Fitch Affirms Jefferson County, AL's Series 2013 GO Warrants at 'BBB-'; Outlook Stable

NEW YORK--()--Fitch Ratings affirms the 'BBB-' rating on the following Jefferson County, Alabama (the county) general obligation (GO) warrants:

--$93.9 million GO warrants, series 2013.

Fitch also affirms the 'BBB' rating on the county's implied unlimited tax general obligation (ULTGO) security.

The Rating Outlook is Stable.

SECURITY

The series 2013 GO Warrants are general obligations of the county supported by its full faith and credit. No legally available revenues, however, are specially pledged for payment.

KEY RATING DRIVERS

COUNTY EXITS BANKRUPTCY: The county declared bankruptcy in November 2011 following default on its sewer warrants and GO warrants. The chapter 9 plan of adjustment (the plan) was approved by the bankruptcy court on Nov. 22, 2013 allowing the county to exit bankruptcy and restructure its defaulted variable rate GO debt with the series 2013 GO warrants.

LACK OF HOME RULE AUTHORITY: The county's lack of authority over revenue decisions is a major credit concern, as all decisions regarding county revenues are left to the state. The county's inability to manage its revenue base restricts financial flexibility and creates ongoing uncertainties as to future state actions which could be detrimental to county operations.

SEVERE BUDGET CUTS MAINTAIN FISCAL BALANCE: In response to the elimination of the county's occupational tax revenues, county officials have made extensive reductions in personnel and operations, cutting expenditures by about a third to match revenue declines. These measures have enabled the county to maintain fiscally balanced operations although at a much reduced service level.

EXCEPTIONAL RESERVE BALANCES: Finances are characterized by unusually large reserve and liquidity balances, which have been maintained despite the severe revenue shortfalls. The reserves provide the county with a degree of flexibility partially offsetting its constrained revenue and spending options.

MANAGEABLE LONG TERM LIABILITIES: The county's debt load is moderate and rapidly amortized. Overall carrying costs are high due to limited obligation school warrants paid from a dedicated sales tax. The county's burden net of school warrants is manageable including payments to the well-funded pension system. Capital needs are relatively modest and no additional debt is planned.

REGIONAL ECONOMIC CENTER: The county's economy is broad and relatively diverse anchored by its largest employer, the University of Alabama at Birmingham. Key sectors include education, healthcare, retail trade and professional and business services supplementing its traditional manufacturing activities. Employment growth has lagged despite some positive economic developments. Wealth indices are significantly below the national averages.

ONE NOTCH DIFFERENTIAL: The security for the series 2013 GO warrants lacks a legally dedicated unlimited property tax pledge resulting in the one notch rating distinction from the implied ULTGO. The lack of a tax pledge makes the series 2013 GO warrants effectively a general fund obligation of the county.

RATING SENSITIVITIES

BALANCED OPERATIONS: The county's sizeable reserves are a key credit strength given the lack of revenue control and limited spending flexibility following steep cuts. Failure to maintain balanced operations could put negative pressure on the rating.

NON-COMPLIANCE WITH ADJUSTMENT PLAN: The rating would likely be downgraded if the county fails to comply with the terms of the plan of adjustment.

SEWER OPERATIONS STABILIZATION: Stabilization of the county's sewer operations would reduce the threat of another county bankruptcy and could lead to upward movement in the GO rating.

CREDIT PROFILE

The county is located in the north-central portion of the state and encompasses 1,111 square miles. The county's population of 660,000 has been static since at least 2000. The city of Birmingham (GO rated 'AA' with Stable Outlook) is the county seat and largest city in the county and the state.

THE COUNTY EMERGES FROM BANKRUPTCY

The county filed for chapter 9 bankruptcy protection on Nov. 9, 2011 (the filing date), its problems stemming from cost overruns in the overhaul of its sewer system. A plan of adjustment settling most claims against the county was approved by the bankruptcy court on Nov. 22, 2013 allowing the county to exit bankruptcy. Implementation of the plan allowed the county to restructure and reissue its variable rate GO warrants, which had been in default since 2008.

