Fitch Rates Ohio's $338MM GO Refunding Bonds 'AA+'; Outlook Stable

NEW YORK--()--Fitch Ratings has assigned an 'AA+' rating to the following general obligation (GO) refunding bonds of the state of Ohio:

--$161.85 million, Common Schools series 2014A;

--$116.07 million Higher Education, series 2014B;

--$59.65 million Infrastructure Improvement, series 2014B

The bonds are expected to be sold competitively on May 1, 2014.

In addition, Fitch affirms the 'AA+' rating on approximately $8.6 billion outstanding GO bonds.

The Rating Outlook is Stable.

SECURITY: General obligation, full faith and credit of the State of Ohio, excluding net lottery proceeds and highway user receipts.

KEY RATING DRIVERS

BROAD ECONOMY WITH LARGE MANUFACTURING SECTOR: The state's economy is broad and diverse, although the manufacturing sector continues to represent a disproportionally large segment of the economy. The state's economy is modestly expanding but at a slower pace than immediately following the recession. The unemployment rate is just under the national average.

MODERATE LIABILITY BURDEN: The state's debt burden is moderate and rapidly amortized. Debt is typically conservatively managed and primarily consists of GOs. On a combined basis, outstanding debt and pension obligations are a manageable and below-average burden on the state.

DEMONSTRATED ABILITY TO MANAGE BUDGET CHALLENGES: The state generally has a careful approach to financial operations and has consistently managed to achieve budgetary balance, inclusive of surplus operating results in fiscal 2013, which provided for full funding of the state's budget stabilization fund (BSF). The budget enacted for the 2014-2015 biennium applies additional fiscal 2013 surplus revenues to pay for a large personal income tax rate cut while incorporating sizable growth in appropriations.

RATING SENSITIVITY

The rating is sensitive to shifts in the state's fundamental credit characteristics, particularly its economic and financial profiles.

CREDIT PROFILE

The state's 'AA+' GO rating is based on its careful financial management, ongoing record of maintaining fiscal balance, and a moderate, rapidly amortizing debt burden. Debt is supported by an economy that is slowly adding jobs lost in the recession. The recession had a widespread impact on the Ohio economy, accelerating a longstanding slump in manufacturing and weighing on the slowly growing service sector. The state has recorded consecutive months of year-over-year (y-o-y) job gains since July 2010, largely reflecting increases in the manufacturing and services sectors. However, while employment growth exceeded the U.S. rate in 2012, it lagged through 2013 and was lower than the U.S. rate of 1.6% in March 2014 at 1.0%.

DEMONSTRATED ABILITY TO MANAGE BUDGET CHALLENGES

Fiscal management practices in Ohio are sound and the state has consistently maintained budgetary balance, including during the recession. The state's fiscal position has substantially improved since the downturn, when the state employed one-time measures for fiscal relief.

In the biennium that ended on June 30, 2013, broad budget balancing actions, notable growth in tax revenues, and the lease of the state's liquor distribution system to JobsOhio, a newly created not-for-profit economic development entity, enabled the state to record sizable operating surpluses and deposits to its rainy day fund. As of the close of fiscal 2013, the state reports that its BSF was fully funded at 5% of general revenue fund (GRF) revenues.

GRF actual revenues in fiscal 2013 were boosted by $500 million in unbudgeted proceeds from the lease of the state's liquor distribution system to JobsOhio as well as robust personal income tax (PIT) revenue that incorporated the acceleration of income into tax year 2012 due to anticipated federal tax law changes. The state reports revenue growth of 8.7% from actual receipts in fiscal 2012, including a 10.6% increase in tax receipts. Included in the growth are a 12.7% increase in PIT revenue and a 4.5% increase in non-auto sales tax revenue.

