Fitch Rates Minneapolis's (MN) $120MM GO Bonds 'AAA'; Outlook Stable
--$120 million GO Improvement and various purpose bonds, series 2016.
As part of the same action, Fitch has affirmed the city's Issuer Default Rating (IDR) at 'AAA' and the 'AAA' ratings on $432 million of the city's outstanding GO debt. See the list of specific series at the end of this release.
The Rating Outlook is Stable.
Sale information: $120,000,000 general obligation improvement and various purpose bonds, series 2016, to sell competitively on the morning of October 5. Purpose: To finance costs related to various capital improvements to city infrastructure including streets and bridges. Final Maturity: Dec. 1, 2026.
SECURITY
The bonds are general obligations of the city, backed by the city's full faith and credit and unlimited ad valorem taxing power. To pay debt service, the city is obligated to levy a tax without limit as to rate or amount on all taxable property within the city.
KEY RATING DRIVERS
Affirmation of the city's 'AAA' IDR and GO ratings reflects the city's favorable revenue growth prospects, broad revenue-raising powers, and superior budgetary flexibility. Debt and retiree benefit liabilities are low relative to the city's economic resource base, which Fitch believes will continue to expand rapidly given Minnesota's healthy economy and favorable location adjoining the state capital. A track record of conservative budget practices is likely to continue. The city has sufficient budgetary flexibility to offset revenue declines in an average downturn with only limited service cuts and reserve reductions.
Economic Resource Base
Minneapolis is the largest city in the state of Minnesota, with a 2015 population of 410,939. Along with its sister city of St. Paul, Minneapolis forms the core for the second-largest economic center in the U. S. Midwest, after Chicago. The city's broad and diverse economic base benefits from the presence of major employers in the relatively stable healthcare, higher education and state & county government sectors, which exhibit less volatile employment patterns. Minneapolis also has a sizable retail and financial presence, being home to Ameriprise Financial, US Bancorp and Target Corporation. Wells Fargo Bank also has a significant presence in the city.
Revenue Framework: 'aaa' factor assessment
Historical revenue growth has generally kept pace with U. S. GDP. Fitch expects this will continue to be the case given the city's growing population, low unemployment and vibrant and diverse economy. The city's independent legal ability to raise revenues is presently strong, although Fitch notes that the state has enacted temporary tax levy caps in the past.
Expenditure Framework: 'aa' factor assessment
Fitch expects spending to grow roughly in line with, to marginally above, the pace of revenue growth. Overall flexibility of the city's main spending items is adequate given that carrying costs were somewhat elevated at 22% of expenditures in fiscal 2015, and likely to remain in this range for the near term. The city has room to reduce headcount, as staffing levels match their previous 2008 highpoint.
Long-Term Liability Burden: 'aaa' factor assessment
Long-term liabilities are low compared to the economic resource base, reflecting a modest level of direct debt and benefitting from steady increases in both the city's population and per capita income levels.
Operating Performance: 'aaa' factor assessment
Minneapolis's strong revenue-raising ability and satisfactory control over expenditures undergird its capacity to manage through future downturns with only minimal impairments to its financial flexibility. The city's historically low tax revenue volatility and ample reserve levels further support financial resilience. Conservative operations have resulted in consistent operating surpluses since 2010.
RATING SENSITIVITIES
GROWTH IN THE LIABILITY BURDEN: The rating is sensitive to material growth in the liability burden such that future increases to liabilities outstrip the pace of expansion in the city's economic resource base.
ENACTMENT OF REVENUE-RAISING CONSTRAINTS: The rating is sensitive to constraints that higher levels of government (i. e. the state of Minnesota) could place on the city's future revenue-raising ability by enacting tax rate and/or levy caps. Such measures would be analyzed for their impact on the city's budget flexibility and could place negative pressure on the rating.
CREDIT PROFILE
Minneapolis's economy is extremely diverse. Major employers include entities active in the fields of health care, banking, higher education, and the retail trade. The city also includes a significant public-sector presence in the form of both city and county government (Minneapolis is the seat of Hennepin County) and Minneapolis public schools. The five largest employers are the University of Minnesota (14,400), Wells Fargo Bank (11,000), Fairview Health Services (10,200), Target Corporation (9,500), and Allina Health (9,400).
