OREANDA-NEWS. Fitch Ratings has assigned a 'AAA' rating to the State of Tennessee's approximately $332 million general obligation (GO) bonds, consisting of:

--$170,000,000 GO bonds 2016 series A;

--$124,645,000 GO bonds 2016 refunding series B;

--$37,790,000 GO bonds 2016 refunding series C (federally taxable).

The par amounts of the refunding series are subject to change prior to sale.

The bonds will be sold via negotiated sale during the week of July 25.

Fitch has also affirmed the ratings on Tennessee's Long-Term Issuer Default Rating (IDR) at 'AAA', and the rating on $1.9 billion of 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

Tennessee's 'AAA' Long-Term IDR reflects the state's solid credit quality, highlighted by very low debt and pension liabilities and a conservative approach to fiscal management. The state by practice builds sizable reserves, including a budgetary reserve to cushion against unexpected volatility and a separate reserve to address unexpected needs in its Medicaid program. After a sharp contraction in the last downturn, economic gains have been steady during the recovery, driving growth in state revenues and enabling the state to build up reserve balances.

Economic Resource Base

Economic growth over time in Tennessee has been driven by a rising population and the state's success at attracting new industries, particularly in manufacturing. Although population gains in the current decade have been slower than in past decades and personal income is relatively low for a state, economic growth has been steady during the recovery. Trade and manufacturing are important anchors; the latter in particular has become source of strength as the state has attracted higher value-added manufacturers over time. Service sector growth has also been notable over the last decade.

Revenue Framework: 'aa' factor assessment

Sales tax is the dominant source of revenue in Tennessee and has been subject to cyclicality, although franchise, transportation and other levies are also important. Consistent with historical experience, state revenue growth is expected to be in line with inflation. Like most states, Tennessee retains nearly unlimited ability to raise operating revenues.

Expenditure Framework: 'aaa' factor assessment

Spending is dominated by Medicaid and education. The natural pace of spending growth in Tennessee, as with most states, is expected to marginally exceed expected revenue growth over time, requiring ongoing cost control. The state retains ample flexibility to cut spending throughout the economic cycle.

Long-Term Liability Burden: 'aaa' factor assessment

The state's liability position is among the lowest of the states, driven by a historical reluctance to rely on debt issuance and a consistently conservative approach to pensions.

Operating Performance: 'aaa' factor assessment

Tennessee's financial resilience is strong, with exceptional gap-closing capacity stemming from a willingness to cut spending, including in high priority areas. The state maintains a high level of fundamental financial flexibility, highlighted by its practice of setting aside excess resources in its budgetary reserve and in a separate reserve for the state's Medicaid program, TennCare.

RATING SENSITIVITIES

CHANGES IN CONSERVATIVE PRACTICES: Tennessee's 'AAA' Long-Term IDR and Stable Outlook assume continued maintenance of the state's conservative debt and fiscal management practices.

CREDIT PROFILE

Tennessee's economic strengths lie in trade and manufacturing, although services have become a source of growth in recent years. In the last downturn 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. The state has recovered 159% of jobs lost since its recessionary trough in February 2010; the comparable figure for the U. S. is 163%. Unemployment rates have typically exceeded the nation's, although most recently the state's rate has dropped below the national average.

Manufacturing is a larger segment of economic activity in Tennessee than for the nation as a whole, with the state attracting increasingly sophisticated manufacturing, notably in the transportation equipment sector, but Fitch notes the exposure of manufacturing to cyclicality. Services growth is likewise solid, but most service sectors remain smaller in Tennessee than for the nation as a whole. The state is less wealthy than average, with 2015 per capita income ranked 36th among the states at 88% of the U. S.

Revenue Framework

The state's revenue framework is dominated by sales taxes, with about 60% of tax revenues generated from its broad statewide levy; there is no tax on personal income beyond a small levy on interest and dividends. The balance of tax revenues are provided by franchise and excise tax on businesses, various transportation taxes and fees, and taxes on alcohol and tobacco.

