Fitch Affirms Texas GO Rating at 'AAA'; Outlook Stable

NEW YORK--()--Fitch Ratings has affirmed the ratings on outstanding GO bonds of the State of Texas and other bonds whose ratings are linked to the state's GO rating. A detailed list of ratings follows at the end of this release.

The Rating Outlook is Stable.

SECURITY

The bonds are general obligations to which the state pledges its full faith and credit.

KEY RATING DRIVERS

LOW DEBT: The state's debt burden remains low despite significant growth-related capital needs, especially for transportation. Amounts for debt service are constitutionally dedicated.

GROWTH-ORIENTED ECONOMY: The state's economy is large, diverse, and is growing rapidly relative to national averages. The state's energy industry remains a significant source of economic activity and is subject to volatility.

SIGNIFICANT RESERVE BALANCES: Financial operations are generally conservative. The state has built a sizable budget reserve, with a portion of natural resource receipts dedicated to funding it.

SALES TAX DEPENDENCE: Finances are dependent on consumption-based (primarily sales) taxes, and volatile energy taxes are also important.

GROWTH-RELATED SPENDING PRESSURES: Longer term fiscal pressures stem from having to adequately fund the state's rapid growth. This includes expanded transportation needs, school funding, and water needs.

RATING SENSITIVITIES

ECONOMIC GROWTH AND HIGH RESERVES: The state's GO rating and Stable Rating Outlook assume the maintenance of high reserve balances and continued economic growth. The rating could be pressured in the event of severe revenue weakness, including stemming from cyclicality in the state's large energy sector, or unwillingness to address potential fiscal challenges in an effective and timely manner.

CREDIT PROFILE

The state's long-term 'AAA' GO rating reflects its low debt burden, conservative financial operations and a growth-oriented economy that continues to outpace national averages. Financial pressures arise from the demands placed on the state's consumption-based tax system by its rapid growth, including transportation, education and water needs.

Texas' GO bonds are payable from a constitutional appropriation out of the first moneys coming into the state treasury not otherwise appropriated. This unrestricted balance equaled $45 billion as of Aug. 31, 2013, the fiscal year-end.

DEBT AND OTHER LIABILITIES

Texas' net tax-supported debt burden is low, with approximately $14.7 billion as of Aug. 31, 2013 equal to 1.3% of 2013 personal income. This figure includes $10.6 billion in GO bonds supported by tax revenues of the general revenue fund or the mobility fund, and $3.8 billion in state highway fund bonds to which constitutionally-dedicated transportation receipts are pledged. Net tax-supported debt has risen with issuance over the last decade for transportation needs, but remains low measured against personal income. On a combined basis, net tax-supported debt and pension liabilities attributable to the state equal 6.1% of personal income, roughly in line with the median for U.S. states.

Funded ratios for the state's two major pension systems declined given investment losses in the last downturn, and annual contributions have been consistently below actuarially calculated levels. As of Aug. 31, 2013, the reported funded ratio for the state employees' system was 79.6%. The teachers' system funded ratio was 80.8%. Using Fitch's more conservative 7% discount rate (compared to each system's 8% discount rate assumption) would lower the funded ratio to 71.7% for the employees' system and 72.8% for the teachers' system.

The 2013 state legislature increased employer contributions for the employees' system, although contributions remain below the level needed to amortize the liability in 30 years. The legislature also adopted teacher plan reforms, including a higher retirement age and phased increases in member, state and district contribution rates; the changes bring amortization of the teachers system to below 30 years. The state reports the teacher system liability as a state obligation.

FINANCES

Finances are generally conservatively managed, though challenges include sustainably addressing long-term growth needs and managing the cyclicality inherent in the state's energy-dominated economy. The state maintains fiscal flexibility both in the form of its rainy day reserve (the economic stabilization fund (ESF), as well as in its demonstrated willingness to make deep spending cuts to maintain budget balance. The ESF benefits from the constitutional dedication of a share of oil and gas production taxes, as well as unencumbered balances at fiscal year-end. As of June 2014, the ESF balance was $6.7 billion, equal to 13.5% of estimated fiscal 2014 general revenues.

Actual revenues during the fiscal 2012 - 2013 biennium performed consistently stronger than assumed at budget adoption, in spring 2011, with the state raising its forecast accordingly. The comptroller's December 2013 revenue certification reported fiscal 2012 - 2013 biennium general revenue fund (GRF) net revenues rising 24.3% from the previous biennium. With stronger revenue performance, the legislature in its spring 2013 session supplemented fiscal 2013 spending, including addressing several unmet needs remaining from the previous legislature, such as the underfunding of Medicaid and a school payment deferral in August 2013, the final month of the biennium. The latter was addressed as part of a $1.9 billion draw from the ESF.

