Fitch Affirms Memphis, TN's GOs at 'AA-'; Outlook Revised to Positive

NEW YORK--()--Fitch Ratings has affirmed the following rating action on Memphis, Tennessee's (the city) bonds:

--$484.3 million general obligation (GO) bonds at 'AA-' (see bond listing at end).

The Rating Outlook is revised to Positive from Stable.

SECURITY

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

--POSITIVE PENSION REFORMS: The Positive Outlook reflects the city's successfully implementing a sustainable plan towards fully funding its annually required pension contribution without associated operational or financial pressures.

--ENHANCED FINANCIAL FLEXIBILITY AND RESERVES: Strong financial management has produced positive operating results. Fitch expects that even slight reserve declines due to potential expenditure pressure would allow general fund reserves to remain at solid levels.

--NOTABLE EMPLOYMENT DIVERSITY: The broad and stable economic base, anchored by transportation and health care, has solidified the city's position as a vital regional employment center.

--WEAK SOCIO-ECONOMIC PROFILE: The expanding economy has yet to elevate below-average wealth levels, decrease the high unemployment, or stem the population decline.

--HIGH DEBT BURDEN: High debt levels could moderate somewhat due to rapid amortization and an ability to limit future debt issuances.

RATING SENSITIVITIES

FULL FUNDING OF THE PENSION ARC: The city is well on its way to achieving full funding of the pension 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 increased costs associated with the increased funding for the pension ARC. Minor use of the fund balance at times would be consistent with the Positive Outlook and eventually an 'AA' rating.

CREDIT PROFILE

The city, which is the largest in the state, is located on the east bank of the Mississippi River in southwest Tennessee. The estimated 2014 population of 656,861 exceeds the 646,889 recorded in the 2010 census. Fitch views the reported gain cautiously, given the 0.5% decline from the 2000 to the 2010 census.

MEANINGFUL RESPONSE TO PENSION PRESSURES

Substantially all permanent full-time salaried city employees participate in the single-employer City of Memphis Retirement System (MRS). The city is successfully executing a five-year plan to contribute the full actuarially determined pension contribution. Plan components include a reduced pension ARC and increased annual funding.

Tighter eligibility for the pension plan coupled with funds available due to a revamped other post-employment benefit (OPEB) program enabled the city to meet its funding goal. Pension-eligible employees with less than seven and one-half years of service as of July 1, 2016 along with new hires must switch to 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 resulted in a reduction of the unfunded pension liability and consequently the ARC. Simultaneously, the city eliminated its subsidy of OPEB payments and reallocated the savings towards meeting the pension ARC. 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 expects that the fiscal 2016 employer contribution will equal the budgeted $50 million, a notable improvement from the $19 million statutory pension contribution of fiscal 2013. Preliminarily management anticipates contributing at least $55 million of the full actuarially determined contribution of $58 million for fiscal 2017. The ARC is well-below the $90.3 million fiscal 2013 ARC. The valuation at the end of fiscal 2015 shows a net pension liability of $2.6 billion. The MRS reports that assets cover 85.2% of liabilities as of the June 30, 2015 measurement date. With a Fitch-adjusted discount rate of 7%, assets cover 80.8% of liabilities.

Adopted State legislation would allow the state to intercept state-shared taxes should the city not remit the full ARC. The state would then pay the intercepted funds to the city's pension plan. City receipts that pass through the state exceed the actuarially determined ARC. Fitch infers that a threatened state intercept would motivate the city to meet its obligation. However, were the state required to withhold funds, Fitch would find the city's inability to manage its own finances as inconsistent with the Positive Outlook or an eventual 'AA' rating.

EXPENDITURE PRESSURE RELIEF UNDERLIES POSITIVE OPERATIONS

Operating margins have widened a bit since the city eliminated a notable cause of budgetary imbalance upon surrendering the Memphis City Schools (MCS) charter and transferring administrative control to Shelby County (the county; GOs rated 'AA+', Stable Outlook by Fitch). Annual school funding costs had been unsustainable and necessitated the utilization of reserves and one-time funding sources. Fitch views positively the removal of this obligation and management's decision that other budgetary increases would not consume funding that had been previously directed to the schools. The city faces some pent-up demand to increase expenditures, which could lead to some use of reserves in the near-term or to the city exercising its ample revenue flexibility. Fitch views the current solid reserve position and even a small dip as consistent with the Positive Outlook.

Since MCS was transferred to the county, the city has achieved solid surplus operations, equal to 6.3% and 3.9% of spending in fiscal years 2014 and 2015, respectively. Likewise, the unrestricted fund balance increased significantly to a solid 20.4% of spending at the end of fiscal 2015 from 10.7% in fiscal 2013. The city does not expect to use a significant portion of the $13.3 million fund balance it appropriated as part of the fiscal 2016 budget. Fitch views this projection as realistic, given past performance favorable to the budget.

