Fitch Affirms Shelby County, TN General Obligation Bonds at 'AA+'; Outlook Stable

Fitch Ratings has affirmed the 'AA+' rating on Shelby County, Tennessee's (the county) bonds:

--$1,374 million general obligation bonds.

The Rating Outlook is Stable.

SECURITY

The bonds are general obligations secured by the full faith and credit and the taxing power of the county.

KEY RATING DRIVERS

DIVERSE ECONOMIC BASE: Shelby County, which includes the city of Memphis, serves as the center for transportation, trade, tourism, and health and education for a sizable multi-state region. Economic recovery is lagging the nation.

WEAK DEMOGRAPHIC METRICS: Despite its prominent role in the regional economy, the county continues to exhibit high unemployment. Poverty and wealth levels compare unfavorably to the nation.

STRONG FINANCES AND PRUDENT FISCAL MANAGEMENT: Consistently positive operating margins coupled with conservative financial policies and strong financial management has yielded healthy reserve levels.

DEBT LEVELS MODERATING: Debt ratios have declined to moderate levels as amortization has exceeded debt issuance.

RATING SENSITIVITIES

SCHOOL REALIGNMENT RISK: The Shelby County Schools (SCS) and Memphis City Schools (MCS) merged effective fiscal 2014, and the county now bears full responsibility for local school funding. Additionally, six municipalities in the county voted to form independent school districts effective fiscal 2015. The rating could be pressured if lost revenues or higher costs under the new structure create budgetary strain for the county.

CREDIT PROFILE

The county, which has the city of Memphis as the county seat, is located in the extreme southwest corner of the state. With a 2011 population of 934,405, the county is the largest in the state.

STRONG BUDGETARY CONTROL

Strong financial operations are underscored by many years of general fund surpluses, ample liquidity and good budgetary control. Reserve fund policies are in place to ensure sufficient resources are available to meet unforeseen emergencies: unassigned fund balances as a percent of revenues are to be maintained at 15% to 25% for the general fund and 20% to 30% for the debt service fund.

The fiscal 2012 general fund net operating surplus of $6 million is notable given the loss of $11.8 million in sales tax as a result of municipal annexations. The positive variance resulted from the county's conservative budgeting of revenues, combined with hospital cuts and other cost containment measures. The fiscal 2012 year-end unrestricted general fund balance was 25.6% of general fund expenditures. In 2012 the county sold its equity interest in the convention center to the city and the proceeds were used for the defeasance of county bonds for the convention center.

A $2.9 million operating surplus in fiscal 2013 boosts the unrestricted general fund balance to $95.8 million, a strong 25.9% of general fund expenditures. Property taxes are the dominant revenue source, accounting for 65% of general fund revenues. Fiscal 2013 revenues included $2.7 million in lieu of taxes collections that had been pending from litigation. On the expenditure side, costs include a 1% raise for employees as well as fringe benefit cost increases. The debt service fund balance was $84.8 million, equivalent to 23.0% of general fund spending, down $6.3 million due to a $6.8 million transfer to the capital projects fund. Total pay-as-you-go spending in fiscal 2013 was $20 million.

The fiscal 2014 budget is balanced with no planned use of reserves. County officials indicate an operating surplus is expected due not only to general budgetary control, but also the unbudgeted receipt of funds pertaining to disputed PILOTs due to the county. Budgeted general fund spending of $374.6 million reflects a 3.1% increase over fiscal 2013 budget and does not include a salary increase for employees. The general fund budget includes a $2.8 million revenue increase from underlying municipalities for reimbursement of services, largely for costs of a property reappraisal. Assessments declined as a result of the reappraisal as well as tax base losses from Delta closing its hub. The county adjusted the tax rate to account for the base decline and also raised the millage an additional .06 mills to provide additional funding for education.

