Fitch Rates NJ Econ. Dev. Auth's $546MM Notes 'A-'; Outlook Remains Negative
--\$3.795 million series 2014A;
--\$3.765 million series 2014B;
--\$59.665 million series 2015A;
--\$12.905 million series 2015B;
--\$99.76 million series 2015C;
--\$87.32 million series 2016A;
--\$3.045 million series 2016B;
--\$67.595 million series 2016C;
--\$100.39 million series 2017A;
--\$1.63 million series 2017B;
--\$106.59 million series 2018A.
In addition, Fitch has affirmed the following ratings for the state of New Jersey:
--\$2.16 billion general obligation (GO) bonds, at 'A';
--\$940.2 million Garden State Preservation Trust bonds, at 'A';
--Approximately \$33.5 billion of state obligations secured by the state's annual appropriation pledge as detailed at the end of this release, at 'A-';
--The program ratings assigned to New Jersey Municipal Qualified Bonds and bonds secured by the New Jersey School Bond Reserve (New Jersey School Credit Enhancement Program), at 'A-'.
Additional affirmations linked to the state's GO rating are listed at the end of this release.
The Rating Outlook is maintained at Negative.
SECURITY
The notes are special, limited obligations of the NJEDA; debt service is paid under a state contract between the state treasurer and the authority subject to annual legislative appropriation.
KEY RATING DRIVERS
APPROPRIATION OBLIGATION OF THE STATE: State contract payments provide for debt service on NJEDA obligations; payments must be appropriated annually by the state legislature, resulting in a rating one-notch below the state's 'A' GO bond rating.
LONG-TERM LIABILITIES CONSIDERABLE: Above-average state debt obligations are compounded by significant and growing funding needs for the state's unfunded retirement liabilities. Continued pension funded ratio deterioration is projected through the medium term and full actuarial funding of the required, statutory contributions is several years off and will require a significant share of the state's resources to fulfill.
WEALTHY ECONOMY AND LAGGING RECOVERY: New Jersey benefits from a wealthy populace and a broad and diverse economy. However, the state's economic performance has lagged the nation in the recovery from the last recession, with very slow year-over-year (yoy) employment growth continuing through 2014 and unemployment rates above the national average.
MINIMAL CASH BALANCES RESULT IN LIMITED OPERATING FLEXIBILITY: Minimal cash balances have been maintained in recent years and the state has no financial reserves to absorb unforeseen needs or revenue under-performance.
BROAD EXPENDITURE REDUCTION AUTHORITY: The governor has strong executive powers to implement any necessary expenditure reductions to balance the budget and the state has a consistent history of doing so; however, options have become more limited as the state's fixed cost burden grows.
NEGATIVE OUTLOOK: The Negative Outlook incorporates the risk, in Fitch's view, that state actions to address near-term budgetary and pension challenges may leave unaddressed the state's longer-term structural and liability challenges, particularly given the state's lagging economic and revenue performance and narrow liquidity.
RATING SENSITIVITIES
MANAGEMENT OF BUDGET CHALLENGES: The GO rating is sensitive to the state's management of its budget challenges. Continued deterioration in the state's budgetary flexibility or a failure to adequately provide for its liabilities could lead to a downgrade.
APPROPRIATION RATINGS LINKED TO STATE GO CREDIT: The rating on the appropriation-backed bonds is sensitive to movement on the state's GO bond rating to which it is linked.
CREDIT PROFILE
New Jersey's 'A' GO rating incorporates the absence of long-term, fiscally sustainable solutions to achieve balanced budgetary operations and address the state's obligations. Recent actions to solve for budgetary imbalance, following significant revenue underperformance late in fiscal 2014, relied upon the state repudiating its planned statutory contributions to the pension systems in fiscal years 2014 and 2015. The rating also incorporates the use of sizable one-time measures to balance its operating budgets; a very weak liquidity position; economic performance that continues to lag that of the nation; and a multitude of long-term spending pressures. The Negative Outlook incorporates Fitch's concern that state actions to address near-term budgetary and pension challenges will compound the state's longer-term structural and liability challenges.
New Jersey benefits from high wealth and a broad economy; these positives are offset, however, by a high debt burden and sizable unfunded retiree liabilities. Despite passage of pension and benefits reform legislation in 2011, the governor has proposed resetting the schedule of escalating pension contributions beginning in fiscal 2016, which Fitch believes is evidence of the state's significant fiscal pressures. Continued pension funding-level deterioration is projected through the medium term given that state contributions under the original phase-in schedule or the proposed delayed schedule are well below actuarial levels for multiple years going forward. Fitch believes the state will continue to have difficulty balancing the need for requisite pension system contributions with other long-term demands, such as infrastructure, property tax relief, and school funding. The state is pursuing additional pension reforms, although reaching consensus is likely to be politically challenging and the timing and extent of any potential fiscal relief is unknown.
