Fitch Rates Oregon's $59MM GOs 'AA+'; Outlook Stable

NEW YORK--()--Fitch Ratings assigns an 'AA+' rating to the state of Oregon's general obligation (GO) bonds, consisting of the following:

--$54.1 million 2014 series A (tax exempt);

--$5 million 2014 series B (federally taxable).

The bonds are expected to sell via negotiation the week of April 21, 2014.

Additionally, Fitch affirms the following ratings:

--$5.2 billion in outstanding state GO bonds at 'AA+';

--$782 million in outstanding state appropriation-backed bonds at 'AA'.

The Rating Outlook is Stable.

SECURITY

The bonds are general obligations of the state of Oregon, with the full faith and credit of the state pledged to bond repayment.

KEY RATING DRIVERS

STRONG FINANCIAL MANAGEMENT OFFSETS REVENUE VOLATILITY: State finances are heavily dependent on the personal income tax, a volatile revenue source which declined sharply during the recession. The state's management reviews revenue and economic forecasts quarterly and takes measures as necessary to maintain balance. State reserve levels were drawn upon among balancing measures in the downturn, but the state is committed to rebuilding reserves in the current, and future, biennia.

DIVERSE ECONOMY WITH SELECT CONCENTRATIONS: Oregon's economy, which was historically based on its natural resources, has diversified. However, the computer and manufacturing sectors play an above-average role, and the state's economy is especially influenced by international trade patterns. Recent economic growth has been well above the national average and unemployment rates, while modestly above average, have moderated.

MODERATE LIABILITY BURDEN: Debt levels are above average for a U.S. state but are only a moderate burden on resources. On a combined basis, the burden of the state's net tax-supported debt and unfunded pension obligations is in line with the U.S. states rated by Fitch. OPEB obligations are small.

RATING SENSITIVITIES

The rating is sensitive to shifts in fundamental credit characteristics, including the state's proactive financial management and commitment to reserve funding.

CREDIT PROFILE

Oregon's 'AA+' GO bond rating reflects a diverse economy with some concentration in computer and electronic manufacturing and agricultural products, moderate debt levels, and the state's record of prompt actions to maintain financial flexibility in a challenging revenue environment. Strong financial management is critical to the rating given a revenue structure largely dependent on the cyclical personal income tax, exposure to voter initiatives that can have negative fiscal impacts, and constitutional 'kicker' provisions that require the return of surplus personal income tax (PIT) revenues to taxpayers. Corporate revenue in excess of the revenue forecast is now directed to elementary and secondary education per approval of a 2012 voter initiative.

While reserve levels decreased during the recession, strong growth in PIT collections aided in increasing reserves at the close of the biennium ending June 30, 2013. The state has also forecast increased long-range reserve levels through fiscal 2023. The 'AA+' rating and Stable Outlook reflect Fitch's expectation that the state will continue to promptly address budgetary gaps as they arise and maintain such cushion against revenue volatility.

RELIANCE ON PERSONAL INCOME TAX FOR OPERATIONS

Oregon's GF is largely dependent on the PIT, which made up 86% of the biennial (BY) 2011 - 2013 GF revenues. PIT collections have been volatile, rising by 22% in BY 2005 - 2007 and just modestly at 1.2% during BY 2007-2009. PIT revenues for BY 2009 -2011 fell by over 6.3%, reflecting the uneven economic recovery, and then rebounded by 15.8% in BY 2011 - 2013, reflecting both the push forward of income into calendar year (CY) 2012 due to uncertainty over federal tax law changes as well as the beginning of a stronger economic recovery in the state.

Oregon's BY 2011 - 2013 GF budget of $13.7 billion projected PIT receipts in anticipation of recovery, with 16% growth projected over the two-year period. Expectations for the PIT varied over the biennium with final estimated growth of 15.8% for the biennium, down by less than 1% from the enacted budget. The corporate income tax (CIT) accounted for just over 6% of BYs 2011 - 2013 GF revenues and ended below the close of session (COS) forecast by 1.2%; 6.8% is estimated as the final growth over the biennium. The budget did not contain revenue raising measures although one-time measures were included for programmatic funding. The ending GF balance of $472.9 million has been applied to appropriations in the current biennium while the state deposited a combined $52.7 million to its rainy day fund (RDF) and educational stability fund (ESF), increasing reserves to $69.4 million or 0.5% of biennial GF revenue.