The city's employment base is strong with a rapidly growing workforce. The city replenished all of the jobs it lost during the recession by the start of 2011 and the workforce has been expanding rapidly ever since. Unemployment in the city has historically tracked below the U. S. average, but has been far below the U. S. rate in recent years. A substantial 48% of the city's population holds a bachelor's degree or higher, compared to 31% for the U. S. In common with many other large U. S. cities, Minneapolis's poverty rate, at 19.5%, is noticeably above the U. S. rate of 14.7%.
Revenue Framework
The general fund's largest revenue sources are property taxes (34%) and state aid (18%), which together account for more than half of operating revenues. Minor, albeit important, revenue sources include sales and use taxes (8%), other taxes (10%), service charges (10%), and fees & fines (10%). Property taxes have risen markedly since 2004, but registered only modest growth between 2011 and 2015 as the city focused on keeping the levy flat to provide tax relief to residents. Local sales, entertainment and hotel taxes have risen at a level approaching 4% per annum since 2000.
Fitch estimates the city's 10-year general fund revenue growth rate at roughly 3.2% per annum after adjusting for accounting changes made in fiscal 2014 that resulted in sales and entertainment tax revenue streams previously recorded in the convention center fund being shifted permanently to the general fund. Because this relatively healthy growth history - slightly below the rate of U. S. GDP - includes the period of the Great Recession and its impact on city finances, as well as several years when the city held the levy relatively flat, Fitch believes general fund revenues are likely to expand at a slightly faster pace going forward. In light of the city's and state's impressive post-recession recovery, Fitch anticipates general fund revenues will continue to rise at, or above, the rate of U. S. GDP expansion.
Significant new residential and commercial construction in various neighborhoods, including downtown, is having a positive impact on city revenues. Building permit values have been above $1 billion annually since 2012 and experienced an historic peak in 2014 at $2 billion versus $750 million three years prior. Assessed values (AVs) have also rebounded following several years of decline following the recession. AVs grew 2% in 2014 and by 10% in 2015 and 2016. They are projected to rise another 7% to 9% in 2017. The proposed fiscal 2017 budget calls for a 5.5% tax levy increase to take advantage of rising AV. Sales and entertainment taxes will likely continue to rise at historical levels approaching 4%.
The city's independent legal authority to increase revenues is essentially unlimited given the absolute authority vested in the mayor and city council to increase the property tax levy, along with service charges, user fines and fees. Together, these revenue sources account for more than 50% of the general fund budget. The city administration can raise property tax revenues by increasing the millage tax rate.
In the past, Minnesota has enacted statewide limits to the property tax levies of its local governments. These limitations have been temporary in nature, generally expiring after one year. These levy limitations have never applied to taxes levied to pay debt service. There is no guarantee that the state will not enact similar limits in the future, or limits of a more permanent nature. Minnesota has, on occasion, enacted multi-year property tax levy caps; most recently for fiscal years 2009 to 2011. The longest such period of multi-year caps was from 1972 to 1992, when the caps were repealed.
Expenditure Framework
The city provides a broad array of services to residents, including police and fire protection, waste removal, water and sewer service, and public parks and recreation. Public safety was the largest general fund expenditure item at 59% of spending in fiscal 2015. General government (17%), public works (13%), and economic development (8%) are the other major general fund spending categories. Capital spending is handled primarily out of a separate permanent improvement fund, and major public services such as water and sewer each utilize separate enterprise funds.
Fitch believes spending demands are likely to grow at a pace approximately equal to, or slightly below, the natural rate of revenue growth. The city is budgeting for annual salary increases that are slightly above the rate of inflation across all bargaining units in its multi-year projections. Salary growth in this range would be consistent with Minneapolis's recent history. However, employee benefit costs linked to health insurance will most likely grow faster than inflation. Given that Fitch expects general fund revenues to expand by over 3% annually, and potentially at rates as high as 4% per annum, it seems reasonable to expect spending to grow no faster than revenues.