Historical growth in revenues over time, adjusted for policy changes, has lagged overall U. S. economic growth but generally approximated inflation. Fitch expects these trends to continue going forward. Revenues have also been subject to economic cyclicality, despite the absence of a personal income tax.

The state has an unlimited ability to raise revenues. Tax rate competitiveness is a more significant challenge in Tennessee given the proximity of its major cities to neighboring states, which generally levy lower combined state and local sales taxes compared to Tennessee.

Expenditure Framework

Tennessee's most significant spending commitments are for education and social services. The latter consume about half of general fund spending, much of which is directed to TennCare, the state's Medicaid program. Unexpected growth in TennCare spending periodically posed a challenge in the past, but the state actively manages the program and maintains a separate TennCare reserve to cushion the impact of unexpected needs. Education spending for local K-12 schools, community colleges and its higher education systems has grown in importance as the state works to attract additional economic activity.

As with most states, spending in the absence of policy actions is expected to be in line with, to marginally above, expected revenue growth, driven by social services, particularly for TennCare. The state retains considerable ability to cut spending.

The state has not hesitated to make deep cuts even to core programs in the face of projected revenue weakness. Carrying costs for liabilities are very low given the state's historical avoidance of borrowing and limited pension obligations.

Long-Term Liability Burden

Tennessee's long-term liabilities are among the lowest of the states, driven by a longstanding practice of limiting debt issuance and historically conservative approach to pensions. The state's metric measuring bonded debt plus unfunded pensions remains among the lowest of Fitch-rated states, at 1.7% of personal income as of Fitch's 2015 state pension update. Net tax supported debt measures 0.8% of personal income. Most of the state's tax-supported debt is GO, for which taxes allocated to the general, highway and debt service funds are pledged.

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 closing the old plan and shifting to a hybrid structure for new employees as of July 1, 2014. As of the June 30, 2015, the ratio of assets to liabilities for the closed state plan equaled 91.3% (GASB 67 basis).

Operating Performance

Tennessee's financial resilience is exceptional, with an ability to weather cyclicality based on a willingness to make budgetary cuts, including to core spending needs, and a demonstrated willingness to set aside resources in its reserve funds. 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 fiscal posture through the recovery as well, limiting spending growth and prioritizing rebuilding reserves. As of fiscal 2016 year-end, the revenue fluctuation reserve (RFR) balance was estimated at $568 million (4.4% of estimated tax revenues), while the TennCare reserve balance was estimated at $194 million (1.5% of estimated tax revenues).

Recent Operating Performance

State operating performance has been very strong in recent years, driven by tax collections well in excess of earlier conservative estimates. For fiscal 2016, which ended on June 30, the adopted budget had assumed tax revenues of $12.5 billion, about 2.8% higher than prior year revenues estimated at the time the budget was adopted. Actual performance appears to have been stronger, driven by solid growth in sales taxes. The state currently estimates tax revenues of nearly $12.9 billion, 1.9% higher than final fiscal 2015 results (which likewise exceeded estimates). Year-to-date for the first 11 months of actual collections in fiscal 2016, total tax revenues are 6% higher than for the same period a year earlier, with sales tax collections 7.2% higher.

Fiscal 2016 general fund expenditures, including mid-year adjustments made by the legislature, are currently budgeted at nearly $29.8 billion, 4.9% higher than fiscal 2015 actual expenditures. Draws totaling $66 million were made from the TennCare reserve to address enrollment and other cost increases not included in the adopted budget.

For fiscal 2017, the state is forecasting tax revenues of $13.2 billion, about 2.6% over currently estimated fiscal 2016 tax revenues. The forecast assumes 3.25% recurring revenue growth and incorporates relatively few tax law changes, including renewals of hospital and nursing home assessments and a lower tax rate on interest and dividends. Consistent with recent years, spending increases are directed mainly to K-12 and higher education and to TennCare. Budgeted expenditures rise 3.3%, and include another $100 million deposit to the RFR, to bring its balance to $668 million (5.1% of estimated tax revenues).