FINANCIAL OPERATIONS ARE STRUCTURALLY UNBALANCED
The state's fiscal 2014 enacted budget was challenged by overly optimistic revenue projections and was exacerbated by an additional \$807 million revenue gap that was announced in April 2014, caused by a significant shortfall in personal income tax (PIT) collections. The total revenue shortfall for fiscal 2014 as compared to the enacted budget reached \$1.3 billion, approximately 3.9% of the state's operating budget. The revenue shortfall, when combined with other revenue and expenditure adjustments, created a \$1.7 billion budget gap for fiscal 2015.
The governor proposed an \$887 million reduction to the statutory \$1.58 billion pension payment for fiscal 2014 as well as a \$1.57 billion reduction from the statutory \$2.25 billion pension payment for fiscal 2015 as the primary means of closing the budget gaps. Despite legal challenge, the fiscal 2014 cut was upheld by a state superior court judge, who cited the state's emergency fiscal situation given the announcement of the gap late in the fiscal year; however, the judge did not rule on the proposed cut to the fiscal 2015 pension payment as the budget had not yet been enacted. Following this ruling, the legislature's approval of personal income and business tax increases commencing in fiscal 2015 to cover the originally scheduled pension contribution were vetoed by the governor, and the pension contribution was reduced instead.
Including the \$887 million reduction to the contribution for the state's pension systems, Fitch believes one-time actions in the fiscal 2014 operating budget ultimately totaled just over \$3 billion, equal to 9.3% of the \$33.2 billion operating budget. These included \$92 million in securitization of the state's remaining tobacco settlement revenues, an EDA bond refunding, tax policy and revenue initiatives, about \$94 million in pension savings from the combined effect of incorporating salary scale changes and a more favorable method of calculating the state's normal cost pension contributions, and various appropriation offsets.
The \$32.5 billion enacted operating funds budget for fiscal 2015 was 2.1% below the final budget for fiscal 2014 and reduced appropriations by \$692 million from fiscal 2014, incorporating the cut to the pension payment. Revenues were forecast to increase by 3.5%, including a 5.5% increase in sales tax revenue, a 4.8% increase in the PIT, a 6.5% increase in the corporation business tax (CBT), and a 17.6% (\$40 million) increase in casino revenues. One-time actions included in the budget were estimated to total \$2.75 billion (8.5% of the fiscal 2015 operating budget) and included the \$1.57 billion pension payment cut, \$231 million in appropriation offsets, \$324 million from the NJ Turnpike to offset appropriations to NJ Transit, and \$391 million in debt restructuring. The state forecast a year-end operating fund balance of \$388 million.
In presenting his proposed fiscal 2016 budget, the governor updated budgetary expectations for fiscal 2015 - reducing the expectation for sales tax growth to 3.4%, increasing expected PIT growth to 5.6%, and revising casino revenues to a 4.4% decline from an earlier growth expectation. Considering appropriation lapses and increases and the net 0.2% shortfall in projected operating revenue sources, the state continues to forecast an ending operating fund balance of \$388 million; a slim 1.2% of operating revenue. The revised budget does not address a February 2015 court ruling against the state regarding the contested pension contribution cut for fiscal 2015. The state has indicated that it will appeal the decision; however, a final ruling against the state would require a restoration of the \$1.57 billion payment; equal to almost 5% of the state's operating expenditures in fiscal 2015, and the state has not indicated the ability or willingness to accommodate a higher pension contribution.
PROPOSED FISCAL 2016 BUDGET ADJUSTS PENSION CONTRIBUTION RAMP-UP
In Fitch's view, the governor's proposed \$33.8 billion budget for fiscal 2016 is based on more realistic revenue assumptions than in the past although the lottery and casino revenue forecast continue to be aggressive. Overall 3.8% projected revenue growth appears to be in line with current revenue trends; however, the proposed budget resets the phase-in schedule of full actuarial pension contributions as required under current statute. It appropriates almost \$1.3 billion to pensions, a sizable increase from fiscal 2015 but far below the approximate \$3.1 billion payment, equal to 5/7 of the actuarially required contribution (ARC) that is currently required under state statute. The \$1.3 billion payment is equal to 3/10 of the ARC under a revised phase-in that the governor is proposing that would reach full contribution funding in fiscal 2023.
In Fitch's opinion, the long timeframe to achieve full actuarial contribution funding under either the existing statutory ramp-up plan or the governor's proposed delay will further raise the state's unfunded obligations and the ultimate annual contribution requirement, compounding future budgetary challenges. The pension contribution reset proposal occurs simultaneously with a separate proposal by the governor's special pension taskforce for additional employee and retiree pension and health care reforms (detailed below). If implemented in their current form, Fitch believes the reforms could provide notable annual state cost savings and thus improve prospects for future budget sustainability.
Ending fund balance in fiscal 2016 is expected to total \$350 million. Fitch believes this level of fund balance, 1.2% of operating revenue, would provide only limited operating flexibility in the event of future negative fiscal developments. The budget proposal is currently being considered by the legislature.
