Fitch Rates New Jersey's $525MM GO Bonds 'A'; Outlook Negative

NEW YORK--()--Fitch Ratings assigns an 'A' rating to $525 million state of New Jersey general obligation (GO) bonds (various purposes).

The bonds are expected to be sold via competitive bid on Dec. 3, 2014.

The Rating Outlook is Negative.

SECURITY

General obligations of the state, secured by the full faith and credit of the state.

KEY RATING DRIVERS

LONG-TERM LIABILITIES CONSIDERABLE: Above-average state debt obligations are compounded by significant and growing funding needs for the state's unfunded retirement liabilities. Continued pension funded ratio deterioration is projected through the medium term and full actuarial funding of the required contributions is several years off.

WEALTHY ECONOMY AND LAGGING RECOVERY: New Jersey benefits from a wealthy populace and a broad and diverse economy. However, the state's economic performance has lagged the nation in recovery from the recent recession, with improvement in 2013 trailing off at the close of the year, and very slow year-over-year (yoy) employment growth continuing through 2014.

MINIMAL CASH BALANCES RESULT IN LIMITED OPERATING FLEXIBILITY: Minimal cash balances have been maintained in recent years, providing limited flexibility to absorb unforeseen needs or revenue under-performance.

BROAD EXPENDITURE REDUCTION AUTHORITY: The governor has strong executive powers to implement any necessary expenditure reductions to balance the budget and the state has a consistent history of doing so; however, options have become more limited as the state's fixed cost burden grows.

NEGATIVE OUTLOOK: The Negative Rating Outlook incorporates Fitch's concern that there is considerable risk that state actions to address near-term budgetary and pension challenges may leave unaddressed the state's longer-term structural and liability challenges, particularly given the state's lagging economic and revenue performance and narrow liquidity.

RATING SENSITIVITIES

The GO rating is sensitive to the state's management of its budget challenges. Continued deterioration in the state's budgetary flexibility or reserves or a failure to adequately provide for its liabilities could lead to a downgrade.

CREDIT PROFILE

New Jersey's 'A' GO rating incorporates the absence of long-term, fiscally sustainable solutions to close identified budget gaps in fiscal years 2014 and 2015. Recent actions to achieve budgetary balance, following significant revenue underperformance at a time of national economic recovery, relied upon the state repudiating its planned statutory contribution to the pension systems. The rating also incorporates the resurgence of sizable one-time measures to balance its operating budgets; a very weak liquidity position; an economic performance that continues to lag that of the nation; and a multitude of long-term spending pressures which are expected to delay its achievement of sound financial operations, in Fitch's view. The Negative Rating Outlook incorporates Fitch's concern that there is considerable risk that state actions to address near-term budgetary and pension challenges may leave unaddressed the state's longer-term structural and liability challenges.

New Jersey benefits from high wealth levels and a broad economy; these positives are offset, however, by a high debt burden and sizable unfunded retiree liabilities. Despite passage of pension and benefits reform legislation in 2011 which restrained future growth in the state's accumulated liabilities, continued pension funding-level deterioration is projected through the medium term as the state's statutory plan phased in a return to full actuarial contributions over time. The state's suspension of its planned statutory contributions in fiscal years 2014 and 2015 is likely to further erode pension funded ratios. Fitch believes balancing the need for requisite pension system contributions with other long-term demands, such as infrastructure needs, property tax relief, and school funding will continue to prove difficult.

FINANCIAL OPERATIONS ARE STRUCTURALLY UNBALANCED

Projected revenues in the enacted budget for fiscal 2014 totaled $32.8 billion and incorporated 6.1% growth from actual 2013 results. Fiscal 2014 revenue underperformance through January 2014 resulted in a net $251 million negative revision to the fiscal 2014 revenue forecast. Factored into the revision was the expected receipt of one-time proceeds from a securitization of the state's remaining tobacco settlement revenues; the transaction brought a net $91.6 million into the general fund, without which the revenue gap would have been $342.7 million. In addition to this revenue gap, in February the state incorporated $694 million of appropriation lapses from unexpended items, including about $94 million in pension savings from the combined effect of incorporating salary scale changes from recently adopted experience studies and a more favorable method of calculating the state's normal cost pension contributions. These lapses allowed the state to fund an increase in appropriations of $292 million for fiscal 2014.

An additional $807 million revenue gap, announced in April 2014, increased the size of the revenue shortfall for fiscal 2014 compared to the enacted budget to approximately $1.3 billion, approximately 3.9% of the state's operating budget. The state reported the shortfall was largely due to an approximate $700 million shortfall in personal income tax (PIT) receipts for fiscal 2014. The revenue shortfall for fiscal 2014, when combined with other revenue and expenditure adjustments, created a $1.75 billion budget gap for fiscal 2015.

The governor proposed an $887 million reduction to the statutory $1.58 billion pension payment for fiscal 2014 as well as a $1.57 billion reduction from the statutory $2.25 billion pension payment for fiscal 2015 as the primary means of closing the newly identified budget gaps. Despite legal challenge, the fiscal 2014 cut was upheld by a state superior court judge, who cited the state's emergency fiscal situation given the announcement of the gap late in the fiscal year; however, the judge did not rule on the proposed cut to the fiscal 2015 pension payment as the budget had not yet been enacted. The judge's ruling, while sustaining the cut to the pension payment in fiscal 2014, concurred with the plaintiffs' contention that pension benefits represent a contractual obligation of the state, paralleling another recent state court decision on pension benefits.

