Fitch Rates West Virginia's GO Rfdg and Lease Rev Bonds; Outlook Stable
In addition, Fitch has assigned an 'AA' rating to \$31.17 million West Virginia Economic Development Authority (EDA) bonds consisting of the following:
--\$11.06 million lease revenue bonds (Fairmont office building) 2015 series A;
--\$3.9 million lease revenue bonds (Fairmont office building) 2015 series B (taxable);
--\$16.21 million lease revenue bonds (Clarksburg office building) 2015 series C.
The bonds are being issued under separate official statements. The GO bonds are expected to be sold via competitive bid on April 16, 2015. The EDA bonds are expected to be sold via negotiation on or about April 23, 2015.
The Rating Outlook is Stable.
SECURITY
The GO bonds are secured by the state's full faith and credit including the obligation to levy a statewide tax for bond repayment. The EDA bonds are special limited obligations payable from lease revenue payments from the state of West Virginia, subject to annual appropriation.
KEY RATING DRIVERS
WELL-MANAGED FINANCIAL OPERATIONS: The state has been challenged in recent fiscal years by underperformance in key revenue sources and sizable growth in its Medicaid program, necessitating expenditure cuts and modest use of fund balances to steady operations. The state expects budgetary imbalance to continue through fiscal year 2016 and has focused its efforts on identifying expenditure solutions in concert with planned, limited use of its rainy day fund (RDF) as well as continued sourcing of one-time revenues.
SIZABLE RESERVES: While the state has applied \$100 million from the RDF to expenditures in fiscal 2015, reserves remain considerable, at over 20% of general fund revenues. The state has appropriated an additional \$14.8 million from the RDF in fiscal 2016 to fund expenditures. Fitch expects the state to maintain significant reserves given the economic and financial reliance on natural resource development.
WEAK DEMOGRAPHICS ALTHOUGH ECONOMY HAS DIVERSIFIED: West Virginia's economic base has diversified, though significant exposure to the cyclical natural resources industry remains, particularly the troubled coal industry. Wealth and other demographic indicators are weak for a U.S. state.
MANAGEABLE DEBT AND LIABILITY POSITION: Tax-supported debt levels are moderate and amortization is above average. The state has made significant progress in reducing a sizable total liability situation although the combined burden of debt and pensions remains well above average.
APPROPRIATION OBLIGATION OF THE STATE: Annual appropriations from the state provide for debt service on EDA's lease revenue obligations, resulting in a rating one-notch below the state's 'AA+' GO bond rating.
RATING SENSITIVITIES
The GO rating is sensitive to shifts in the state's fundamental credit characteristics, particularly its economic, liability, and financial profiles. The ratings assume the state's continued maintenance of high reserve balances while making progress toward restoring fiscal balance and reducing its long-term liability burden.
The rating on the EDA bonds is sensitive to shifts in the state's GO bond rating to which it is linked.
CREDIT PROFILE
GO bonds are supported by a full faith and credit pledge of the state and are rated 'AA+', reflecting the state's strong financial management, sound reserve position, and the substantial progress made in reducing its liabilities for the teachers' pensions and workers' compensation systems, as well as the liability for other post-employment benefits (OPEB). The state's economy has experienced a shift in recent years, with increased development of its natural gas reserves in the Marcellus Shale while production of the state's coal resources has declined, spurred by low natural gas prices, decreasing export markets for its coal, and more stringent environmental regulations that have negatively impacted coal production.
This shift has also impacted the state's financial resources as the less labor-intensive gas development contributed to marginal to declining personal income tax (PIT) and sales tax collections, furthered by the cost of a meaningful but now reduced alternate vehicle fuel PIT credit. A concurrent reform of its business-related taxes and decline in lottery revenues due to increasing competition also reduced the revenues available to the state. This revenue weakness has resulted in recent and projected budget gaps that the state has solved through expenditure reductions, one-time actions, and the planned use of its RDF. Debt levels are moderate although the state's long-term liabilities remain high.
The current GO issue will refund outstanding obligations of the state for present value savings with no extension of maturities. The state intends that revenues in its road fund, consisting of a motor fuel tax, motor vehicle sales tax, and license and registration fees, will be applied for payment of debt service on this obligation. The lease revenue bonds are limited obligations of the state, with lease payments subject to annual legislative appropriation; as such, the 'AA' rating is one notch below the GO rating of the state. The state has covenanted to include lease payments in its budget requests and lease payments are not subject to abatement. The current Fairmont office building lease issues will reimburse the state for already expended funds advanced for the construction of the building while the Clarksburg office building lease issue is similarly structured but with funding for capitalized interest through Dec. 1, 2016. Both buildings will house various agencies and departments of the state.
