NEW YORK--(BUSINESS WIRE)--Fitch Ratings has assigned a 'AA+' rating to the state of Alaska's $150 million general obligation (GO) bonds, series 2016B. The bonds are scheduled to sell via competitive bid on June 22, 2016.
In addition, Fitch has downgraded the following ratings:
--The state's Long-Term Issuer-Default Rating to 'AA+' from 'AAA';
--Approximately $753.8 million in outstanding GO bonds to 'AA+' from 'AAA';
--$244 million in outstanding lease obligation bonds, subject to annual appropriation to 'AA' from 'AA+'.
The ratings for the Alaska Municipal Bond Bank Authority have been downgraded as follows:
--2005 bond resolution to 'AA' from 'AA+';
--2010 bond resolution to 'AA-' from 'AA';
--2016 bond resolution to 'AA-' from 'AA.'
The ratings have been removed from Rating Watch Negative. The Rating Outlook is Negative.
The GO bonds are general obligations of the state of Alaska to which the full faith, credit, and resources of the state are pledged.
KEY RATING DRIVERS
The downgrade of the state's IDR to 'AA+' from 'AAA' reflects the substantial operating deficits recorded by the state in recent fiscal years and the modest reform efforts taken to date to realign its stressed, petroleum-based revenue structure with expenditure demands. The 'AA+' rating reflects the still sizable level of reserves at the state's disposal; reserves currently approximate 2.5x annual unrestricted general fund (UGF) expense. This provides the state with a substantial financial cushion while it seeks fiscal reform. The Negative Outlook reflects the state's need to reach and maintain budgetary balance given the sizable economic concentration in natural resource development, subdued growth prospects for revenue derived from this sector, and expected continued draws on reserves over the medium term.
Economic Resource Base
Alaska's economy is largely based on the development and application of its abundant natural resources, the production of crude oil and natural gas deposits, prominent fishing industry, and mining and tourism. An estimated one-third of the state's gross state product is attributed to the drilling, production, and economic multiplier effects of the turbulent oil and natural gas sectors; a primary source of vulnerability for the state. Rapid deterioration in crude oil prices over the past 18 months has led to rig closures and reduced employment. The state's recent unemployment rate was equal to 132% of the nation's and has climbed on an annual basis since 2013, prior to the severe, global decline in oil prices. The Federal government is a large employer and a key driver of the state's economy (an estimated 36% of the state's economy is derived from Federal employment.).
Revenue Framework: 'a' factor assessment
The state is expected to continue to derive an outsized proportion of its operating revenues from taxation, leasehold interest, and royalty payments related to petroleum development. These narrow revenue sources will continue to reflect the economic volatility tied to the extensive natural resources sector, impeding the development of a more predictable financial performance. The state has complete control over its revenues, with an unlimited independent legal ability to raise operating revenues as needed.
Expenditure Framework: 'a' factor assessment
The state maintains solid expenditure flexibility with a manageable burden of carrying costs for liabilities and the broad expense-cutting ability common to most U.S. states. As with most states, Medicaid remains a key expense driver and Fitch believes the state will be challenged in meeting increased expenditures due to insufficient expected revenue growth.
Long-Term Liability Burden: 'aa' factor assessment
Debt levels are low for a U.S. state but on a combined basis, the state's net tax-supported debt and unfunded pension obligations are well above the median for U.S. states as a percentage of personal income. Other post-employment benefit (OPEB) obligations are sizable but well-funded. Both pension and OPEB liabilities are constitutionally protected benefits.
Operating Performance: 'aa' factor assessment
The state's strong management of its financial operations and extraordinarily sizable reserve balances has historically offset volatility in its revenue sources; however, the state will be ending fiscal 2016 with its fourth consecutive operating deficit and a sizable deficit is expected in fiscal 2017. Available reserves are forecast to remain strong at the end of fiscal 2017 under various scenarios although eventual depletion is expected absent revenue reform, sharp expenditure reductions, or a return to more robust oil prices; a scenario that Fitch's views as unlikely through the medium term. While the state's permanent fund (PF) is robustly funded, it may only be accessed through an amendment to the state constitution, which is a limiting factor.
ACHIEVEMENT OF MEANINGFUL FISCAL REFORM: Failure to enact measures to improve fiscal balance will put negative pressure on the rating.
Historically, the UGF has been almost entirely supported by volatile petroleum-related revenues. In fiscal 2014, 88% of UGF revenues were derived from this sector; this ratio has declined to about 60% in fiscal 2016 due to the substantial decline in oil prices. Modest, additional sources of UGF revenue include various excise taxes, corporate income taxes, and fisheries and mining taxes. Historically, the state has applied funds from its accessible reserves, principally the constitutional budget reserve (CBR) and the statutory budget reserve (SBR), to fund operations when petroleum-related revenue has fallen short.