The county still faces numerous challenges including a sewer system (senior lien sewer revenue bonds rated 'BB+' and subordinate lien sewer revenue bonds rated 'BB' with a Stable Outlook) with very high leverage ratios, an above average cost structure and ongoing litigation regarding the bankruptcy court's future ability to enforce the approved sewer system rate structure. Fitch notes that the GO warrants are fixed rate obligations, mitigating the risk of repayment acceleration which led to the default of variable rate GO warrants prior to the bankruptcy. Ongoing compliance with the plan and resolution of remaining legal issue leading to stabilization of the sewer system could improve the ratings on the county's GO bonds.

EXCEPTIONAL RESERVES MITIGATE REVENUE AND SPENDING CONSTRAINTS

The county has maintained a very sizable and expanding level of reserves since fiscal 2010. The county's elevated fiscal balance is a key credit strength mitigating its inability to control revenues and limited remaining spending flexibility. Reserves were bolstered in fiscals 2010 and 2011 with the receipt of $50 million from JP Morgan as a result of its settlement with the Securities and Exchange Commission over illegal payments to government officials. Remaining settlement payments of $25 million were received in fiscal 2011. Operating results since have further added to already elevated fund balances. Maintenance of superior reserves provides a crucial cushion against future unanticipated spending and cost pressures.

STELLAR FISCAL 2013 FINANCIAL RESULTS

The county reported a $33.8 million general fund net surplus for fiscal 2013 equal to over 21% of spending. The positive result was supported by a much larger than usual $37 million transfer from the bridge and public building fund into the general fund. The suspension of GO bond payments through fiscal 2013 due to bankruptcy enabled a larger share of taxes recorded in the bridge and public building fund to be available for transfer to the general fund. In addition, actual spending was approximately $30 million below budget with most of the variance attributable to reductions in general government spending. At least part of the positive spending variance was attributable to budgeting for vacant positions which were not filled. Fiscal 2013 general fund balance of $119.5 million represents over 75% of spending. Unrestricted general fund balance is also extensive at over 59% of expenditures and transfers out.

FISCAL 2014 BUDGET SURPLUS; DEBT SERVICE PAYMENTS RESUME

The fiscal 2014 general fund budget of $152 million represents a moderate decrease in spending from the fiscal 2013 budget. Most of the reduction in spending was attributable to lower outside legal costs due to termination of the bankruptcy last year. Budgeted legal costs declined by nearly $10 million. The budget increases the amount of capital spending and IT services and makes provision for payment of GO debt service of about $24.5 million, utilizing the 5.1 mill special ad valorem tax dedicated for debt service and capital spending. Budgeted general fund revenues and transfers in from the bridge and public building fund exceed budgeted expenditures by about $5.5 million.

Preliminary projections for fiscal 2014 adhere close to budget show a small general fund surplus of about $4.7 million with unrestricted fund balance remaining about the same as in the prior year level. Officials caution that they have not completed their year-end closing procedures so that final audited results could differ materially from current projections.

BALANCED FISCAL 2015 OPERATIONS

The county's fiscal 2015 general fund budget is balanced with an approximate $20 million transfer in from the bridge and public building fund. The budget provides for increased funding of jails, general services, human resources and IT projects. A 2% cost of living increase adjustment (COLA) in salaries is also included; the first COLA rise since before the recession.

INFLEXIBLE REVENUE STRUCTURE

County finances are hampered by an inflexible revenue structure due to its lack of home rule; any revenue enhancement requires legislative approval. Furthermore, state actions have adversely affected the county's credit as amply demonstrated by the legislature's repeal of the occupational tax in 1999 with eventual affirmation by the courts in 2011. The tax had once provided over 40% of funding for the county's general administration and sheriff activities and the legislature failed to approve a satisfactory substitute. While county officials contend that none of their remaining revenue sources are controversial, the county will continue to be exposed to arbitrary actions at the state level.

In response to the loss of the occupational tax as well as reduced property tax and other revenues, officials were forced to slash operations to conform to the much reduced revenue flow. Between fiscals 2008 and 2013, general fund spending fell by over 40%. Measures included the elimination of over 1,200 positions or 33% of the county's workforce through a combination of layoffs and attrition, the closure of satellite courthouses, non-essential service reductions and the sale of the county-owned nursing home.