Including the $887 million reduction to the contribution for the state's pension systems, one-time actions in the fiscal 2014 operating budget ultimately totaled just over $3 billion, equal to 9.3% of the $33.2 billion operating budget. These included $92 million in tobacco securitization, an EDA bond refunding, tax policy and revenue initiatives, the change to the normal cost pension contribution, and various appropriation offsets.

A sharp disagreement arose between the New Jersey governor and legislature on how to close the budget gap for fiscal 2015. The disagreement resulted in the governor's line item veto of $1.57 billion from the $2.25 billion pension contribution for fiscal 2015 following the legislature's approval of personal income and business tax increases to cover the scheduled pension contribution. The governor vetoed the tax increases and reduced the pension contribution instead. The timeline for resolving litigation regarding the pension contribution cut for fiscal 2015 is not yet clear.

The fiscal 2015 enacted operating funds budget is 2.1% below the final estimated budget for fiscal 2014. Appropriations have been reduced by $692 million from fiscal 2014 and total just over $32.5 billion. Revenues in support of the budget are forecast to increase by 3.5%, including a 5.5% increase in sales tax revenue, a 4.8% increase in the PIT, a 6.5% increase in the corporation business tax (CBT), and a 17.6% ($40 million) increase in casino revenues. One-time actions included in the budget are estimated to total $2.75 billion (8.5% of the fiscal 2015 operating budget) and include the $1.57 billion pension payment cut, $231 million in appropriation offsets, $324 million from the NJ Turnpike to offset appropriations to NJ Transit, and $391 million in debt restructuring.

In Fitch's view, past state economic and revenue forecasts have been optimistic. The current economic and revenue forecast appears to be more closely in line with those of independent forecasters. Revenue results for the first four months of fiscal 2015, through October, show 5.6% yoy growth, or 0.4% ahead of the forecast for the full year; the state is no longer disclosing monthly revenue expectations. Solid yoy growth is being recorded in the PIT (up 6.6% yoy and ahead of the full year budget forecast by 1.7%) and the CBT (up 25.8% yoy and ahead of the budget forecast by 18.1%) while there are revenue misses in the sales tax (3.4% yoy growth but 2% below the budget forecast), lottery (down 9.2% yoy and 15.4% below the budget forecast), and casino revenue (down 0.3% yoy and 15.2% below the budget forecast) revenue sources.

The state has indicated its intent to increase its ending fund balance to $388.5 million at the close of fiscal 2015, up from a targeted $300 million ending fund balance in fiscal 2014. Fitch believes this level of fund balance, 1.2% of operating revenue, would provide only limited operating flexibility in the event of future negative fiscal developments. Additionally, there are some risks to the state achieving both the ending, estimated fund balance for fiscal 2014 as well as some one-time items included in the fiscal 2015 budget.

ECONOMIC GROWTH HAS LAGGED THE NATION

State employment growth during most of the last decade lagged the national experience, and while growth has returned following recessionary losses, the pace of expansion remains well below the national average. The state entered the recession with the nation in 2008 and its experience from 2008 to 2010 was similar, although the state recorded a decline of 1.2% in non-farm employment levels in 2010, higher than the 0.7% contraction seen nationally; growth in 2011 was essentially flat to 2010 and below the 1.2% national growth rate. Modest employment growth in both 2012 and 2013 of 1.1% was below the national 1.7% growth rate for both years.

Employment growth in 2014 has been very slow and employment growth in September 2014 was negligible at 0.1% yoy as compared to 2% yoy nationally. The state's unemployment rate of 6.5% for September was improved from the rate one year prior of 7.9%; however, the decline in the rate continues to be highly influenced by declines in the workforce participation rate; down 0.3% yoy.

New Jersey's wealth levels are high, with 2013 per capita personal income equaling 126% of the national level, ranking it fourth among the states.

COMPARATIVELY HIGH LONG-TERM LIABILITIES

New Jersey's debt levels are high for a U.S. state, and ongoing capital demands for school construction, environmental protection and transportation remain large. Net tax-supported debt as of June 30, 2014 equaled 7.4% of 2013 personal income as compared to a median of 2.6% for the states.

Unfunded pension liabilities attributable to the state are also well above average. These liabilities are expected to increase over the next several years absent additional reform measures and materially higher contributions than currently expected. Fitch expects the pension contribution increases, combined with expected annual increases in OPEB funding demands, to further strain the state's operating budget.

For the public employees' retirement system (PERS) and the teachers' pension and annuity fund (TPAF), as of July 1, 2013, system wide reported funded ratios were 62.1% and 57.1%, respectively. Using Fitch's more conservative 7% discount rate assumption, the plans were 56.5% and 51.9% funded, respectively. As of July 1, 2013, the state portion of pension liabilities for PERS was 46% funded on a reported basis, or 41.8% using Fitch's more conservative 7% discount rate. On a combined basis, as of July 1, 2013, New Jersey's net tax-supported debt and adjusted, unfunded pension obligations attributable to the state, as adjusted for a 7% return, totaled 16.5% of 2013 personal income, well above the 6.1% median for all U.S. states.

The governor has convened a special pension taskforce to propose options for additional pension reform. The governor has acknowledged the sizable and increasing burden of pension contributions and expects to recommend that additional, as yet unspecified, reform measures be considered in the next legislative session.

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

In addition to the sources of information identified in Fitch's 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);

--'State of New Jersey Full Rating Report' (March 28, 2014).

--'Fitch Downgrades New Jersey's GO and Appropriation Ratings; Outlook Remains Negative' (Sept. 5, 2014).

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

State of New Jersey

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=741256

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=933015

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Contacts

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

Contacts

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