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Fitch Rates Minneapolis Special SD GOs & COPs 'AA+'/'AA-'; Downgrades Outstanding on Criteria ChangeFitch Ratings has assigned a programmatic rating of 'AA+' and underlying rating of 'AA-' to the following Minneapolis Special School District No. 1, MN general obligation (GO) bonds and certificates of participation (COPs) :
--$45.4 million GO school building bonds, series 2016A; The 'AA+' programmatic rating is based on the district's participation in the Minnesota School District Credit Enhancement Program. Fitch also has downgraded the following underlying ratings due to a change in rating criteria:
--The district's Issuer Default Rating (IDR) to 'AA-' from 'AA'; The Rating Outlook is Stable.
SECURITY 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, subject to annual appropriation. KEY RATING DRIVERS Fitch's downgrade of the Minneapolis Special School District No. 1's IDR and GO ratings to 'AA-' from 'AA', and annual appropriation-backed bonds to 'A+' from 'AA-', reflects the application of its revised rating criteria for U.S. tax-supported issuers published on April 18, 2016. The revised criteria place greater emphasis on the independent ability to raise revenues without recourse to voters than did Fitch's prior criteria. In addition, the revised criteria consider an issuer's relative ability to maintain fiscal resilience in a mild downturn in light of historical revenue volatility and inherent budget flexibility. In Fitch's opinion, the district's standalone revenue-raising flexibility is heavily constrained by state statute. Its reserve cushion is adequate, but not especially strong, relative to the year-over-year swings in state revenues that it has experienced during past economic downturns. The rating continues to incorporate the district's low long-term liability burden and solid expenditure flexibility.
Economic Resource Base
Revenue Framework: 'bbb' factor assessment
Expenditure Framework: 'aa' factor assessment
Long-Term Liability Burden: 'aaa' factor assessment
Operating Performance: 'a' factor assessment
RATING SENSITIVITIES INCREASED LONG-TERM LIABILITIES: If Fitch expected the long-term liability burden to materially increase above current levels in relation to Minneapolis's population and resident income levels, then this could also place downward pressure on the ratings. PACE OF STATE REVENUE GROWTH: If state aid revenues grow at a more robust pace than is currently anticipated (i.e. faster than the rate of inflation), then this could generate upward pressure on the ratings particularly if stronger revenue growth occurred across economic cycles. Conversely, sustained reductions in aid that impacted operations and reserves would lead to negative rating pressure. CREDIT PROFILE The district provides K-12 public education for children of Minneapolis residents. Minneapolis is the largest city in the state of Minnesota (GO rated 'AAA'/Outlook Stable) with an estimated 2015 population of 411,000. The city and state are notable for their economic vibrancy. Population and labor force growth have been strong since the 2008-2009 recession, and unemployment has trended below 4% in recent years and below the US average historically. Resident wealth levels are above-average. The city's tax base has experienced a strong rebound since 2011, with taxable assessed value (AV) rising by over 10% in 2015 alone. The commercial portion of the tax base, which is primarily located in Minneapolis's central business district, is supported by a diverse group of businesses and is home to numerous corporate headquarters, including those of Target (News - Alert) Corporation and US Bank.
Revenue Framework Fitch anticipates that revenues will likely expand at a pace approximating the U.S. rate of inflation, which would be somewhat stronger than their historical growth rate. The district's 10-year compound annual growth rate (CAGR) for general fund revenues was 1.2% for the period from fiscal 2005 to 2015. The U.S. Consumer Price Index (CPI) CAGR for the same period was 2%. A sharp decline in enrollments between the early 2000s and 2011 was largely responsible for the district's volatile general fund revenue pattern during this period - revenues actually declined for several years before rebounding post-fiscal 2011. This was a natural result of how state aid revenues are determined under public-funding formulas, which assign a high degree of importance to enrollment levels when determining state aid allotments. Enrollments fell from 49,190 in fiscal 2001 to 33,147 in fiscal 2011 - a 33% cumulative decline. Since 2011, enrollment has recovered some lost ground, rising to 37,299 in the current fiscal/school year (i.e. 2017), a nearly 13% increase. Rebounding enrollments have positively impacted state aid and overall general fund revenue patterns since 2012. It is unclear whether this renewed growth will be sustained, however. District officials conservatively project a gradual decline in enrollments to about 34,000 by 2026 based on a continued, intense challnge from charter, private and parochial schools, which compete directly with the district to educate Minneapolis's K-12 population. Because the student body contains a high proportion of English learners, low income students, and students requiring special education, the effect of modest enrollment declines on state aid revenues may be muted if the declines occur gradually. The state's public school funding formula provides additional support to districts with a higher number of students requiring supplemental instruction. As with public school districts in most other U.S. states, Minnesota's K-12 school districts' legal, independent revenue-raising ability is heavily restricted by state statute. As a result, the school board's standalone ability to raise new recurring revenues to fund operations is highly circumscribed. The board and management team have no control over the nearly 70% of general fund revenues originating from the state of Minnesota. Under state statute, the Minnesota Department of Education must certify and approve the district's annual property tax levy. Using the funding formula, the Department calculates the district's levying margin each year. The school board can ask the Department to certify a property tax levy increase up to the maximum permitted margin, or some lesser amount. The annual margin calculated by the Department is based partly on enrollments, and partly on the district's prior-year rate of expenditure growth, along with other factors. The board has not always requested the maximum annual levy increase; its margin within the formula's limitations is typically not very broad, however. The district has traditionally supplemented its limited levying capacity under the state formula with new levies approved through voter referendums. In November 2016, district voters approved by 84% a referendum that renewed $65 million of annual property taxing capacity for another nine years. The referendum levy includes a 1.04% annual growth factor. The referendum levy equals 11% of fiscal 2016 (unaudited) general fund revenues. The recent referendum was the second extension of the levy.
