OREANDA-NEWS. Fitch Ratings assigns an 'AA' rating to the following Minneapolis Special School District No. 1, Minnesota (the district) obligations:

--$21.925 million general obligation (GO) school building bonds, series 2015A;
--$36.845 million GO alternative facility bonds, series 2015B;
--$12.025 million GO refunding bonds, series 2015C;
--$42.165 million full-term certificates of participation (COPs), series 2015D.

The 'AA' rating is based on the district's participation in the Minnesota School District Credit Enhancement Program (the program).

Fitch also assigns an 'AA' underlying rating to the series 2015A, 2015B, 2015C bonds and 2015D COPs. The series 2015D COPs are full-term COPs as described below. The bonds and COPs are expected to sell via competitive sale on or about Dec. 8. Proceeds are being used for various capital improvement projects and to refund outstanding bonds.

In addition, Fitch affirms the underlying ratings on the following district obligations:

--Approximately $282 million of outstanding district GO bonds at 'AA';
--Approximately $200 million of full-term COPs at 'AA';
--Approximately $37 million of outstanding series 2010A and 2010B COPs at 'AA-'.

The Rating Outlook is Stable.

SECURITY
The GO bonds are backed by a pledge of the full faith and credit and unlimited taxing power of the district. The full-term COPs are payable from district lease payments that come from a separate unlimited property tax levy and are not subject to appropriation. Both the GO bonds and full-term COPs are backed by the program.

The series 2010A and 2010B COPs are special limited obligations of the district payable solely from rental payments made by the district under the terms of the lease purchase agreement between the trustee and the district.

KEY RATING DRIVERS
RATING BASED ON STATE PROGRAM: The GO bonds and full-term COPs benefit from the state of Minnesota's (rated 'AA+' by Fitch) school district credit enhancement program rated, 'AA'. The state will make payments to the trustee for debt service upon notification from the district that funds are insufficient to do so. Payments are subject to annual appropriation to the state department of education from the state general fund.

DISTRICT CREDITWORTHINESS: The 'AA' underlying rating on the GO bonds and full-term COPs reflects the district's large and diverse economic base, coterminous with the city of Minneapolis. Debt levels are moderate, and reserves remain at a level that provides solid financial flexibility despite recent declines.

RELIANCE ON STATE FUNDING: The district is highly dependent on funding from the state. Past delays in state aid payments have created long-term budgetary uncertainty and reduced liquidity. Those delays have been reversed, but could recur in the future.

APPROPRIATION COPS RATIONALE: The one notch rating distinction for the appropriation COPs incorporates the risk of non-appropriation. While the covenant to budget and appropriate lease rental payments is absolute and unconditional, there is no legal obligation to do so.

RATING SENSITIVITIES
RESERVE DECLINES: Further declines in reserves could challenge the district's financial flexibility, particularly in light of frequent fluctuations in state funding, and could pressure the rating.

RATING-LEVEL RELATIONSHIP CHANGES: The rating is sensitive to changes in the district's underlying and state program rating. The GO bonds and the full-term COPs are rated based on the higher of the state program rating and the district's underlying rating, which are currently the same.

CREDIT PROFILE
The district is coterminous with the city of Minneapolis (GO bonds rated 'AAA') whose diverse and broad economic base benefits from the strong presence of the relatively stable health care, financial institutions, higher education, and government sectors. July 2015 unemployment equaled a low 3.8%, well below the national rate of 5.6% and equal to the state rate.

BROAD LOCAL ECONOMY

The tax base has shown growth in recent years after several years of declines and further growth is expected due to a rise in home prices and substantial construction activity. The commercial tax base, primarily located in the city's central business district, is supported by a diverse group of businesses and is home to numerous corporate headquarters including Target and US Bank.

ENROLLMENT STABILIZES
The district serves over 34,000 students. After several years of severe enrollment declines, the district has had four consecutive years of growth and projects relatively flat enrollment over the next 10 years. Capital costs are expected to be manageable.

FUND BALANCE DECLINES FOLLOW BUILDUP
The district's primary revenue source is state aid, which represented 74% of fiscal 2014 general fund revenues. State aid has been gradually increasing on a per pupil basis. In order to make up for its own budget gaps, in 2011 the state shifted its funding formula such that 70% of a year's budgeted funding was received in the current year, with 30% deferred to the following year; previously the ratio was 90/10. The state extended the shift further to 64/36 in 2012. These shifts resulted in a significant decline in the district's liquidity levels. Recent improvements in the state's finances have allowed it to reverse these shifts back to 90/10, which materially improved the district's liquidity position. However, the district remains at risk for future payment shifts should the state's fiscal condition deteriorate again.

The district had substantial general fund balance growth despite declining liquidity, with consecutive net operating surpluses after transfers from fiscal 2004 through fiscal 2011. However, fiscal 2015 will mark the fourth straight year of general fund balance draws. Fiscal 2013 had a notable $38.6 million decline that was planned for capital spending. Fiscal 2014 finished with a $2.9 million net operating deficit. Prior state aid shifts were reversed, increasing this source of revenue, but this was largely offset by a decline in property tax revenues from a tax shift, and federal aid was also down. This net operating deficit brought unrestricted general fund balance down to $84 million or 15.7% of expenditures.

The initial fiscal 2015 budget was balanced, but was revised mid-year to include a $12.5 million draw for several new administrative programs and smaller class sizes. Approximately 125 central office positions were eliminated during the year. Unaudited results show the district finishing roughly at this level. Management is targeting balanced operations in fiscal 2016. They are anticipating additional cost cutting to offset several departments which are projecting to overspend their budgets. Efforts are being made to shift spending from the central office to the individual schools. Further sizeable declines in general fund balance could begin to pressure the current rating level.

MODERATE DEBT BURDEN
The district's overall debt burden (including debt of the city, county and other overlapping governments) is moderate at $2,019 per capita and 2.3% of estimated market property value. Principal amortization is fairly rapid with 67% maturing in 10 years. No major capital needs are projected.

District employees participate in the state's retirement plans, namely the Teachers Retirement Fund and the Public Employees Retirement Fund, with payments set by the state. Both plans have below-average funding levels with the teacher's plan at 72% or approximately 62% using a Fitch-adjusted 7% return level and the other plan at 74% or approximately 63% using the 7% return level. Pension contributions have been increasing at a manageable rate, though are not actuarially based. The district's unfunded actuarial accrued liability for other post-employment benefits (OPEB) is modest at $56 million or 0.2% of market value, and the district recently prudently set aside funds in an OPEB trust. Total carrying costs for the district in fiscal 2014 were moderate at approximately 14% of government fund expenditures.

ENHANCEMENT PROGRAM AND COPS DETAILS
The Minnesota School District Credit Enhancement Program provides timely debt service payments in the event the district notifies the state that it is unable to meet debt service requirements on the GO bonds or COPs. The district must notify the state 15 working days ahead of time that it has insufficient funds, and the state must deposit funds with the paying agent three business days before the payment date or notify the state.

The series 2010A and 2010B COPs are special limited obligations of the district payable solely from rental payments made by the district under the terms of the lease purchase agreement between the trustee and the district. The district has covenanted in the lease to include in its annual budget for each fiscal year moneys sufficient to pay all rental payments. While the covenant is absolute and unconditional, there is no legal obligation to actually appropriate such amounts. The lease is not subject to abatement.