The December 2013 revenue forecast for the fiscal 2014 - 2015 biennium assumes GRF net revenues rising a modest 6.5% from the 2012 - 2013 biennium, to nearly $99.4 billion. GRF appropriations in the fiscal 2014-2015 budget total nearly $95 billion, about 10.4% ahead of fiscal 2012 - 2013 biennium appropriations. Among other changes the adopted budget included significant spending increases for schools, pay raises for state employees, and the higher pension contributions noted earlier. Despite higher school funding, litigation regarding the constitutionality of school funding continues.

With a rapidly growing ESF balance from strong energy tax performance, the adopted budget diverted portions of ESF resources for other state needs. In addition to the $1.9 billion draw noted earlier for fiscal 2013 budget needs, the legislature established a $2 billion revolving fund for water-related projects, a perennial need in the state given its high growth and scarce water resources; voters authorized the new fund in November 2013.

Additionally, a proposed constitutional amendment diverting half of future incremental oil and gas taxes dedicated to the ESF to instead support highway funding will be put before voters in November 2014. The measure, which Fitch believes will be approved, would lower the fall 2014 ESF deposit to $1.71 billion, with the same amount dedicated to highways. Including this change, the comptroller currently forecasts an ESF balance of nearly $8.4 billion as of Aug. 31, 2015, equal to 16.7% of fiscal 2015 GRF revenues.

Actual revenue performance through June 2014 remains solid, with total year-to-date general revenues rising 9.1% from a year earlier, and sales tax revenues rising 5.2%.

ECONOMY

The state's economy has expanded rapidly and diversified over the last two decades, although the cyclical energy sector still represents a large share of economic activity. Population growth is very rapid, rising nearly 27% since 2000 (compared to 12.3% nationally). The state outperformed the nation into the last downturn given growth-related momentum and strong energy sector performance in 2007 and 2008, and has continued to outpace the nation since the recovery started.

Employment in 2012 and 2013 in Texas rose 2.9% in both years, compared to the 1.7% gains in both years reported nationally. June 2014 employment rose 3.3% year-over-year, compared to a 1.9% gain nationally. Growth remains particularly strong in oil and gas-related sectors, although services are also rapidly gaining. The unemployment rate, at 5.1% in June 2014, is well below the 6.1% rate reported nationally for the same period. Personal income has shown strong growth in recent quarters, rising 4.9% in the first quarter of 2014, compared to 3.5% nationally. Personal income per capita measured 98% of the nation's in 2013, ranking 25th among the states.

The state forecasts continued gains in economic performance through the current biennium, although at a slower pace compared to the pace immediately following the recession. Gross state product is forecast to rise 5.2% and 5.3% in 2014 and 2015, while employment rises 3.3% in 2014 and 2.9% in 2015. Current forecast indicators are somewhat higher than the level forecast by the comptroller in December 2013 with the biennial revenue certification. The price of oil is forecast to end the biennium at a modestly lower level than recent actuals, while the price of natural gas is forecast to rise.

RELATED AFFIRMATIONS

Fitch Ratings affirms the following rating linked to the GO rating of the state:

--$5,545,000 constitutional appropriation bonds (Stephen F. Austin State University), series 2008.

The Rating Outlook is Stable.

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

In addition to the sources of information identified in the Tax-Supported Rating Criteria, this action was additionally informed by information from IHS Global Insight.

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=848434

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Contacts

Fitch Ratings
Primary Analyst
Douglas Offerman
Senior Director
+1-212-908-0889
Fitch Ratings
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Marcy Block
Senior Director
+1-212-908-0239
or
Committee Chairperson
Karen Krop
Senior Director
+1-212-908-0661
or
Media Relations
Elizabeth Fogerty, New York, +1-212-908-0526
elizabeth.fogerty@fitchratings.com

Sharing

Contacts

Fitch Ratings
Primary Analyst
Douglas Offerman
Senior Director
+1-212-908-0889
Fitch Ratings
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Marcy Block
Senior Director
+1-212-908-0239
or
Committee Chairperson
Karen Krop
Senior Director
+1-212-908-0661
or
Media Relations
Elizabeth Fogerty, New York, +1-212-908-0526
elizabeth.fogerty@fitchratings.com