Petroleum-related revenues include the state's tax on the value of oil and gas production and the collection of oil and gas royalties, lease payments, and bonuses. The state receives these revenues on both its land leased for natural resource development as well as 50% of royalties and leases from development on federal land in the National Petroleum Reserve (NPR). A portion of these revenues are restricted with constitutional and statutory requirements for deposits to certain accounts including the state's permanent fund, the public school fund trust, and special revenue funds for municipalities that are impacted by development in the NPR.
Oil and gas production tax revenue is a function of both price and production with significant declines in oil prices over the past 18 months eroding collections. The state continues to project long-term declines in production along the Alaska North Slope (ANS) which will reduce UGF revenue collections.
Historical growth in the state's revenues, after adjusting for the estimated impact of tax policy changes, was well ahead of national GDP growth over the 10 years through 2014, with solid growth in oil prices in most years more than offsetting declines, producing increasing but volatile state tax revenues. However, the loss of state tax revenues related to the continuing slump in oil prices to lows reaching $30/bbl has resulted in sizable operating deficits in fiscal years 2015 and 2016, and a forecast deficit in 2017. The state's revenue forecast assumes steady growth in oil prices; however, while the gradual price escalation to $65.90/bbl by 2025 and revenue performance expectations demonstrate positive growth prospects, they build from an extremely low base that is insufficient to fund the state's current expenditures.
The governor proposed a number of recurring revenue measures to reduce the reliance on petroleum-based revenues; however, the proposals did not receive sufficient traction in the regular legislative session to move ahead. The legislature is currently discussing these proposals in a special session that is expected to conclude in the near future. Currently, one piece of approved revenue legislation from the special session was a change to the state's tax credits for oil and gas development that would initially increase revenues to the state beginning in fiscal 2018. The governor is currently reviewing this bill.
The state has no legal limitations on its ability to raise revenues through base broadenings, rate increases, or the assessment of new taxes or fees.
As in most states, education and health and human services spending are Alaska's largest operating expenses. Education is the larger line item, as the state provides significant funding for local school districts and the public university. Health and human services spending is the second largest area of spending, with Medicaid being the primary driver.
Fitch expects that spending growth, absent policy actions, will be well ahead of natural revenue growth, driven primarily by education expense and Medicaid. While the fiscal challenge of Medicaid is common to all U.S. states, Fitch believes the state will be hard-pressed to fund program requirements and other spending priorities absent reform to its budget funding given the forecast for an extended low oil price environment and the state's reliance on revenue sources tied to this revenue source.
Alaska retains a solid ability to adjust expenditures to meet changing fiscal circumstances. While Medicaid remains a notable cost pressure, spending requirements for debt service and pension obligations are manageable and the state has taken important steps to improve pension funding through deposits from the CBR to lower its annual required contributions (ARC). Pension and OPEB benefits for state employees and teachers are constitutionally protected, reducing the state's flexibility to make cuts as both an employer as well as for additional contributions that are required by state statute; SB125 commits the state to funding the difference between specified employer contributions and the ARC although the statute may be amended. Based on the state's actual contributions for OPEB, debt service, and pensions, carrying costs accounted for 11% of expenditures in fiscal 2015.
Long-Term Liability Burden
The state has been an infrequent debt issuer, meeting most capital needs from annual revenues. The debt burden as of June 30, 2015 is low, with almost $1.1 billion in net tax-supported debt measuring 2.7% of personal income after excluding guaranteed debt of the Housing Finance Corporation, which has never required state support, and reimbursable municipal general obligation debt issued for school construction. Fitch notes that the majority of state debt is currently repaid from petroleum-related revenue, so the debt-to-income ratio is not as meaningful for Alaska as for other states.
The state has undertaken multiple pension reforms in recent years, including switching to defined contribution plans for new employees beginning July 1, 2006, and enacted legislation in 2007 obligating the state to appropriate for system employers' contributions over a fixed percentage of payroll. The application of $3 billion of CBR funds in 2015 to accelerate progress toward full funding has also improved state employees (PERS) and teachers' (TRS) funded ratios. As of the June 30, 2015 financial statements, PERS' funded ratio was 59.7% and TRS' funded ratio was 54.5%. Incorporating the one-time payments to the system and other programmatic adjustments, the state's actuary in the fiscal 2015 valuations increased these ratios to 78.2% and 83.3%, respectively.
