Fitch Rates Alabama's $54MM GO Refunding Bonds 'AA'

NEW YORK--(BUSINESS WIRE)--Fitch Ratings assigns an 'AA' rating to the following State of Alabama bonds:

--$41.86 million general obligation (GO) refunding bonds (Alabama Agricultural Development Authority) series 2010-A;

--$12.81 million GO refunding bonds (Alabama Forensic Sciences Bond Authority) series 2010-B.

The bonds, which are expected to price via competitive bid March 23, 2010, will refund for debt service savings $52.5 million of outstanding GO bonds series 2001 A and B.

Fitch also affirms the 'AA' rating on approximately $54.4 million GO bonds, series 2006. The Outlook is Stable.

RATING RATIONALE:

The trend in Alabama's economy is toward more diversification although it retains a sizeable manufacturing base. There is an on-going positive shift from low-paying textile and apparel jobs to higher paying durable subsectors including automobile and aerospace manufacturing. Employment and income gains were strong coming into the recession but the state has been hit hard by the economic downturn.

Debt levels are moderate at 2.3% of 2008 personal income, with most debt issued by a variety of authorities. Pension funding has weakened steadily over the past six years.

Strong spending controls include a statutory requirement to make across-the-board appropriation reductions to maintain budgetary balance. Recent revenue performance has been weak - the budget has been balanced through combination of spending reductions, federal stimulus funds, and use of reserves.

The state benefits from the maintenance of sizeable reserves in the Alabama Trust Fund, which is protected from the operating funds. The fund's corpus cannot be used without constitutional amendment.

KEY RATING DRIVERS:

--Resumption of economic growth and diversification;

--Maintenance of Alabama Trust Fund funding levels.

SECURITY:

The bonds are a general obligation of the state of Alabama to which its full faith and credit are pledged.

CREDIT SUMMARY:

The rating reflects the state's longer term trend toward a more diversified economy despite a severe downturn in manufacturing, strong spending controls which contribute to balanced operations, and manageable debt levels.

Alabama's economy was historically dominated by agriculture, natural resource extraction, and manufacturing, including textiles and iron and steel production. Today, the state still depends more heavily on manufacturing relative to the national average, but manufacturing has shifted away from textiles and apparel, in particular, to the automotive sector. This sector has been hard hit in the current recession, but the foreign-owned automakers in the state, including Honda, Hyundai, and Daimler AG, continue to invest and produce in Alabama. Further, auto supplier activity is expected to grow as assembly plants open near the Alabama border.

Following several years of job growth leading into the recession, non-farm employment declined 5.3% in 2009, much higher than the national rate of 4.3%, with weakness evident across all areas of the state and all employment sectors. Although the rate of decline is abating, employment losses continue to be higher than the national average with employment declining 3.7% year-over-year in January 2010, versus the national level of 3%.

Unemployment is also higher than the national average at 11.1% in January, versus the U.S. rate of 9.7%. The state does not expect the labor market to recover until mid-way through 2010 as trade and manufacturing are likely to lag in the national recovery. Wealth indicators have typically been well below national averages, but show improvement in recent years. Personal income per capita is just 84.6% of the U.S. average, but has increased from 81.9% 10 years ago. Quarterly personal income has declined slower than the national and regional rates over the past several quarters and had been increasing faster prior to the recession. The poverty level is still among the highest of the states.

State financial operations are dispersed among a variety of funds, supported by a diverse revenue stream. General fund operations are relatively small, limited to general government functions, health, and police/corrections, and supported by a variety of taxes and fees, including a portion of the sales and use tax and earnings on the Alabama Trust Fund. The state has significant responsibility for education funding with operations funded through the Education Trust Fund (ETF), which receives the state income tax, sales and use tax, and utility taxes.

Financial operations benefit from strong spending controls, with a statutory requirement to make across-the-board appropriation reductions, called "proration," when a deficit is projected in one of several funds. Debt service is not subject to proration. This device has been implemented several times, including in fiscal year 2009, when weak revenue performance necessitated a 17.9% reduction in education appropriations. By depleting its education rainy day fund, the state was able to limit the reduction to 11%. With further revenue weakness becoming evident in the fiscal year that began Oct. 1, the Governor has already declared a 7.5% proration of the education appropriation for fiscal year 2010. General fund spending was reduced 6.5% in fiscal year 2009 and the fiscal year 2010 budget declines 16.9%; this was accomplished to date through targeted spending controls rather than across-the-board cuts.

The state maintains a sizeable balance in the Alabama Trust Fund, which was initially capitalized with proceeds from off-shore lease sales in 1981 and still receives portions of oil and gas royalty payments to the state. Earnings from the fund, which has a current balance of approximately $3 billion, support the general fund, a land trust, and a variety of state and local capital projects. It also is the source of the general fund and ETF rainy day funds, which, when used, must be repaid over a specified time period. The ETF rainy day fund balance of $467 million was depleted in fiscal year 2009. The general fund rainy day fund balance, which varies according to a number of factors and is limited to 10% of prior year appropriations, was not utilized in fiscal year 2009 and retains $170 million.

With a constitutional prohibition against issuing GO debt, except by constitutional amendment, state debt issuance is diffuse, issued by a variety of authorities, with only approximately 20% of debt general obligation. Debt levels are moderate at 2.3% of personal income. However, a longer term concern is the deterioration in pension funding levels: the two largest systems, state employees and public education, were overfunded as recently as 2001 but are now funded at 77.6% and 74.1%, respectively.

The state's ongoing litigation concerning swap options entered into by the Public School and College Authority is noted, despite the relatively small financial implications of a negative outcome. In Fitch's view, the course of events leading into entering the swap option and its disposition reflect somewhat negatively on management.

Applicable criteria available on Fitch's website at www.fitchratings.com include:

--'Tax-Supported Rating Criteria' (Dec. 21, 2009);

--'U.S. State Government Tax-Supported Rating Criteria' (Dec. 28, 2009).

Additional information is available at www.fitchratings.com.

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