ECONOMIC GROWTH HAS LAGGED THE NATION
State employment growth during most of the last decade lagged the national experience, and while growth has returned following recessionary losses, the pace of expansion remains well below the national average. The state entered the recession with the nation in 2008 and its experience from 2008 to 2010 was similar, although the state recorded a decline of 1.2% in non-farm employment levels in 2010, higher than the 0.7% contraction seen nationally; growth in 2011 was essentially flat to 2010 and below the 1.2% national growth rate. Modest employment growth in both 2012 and 2013 of 1.1% was below the national 1.7% growth rate for both years.
Employment gains in 2014 were very slow with growth in December 2014 a negligible 0.7% yoy as compared to 2.3% yoy nationally. The state's unemployment rate of 6.2% for December was improved from the rate one year prior of 7.2% and differing from trends through most of 2014, workforce participation notably increased, with 1.4% growth in seasonally adjusted labor force growth, partly contributing to the increase in the unemployment rate from one year prior.
New Jersey's wealth levels are high, with 2013 per capita personal income equaling 126% of the national level, ranking it fourth among the states.
COMPARATIVELY HIGH LONG-TERM LIABILITIES
New Jersey's debt levels are high for a U.S. state, and ongoing capital demands for school construction, environmental protection and transportation remain large. Net tax-supported debt as of June 30, 2014 equaled 7.4% of 2013 personal income as compared to a median of 2.6% for the states.
Unfunded pension liabilities attributable to the state are also well above average. These liabilities are expected to increase over the next several years absent additional reform measures and materially higher contributions than currently expected.
Under the new GASB 67 standard for pension systems, in the aggregate, the state's seven systems covering retired state employees and local teachers have assets sufficient to cover only 32.6% of projected liabilities as of June 30, 2014, and all of New Jersey's large plans show significantly lower ratios of assets to liabilities under the new standards. For the two largest plans, covering state public employees and teachers, the new disclosure reports that assets equaled only 27.9% of liabilities for state public employees (PERS), and only 34.1% of liabilities for teachers. In contrast, as of July 1, 2013, the last valuation date, the funded ratios for the state employees and teachers plans were 46% and 57.1%, respectively, as reported under the prior GASB standards.
Moreover, six of the seven state plans under the new GASB reporting disclose specific depletion dates for when assets set aside to fund benefits are expected to run out. The state employees' and teachers' plans forecast depletion dates in 2024 and 2027, respectively. Plan liabilities payable after the depletion dates are discounted at a 4.29% muni bond index rate, rather than the 7.9% rate assumed for investment returns, elevating the reported liability. As reported in Fitch's 2014 pension report, on a combined basis, as of July 1, 2013, New Jersey's net tax-supported debt and adjusted, unfunded pension obligations attributable to the state, as adjusted for a 7% return, totaled 16.5% of 2013 personal income, well above the 6.1% median for all U.S. states.
The governor's special pension taskforce proposed wide-ranging reform to state and local pension and retiree health benefits. Proposals include freezing the current pension plans that would end the accrual of benefits for current employees; creating new pension plans that would be structured as cash-balance plans, a hybrid defined benefit plan; increasing local school district responsibility for funding pensions; targeting health care savings as a way to offset increasing pension contributions; passing a constitutional amendment guaranteeing higher state contributions to the pension systems; and transferring pension system management to newly created employee entities. Together with the proposed fiscal 2016 budget, the task force's proposals are expected to be considered during the legislative session.
RELATED DEBT
The ratings on the following credits, which are linked to the state GO rating, have been affirmed. The Rating Outlook on all the bonds remains Negative.
--Approximately \$13.5 billion New Jersey Economic Development Authority annual appropriation bonds at 'A-';
--Approximately \$14.8 billion New Jersey Transportation Trust Fund Authority annual appropriation bonds at 'A-';
--Approximately \$940 million Garden State Preservation Trust revenue bonds at 'A';
--Approximately \$541.9 million New Jersey Building Authority annual appropriation bonds at 'A-';
--Approximately \$673.5 million New Jersey Educational Facilities Authority annual appropriation bonds at 'A-';
--Approximately \$703.5 million New Jersey Health Care Facilities Financing Authority annual appropriation bonds at 'A-';
--Approximately \$440.5 million New Jersey Sports and Exposition Authority annual appropriation bonds at 'A-';
--Approximately \$671.1 million of state of New Jersey certificates of participation at 'A-';
--The program ratings assigned to New Jersey Municipal Qualified Bonds and bonds secured by the New Jersey School Bond Reserve (New Jersey School Credit Enhancement Program) at 'A-'.
The 'A-' ratings for the state's appropriation obligations, one notch below the state's GO rating, reflects the requirement of annual legislative appropriations for debt service. The 'A' rating for the Garden State Preservation revenue bonds reflects that while annual legislative appropriation of dedicated sales tax revenue is necessary, the provision that if the legislature fails to make the appropriation, dedicated funds may not be for any other purpose, effectively eliminates the risk of non-appropriation in Fitch's opinion, allowing for a rating on par with the state's GO debt.
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