Fitch Affirms Memphis, TN GOs at 'AA-'; Outlook Remains Positive
OREANDA-NEWS. Fitch Ratings has affirmed the following city of Memphis, Tennessee ratings:
--$484.3 million general obligation (GO) bonds at 'AA-';
--The city's Issuer Default Rating (IDR) at 'AA-'.
The Rating Outlook remains Positive.
The GO bonds are payable by the city's full faith and credit pledge, payable from property taxes without limitation as to rate or amount.
KEY RATING DRIVERS
The 'AA-' rating reflects management's ability and willingness to raise revenues to counter notable fixed costs pressures and maintain strong reserves. Recent city reforms have enabled the city to craft a sustainable plan towards fully funding its annually required pension contribution while reducing both pension and OPEB liabilities.
Economic Resource Base
The city, with an estimated 2015 population of 656,000 is the job center for a three-state, four-county metropolitan statistical area (MSA) encompassing jurisdictions in Arkansas, Mississippi, and Tennessee. The deep and diverse economic base is anchored in transportation and distribution. The economy has yet to elevate below-average wealth levels, decrease the relatively high unemployment, or stem the modest population decline of 0.5% from the 2000 to 2010 census. Intermediate-term tax base projections are for minimal growth, a reversal of the modest drop over the past few years.
Revenue Framework: 'a' factor assessment
Given the modest economic expectations and recent population trends, Fitch expects that revenue growth will continue to remain sluggish. Positively, the city has an unlimited legal ability to raise ad valorem revenues independently.
Expenditure Framework: 'a' factor assessment
Expenditures are expected to rise at a rate that exceeds slow-growing revenues. High carrying costs and public safety pressures limit the city's expenditure flexibility, although the city has made notable strides in moving towards full pension funding.
Long-Term Liability Burden: 'aa' factor assessment
The combined debt and pension burden is moderate as a percentage of personal income. Recent meaningful pension and OPEB reform coupled with increases in pension contribution amounts have strengthened the city's long-term liability positions.
Operating Performance: 'aa' factor assessment
The unlimited ability to raise revenues coupled with high reserves provides strong gap-closing ability through down business cycles. However, the city has a history of underfunding pensions, weakening its financial position even at times of economic recovery.
FULL FUNDING OF THE PENSION ARC: The city is well on its way to achieving full funding of the pension actuarially calculated annual required contribution (ARC). The Positive Outlook signifies Fitch's expectation that the city will successfully realize full ARC funding without concomitant financial pressure.
STRUCTURAL BALANCE: The city has returned to structural balance despite the additional costs associated with the increased funding for the pension ARC. High expenditure demands resulting in a failure to maintain this balance would be inconsistent with the Positive Outlook.
The trade and transportation sector accounts for a notable percentage of regional employment, led by FedEx Corporation, where approximately 30,000 employees represent around 5% of the regional employment base. Layoffs at FedEx a few years ago highlight the risk inherent in this concentration. Both the government and health services sector have helped balance the employment composition. The metro area also has a sizable tourism base.
Property taxes are the largest revenue source, accounting for about half of general fund revenues, followed by a local option sales tax at about 20%. The largely developed nature of the city coupled with limited prospects for significantly reversing recent population declines constrains notable revenue growth linked to the capture of economic activity. The unlimited legal ability to raise property revenues somewhat mitigates expectations for anemic revenue growth absent revenue-raising measures.
Historical revenue growth has trailed the growth in national GDP and CPI. The minimal expectations for tax base and population growth likely will contribute to a flat economy and consequently stagnant revenue performance.
The city has complete independent legal ability to raise revenues, with no legal limitation on the property tax millage or levy. This is a positive credit factor.
Public safety represents about two-thirds of expenditures. The city no longer bears, as of fiscal 2014, responsibility for funding the school system, a change that removed a high and structurally insupportable spending pressure. The newly created expenditure capacity enabled the city to make notable progress toward meeting a state legislative mandate requiring the city to fund its pension plan at the actuarially determined contribution level. The increased pension funding, high debt service costs, public safety needs, and pent-up demand to increase other expenditures contribute to the somewhat pressured expenditure framework.
