Fitch Rates South Dakota Health & Ed. Facilities Auth's. $17.5MM Vocational Ed Revs 'AA'
--\$17,495,000 vocational education program revenue bonds, series 2015C.
The series 2015C bonds will sell via negotiated sale on March 18, 2015.
The Rating Outlook is Stable.
SECURITY
SDHEFA's vocational education program revenue bonds are limited obligations of the authority, payable solely from lease rentals and amounts in the debt service reserve. Lease rentals are subject to appropriation by the state legislature and derive from two sources, program revenues collected by participating institutions and appropriations from the state's general fund.
KEY RATING DRIVERS
RATINGS LINKED TO STATE CREDIT QUALITY: The 'AA' rating on SDHEFA's vocational education program bonds, one notch below the state's implied general obligation (GO) rating, reflects the appropriation required for debt service payment and solid program mechanics. Bonds of SDHEFA are secured by lease revenues subject to annual legislative appropriation, including a general fund subsidy and facility fee revenues charged to all students enrolled at South Dakota's four vocational technical institutes. All bonds are parity and are cross-collateralized and cross-defaulted, providing strong incentive to appropriate.
LOW LIABILITIES: The state's long-term liabilities, including debt, pensions and OPEB, are low. Tax-supported debt is primarily issued through the SDHEFA and the South Dakota Building Authority (SDBA), as the state does not issue general obligation bonds. The state's main pension system covering state and participating local employees is fully funded.
CONSERVATIVE FISCAL MANAGEMENT: Fiscal management is conservative. Financial flexibility is healthy, guided by a requirement to start and end the fiscal year with a balanced budget. Additionally, the state maintains ample flexibility through several well-funded reserve funds.
CYCLICAL ECONOMY: The state economy has a long history of reliance on the cyclical agriculture and banking sectors, although manufacturing and services are leading the state's diversification, and state wealth measures have grown steadily in recent years.
RATING SENSITIVITIES
CONTINUED ADHERENCE TO CONSERVATIVE MANAGEMENT: The rating is sensitive to the continuation of South Dakota's prudent approach to fiscal and debt management. The Stable Outlook reflects Fitch's expectation that strong state practices will remain unchanged.
CREDIT PROFILE
South Dakota's implied GO rating of 'AA+' reflects the general credit quality of the state. GO debt is constitutionally restricted to no more than \$100,000, and thus debt issued for state purposes is done in the form of appropriation-supported borrowing, primarily through SDHEFA and SDBA. The state has no GO debt outstanding.
The state's conservative approach to fiscal management and limited, manageable burden of liabilities are key credit strengths, offsetting its exposure to economic and revenue cyclicality from its prominent agriculture and banking sectors. By longstanding practice, the state has started and ended the year in balance, a policy that was further solidified by a constitutional balanced budget amendment approved by voters in 2012. Prudent fiscal management policies include the establishment of various trust funds that support certain spending priorities and which are available to provide a cushion in the event of unexpected revenue weakness. The state has used recent revenue windfalls and other available resources to further reduce liabilities, including early repayment of SDBA debt and the elimination of pension system unfunded liabilities.
STRONG LEASE STRUCTURAL FEATURES
The SDHEFA issues debt to finance higher education and health care facilities. Security on the vocational education program revenue bonds is derived from lease rental payments, subject to annual legislative appropriation, made by the state board of education from both facility fees paid by students of the four participating vocational technical institutes and from a state subsidy.
The four vocational technical education institutions must set their facility fees at a level that, along with appropriated payments, equals or exceeds 103% of scheduled debt service. Lease payments are due two days prior to the Feb. 1 and Aug. 1 debt service payment dates, although state practice is to transfer all amounts due for the entire bond year before the Aug. 1 payment. The tuition subaccount held by the bond trustee, which receives the facility fee revenues and appropriated subsidy payments, is pledged and assigned for benefit of bondholders and is not available to transfer to the state's general fund.
Security features include a covenant to budget subject to appropriation, and cross-collateralization and cross-default provisions that provide strong incentive to appropriate. The state has strengthened its commitment to the vocational education program revenue bonds in recent years. A 2013 statutory change requires legislative approval of new issuance and a minimum 103% coverage of maximum debt service upon new issuance. Moreover, the legislature expressed its intent to appropriate a level of state subsidy equal to 50% of facility fees; under this provision, the state appropriated \$2.217 million in fiscal 2015, well above the \$1.65 million fixed appropriation that had been in place since fiscal 2009.
In the event that pledged revenues are insufficient, a debt service reserve funded at MADS provides additional security. The board also covenants to seek a supplemental state appropriation to address the deficiency. This provision has never been triggered.
CYCLICAL, DIVERSIFYING ECONOMY
South Dakota's economy has had a longstanding reliance on agriculture, although manufacturing and services continue to grow. Key sources of economic activity, including agriculture and banking, have been subject to cyclicality in recent years, affecting state employment, personal income and tax collection trends.
South Dakota was much less severely affected by the last recession than the nation as a whole and its recovery has been steady, albeit at a pace slightly below the nation's. Employment in the state rose 1.6% in 2012 and 0.7% in 2013, below the U.S. growth rate of 1.7% in both years. More recently employment has slowed, with December 2014 employment rising only 0.8% in South Dakota, compared to 2.2% nationally. Unemployment has historically been much lower in South Dakota than the nation. The unemployment rate in December 2014 was 3.3% in the state, compared to 5.6% nationally.
