Fitch Rates Texas Transportation $624 Million Highway GO Bonds 'AAA'; Outlook Stable

NEW YORK--()--Fitch Ratings has assigned an 'AAA' rating to approximately $623.5 million in Texas Transportation Commission (TTC) State of Texas highway improvement general obligation (GO) bonds series 2016.

The bonds are expected to sell via negotiated sale in early April.

In addition, Fitch has affirmed the state's outstanding GO bonds and related debt ratings as noted 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.

ECONOMIC GAINS CONTINUE: The state's economy is large and diverse. Growth continues despite the recent energy industry weakness which to date has been concentrated in specific sectors and regions. The state's oil and gas sector remains a significant source of economic activity and is subject to volatility.

SIGNIFICANT RESERVE BALANCES: Financial operations are generally conservative. The state maintains 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; 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, school funding, and water needs.

RATING SENSITIVITIES

ECONOMIC GROWTH AND AMPLE FLEXIBILITY: Texas' 'AAA' GO rating and Stable Outlook assume continued economic gains and the maintenance of ample fiscal flexibility both in its conservative approach to budget management and its high reserve balances. The rating could be pressured in the event of the state's unwillingness to address potential fiscal challenges in an effective and timely manner.

CREDIT PROFILE

Texas' Long-term 'AAA' GO rating reflects its low debt burden, conservative financial operations and an economy that continues to grow despite the severe contraction in the state's globally important energy sector. Although the oil price plunge that began in late 2014 has interrupted a long period of economic and revenue momentum, the state's diversification in recent decades has left it better positioned to weather the current energy sector uncertainty relative to past cycles.

Fitch believes that the state has ample flexibility to absorb near-term economic and revenue volatility, both in the form of its very large reserve balances and a tradition of taking budgetary actions to maintain balance. Liquidity remains ample, and the state is not undertaking cash flow borrowing in fiscal 2016 to meet intra-year cash needs for the first time in decades. The state has been an economic growth leader for decades, diversifying well beyond the resource sectors that were dominant during the last severe oil price shock, in the 1980s. However, rapid growth and the concomitant demand for public services, including for transportation, education and water, continue to pose long-term fiscal pressures.

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 $49.4 billion as of Aug. 31, 2015, the fiscal year-end.

GO bonds are issued by various state agencies; with TTC authorized to issue transportation-related GO bonds administered by the Texas Department of Transportation (TxDOT). Transportation needs, driven by the rapid population growth and economic expansion of the last decade, have been funded by the TTC via multiple bond programs, including the highway improvement GO bonds, GO mobility fund bonds, state highway fund (SHF) revenue bonds, and various toll road borrowings. Highway improvement GO bonds are issued under a 2007 constitutional amendment which authorized $5 billion of such debt. Debt service is supported from state general revenue fund (GRF) resources, with current proceeds intended for capital projects to relieve congestion, among other priorities.

LOW BONDED DEBT

Texas' net tax-supported debt burden is low, with approximately $17 billion as of Aug. 31, 2015 equal to 1.4% of 2014 personal income. This figure includes $12.3 billion in GO bonds supported by tax revenues of the GRF and the mobility fund, and $4.5 billion in SHF 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 as of Fitch's 2015 state pension update report equaled 6.2% of personal income, above the median for U.S. states.

SOME PENSION REFORMS IMPLEMENTED

Funded ratios for the state's two major pension systems, covering state employees and teachers, have declined given investment losses in the last downturn and annual contributions that have been consistently below actuarially calculated levels.

The last two state legislative sessions achieved consensus on improving contribution practices. In its 2013 session, the legislature adopted teacher plan reforms, including a higher retirement age and phased increases in member, state and district contribution rates, bringing amortization to below 30 years; actual contributions remain below the actuarially-calculated level. The state reports the teacher system liability as primarily being a state obligation.

Following minor contribution increases to the state employees' system approved in the 2013 session, the 2015 session approved sizable increases to employer and employee contributions. The bill was estimated to result in amortization of the unfunded liability over 32 years, although this assumed achieving the system's 8% investment return assumption over the long term.

