Fitch Rates West Virginia Economic Dev Auth's $29MM Lease Rev Bonds 'AA'; Outlook Stable
The bonds are expected to sell via negotiation the week of Aug. 10, 2015.
In addition, Fitch affirms the ratings on the following outstanding bonds:
--Approximately \\$286 million West Virginia EDA lease revenue bonds at 'AA';
--Approximately \\$420 million state of West Virginia general obligation (GO) bonds at 'AA+';
--Approximately \\$148 million West Virginia School Building Authority (SBA) appropriation-backed bonds at 'AA'.
The Rating Outlook is Stable.
SECURITY
The bonds are special limited obligations of the EDA payable from lease revenue payments from the state of West Virginia, subject to annual legislative appropriation.
KEY RATING DRIVERS
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.
WELL-MANAGED FINANCIAL OPERATIONS: The state has been challenged in recent fiscal years by underperformance in key revenue sources, necessitating expenditure cuts and limited use of its rainy day fund (RDF) balance to steady operations. Financial operations are well-managed and Fitch expects the state to maintain strong control over appropriations as it adheres to its financial plan.
SIZABLE RESERVES: Despite the use of \\$100 million of the RDF in fiscal 2015, reserves remain appreciable, at over 21% of general fund revenues. In enacting the fiscal 2016 budget, the state lowered its expected RDF draw to \\$14.8 million in fiscal 2016 from an earlier expected \\$85 million. Fitch expects reserves to remain robustly funded given the state's 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 natural resources 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 retirement liabilities although the combined burden of debt and pensions remains well above average.
RATING SENSITIVITIES
Annual Appropriation Bonds: The rating on the appropriation-backed bonds are sensitive to movement in the state's GO bond rating to which they are linked.
CREDIT PROFILE
The lease revenue bonds are limited obligations of the state, subject to annual legislative appropriation; as such, the 'AA' rating is one notch below the state's GO rating. The state has covenanted to include lease payments in its budget requests and lease payments are not subject to abatement. The current bond issue will provide funding for a renovation of a state office building housing various agencies of the department of commerce.
The state's GO rating, at 'AA+', reflects its 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 coal resources has declined. Low natural gas prices, decreasing export markets for its coal, and more stringent environmental regulations affecting coal production have coalesced to markedly lower the state's annual severance tax revenue while also decreasing employment in this sector.
A concurrent reform of the state's business-related taxes and decline in lottery revenues due to increasing competition has 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 funds from its RDF. Debt levels are moderate although the state's other long-term liabilities remain high.
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 reflected in its proactive approach to addressing long-term liabilities and maintaining sizable reserve balances. While reserves declined in fiscal 2015, with a further decline expected in fiscal 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.
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 medical inflation.
In support of the fiscal 2015 budget, the state expected considerable growth in the personal income tax (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 lottery transfers affected by increased competition in neighboring states. The fiscal year closed with total general fund (GF) revenues 1.2% below forecast; the PIT was 1.7% above forecast but was offset by sales, severance, and CIT revenues that were 2%, 12.7%, and 7.6%, respectively, below forecast.
The below-forecast results contributed to a fiscal 2015 revenue shortfall of \\$60 million. The state resolved the revenue shortfall through a hiring freeze in concert with other mid-year expenditure reductions, as well as draws of expiring cash balances in other accounts and reserves to the general fund. The fiscal year ended without an additional appropriation from the RDF and a modest cash surplus. The RDF is estimated at 21% of revenues at year-end; a continuation of a solid financial cushion, 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 an earlier forecasted \\$85 million draw, as well as about \\$23 million in other one-time actions. The reduced RDF appropriation was 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.
Baseline revenues in fiscal 2016 are forecast to grow by 2.7% from fiscal 2015, inclusive of the one-time revenues noted above. Projections include 1.1% expected growth in the PIT and 3.4% growth in sales tax collections; these expectations are reasonable in Fitch's view given fiscal 2015 collection trends. The budgeted RDF draw in fiscal 2016 would bring it to just about 20% of general fund revenues, a level that Fitch believes provides sufficient cushion for the state.
The state is currently in the process of updating its six-year financial plan; prior updates of the plan forecast a 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 given natural resource momentum; however, more recent comparative trends have been unfavorable, 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. Year-over-year (Yoy) through June 2015, employment has fallen still further, declining 0.6% compared to 2.1% growth for the nation. The unemployment rate climbed to 7.4% in June 2015 from 6.6% recorded one year earlier, despite a 0.9% yoy contraction in the state's labor force.
The state's important natural resources and mining industry's three-month moving average for employment through June 2015 was a significant 8.7% decline, contributing to a 12% loss in construction employment. Other notable sector employment losses included a 2.3% decline in financial activities, 2.8% decline in leisure and hospitality, and 2.3% decline in government employment, offset by modest growth in manufacturing employment for a net 1.2% decline as compared to the nation with 2.2% employment growth.
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 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.
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 reversal of that trend with 3.8% yoy growth in the first quarter of 2015 compared to 4.4% 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 2014 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 as of June 30, 2014 with a net pension liability of \\$352.7 million borne by the state. TRS reports a 66% ratio of pension assets to liabilities as of June 30, 2014 with a net pension liability of \\$3.4 billion borne by the state.
For funding purposes, the most recent valuation data is as of June 30, 2013. The funded ratio as of June 30, 2013 for TRS was 57.9%, up from less than 20% in 2002. Similarly, the funded ratio for PERS was 79.7%. Adjusting these funded ratios to incorporate Fitch's more conservative 7% return rate assumption would bring the funded ratios for PERS to 75.5% and for TRS to 54.9%. As of 2014, the state's adjusted unfunded pensions plus debt as a percentage of personal income was approximately double the median for U.S. states.
In keeping with its efforts to reduce its long-term liabilities, West Virginia has undertaken several efforts to address its other post-employment benefits (OPEB) liability. In December 2011, the state's public employee insurance agency (PEIA) took action to cut health benefits, cap subsidies to retirees, and limit growth in such subsidies, dropping the OPEB liability to approximately \\$5 billion, from \\$10 billion. The state legislature took additional action 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 state to the extent they are funded by the state school aid formula to include this liability in their reform efforts. As of June 30, 2014, the state's unfunded actuarial 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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