJKK or MSFJ (as applicable) have, prior to assignment of any rating, agreed to pay to MJKK or MSFJ (as applicable) for appraisal and rating services rendered by it fees ranging from JPY200,000 to approximately JPY350,000,000. MJKK and MSFJ also maintain policies and procedures to address Japanese regulatory requirements. 10 18 JUNE 2015 LOCAL GOVERNMENT: VIRGINIA'S HAMPTON ROADS REGION RESPONDS TO FLOOD RISK MOODY'S INVESTORS SERVICE U.S. PUBLIC FINANCE AUTHOR Tiphany Lee-Allen CO-AUTHOR Alfred Medioli ASSOCIATE ANALYST Tamer Abu Bakr DATA VISUALIZATION Danielle Jett 11 18 JUNE 2015 LOCAL GOVERNMENT: VIRGINIA'S HAMPTON ROADS REGION RESPONDS TO FLOOD RISK