Personal income growth has generally been more volatile than the nation as a whole in particular due to the prominence of farm income, but has trended materially higher over the last few decades as the state's economy has diversified. Over the last four quarters, personal income growth ranged from -1.2% to 2.3% year-over-year. As of the third quarter of 2014, personal income rose 1.8% over the third quarter of 2013, below the 3.9% national rate. State personal income per capita as a percentage of the U.S. level stands at 102.8% in 2013, ranked 19th among the states; as of 2004, the same figure stood at 95.1%.
MULTIPLE RESERVES
The state maintains a budget reserve fund (BRF) as well as several sizable trust funds whose earnings support ongoing spending and which provide additional budgetary cushion in the event of unforeseen needs, including recessionary weakness. As of Jan. 31, 2015, the BRF balance stood at \$105.2 million, equal to 7.5% of forecast fiscal 2015 general fund revenues; this figure includes \$9.9 million in unobligated cash balance from fiscal 2014 overperformance.
Other reserve and trust funds receive constitutionally dedicated resources and support specified education and health-related spending priorities through annual transfers to the general fund. Among them is the property tax relief fund (PTRF), the balance of which stood at \$44 million (3.1% of general fund revenues) as of Jan. 31, 2015. The state has periodically used PTRF balances for one-time purposes, for example drawing \$19.6 million in fiscal 2014 to repay debt and produce ongoing debt service savings.
SOLID BUDGETING PRACTICES
South Dakota cemented its longstanding practice of starting and ending each fiscal year with a balanced budget by passing a constitutional amendment requiring budget balance in 2012.
About 60% of general fund revenues come from the state's broad-based 4% sales tax, with additional revenue generated by a contractor's excise tax, insurance company taxes, banking taxes and other smaller levies. There are no individual or corporate income taxes. State revenues from banking activity, including the bank franchise tax and unclaimed property receipts, have been cyclical in recent years, reflecting broader national economic trends as well as bank consolidation.
The state by practice budgets conservatively, distinguishing between ongoing and one-time revenues and expenditures, and more recently implementing multi-year budget planning. Revenue collections in recent years have shown steady gains in line with broader state economic trends. The state prudently diverted an unexpected windfall from fiscal 2014 one-time receipts to cover a range of one-time needs, including early debt repayment, economic development and capital investment. The state has been able to absorb rapidly rising health care spending in recent years, driven by provider charges, a growing Medicaid population, and the impact of rising wealth on the state's share of Medicaid funding.
The governor released a revised fiscal 2015 budget in December 2014 along with the executive budget proposal for fiscal 2016, and the state updated its revenue outlook in March 2015. Based on the March revenue update, fiscal 2015 general fund revenues are forecast to decline 4.5% from fiscal 2014, to \$1.41 billion, reflecting lower non-recurring revenues in fiscal 2015. Ongoing receipts are forecast at \$1.37 billion, slightly below expectations in earlier forecasts, with sales taxes rising 1.7% from a year earlier. One-time receipts are currently forecast at \$34.8 million; none were forecast as of budget adoption.
In the governor's proposal, fiscal 2015 spending changes included a net \$13.5 million in cuts while directing \$26 million to one-time needs, including setting aside funds for disaster response. The fiscal year was forecast to end in balance. Year to date through January 2015, actual fiscal 2015 revenue collections reflecting only ongoing receipts are up 1.1% from one year earlier, with sales taxes up 1.6%.
Under the governor's executive proposal for fiscal 2016, general fund spending was expected to rise 2.5%, to \$1.44 billion, with increases for Medicaid, education aid, and employee salaries, among other needs, and the year was forecast to end with reserve fund balances unchanged from current levels. The March 2015 revenue forecast for fiscal 2016 lowered expected revenues slightly from levels forecast in December, with the state assuming total general fund revenues rising 1.6%, to \$1.43 billion, and sales taxes rising 3.8%, driven by continued economic gains. No one time receipts are budgeted. The legislature continues to deliberate on the fiscal 2016 budget.
VERY LOW LIABILITIES
As of June 30, 2014, South Dakota's net tax-supported debt burden is low, equal to approximately 1.1% of 2013 personal income; tax-supported debt includes SDHEFA's vocational education program revenue bonds and outstanding bonds of the SDBA. State retiree obligations are minimal.
The state's primary pension system, the South Dakota Retirement System (SDRS) covers both state and participating local retirees. Although long a relatively well-funded plan, in 2013 SDRS transferred a portion of system reserve balances to pay off the unfunded liability and bring its funded ratio to 100% on a reported basis. Under GASB 67 accounting, the system's ratio of assets to liabilities is 107.3% as of June 30, 2014; using Fitch's more conservative 7% return assumption would lower its funded ratio to a still strong 101.7%.
As of Fitch's 2014 state pension report, on a combined basis net tax-supported debt and the state's share of the Fitch-adjusted unfunded liability of SDRS measure 1.5% of personal income, among the lowest levels of any state. Additionally, the state took action in the last legislative session to eliminate its already minimal OPEB liability.
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