As of Aug. 31, 2015, the most recent valuation date, the reported funded ratio for the state employees' system was 76.3%, and the GASB 67 ratio of net assets to total liabilities was 64.4%. The lower GASB 67 figure reflected a depletion date forecast in 2053, despite incorporation of the higher statutory contributions. As of the same valuation date, the reported funded ratio for the teachers' system was 80.2%, and the GASB 67 ratio was 78.4%. Using Fitch's more conservative 7% discount rate assumption would lower the funded ratios to 68.8% for the employees' system and 72.2% for the teachers' system.

RESERVES PROVIDE LARGE CUSHION

Finances are generally conservative, though challenges include managing the cyclicality inherent in the state's important energy sector and sustainably addressing long-term growth needs. The state historically has been reluctant to increase taxes and the scope of spending, and fiscal uncertainties periodically have arisen from litigation, adverse court outcomes or incompletely budgeted spending, including for Medicaid in the fiscal 2012 - 2013 biennium. At present, litigation regarding the adequacy and equity of state school funding poses an uncertainty, with a decision by the state Supreme Court expected in spring 2016.

The state maintains fiscal flexibility both in the form of its economic stabilization fund (ESF - the state's budget reserve), as well as in its demonstrated willingness to make deep spending cuts to maintain budget balance. ESF balances were small relative to the budget until the natural resources boom of the last decade, which led to sizable deposits even with several one-time draws, including for budget relief during the last downturn. As of January 2016, the ESF balance was $9.6 billion, equal to 18.6% of estimated fiscal 2016 general revenue-related net revenues.

The ESF receives a constitutional dedication of a share of oil and gas production taxes, as well as unencumbered balances at fiscal year-end. High deposits driven by energy prices prior to fiscal 2014 have led the state to allocate ESF resources to other key needs. These included a one-time, $2 billion draw to establish a loan program for water-related projects, and a second, permanent diversion of half of future dedicated taxes to support highway funding. Both measures were ratified by voters. Despite these changes, Fitch believes the current ESF balance continues to provide a material fiscal cushion in the event that more severe economic and fiscal risks materialize.

FISCAL 2016 - 2017 BUDGET ADOPTED

The legislature finalized the state's fiscal 2016 - 2017 biennial budget in May 2015. Total general revenue (GR) and GR dedicated appropriations in the adopted budget equal $106.2 billion through the biennium, after adjustments including vetoes. This figure is approximately 12% higher than the comparable figure for the fiscal 2014 - 2015 biennium, based on the legislative budget board (LBB) analysis of the joint Senate-House budget bill.

The budget includes $3.8 billion in additional funding for schools to offset budgeted tax reductions, including a 25% decrease in the state's franchise tax and an increase to the homestead exemption for local property taxpayers. Other bill provisions included employee pay raises and the employees' retirement system contribution increase noted earlier. The legislature increased funding for transportation by shifting other agencies' operating appropriations away from the SHF; moreover, it enacted a shift of portions of statewide sales taxes and other sales taxes to the SHF, beginning with $2.5 billion in fiscal 2018; voters approved the measure in November 2015.

STATE FORECAST ASSUMES OIL REVENUE SLOWDOWN

The comptroller's certification revenue estimate (CRE), released in October 2015, further lowered the state's outlook for energy-related receipts, while continuing to assume broader economic and revenue gains. Fiscal 2015 ended with general revenue-related net revenues rising 1.9% from fiscal 2014 actuals, slightly ahead of the growth expected as of the January 2015 estimate. Sales tax growth of 5.5% was slower than the previous estimate. Oil and natural gas production taxes fell 25.7% and 32.6%, respectively. The ESF balance was $8.5 billion, equal to 16.1% of general revenue-related net revenues.

For the fiscal 2016 - 2017 biennium, the comptroller is estimating general revenue-related net revenues falling 1.7% in fiscal 2016 and rising 4.4% in fiscal 2017. Sales taxes are forecast to rise 1.2% in fiscal 2016 and 4.8% in fiscal 2017, while oil production taxes decline 35.9% in fiscal 2016 and rise 11.8% in fiscal 2017. Under the October 2015 forecast, total biennium general revenue-related net revenues equal $105.8 billion, about $4.7 billion lower than the January 2015 forecast. The biennium is forecast to end with a certification balance of almost $4.1 billion. ESF balance is forecast at $10.4 billion as of Aug. 31, 2017, equal to 19.2% of forecast fiscal 2017 net revenues.