Fitch regards the flexibility of Minneapolis's main expenditure items as adequate. The city has moderately high carrying costs that approximated 22% of total governmental spending for the prior two fiscal years. Carrying costs include spending for debt service, pension contributions, and other post-employment benefits (OPEB). Fixed costs are set to rise in fiscal 2017 and 2018 due to large principal payments scheduled for those years, but are scheduled to drop off considerably beginning in fiscal 2019. In light of the city's high near-term fixed expenditures and planned new debt issuance, Fitch believes Minneapolis's spending flexibility will remain satisfactory, but below that of some peers.
Minneapolis has contracts with 23 bargaining units representing 93% of full-time employees. Public safety makes up 40% of the unionized workforce. Police and firefighters do not have the right to strike under Minnesota law, but most other collective bargaining units do, including clerical, technical and maintenance workers. Recent contracts included annual salary increases that were slightly above the rate of inflation. The city's labor agreement with its police union expired on Dec. 31, 2014 and is still under negotiation. All units have access to binding arbitration under the Minnesota labor statute, and arbitrators have to consider economic conditions and their impact on municipal finances.
Roughly 25% of Minneapolis's $906 million five-year capital program is funded with internal cash resources and fund balances, including approximately $5 million of general fund balances per annum and more than $30 million of transfers from various special revenue funds. The cash-funded portion of the city's capital improvement plan (CIP) represents an area of potential budgetary flexibility for Minneapolis, as management would be able to easily pull back on capital funding if the economy went into a recession in order to fund recurring operations and conserve fund balances.
Long-Term Liability Burden
Minneapolis's long-term liability burden is low compared to the size and affluence of its economic resource base. The city's combined contractual pension liabilities and net overlapping debt will account for 9.1% of the combined resident personal income following the current bond issuance. Total debt is split almost even between the net direct debt of the city after factoring out debt supported by user fees and $520 million in overlapping debt issued by Hennepin County, the Minneapolis school district, and several smaller taxing jurisdictions. Amortization of the city's direct debt is rapid with 86% scheduled to be retired within 10 years, potentially resulting in some additional operating flexibility to re-allocate resources within the budget to support operations.
The city's five-year 2017-2021 CIP identifies $906 million in projects, the majority of which (about 60%) will be financed using a combination of internal resources and state & federal grants. The remaining 40% will be debt-financed with an estimated $241 million of GO bonds and $160 million of revenue bonds. New debt supported by the general fund will be issued in increments of roughly $47 million per annum, which is less than the amount of principal maturing in each fiscal year through 2021. Fitch therefore expects Minneapolis's long-term liability metric to improve over time. Rapid population and personal income growth will also push the metric lower.
Nearly half of Fitch's total long-term liability metric for Minneapolis consists of employee pension liabilities. The city merged its closed police and fire pension funds into the state pension plan several years ago, and most current employees are also members of the Minnesota-run Public Employees Retirement Association (PERA), which is divided into several sub-plans in which employees participate. Minneapolis also participates in the Minnesota Teachers' Retirement Association (TRA) plan as a non-employer contributing entity. The aggregate assets-to-liabilities ratio for all plans was 82% as of June 2015 using a 7.9% rate of return assumption. Using a slightly more conservative 7% rate of return assumption, Fitch estimates the combined assets-to-liabilities ratio of the plans at 75% on the same date. The adjusted unfunded liability for all plans is $953 million, as per Fitch's calculation.
Annual funding of PERA and TRA is done on a statutory basis, with contributions equal to a percentage of payroll and adjusted gradually upwards to achieve full funding of the various plans in 25 years, or less, depending on the plan. The city expects its employer contributions to increase continually, at a modest rate, in order to reach these state-mandated funding targets. Fitch believes the city has adequate spending flexibility to absorb these cost increases, which have ranged around 5% per annum since 2010.