WELL-MANAGED FINANCIAL OPERATIONS
West Virginia's institutionalized fiscal and management practices, highlighted by the governor's broad power to cut spending and the consolidated executive control of debt issuance, are also reflected in its proactive approach to addressing long-term liabilities and maintenance of sizable reserve balances. While reserves are expected to decline in fiscal years 2015 and 2016 due to revenue weakness and increased funding needs for its Medicaid program, Fitch expects these practices to aid the state as it navigates forecast budgetary imbalance through fiscal 2017.
Fiscal 2014 general fund revenues were 0.7% below forecast and incorporated losses in business-related taxes, PIT receipts that were 5.8% below forecast, and sales tax revenue that was 2.6% below forecast. The state responded to the reduced revenues through mid-year state agency reductions and the transfer of special revenue fund cash balances to the general fund, and benefited from a timing adjustment to the revenue sharing of local severance tax. The state also applied available cash balances in the general fund to operations and appropriated almost \$55 million from the tax reduction reserve. Combined, one-time revenues applied to support the general and lottery fund budgets totaled \$209 million; 4.5% of general fund revenues. The RDF was not tapped in this fiscal year and total reserves were maintained at 24% of revenues. The rainy day funds cannot be spent without legislative appropriation.
For fiscal 2015, the enacted \$4.25 billion general fund budget was a sizable 7.3% increase from fiscal 2014, incorporating double-digit growth in general funds for Medicaid and social service expense as well as public safety. The state applied \$100 million from its RDF to reduce base appropriations in the Medicaid program through a transfer to the state's Medical Services Trust Fund; the state's share of Medicaid costs has grown significantly in recent fiscal years due to a declining federal match rate and Medicaid inflation.
In support of the fiscal 2015 budget, the state forecast aggressive growth in the PIT and sales tax; 8.7% growth in the PIT, partly attributable to the repeal of a PIT credit for alternative-fuel motor vehicles, and 6.9% growth in sales tax revenue; offset by expected declines in corporate (CIT) and severance tax revenue as well as declines in transfers from the excess lottery fund that has been impacted by increased competition in neighboring states. Fiscal year to date, PIT and sales tax collections are up 3% yoy while both the CIT and severance taxes are down 4% yoy. Through February 2015, revenues are running 1.8% below forecast although this includes the impact of a \$31 million transfer to the Income Tax Refund Reserve Fund (refund reserve) for greater than anticipated PIT refunds, which reduced general fund revenues. Absent the transfer, revenues would be below forecast by a smaller \$16.1 million (0.6%).
The state is currently estimating a fiscal 2015 revenue shortfall approximating \$62 million but believes a hiring freeze and application of monies in various reserve funds and fund sweeps will be sufficient to cover the gap. The RDF is not expected to be tapped beyond the \$100 million initial application and reserves at the end of fiscal 2015 are expected to be over 20% of revenues at year-end, providing a solid cushion for operations in Fitch's view.
The enacted fiscal 2016 general fund budget totals almost \$4.3 billion and incorporates the use of \$14.8 million from the RDF, down significantly from a \$85 million earlier expected use, as well as a one-time use of \$15 million from the Unclaimed Property Fund and an \$8 million one-time reduction in the amount of sales tax revenue dedicated to the state school building authority. The state reduced its expected appropriation from the RDF due to both strong investment returns on its pension system assets in fiscal 2015 that lowered the actuarially calculated annual required (ARC) payment in fiscal 2016 as well as a lower required payment under the K-12 education funding formula. Revenues in support of the budget are forecast to grow by 2.6% from fiscal 2015, inclusive of the one-time revenues noted above. Absent one-time revenues, projected revenue growth is approximately 2.1% and factors in 4.1% projected growth in the PIT and 2.3% growth in sales tax collections; these expectations are reasonable in Fitch's view given the current trend in collections in fiscal 2015. The use of the RDF in 2016 at the currently contemplated amount would bring the RDF to just below 20% of general fund revenues, a level that Fitch believes provides sufficient cushion for the state.
The state's six-year financial plan currently forecasts a \$46 million revenue shortfall in fiscal 2017 for the combined general and lottery revenue funds with surplus operations forecast in the out-years of the plan. Fitch expects the state to take the necessary actions in fiscal 2017 to achieve balanced operations; however, given the state's continued reliance on natural resources production for support of its economy and financial operations, continued use of reserves beyond fiscal 2016 would be a negative rating factor.
MODESTLY DIVERSIFIED ECONOMY WITH BELOW AVERAGE DEMOGRAPHICS
West Virginia's economic profile has evolved to more closely resemble that of the nation with increases in the service sectors. However, its economy remains relatively narrow with a still important presence of cyclical natural resource industries. The state only modestly participated in the national recession, recording one year of employment decline at 2.2% in 2009 compared to a 4.3% decline for the U.S. However, more recent comparative trends have not been as favorable, largely reflecting weak markets for coal and lower employment demand in the natural gas industry.