The close of session (COS) forecast for the current 2013 - 2015 biennium that began on July 1, 2013 included an 11.7% baseline growth assumption in PIT revenue although the baseline growth was expected to be offset by a falloff of one-time revenues, some related to the federal tax law changes. Overall, GF revenues were forecast to grow 9.5% from the 2011 - 2013 biennium and total $15.6 billion. The enacted budget for the biennium incorporated estimated savings from program changes to the public employees' retirement system (PERS), including limiting cost of living increases and eliminating a tax benefit for out-of-state retirees. The budget also included savings related to changes in sentencing requirements for the prison population and increased funding to K-12 education, human services, and transportation. Per typical expenditure patterns, the state estimated 52% of the enacted budget would be spent in the first year of the biennium and the balance spent in the second year.

The most recent quarterly economic and revenue forecast, dated March 2014, updated the state's expectation for the current biennium while also incorporating legislative changes that were enacted as part of a special session held in the fall of 2013. Enacted legislation from the special session implemented several changes to Oregon PIT and CIT tax laws, estimated to result in approximately $189 million in additional General Fund and other fund revenues for the current biennium. The changes to the tax code were effective for the 2013 tax year. Legislation was also enacted increasing taxes on the distribution of cigarettes from $0.059 to $0.065 per cigarette beginning in January 2014. The additional revenue has been allocated to increase education funding through the current biennium.

The March 2014 forecast projects GF revenues at $15.8 billion for the current biennium with almost $15.8 billion in appropriations. The forecast projects a $237 million ending balance for the biennium in the general fund, down from $473 million at the end of the last biennium; however, actions in the 2014 legislative session have since reduced the expected ending balance to $120 million. The forecast anticipates deposits of $146.7 million to the RDF and $169.5 million to the ESF. The reserve balances are expected to total $387.2 million at the end of fiscal 2015, or 2.5% of biennial GF revenues, and the state forecasts an additional deposit in the 2015 - 2017 biennium.

CYCLICAL ECONOMY WITH SLOW EMPLOYMENT GAINS

Oregon's economy tends to be more cyclical than the nation's due historically to its reliance on agriculture and natural resources and today because of its large high-tech sector and international trade activities. The state's largest exports are computer and electronics products (35.1%) and agricultural products (14.1%) and the largest destination are Canada (16.3%), China (14.5%), and Malaysia (10.7%).

Following 7.6% total job loss in CYs 2008 through 2010 as compared to 5.6% for the nation, the state added jobs in CYs 2011 and 2012 at rates of 1.1% and 1.3%, respectively, compared to 1.2% and 1.7%, respectively, for the nation. Employment growth in CY 2013 was a solid 2%; above the national average of 1.7%, as the state's economic recovery progressed. As of February 2014, year over year (yoy) employment growth is 2.7% compared to 1.5% for the nation. The largest positive growth sectors by number of employees were trade, transportation, and utilities at 3% yoy and professional and business services at 4.8% yoy.

The March 2014 forecast estimates annual employment growth of 2.2% in CY 2014, 2.4% in 2015, and 2.2% in 2015. Overall, the state estimates slow but steady recovery of jobs lost in the recession. State unemployment, typically above the national level, was 7.7% in 2013 against a national rate of 7.4%; a much closer margin as compared to the peak of the recession in 2009 when state unemployment was 120% of the national rate. For February 2014, the state unemployment rate of 6.9% continued to narrow the trend above the national average of 6.7%.

In 2013, Oregon's personal income (PI) growth of 3.5% was better than the 2.6% U.S. rate of growth, and recent quarterly trends have been robust; 3.1% yoy growth in the fourth quarter of 2013 as compared to 1.4% for the U.S. and 1.1% for the region. Per capita personal income in 2013 totaled $40,233, representing 90.3% of the U.S. level and ranking Oregon 32nd among the states. The state estimates 3.1% growth in PI in 2014 with improving 4.5% and 5.3% growth forecast in 2014 and 2015, respectively.

MODERATE DEBT BURDEN

As of June 30, 2013, the state's debt at 4.9% of 2013 personal income is above average but still a moderate burden on resources. Principal amortizes at a below-average pace but amortization has improved from fiscal 2011. In contrast to the prior downturn, the state did not undertake any deficit borrowing in the recent recession.