RECENT REVENUE COLLECTIONS NEAR EXPECTATIONS

Cash receipts for fiscal 2016 year-to-date through January 2016 are near expectations, with total GRF receipts 1.8% ahead of forecast and 0.1% below the same period in fiscal 2015. Excluding federal receipts, total GRF receipts are at the forecast level. Sales taxes, by far the state's largest source of tax revenue, are 4.9% below forecast and 2.5% below the prior year. Energy related taxes have slumped, with oil and natural gas production tax collections falling 32.1% and 20.4% below forecast, respectively.

ECONOMIC GROWTH DESPITE ENERGY-RELATED WEAKNESS

Texas' 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 more than twice the national rate, rising 29.3% since 2000 (compared to 13.3% nationally). The state outperformed the nation into the last downturn given growth-related momentum and strong energy sector performance, and growth outpaced the nation until just recently, as the deepening energy sector slump has begun to affect statewide growth averages.

The oil price decline to date has had a relatively targeted impact on Texas. Employment in Texas rose 3.1% in 2014, compared to 1.9% growth nationally, and gains continued at a slower pace through 2015, with December 2015 up 1.4% from a year earlier, compared to the 2% gain reported nationally. Unemployment rates in Texas have been consistently below the nation's over most of the last decade; in 2014, the state's unemployment rate was 5.1%, compared to 6.2% for the U.S., and the December 2015 rate was 4.7% in Texas, compared to 5% nationally.

Sectors affected by the oil price decline include natural resources and mining, where employment as of December 2015 is down 10% year-over-year (three-month moving average basis), and manufacturing, which is showing a 4.2% decline over the same period. Services continue to show strong growth, with professional and business services rising 2.9%, and education and health rising 4.5%. Personal income in Texas has continued to grow, although now is rising more slowly than the nation's. As of the third quarter of 2015, personal income in the state rose 3.9% from a year earlier, compared to 4.6% nationally. Personal income per capita measured 99.2% of the nation's in 2014, ranking 23rd among the states.

The comptroller's October 2015 economic outlook, extending through fiscal 2017, foresees continued economic gains, albeit at a much slower pace compared to earlier forecasts. Oil prices are forecast at $64.94 per barrel in fiscal 2015, well under the $101.05 level reported in fiscal 2014. The forecast assumes prices fall to a low of $49.48 in fiscal 2016, and then rise to $56.52 in fiscal 2017. After rising 5.8% in fiscal 2014, real gross state product is estimated to have risen only 2.4% in 2015 as the state adjusts to the energy slowdown, with the forecast assuming fiscal 2016 and 2017 growth of only 2.4% and 2.3%, respectively. Non-farm employment is estimated to have risen a slow 2.8% in fiscal 2015, well below the earlier pace of growth, and the forecast assumes this pace slowing further in fiscal 2016 and 2017, to 1.7% and 1.8%, respectively.

RELATED AFFIRMATIONS

Fitch Ratings affirms the 'AAA' ratings on the following outstanding GO bonds and related debt of the State of Texas, consisting of:

--Approximately $17.3 billion in GO bonds;

--Approximately $3.5 million in 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 applicable criteria specified below, this action was informed by information from CreditScope and IHS.

Fitch recently published exposure drafts of state and local government tax-supported criteria (Exposure Draft: U.S. Tax-Supported Rating Criteria, dated Sept. 10, 2015 and

Exposure Draft: Incorporating Enhanced Recovery Prospects into U.S. Local Tax-Supported Ratings, dated Feb. 2, 2016). The drafts include a number of proposed revisions to existing criteria. If applied in the proposed form, Fitch estimates the revised criteria would result in changes to less than 10% of existing tax-supported ratings. Fitch expects that final criteria will be approved and published in the first quarter of 2016. Once approved, the criteria will be applied immediately to any new issue and surveillance rating review. Fitch anticipates the criteria to be applied to all ratings that fall under the criteria within a 12-month period from the final approval date.

Applicable Criteria

Exposure Draft: U.S. Tax-Supported Rating Criteria (pub. 10 Sep 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869942

Tax-Supported Rating Criteria (pub. 14 Aug 2012)

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

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

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

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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, +1-212-908-0526
elizabeth.fogerty@fitchratings.com

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, +1-212-908-0526
elizabeth.fogerty@fitchratings.com