In fiscal 2014 the county and city of Memphis school districts merged with all costs to be borne by the county. The loss of $65 million in school funding previously provided by the city of Memphis was partially offset by the closing of five schools, the conversion of seven schools to a state-operated Achievement School District, over 1,500 layoffs and the use of $10 million of school district reserves, a spending gap that may need to be addressed in fiscal 2015. County fiscal 2014 education spending increased 5.5%, from $361.3 million to $381.3 million. Conservative budgeting on the part of the schools could lessen the potential future gap.

Six municipal school districts will begin educating students now attending the county district, effective fiscal 2015. The new districts represent approximately 20% of county school average daily membership. Agreement has been reached on the transfer of buildings to the new districts. Debt service costs associated with the transferred school buildings will stay with the county, as will the ability to levy taxes countywide for the debt. County school district teachers may apply to work in the new districts, and beyond the shifting of staff, additional layoffs are expected at the county district. County officials expect the county school district will adjust its budget as necessary, with no net budgetary impact on the county.

REGIONAL ECONOMIC IMPORTANCE

Shelby County is the employment center for a three-state, four-county metropolitan statistical area (MSA) encompassing jurisdictions in Arkansas, Mississippi, and Tennessee. The economic base is deep and diverse but mostly recognized for its distribution capabilities, which stem from its network of road, train, and Mississippi River port facilities, as well as Memphis International Airport, with its massive air cargo operations and Federal Express headquarters. Other large private employers within the transportation sector include UPS and Pinnacle Airlines.

Economic recovery is lagging the nation: the October 2013 county unemployment rate of 9.1% exceeds the national rate of 7.0%. Cutbacks by FedEx and Delta, which formerly had a hub in the airport, are contributors to unemployment. A realignment by FedEx involving voluntary departures through buyouts is underway. The departures began in 2013 and are expected through May 2014. A number of expansion projects have been recently announced; the largest are International Paper, JM Smuckers and UPS. The expansions offer some prospect for economic buoyancy.

In addition, strong education and health services sectors, which represent 14.5% of total employment, aid economic stability. Methodist Health Care, the largest employer in this sector, and another prominent healthcare provider, St. Jude Children's Research Hospital, a premier pediatric cancer research hospital, recently completed a sizable expansion program.

The metro area also has a sizable tourism base, which has benefited from the development of the gaming industry in nearby Tunica, Mississippi (40 miles southwest of Memphis).

DEBT LEVELS NOW MID-RANGE

Management has sought to reduce debt levels and with amortization outpacing new issuance, debt levels are now what Fitch considers moderate. Debt burden is 4.3% and the 10-year amortization rate is 56%. A moderate 24% of the county's direct debt is variable rate with the debt swapped to fixed. The county's fiscal 2014 to 2018 capital improvement plan identifies $339 million in needs. The largest project category is the schools, with $220 million in project needs. Annual general obligation borrowing of approximately $55 million per year is anticipated. The fiscal 2014 CIP budget includes $20 million, financed with pay-as-you-go and federal funding.

The county provides pension benefits to its employees through a single-employer defined benefit plan. The unfunded actuarial accrued liability (UAAL) at June 30, 2012 totaled $161 million, or a low 0.2% of real property market value. The funded ratio of the plan is 87.8%, Fitch-adjusted with a 7% discount rate to an estimated 79.1%. The county's pension contributions have sharply risen over the past two years, although the annual required contribution (ARC) is still an affordable 3.0% of total governmental spending. The most recent reported UAAL associated with other post-employment benefits (OPEB) totaled $306 million as of July 1, 2012, or 0.5% of market value. Total carrying costs, debt service, pension, and OPEB, account for a moderate 21.4% of governmental spending.

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:

--'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=814298

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

Fitch Ratings
Primary Analyst
Patricia McGuigan
Director
[phone]
Fitch Ratings, Inc.
One State Street Plaza
New York, NY 10004
or
Secondary Analyst
Barbara Ruth Rosenberg
Director
[phone]
or
Committee Chairperson
Arlene Bohner
Director
[phone]
or
Media Relations:
Elizabeth Fogerty, New York, [phone]
Email: [e-mail]