Two rounds of pension reform occurred in 2013; the first in the regular legislative session and the second, as part of a special fall legislative session. Reforms enacted in the regular session included; changes to the public employees' retirement system (PERS) to provide annual savings to employers, including limiting COLAs, and eliminating a benefit increase for out-of-state retirees based on the Oregon income tax; reducing employer contribution rates in the coming biennium. This legislation (SB 822) reduced the total system liability by approximately $2.6 billion (4.6%), providing $460 million in total system savings over the coming biennium to all employers, which included approximately $131 million in PERS contribution reductions for state agencies.

SB 822 contained a budget note that directed the PERS board to recalculate employer contribution rates, expected to provide an additional $350 million in total system savings over the 2013-2015 biennium. In May, 2013, the PERS board provided for a reduction of up to 4.4% of covered payroll for employer contribution rates; however, the board required that no employer pay less than the rate that was paid in the 2011-2013 biennium. Implementation of the directions in the budget note was expected to result in the full actuarially-calculated annual required contribution (ARC) not being met by employers for the two years in the current biennium. The legislation required contribution rates to increase in future biennia to offset the rate increase deferral.

The fall 2013 special legislative session implemented additional reforms to PERS. The enacted legislation (SBs 861 and 862) adjusted and further limited COLA benefits to retirees, redefined salaries used in calculating benefits, and reduced legislators' participation in PERS. These changes provided for an additional reduction of the PERS accrued liability of about $2 billion, improved the funded ratio, and alleviated the need for rates to increase in future biennia solely based on the implemented payroll contribution rate change. After enactment of the 2013 PERS Bills, the Board reduced employer contribution rates by 4.28% of payroll on a system-wide average basis for the 2013 - 2015 biennium.

Also in 2013, the PERS board lowered its investment return assumption from 8% to 7.75%, effective Jan. 1, 2014, thereby increasing the calculated actuarial accrued liability. The board also implemented additional changes to its actuarial methods and assumptions including moving to entry age normal and providing for a 20-year re-amortization of the unfunded actuarial liability. Incorporating the legislative and assumption changes in 2013 as well as the employer contribution rate deferral and re-amortization, the unfunded actuarial liability (UAAL) of the PERS system decreased from $11.03 billion as of December 31, 2011 to $5.621 billion as of December 31, 2012. PERS' reported funded ratio improved from 82% as of Dec. 31, 2011 to 90.7% as of Dec. 31, 2012 (the Dec. 31, 2012 PERS valuation was issued after reform passage.) Using Fitch's more conservative 7% discount rate assumption, the funded ratio for the plan declines to 83.8% as of Dec. 31, 2012.

Several legal cases have been filed in regard to the earlier 2013 legislative changes to benefits citing breach of contract and taking of property rights. Fitch will monitor the status of all legal challenges to these reforms as to impact on the financial and liability position of the state.

On a combined basis, the burden of the state's net tax-supported debt and adjusted UAAL obligations equals about 6.3% of 2013 PI; down from 7.9% in 2012. The calculations include 21.4% of the liability of PERS that Fitch estimates to be attributable to the state; the state reported their portion to be 93% funded as of Dec. 31, 2012. The state's share of other-post employment health benefits is small and funded at 62%, with a 7% funded ratio for the much smaller premium account, which provides monthly subsidies to pre-Medicare-age state retirees.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Tax-Supported Rating Criteria' (Aug. 14, 2012);

--'U.S. State Government Tax-Supported Rating Criteria' (Aug. 14, 2012).

Applicable Criteria and Related Research:

Tax-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=686015

U.S. State Government Tax-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=686033

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=826771

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Contacts

Fitch Ratings
Primary Analyst
Marcy Block
Senior Director
+1-212-908-0239
Fitch Ratings, Inc.
One State Street Plaza
New York, NY 10004
or
Secondary Analyst
Karen Krop
Senior Director
+1-212-908-0661
or
Committee Chairperson
Laura Porter
Managing Director
+1-212-908-0575
Elizabeth Fogerty, +1-212-908-0526 (New York)
elizabeth.fogerty@fitchratings.com

Sharing

Contacts

Fitch Ratings
Primary Analyst
Marcy Block
Senior Director
+1-212-908-0239
Fitch Ratings, Inc.
One State Street Plaza
New York, NY 10004
or
Secondary Analyst
Karen Krop
Senior Director
+1-212-908-0661
or
Committee Chairperson
Laura Porter
Managing Director
+1-212-908-0575
Elizabeth Fogerty, +1-212-908-0526 (New York)
elizabeth.fogerty@fitchratings.com