Expenditure Framework Fitch expects the district's general fund spending will grow at a somewhat faster pace than its natural rate of revenue growth in the absence of continuous policy action to control costs. Fitch bases its view on the last five years of audited financial statements, along with draft results for fiscal 2016 and the district's annual budget books for fiscals 2015 through 2017. Expenditure growth has outstripped the pace of revenue expansion for the last several years, likely due in part to rising enrollments that have included a high proportion of students requiring special education instruction. Spending and revenues have both been above budget in recent years. Fitch expects new budgeting policies that are being adopted by management and the hiring of an internal auditor could slow these trends over time, but believes continued cost pressures remain a vulnerability that will require management vigilance. Fitch believes that Minneapolis Public Schools has solid flexibility to reduce its main expenditure items. Management has the ability to lay off teachers and support staff, institute hiring freezes, increase class sizes, and redesign academic, athletic and extra-curricular programs to control costs. The district also has the ability to slow down its rate of pay-go capital spending during leaner economic times and reconfigure its facilities footprint in response to enrollment changes. Carrying costs for debt, pensions and other post-employment benefits (OPEB) are moderate, equaling approximately 15% of total governmental expenditures in fiscal 2015 and fiscal 2016 (unaudited). District management engages in collective bargaining agreements with 13 employee bargaining units. Contracts with the unions typically run for two years to provide management with greater flexibility to bargain for revised contract terms and potential labor concessions such as increased employee healthcare contributions.
Long-Term Liability Burden The district participates in two cost-sharing multi-employer defined benefit pension plans administered by the state: the General Employees Retirement Fund (GERF) and the Minnesota Teachers' Retirement Association (TRA). Annual payments to the plans are set by state statute, rather than by actuarial recommendations, and have been lower than actuarially sustainable levels. The TRA had an assets-to-liabilities ratio of 82% as of June 30, 2014, using the plan's official 8.25% rate of return on investments assumption. Using Fitch's more conservative 7% discount rate assumption, the plan's ratio of assets to liabilities was 72%. The GERF's assets-to-liabilities ratio was 81% as of June 30, 2015. Using the Fitch-adjusted 7% rate of return assumption, the ratio was 74%. The district's pension contributions are increasing at a manageable rate. The district's unfunded actuarial accrued OPEB liability is modest at $56 million, or 0.3% of resident personal income. The district has set aside funds to cover this liability by establishing an OPEB trust.
Operating Performance Only a small portion of the budget goes to administration, with the bulk of spending on instruction. Many programs targeted at specific student groups could be merged or consolidated, at least temporarily, to control spending. The district also retains a healthy reserve cushion. Fitch believes financial operations could be more challenged in a downturn than would be the case for more highly-rated entities, but expects the district would recover financial flexibility quickly. Management has made consistent efforts to maintain financial flexibility during the present economic recovery, with reserves sustained in line with policy targets. The district has also avoided material deferral of required spending on capital maintenance and programs. It has occasionally resorted to non-recurring actions to support operations, including inter-fund transfers. Liquidity remains healthy. Four operating deficits between fiscal 2012 and fiscal 2015 were due to a combination of factors that included late state aid payments, planned pay-go capital spending, and above-budget special education costs. Despite state aid gradually increasing on a per-pupil basis, state-level actions exerted negative pressure in fiscals 2011 through 2013. To close its own budget gaps, the state shifted its funding formula such that aid was deferred. These state aid shifts were reversed in fiscal 2014, increasing this source of revenue, but this growth was largely offset by declines in property taxes and federal aid. Fiscal 2015 concluded with a $7.3 million general fund deficit (1.3%) caused by above-budget special education and student transport costs, and a decision to lower class sizes. Revenues and expenditures were above-budget in fiscal 2015, but spending grew more quickly than revenues. Fiscal 2016 ended with a narrow $771,000 surplus made possible by a $16 million inter-fund transfer. Absent the transfer, fiscal 2016 would have concluded with an operating deficit. Fiscal 2016 spending was $49 million (9%) above-budget as a result of increased regular instruction, special education and support costs. Available reserves equaled 13% of general fund spending at fiscal 2016-year end, slightly below the prior-year's 14% of spending. The fiscal 2017 budget grows by 5% over fiscal 2016 and is balanced without the use of reserves. District officials report revenues and expenditures tracking close to budget. Additional information is available at 'www.fitchratings.com'. In addition to the sources of information identified in the applicable criteria specified below, this action was informed by information from Lumesis and InvestorTools.
Applicable Criteria
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