As national employment grew 1.7% in 2013 and 1.9% in 2014, the state's employment shrank 0.2% and 0.4%, respectively, in those years. Yoy through February 2015, employment improved only modestly, growing 0.3% compared to 2.4% for the nation; while the unemployment rate fell from 6.8% in February 2014 to 6.1% one year later, the drop largely encompassed a 2.7% yoy contraction in the state's labor force. Through February 2015, the state has only recovered 76% of the jobs lost during the recession. The state's important natural resources and mining industry's three-month moving average for employment through February was a 1.6% decline, and most other sectors recorded losses as well aside from 5.6% growth in professional and business services, for a net 0.1% decline as compared to the nation with 2.3% growth.
The U.S. Energy Information Administration reports the number of the state's coal mines declined by 17.1% between 2012 and 2013 and production dropped by 3.7%. This trend was closely aligned to the nation as a whole with a 13.7% decline in coal mines and 3.1% production declines. Fitch expects the state's coal industry to continue to contract, incorporating export markets for coal that have weakened over the past year and new and proposed federal emissions standards that would have a detrimental impact on the state's coal industry. Offsetting this negative trend, the state's natural gas industry on the Marcellus Shale has flourished; with annual production increasing from about 264,000 million cubic feet in 2009 to almost 718,000 in 2013. This trend contributed to the solid 5.1% boost in the state's gross domestic product in 2013 compared to a national 1.8% growth rate.
West Virginia's economy had generally been marked by low and generally slow-growing personal income, but performance through the recessionary years was notably stronger than that of the nation. Recent quarterly income trends show a reversion of that improvement with 3.8% yoy growth in the fourth quarter of 2014 compared to 4.5% for the nation. West Virginia's per capita personal income ranks 47th of the states, at 79.4% of the U.S. rate, an improvement from 72.2% in 2000.
MODERATE DEBT AND LIABILITY POSITION
Overall, tax-supported debt has been declining as a percentage of personal income and represents a moderate burden on resources, as the state funds most of its capital needs on a pay-go basis, enhancing its budgetary flexibility. As of June 30, 2014, net tax-supported debt approximated \$1.7 billion, or 2.6% of 2013 personal income.
West Virginia's pension funding levels, in particular, those of the teachers' retirement system (TRS), had been amongst the worst of the states, but have shown significant improvement. The state made a concerted effort to not only fund the ARC but to add assets in excess of the ARC to the pension systems. The state deposited \$1.6 billion from budget surpluses and a tobacco securitization into the teachers' plan in addition to paying the ARC in recent years. More recent reform efforts include the passage of senate bill 529 in the 2015 legislative session, which tightened retirement benefits and increased member contribution rates for new employees hired on or after July 1, 2015 for both the state employees' retirement system (PERS) as well as TRS, effectively creating a new Tier II retirement benefit structure.
Under the new GASB 67 standard for pension systems, PERS reported a 94.2% ratio of system-wide plan fiduciary net position to the total pension liability in fiscal 2014 with a net pension liability of \$352.7 million borne by the state. TRS reports a 66% ratio of pension assets to liabilities in fiscal 2014 with a net pension liability of \$3.4 billion borne by the state.
While not directly comparable, the actuarially determined funded ratio as of July 1, 2013 for TRS was 57.9%, up from less than 20% in 2002. Similarly, the funded ratio for PERS was 79.7% in 2013. Adjusting the funded ratios to incorporate Fitch's more conservative 7% return rate assumption, the funded ratio in 2014 for PERS was 75.5% and for TRS was 54.9%. In Fitch's 2014 pension report, when the state's adjusted unfunded pension liabilities were added to debt burden, debt and liabilities as a percentage of personal income equaled approximately 12.4% compared to a median of 6.1% for the states.
In keeping with its efforts to reduce its long-term liabilities, West Virginia has undertaken several efforts to address its OPEB liability. In December 2011, the state's public employee insurance agency (PEIA) took action to reduce liabilities related to OPEB. By cutting health benefits, capping subsidies to retirees, and limiting growth in such subsidies, the OPEB liability dropped from approximately \$10 billion to approximately \$5 billion. The state legislature took additional action to eliminate the remaining liability by allocating \$30 million per year from income tax collections currently dedicated to eliminating the unfunded liability of the workers' compensation fund, once that liability has been eliminated, to the OPEB trust fund and \$5 million per year to the health care subsidy for employees hired on or after July 1, 2010. The legislature also transferred the county school boards' OPEB liabilities; to the extent they are funded by the state school aid formula, to the state to include this liability in their reform efforts. As of June 30, 2014, the state's accrued liability is estimated at \$2.6 billion and the state's portion of OPEB trust totaled \$639 million. The state currently expects to eliminate its OPEB liability by 2057.
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