Based on Fitch's state pension update report, on a combined basis the burden of the state's net tax-supported debt and unfunded actuarial accrued liability for pension obligations, adjusted by Fitch to reflect a 7% return assumption, equaled 14% of 2014 personal income; however, Fitch expects that figure to have moderated following the CBR transfer noted above. Healthcare trusts were established for both PERS and TRS, and as of June 30, 2015, were funded at 98.5% and 100.3%, respectively.
The state's financial performance has been tied closely to trends in its natural resource base with sizable accessible reserves bolstering operations during downturns. Fluctuating global energy prices have led to sharp surges and drops in the state's unrestricted general fund revenues, with strong revenue growth increasing balances in the state's various reserve funds. The CBR and SBR together grew from $8.1 billion in fiscal 2009 to $17.6 billion in fiscal 2014 prior to declining to about $10.3 billion in fiscal 2015. The SBR needs only a simple legislative majority to access when the state's budget is in a deficit; a 3/4 majority vote of the legislature is required to access the CBR unless the current year's proposed budget is less than the prior year's budget, in which case the simple majority rule applies as well. The state also has access to earnings of the permanent fund held in the PF's earnings reserve (PFER) by a simple majority vote; that balance totaled $7.2 billion in fiscal 2015. Combined, the balances in fiscal 2015 were equal to 2.9x the state's annual UGF budget and have provided significant cushion for operations expense during the current commodity price collapse.
Including the PFER, the state's PF held a fund balance of $52.8 billion as of June 30, 2015. The PF receives an annual allocation of state-derived oil royalties, rents, and bonuses. Access to the PF corpus itself would require an amendment to the state's constitution, a path the state has never pursued even during past multi-year periods of low petroleum prices.
Aside from substantial reserves, financial operations are supported by conservative fiscal management that includes close tracking of revenue collections and expenditures during the year. The state updates its revenue forecasts twice yearly and each forecast extends for ten years. The forecast employs the state's extensive knowledge of ongoing and planned natural resource development.
The state's recovery from the oil price burst in 2008 and 2009 has proven to be uneven, with sizable surpluses derived from strong price growth in fiscal years 2011 and 2012 and deposited to state reserves later tapped in fiscal years 2013 through the current fiscal 2016. The state conservatively allocated a portion of the CBR in fiscal 2015 to reduce the unfunded pension liability, thus improving the funded ratio and lowering annual expense related to the ARC. However, the state failed to take other steps during periods of financial stability to improve financial flexibility and reduce its reliance on petroleum-based revenue sources given the known variability in this sector.
Recent Operating Performance
The steep drop in crude oil prices in late calendar year 2014 led the state to substantially revise its revenue expectations for fiscal 2015, while increasing an anticipated revenue shortfall in fiscal 2015 to $3.5 billion. The fiscal year ended with oil prices even lower than forecast, at $72.58/bbl, resulting in a revenue shortfall that was funded by an appropriation of $2.5 billion from the SBR. The state also drew about $3 billion from the CBR for deposit to the state's pension systems.
The enacted budget for fiscal 2016 funded UGF expenditures of almost $5 billion, a 19% reduction as compared to fiscal 2015. The budget incorporated an expectation of continued soft crude oil prices and a planned $2.7 billion operating deficit funded by a further draw from the CBR. The state's spring 2016 revenue forecast recognized the continued turbulence in crude oil prices and lowered the state's revenue forecast to reflect an average price of $39.99/bbl. The forecast revision, combined with actions taken by the governor and legislature, has increased the expected budget gap in fiscal 2016 to $4.2 billion (76% of the UGF budget). The state plans to fund the gap by drawing on reserves. Reserves of $13.9 billion are expected to remain substantial at the close of fiscal 2016; equal to 2.5x the UGF budget.
The legislatively-approved UGF budget for fiscal 2017 totals $4.4 billion, a 20.5% reduction from fiscal 2016, and does not currently contain significant revenue raising measures despite the governor's proposals to increase taxes and shift volatility in the natural resource sector to the PF and PFER from the UGF. The legislature is currently meeting in a special session to debate providing alternative revenue sources for funding the budget. Without enacting new revenue measures, the budget as approved by the legislature relies upon an additional $3.17 billion allocation from the state's reserves (72% of the UGF budget). Due to the reduction in expenditures, reserves at the end of fiscal 2017 are expected to total $10.7 billion, equal to 2.4x the UGF budget.
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 Lumesis and InvestorTools.
U.S. Tax-Supported Rating Criteria (pub. 18 Apr 2016)
Dodd-Frank Rating Information Disclosure Form