Fitch Rates Nashville-Davidson County Metro Gov't, TN $203MM GOs 'AA+'.

NEW YORK -- Fitch Ratings assigns a rating of 'AA+' to the Metropolitan Government of Nashville and Davidson County's (Metro) approximately $203.8 million general obligation bonds, series 2006 B. The bonds are scheduled to sell competitively on June 6. Public Financial Management Inc. is the financial advisor. Fitch affirms the 'AA+' rating on Metro's $1.4 billion in outstanding general obligation bonds, and 'AA' rating on their $66.7 million district energy system revenue bonds series 2002A, for which Metro has committed a debt service reserve deficiency make-up, subject to annual appropriation. The Rating Outlook on all bonds is Negative.

The 'AA+' rating is based on Nashville's broad and diverse economy and Metro's historically sound financial operations, revenue-raising capacity, and moderate debt levels. The Rating Outlook has been Negative since November 2003 because of Metro's weakened financial position. Reserves are at a substantially lower level than they have been historically due in part to a change in financial policies.

Maintenance of the current rating and a return to a Stable Outlook will depend on general fund results for fiscal 2006 yielding an unreserved, undesignated balance at or above the policy target of 5% of spending, as officials expect, and on Metro's ability to control spending and/or increase revenues sufficiently in its fiscal 2007 budget to maintain this level of reserves. Spending pressures, particularly subsidies to public hospital facilities and employee compensation, appear to be great, and further revenue-raising flexibility may be hampered by a large property tax increase adopted for fiscal 2006.

As a consolidated city/county government, Metro benefits from the combination of resources from urban and suburban areas. Nashville has a diversity of economic sectors, including finance, health care, retail, manufacturing, services, entertainment and agriculture. Metro's credit profile is enhanced by the stability of its substantial government and education employment. Economic growth was sluggish in the early years of the decade but appears to be strengthening.

Metro recently changed its approach to budgeting. In the past, officials increased the property tax rate significantly on a four-year cycle, coinciding with property reappraisals, in order to increase the fund balance. This balance was used in the ensuing three fiscal years to fund growing expenditures while keeping the tax rate constant. Going forward, officials expect to implement tax increases or expenditure reductions as needed on an annual basis to maintain reserves at 5% of spending. In accordance with the new budgeting practice, a fiscal 2006 property tax increase of 18%, while significant, provides only enough revenues to fund current-year expenditure needs and maintain the 5% reserve. Fitch believes that either approach provides sufficient levels of reserves, as long as it is applied consistently and effectively.

Fiscal 2005 audited general fund results were about break-even, yielding an unreserved general fund balance of 5.3% of expenditures and other uses. Expenditures decreased by about 4% from fiscal 2004 levels, due in part to transfers of some functions from the general fund to internal service funds, while revenues grew by 3%. Fiscal 2003 and fiscal 2004 both ended with sizable operating deficits, although the fiscal 2004 unreserved balance increased slightly since no reserves were budgeted for fiscal 2005. Year-to-date, fiscal 2006 financial operations appear to be positive, as sales tax is ahead of budget and most other items are close to budgeted levels.

Fitch believes that Metro's relationship with Nashville's public health care facilities still presents financial uncertainties and potential pressure for increased general fund subsidies. The subsidy to Metro General Hospital grew from $20 million in fiscal 2005 to $35 million in fiscal 2006, largely due to reductions in coverage by TennCare, the state's Medicaid program. Officials expect to transition Metro General Hospital to a stand-alone entity in calendar year 2007, a move they expect will somewhat curb the general fund's obligation to support it. Metro's fiscal 2005 audited financial statements express concerns about the hospital's ability to continue as a going concern.

Debt levels are in the moderate range, with overall debt at 4.2% of full market value and $3,321 per capita. Fitch expects debt levels to increase as officials plan to issue about $200 million in general obligation bonds annually, compared with amortization of less than $100 million. The amortization rate is about average. Further growth in debt levels, if not accompanied by similar gains in economic indicators, could become a burden on residents and taxpayers. Metro's annual six-year capital improvement budget is a planning document designed to implement long-range policies. Capital spending is refined after the beginning of each fiscal year to match high-priority needs and available funding.

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