Operating Performance
Fitch believes that the city is well-positioned to face the challenges associated with a moderate economic downturn. Fitch calculates a low level of estimated revenue volatility within the city's general fund based on 16 years of historical data. A 1% decline in U. S. GDP would lead to a general fund revenue decline of less than 1%. In our view, the city's broad revenue-raising flexibility and adequate spending controls would allow the administration to quickly close the resulting budget gap, likely with minimal to no use of fiscal reserves to bridge the shortfall.
After a $3.6 million operating surplus after transfers in fiscal 2015, the general fund held an available fund balance of $105 million, equal to nearly 23% of spending. Higher-than-budgeted building permit fees and sales tax over-performance drove the surplus, as did below-budget police overtime and snow removal costs. Management also achieved a $5.5 million operating surplus in fiscal 2014. Recent results are notable, given that the city had budgeted $24 million of reserves to balance the fiscal 2014 budget and had projected a $7 million to $9 million deficit as late as October 2014 - just two months prior to fiscal year-end. The fiscal 2015 budget was balanced with $13 million of general fund reserves. The city has a solid track record of conservative budgeting and cautious revenue estimates. It achieved five consecutive operating surpluses between fiscals 2011 and 2015.
The fiscal 2016 budget was balanced with a 3.4% property tax levy increase and included the planned use of $28 million of general fund reserves to fund a variety of capital projects, including repair of a city bridge. Management now estimates using only $14 million to $20 million of the planned draw-down, and Fitch believes it is likely that the city will spend even fewer reserves by 2016 fiscal year-end (December 31). The draft fiscal 2017 budget includes a 5.5% property tax levy increase across all funds (10% for the general fund), and the planned use of $5.5 million of general fund balance as a contingency.
Fitch has affirmed the ratings on the following series of bonds and notes previously issued by the county:
--$4.4 million GO tax increment refunding bonds (900 Nicollet Mall), Series 2009B
--$5.9 million GO bonds (taxable) (Downtown East Office), Series 2014
--$2.3 million GO tax increment refunding bonds (Heritage Park), Series 2012
--$1.0 million GO tax increment bonds (Midtown Exchange), Series 2008
--$4.0 million GO tax increment refunding bonds (Milwaukee Depot), Series 2009A
--$4.1 million GO tax increment refunding bonds (St. Thomas/WMPE Parking Ramp), Series 2009C
--$43.1 million GO tax increment refunding bonds (taxable) (Target Center Project), Series 2009D
--$9.7 million GO tax increment refunding bonds (taxable) (West Side Milling), Series 2010
--$2.5 million GO Block E Refunding Bonds (taxable), Series 2010
--$71.3 million GO Convention Center Refunding Bonds (taxable), Series 2011
--$4.5 million GO Convention Center Refunding Bonds, Series 2011
--$39.3 million GO Convention Center Refunding Bonds, Series 2011A
--$1.2 million GO Housing Improvement Area Bonds (taxable), Series 2013
--$1.1 million GO Improvement Bonds, Series 2010
--$2.8 million GO Improvement Bonds, Series 2011
--$3.0 million GO Improvement Bonds, Series 2012
--$9.0 million GO Improvement Bonds, Series 2013
--$4.5 million GO Improvement Bonds, Series 2014
--$1.5 million GO Library Bonds, Series 2008
--$33.1 million GO Library Referendum Refunding Bonds, Series 2011
--$24.3 million GO Library Referendum Refunding Bonds, Series 2012
--$14.9 million GO Library Referendum Refunding Bonds, Series 2013
--$19.9 million GO Parking Assessment Refunding Bonds, Series 2012
--$31.4 million GO Refunding Bonds, Series 2010
--$3.6 million GO tax increment refunding bonds, Series 2010
--$4.8 million GO Various Purpose Refunding Bonds, Series 2005B
--$36.6 million GO Various Purpose Bonds, Series 2009
--$2.3 million GO Various Purpose Bonds, Series 2010
--$5.8 million GO Various Purpose Bonds, Series 2012
--$11.1 million GO Various Purpose Bonds, Series 2013
--$18 million GO Various Purpose Bonds, Series 2014
--$6.8 million GO Various Purpose Park Bonds (taxable), Series 2013
--$4.9 million GO Various Purpose Refunding Bonds, Series 2009B
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