TAX CUTS INTRODUCE DOWNSIDE REVENUE RISK

The legislatively enacted budget for the current 2014-2015 biennium authorized GRF expenditures of $30.26 billion in fiscal 2014 and $31.7 billion in fiscal 2015. The budget included a change to the personal income tax (PIT) that will lower rates by 10% over three tax years beginning in 2013, increased the sales tax rate by 0.25% as an offset, and reduced income taxes on small business owners, among other provisions. The PIT rate reductions and tax modifications for small business owners are expected to result in a sizable amount of foregone revenue over the biennium and are only partly offset by the sales tax rate increase, some PIT index and exemption freezes, and other tax reform measures.

The governor has proposed several mid-biennial initiatives that are being considered by the legislature. These include additional reductions in personal income tax rates that are intended to be fully offset by increases in various taxes, such as tobacco related taxes and severance taxes on gas and oil. There are also some modest proposed changes in appropriations, largely offset by lower than anticipated debt service costs.

Although revenue performance year-to-date has slightly exceeded forecast, Fitch believes there is downside risk to the state's expectation of PIT growth given that employment growth in the state has slowed. In the event of economic and revenue under-performance, the state may face structural imbalance beyond the current 2014 - 2015 biennium, in part due to its reliance on application of fiscal 2013 surplus monies to the current operating budget, but also due to further reductions in tax rates. Fitch notes the state's accurate and conservative forecasting and its history of taking action to achieve fiscal balance.

CONSERVATIVE DEBT MANAGEMENT

The state's debt management is generally conservative. Debt amortization is rapid, with all debt fully retired in 20 years and 78% of GRF-backed debt amortized in 10 years. Total tax-supported debt of $11.2 billion is equivalent to a manageable 2.4% of 2013 personal income.

A $2.39 billion capital improvement plan (CIP) for fiscal years 2015 and 2016 was enacted in the 2012 legislative session and will be largely funded by $2.07 billion of GRF-backed debt; the balance will be funded with non-GRF debt and cash. The largest beneficiaries of the plan are higher education, primary and secondary education, and local infrastructure projects. The current offering refunds various outstanding general obligation bonds for debt service savings. Debt ratios are expected to approximate current averages as GRF principal continues to roll off. Personal income is also expected to continue to grow.

Funding for Ohio's pension systems had declined significantly, with the largest system, PERS, declining from a strong 96% funded ratio as of Dec. 31, 2007 to 77.4% funded as of Dec. 31, 2011. In September 2012, the governor signed several pieces of pension reform legislation targeted to improve the financial condition of all five Ohio pension systems. Reform measures affected employee contributions, number of years of service credit, minimum retirement age, cost of living calculations, and final average salary calculation. The most recent PERS valuation, from Dec. 31, 2012, showed the benefit of the reform measures as the reported funded ratio increased to 80.9%. Using Fitch's more conservative 7% discount rate assumption, PERS would have a 69.7% funded ratio.

On a combined basis, the burden of the state's net tax-supported debt and adjusted unfunded pension (UAAL) obligations at approximately 4% remains well below the median for U.S. states rated by Fitch, assuming 45% of the liability of PERS to be attributable to the state division of PERS and a small share of the teachers' retirement system (TRS) UAAL for which the state is responsible.

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=827421

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Contacts

Fitch Ratings
Primary Analyst
Karen Krop, +1 212-908-0661
Senior Director
Fitch Ratings, Inc.
One State Street Plaza
New York, NY 10004
or
Secondary Analyst
Marcy Block, +1 212-908-0239
Senior Director
or
Committee Chairperson
Douglas Offerman, +1 212-908-0889
Senior Director
or
Media Relations:
Sandro Scenga, +1 212-908-0278
sandro.scenga@fitchratings.com

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Contacts

Fitch Ratings
Primary Analyst
Karen Krop, +1 212-908-0661
Senior Director
Fitch Ratings, Inc.
One State Street Plaza
New York, NY 10004
or
Secondary Analyst
Marcy Block, +1 212-908-0239
Senior Director
or
Committee Chairperson
Douglas Offerman, +1 212-908-0889
Senior Director
or
Media Relations:
Sandro Scenga, +1 212-908-0278
sandro.scenga@fitchratings.com