Fitch Rates Tennessee’s $425MM GOs ‘AAA’; Outlook Stable

NEW YORK

Fitch Ratings has assigned an ‘AAA’ rating to the State of Tennessee’s approximately $425 million general obligation (GO) bonds consisting of:

–$320,000,000 GO bonds 2015 series A;

–$105,000,000 GO bonds 2015 refunding series B.

The par amount of the refunding series is subject to change prior to sale.

The bonds will be sold via negotiated sale during the week of October 26.

Fitch has also affirmed the ‘AAA’ rating on:

–$1.7 billion outstanding state GO bonds.

The Rating Outlook is Stable.

SECURITY

Full faith and credit, payable as to principal and interest from any funds or monies of the state from whatever source derived.

KEY RATING DRIVERS

CONSERVATIVE DEBT PROFILE: The state’s debt profile is very conservative, with low debt ratios, swift amortization, few non-general obligation commitments, and strong security provisions. The state has fully funded its pension contributions for four decades.

CONSISTENTLY BALANCED FINANCIAL OPERATIONS: Financial operations are conservative and consistently balanced, although largely reliant on sales tax revenues. The state retains considerable operating flexibility, including large reserve balances.

DIVERSIFYING ECONOMY: The state has a large manufacturing sector which was a vulnerability in the last downturn, although the economy has returned to steady growth and continues to diversify. Wealth levels are below average.

RATING SENSITIVITIES

CHANGES IN CONSERVATIVE PRACTICES: The rating is sensitive to continued maintenance of the state’s conservative debt and fiscal management practices.

CREDIT PROFILE

Tennessee’s ‘AAA’ GO rating reflects its low debt levels, among the lowest of any state, and an ongoing commitment to budget balance. Conservative fiscal management has been in evidence repeatedly over the last decade, including in the state’s proactive approach to maintaining fiscal balance and preserving flexibility in the form of budget reserves. The economy has registered generally steady growth through the recovery, with sales tax revenue, the state’s largest source of revenue, following suit.

In response to economic and revenue weakness during the last downturn, the state repeatedly lowered base spending while relying on one-time resources, including federal stimulus and state reserve balances, to maintain budgetary equilibrium. The state has maintained a conservative posture since then, limiting spending growth while continuing to deposit resources to the revenue fluctuation reserve (RFR), its rainy day fund, as well as a separate reserve for TennCare.

VERY LOW LIABILITY BURDEN

The state’s debt places a very low burden on resources, is well-protected by security provisions, and amortizes rapidly. Taxes allocated to the general, highway and debt service funds are pledged to GO debt service, and their yield is the basis for a debt service limit that is only 37.4% used as of the current sale. Net tax-supported debt of $2 billion as of Sept. 30, 2015 equals 0.8% of 2014 personal income.

Tennessee’s pension liabilities are very limited given the state’s steady commitment to controlling retirement obligations. The state has met the full actuarially calculated required employer contribution each year since 1972, and has periodically revisited benefit provisions, including shifting to a hybrid plan as of July 1, 2014. As of June 30, 2014, the state has set aside assets equal to 95.1% of its total pension liability (GASB 67 basis). The state’s metric measuring bonded debt plus unfunded pensions remains among the lowest of Fitch-rated states, at 1.7% of personal income in 2014.

CONSERVATIVE FINANCIAL OPERATIONS

Tennessee’s financial operations are conservative and its budget is consistently balanced. The state addressed recessionary weakness by repeatedly cutting recurring spending and by using one-time items, including reserve draws and federal stimulus. The state has generally benefitted from consistent tax revenue growth through the slow economic recovery.

Fiscal vulnerabilities include the state’s dependence on sales taxes, which make up 62.5% of total tax revenues, as well as challenges controlling the spending growth in TennCare, the state’s Medicaid program. However, the state has prioritized building and maintaining flexibility in the form of the RFR and the separate TennCare reserve.

The state has maintained a conservative budget posture through the course of the current economic expansion. For fiscal 2015, which ended on June 30, the adopted budget had assumed tax revenues rising 2.8%, to $12.1 billion, with sales and use taxes rising 3.3%. Total revenues (all funds basis) were forecast at $32.6 billion, 2% below the fiscal 2014 level estimated at the time. General fund spending as enacted fell 1.1%, to $29 billion, with growth in the TennCare budget absorbed through reductions in other spending categories, including education and corrections. The state expected the combined balance of the RFR and TennCare reserves to be $773 million (6.4% of total tax revenues); the budget assumed no draws on the latter, after having had a draw in fiscal 2014 to support unexpected Medicaid spending needs.

Fiscal 2015 ended on a stronger note than originally expected. Estimated tax revenues rose 3.6%, to nearly $12.2 billion, with sales and use taxes rising 4.4%. Total revenues of $33 billion (all funds basis) were 4.3% over fiscal 2014 actual revenues. General fund expenditures grew 5.7%, to $29.5 billion. The bulk of expenditure growth continued to be for health and social services, including TennCare, with much slower growth in other program areas. The RFR and TennCare reserve ended the fiscal year with a combined balance of $798 million, equal to 6.5% of total tax revenues.

Fiscal 2016 performance is forecast to continue recent trends. Tax revenues are forecast to rise 2.8%, to $12.5 billion, with sales taxes rising 3.7%. Total revenues (all funds basis) are forecast at nearly $34 billion, 2.8% above the estimated fiscal 2015 level. General fund expenditures rise 1.1%, to just below $29.8 billion. After more rapid growth in recent years, TennCare expenditures are forecast to rise much more slowly, at 0.4%. The state has budgeted a deposit of $76.5 million into the RFR. The RFR and TennCare reserve are forecast to hold a combined $874.9 million at fiscal year-end, equal to 7% of total tax revenues.

State tax collections in fiscal 2016 are starting on a strong note, with year-to-date collections through September up 5.5% over the same period in fiscal 2015; sales taxes are up 7.4%.

GROWING ECONOMY

The state’s economic strengths lie in trade and manufacturing, although cyclicality in the latter has been a concern, particularly given the growing importance of automotive-related manufacturing. In the last downturn the state’s job losses exceeded the U.S., with nonfarm employment in the 2007-2010 period falling 6.5%, compared to 5.6% nationally. Job growth resumed in late 2010 and has been steady since then, with the state having recovered 131% of jobs lost since its recessionary trough in February 2010; the comparable figure for the U.S. 145%.

Employment in the state grew 2.1% in 2014, compared to 1.9% nationally. Gains have continued into the current year; August 2015 employment in the state was up 1.8% year-over-year, below the 2% rate for the nation. Certain services and durable goods manufacturing are showing solid gains; manufacturing sector growth has been a particular strength for the state in the current recovery. Tennessee’s unemployment rate was 5.7% in August 2015, down from 6.6% a year earlier and higher than the 5.1% national unemployment rate. The state is less wealthy than average, with 2014 per capita income ranked 37th among the states at 88% of the U.S.

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

Fitch recently published an exposure draft of state and local government tax-supported criteria (Exposure Draft: U.S. Tax-Supported Rating Criteria, dated Sept. 10, 2015). The draft includes a number of proposed revisions to existing criteria. If applied in the proposed form, Fitch estimates the revised criteria would result in changes to fewer than 10% of existing tax-supported ratings. Fitch expects that final criteria will be approved and published by Jan. 20, 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, and IHS.

Applicable Criteria

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. State Government Tax-Supported Rating Criteria (pub. 14 Aug 2012)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=686033

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