SOME EXPOSURE FROM LAWSUITS

Employee litigation is pending concerning eligibility changes for the pension and OPEB. In addition, the city is litigating with AT&T for right-of-way costs and with Memphis Light, Gas, and Water (MLGW, rated 'AA+' Stable Outlook) for reduced PILOT payments. Should the city not prevail, Fitch believes that it will have the necessary flexibility to structure any payments without undermining its financial structure.

DIVERSE ECONOMIC BASE GROUNDED IN TRANSPORTATION

The city 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. Sector strengths derive from a network of road, train, and Mississippi River port facilities, as well as Memphis International Airport (Memphis-Shelby County Airport Authority, Fitch rated 'A' Stable Outlook), with its massive air cargo operations and Federal Express (FedEx) headquarters.

The trade and transportation sector provides a high 21.7% of regional employment. Fitch continues to view this sector as viable despite past employment reductions. FedEx dominates the employment base, with about 30,000 workers, or approximately 5% of the Memphis MSA employment base. Both the government and education and health services sectors have served as a stabilizing force. Two hospitals along with various county, state, and federal departments are among leading employers.

The metro area also has a sizable tourism base, which the opening of a Bass Pro shop in The Pyramid recently strengthened.

Unemployment, which remained stubbornly high as other areas of the country recovered from the Great Recession, declined to 6.7% in December 2015, an improvement from the 8.1% of the previous year. It remained, though, well-above the state and national levels. Wealth indicators are below state and national averages and the poverty rate is nearly double that of the nation.

HIGH DEBT BURDEN

Overall debt levels are high at $3,542 per capita and 6.6% of market value. Debt service costs have escalated over the past few years to an above-average 16.3% in fiscal 2015 due to the ramifications of previous debt restructurings. The rapid amortization at 64.7% of principal retired within 10 years somewhat contributes to the high debt service costs.

The fiscal 2016 - 2020 capital improvement program (CIP) totals $1.1 billion or $848 million excluding the city's self-supporting sewer program. Tax-supported debt is scheduled to fund about one-half of the 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 has traditionally funded above the pay-as-you go amount for its OPEB obligations. The fiscal 2015 OPEB contribution equaled 3.9% of government spending. Total fiscal 2015 carrying costs, consisting of debt service, a fully funded pension ARC (including that of MLGW) and actual OPEB payments equaled a high 31% of government spending.

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

Fitch recently published exposure drafts of state and local government tax-supported criteria (Exposure Draft: U.S. Tax-Supported Rating Criteria, dated Sept. 10, 2015 and Exposure Draft: Incorporating Enhanced Recovery Prospects into U.S. Local Tax-Supported Ratings, dated Feb. 2, 2016). The drafts include a number of proposed revisions to existing criteria. If applied in the proposed form, Fitch estimates the revised criteria would result in changes to less than 10% of existing tax-supported ratings. Fitch expects that final criteria will be approved and published in the first quarter of 2016. Once approved, the criteria will be applied immediately to any new issue and surveillance rating review. Fitch anticipates the criteria to be applied to all ratings that fall under the criteria within a 12-month period from the final approval date.

In addition to the sources of information identified in the applicable criteria specified below, this action was informed by information from CreditScope, Lumesis, and Zillow Group.

Applicable Criteria
Exposure Draft: Incorporating Enhanced Recovery Prospects into US Local Tax-Supported Ratings (pub. 02 Feb 2016)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=875108
Exposure Draft: U.S. Tax-Supported Rating Criteria (pub. 10 Sep 2015)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869942
Tax-Supported Rating Criteria (pub. 14 Aug 2012)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=686015
U.S. Local Government Tax-Supported Rating Criteria (pub. 14 Aug 2012)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=685314

Additional Disclosures
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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1000686
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https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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Contacts

Fitch Ratings
Primary Analyst
Barbara Ruth Rosenberg
Director
+1-212-908-0731
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Jeremy Stull
Analyst
+1-646-582-4981
or
Committee Chairperson
Karen Ribble
Senior Director
+1-415-732-5611
or
Media Relations
Elizabeth Fogerty, New York, +1 212-908-0526
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Barbara Ruth Rosenberg
Director
+1-212-908-0731
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Jeremy Stull
Analyst
+1-646-582-4981
or
Committee Chairperson
Karen Ribble
Senior Director
+1-415-732-5611
or
Media Relations
Elizabeth Fogerty, New York, +1 212-908-0526
elizabeth.fogerty@fitchratings.com