Given the stagnant nature of the city's revenue system and significant spending responsibilities, Fitch believes that growth in major spending areas on average will likely surpass expected revenue growth.
Ongoing expenditure pressures are reflected in high carrying costs (debt, actuarially calculated pension costs, and OPEB actual) of approximately 31% of governmental spending in 2015. Actual pension contributions are nearing the required amount, with the under-contribution equal to about 3.4% of governmental expenditures in fiscal 2015. Rapid debt amortization somewhat offsets the high carrying costs. Reasonable work force flexibility reflects the city's ultimate ability to impose contract terms along with the prohibition against labor strikes.
Tighter eligibility for the pension plan coupled with funds available due to a revamped OPEB program have been key components in the city's notable success in executing a five-year plan to contribute the full actuarially determined pension contribution. Adopted state legislation would allow the state to intercept state-shared taxes should the city not remit in full the required pension funding; the city is in the middle of the five-year phase-in. The state would then pay the intercepted funds to the city's pension plan. City receipts that pass through the state exceed the ARC. Fitch infers that a threatened state intercept would motivate the city to meet its obligation.
Long-Term Liability Burden
A manageable debt burden coupled with a willingness to control pension and OPEB liabilities underscore the 'aa' assessment. Substantially all permanent full-time salaried governmental employees participate in the single-employer City of Memphis Retirement System (MRS). Pension-eligible employees who have less than seven and one-half years of service as of July 1, 2016 and new hires are in a new hybrid plan, consisting of a market based cash balance plan and a defined-contribution plan. The hybrid plan as well as improved asset valuations is expected to result in a notable reduction of the unfunded pension liability in fiscal 2017, to approximately $58 million from the $79.7 million of fiscal 2015. Based on plan assumptions, the city's phasing into the full actuarially calculated contribution should yield assets sufficient to ensure future benefit payments to current plan members. The city has funded its OPEB obligations at or above the annual OPEB cost for the past two years.
The fiscal 2017-2021 capital improvement program (CIP) totals $1.2 billion or around $924 million excluding the city's self-supporting sewer program. Tax-supported debt is scheduled to fund two-thirds of general government projects. The city historically funds the CIP with commercial paper (CP) and subsequently takes out the CP with long-term debt. Fitch's long-term rating incorporates the assumption of strong access to the capital markets.
The city's robust reserve levels and revenue-raising capacity would provide strong gap-closing capacity in the event of a cyclical downturn. Reserves have historically remained ample, even when the city was faced with notable school funding pressures.
Fitch's concerns about the sustainability of budget decisions remain but are receding, given the city's movement toward achieving full funding of the pension ARC. Fitch notes positively that the city has successfully managed a notably higher annual contribution while simultaneously increasing reserves. Full realization of the pension funding goal without related, notable operating pressures could result in an upward shift for this assessment and the IDR rating.
Fitch believes that any potentially negative outcomes of pending litigation would not undermine the city's financial structure. Employees are currently pursuing legal means to address eligibility changes for the pension and OPEB. In addition, the city and AT&T are in litigation for right-of-way costs and with Memphis Light, Gas, and Water (MLGW, rated 'AA+' Stable Outlook) for reduced PILOT payments.
The city concluded fiscal 2015 with an operating surplus equivalent to 3.9% of general fund expenditures. Available fund balance including reserves in the debt service fund that can be utilized for general operations equaled 24.1% of general fund expenditures. Current city projections indicate the city will not utilize the $13.3 million fund balance appropriation included in the fiscal 2016 budget. The proposed $667 million fiscal 2017 budget has increased MRS pension funding to approximately $54 million, equivalent to 93% of the actuarial determination and $4 million above the prior year's allocation. The city has not budgeted the use of reserves, despite the augmented pension payment and increases for public safety workers.