REGIONAL ECONOMIC CENTER

The county is the economic center of the Birmingham-Hoover metropolitan statistical area (MSA). The area economy has diversified over the past several decades from a focus on steel production to one based on a combination of healthcare, banking and professional services, retail trade as well as some heavy industry. The University of Alabama at Birmingham (UAB) is the largest employer with 21,550 jobs while UAB's medical school is the primary driver of the county's growing healthcare sector. The presence of the university has also fostered an active and expanding high tech hub in medicine, telecommunications, engineering and aerospace. Other leading employers include Regions Financial Corporation, AT&T, St. Vincent's Health System and Baptist Health System.

STATIC EMPLOYMENT TRENDS

County employment trends have been stagnant recently with a 0.3% annual decline in jobs in 2013 and employment down an additional 0.6% through 2014. September 2014 employment was 1.2% below September 2013 levels. Employment has been adversely affected by reductions in government personnel and a number of significant layoffs in the region over the past two years. However, the unemployment rate fell during that period from 6.1% to 5.7% due mostly to a 1.6% drop in the labor force. The county's 5.7% unemployment rate was lower than the state (6.6%) and national (5.9%) averages; consistent with past trends. The county reports some developments underway which should have a positive impact on employment.

County wealth levels exceed the state norms but fall somewhat below the national averages. Since 2007, per capita income and median household income levels have declined relative to those of the state and nation. Educational attainment rates are above the national norms, typical of localities with a large university presence.

Housing values weakened significantly during the recession and recovery has been uneven. Values declined by nearly 17% between October 2007 and January 2012, according to Zillow.com. Home prices have generally trended upwards since but the recovery has been anemic. September 2014 home values were down 0.3% year-over-year. Net assessed values dropped consistently between fiscal 2008 through fiscal 2012 for a cumulative contraction of 5.5%, however, fiscal 2013 and 2014 rebounded with gains of 1.7% and 2%, respectively.

MANAGEABLE LONG TERM LIABILITIES; HIGH CARRYING COSTS

Debt levels are generally moderate both on a market value and per capita basis. Amortization of direct debt is accelerated with 75% of principal retired within the next 10 years. However, debt service costs relative to operations is extremely high at 37.5% of governmental spending. This is largely attributable to over $700 million outstanding of limited obligation school warrants issued for school purposes and distributed to local school districts.

The school warrants are secured by a separate dedicated sales tax and reported on the county's financial statements although school operations of the various school districts are reported separately. Carrying costs net of school warrants are less burdensome at about 10% of fiscal 2013 governmental fund spending. Resumption of debt service payments, which began in fiscal 2014, is not expected to substantially change the overall fixed cost load. Capital needs are manageable and officials have no plans to issue additional GO warrants for the foreseeable future.

Retirement obligations are not a pressure. The county administers its own defined benefit pension plan covering most employees. The plan is exceptionally well funded at over 100% using a conservative 7% discount rate and annual pension costs are manageable relative to spending. Retiree health insurance costs are subsidized by the county. This other post-employment obligation (OPEB) is funded on a pay-go basis. The plan's unfunded actuarial, accrued liability of approximately $64.6 million is moderate, representing less than 1% of taxable values.

Additional information is available at 'www.fitchratings.com'.

In addition to the sources of information identified in Fitch's Tax-Supported Rating Criteria, this action was additionally informed by information from Creditscope, University Financial Associates, S&P/Case-Shiller Home Price Index, IHS Global Insight, National Association of Realtors,

Applicable Criteria and Related Research:

--'Fitch Affirms its 'BB+' and 'BB' ratings on Jefferson County, AL Sewer Revs; Outlook Stable' (Nov. 18, 2014);

--'Tax-Supported Rating Criteria' (Aug. 14, 2012);

--'U.S. Local Government Tax-Supported Rating Criteria' (Aug. 14, 2012).

Applicable Criteria and Related Research:

Tax-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=686015

U.S. Local Government Tax-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=685314

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=927296

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Contacts

Fitch Ratings
Primary Analyst
Larry Levitz
Director
+1-212-908-9174
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Kathryn Masterson
Senior Director
+1-512-215-3730
or
Committee Chairperson
Jessalynn Moro
Managing Director
+1-212-908-0608
or
Media Relations
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Larry Levitz
Director
+1-212-908-9174
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Kathryn Masterson
Senior Director
+1-512-215-3730
or
Committee Chairperson
Jessalynn Moro
Managing Director
+1-212-908-0608
or
Media Relations
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com