NEW YORK--(BUSINESS WIRE)--Fitch Ratings has assigned an 'A+' rating to the Pennsylvania Commonwealth Financing Authority's (CFA) $767,875,000 revenue bonds, series A of 2016.
The bonds are expected to sell on or about the week of Oct. 17, 2016 through negotiated sale.
In addition, Fitch has affirmed the 'A+' rating on $1.6 billion in outstanding CFA revenue bonds
The Rating Outlook is Stable.
SECURITY
The revenue bonds are limited obligations of the authority secured by service fees paid by various commonwealth agencies to the authority and assigned to the trustee. Act 85 of 2016 established a continuing appropriation of Article II revenues from Pennsylvania's general fund to a restricted account to be used for debt service. The continuing appropriation does not require annual renewal but can be amended or repealed by the legislature.
KEY RATING DRIVERS
APPROPRIATION SECURITY
Fitch views appropriations for CFA debt service payments as subject to legislative discretion, despite the continuing deposit of Article II revenues for the benefit of CFA included in statute, resulting in a rating one-notch below Pennsylvania's 'AA-' Issuer Default Rating (IDR). A 2016 statutory change allocates specific general fund revenues (Article II revenues, mainly sales tax) for debt service on all authority revenue bonds through maturity without requiring additional legislative action. While no annual legislative appropriation is required, the legislature retains the ability to alter or repeal the continuing appropriation with a statutory change.
SERVICE FEE AGREEMENTS IN PLACE
All CFA revenue bonds also benefit from service fee agreements with commonwealth agencies. The agreements require payments from the agencies to support CFA debt service in addition to the continuing appropriation of Article II revenues. Under the agreements, the agencies covenant to seek annual appropriations in amounts sufficient to pay debt service on CFA revenue bonds.
Economic Resource Base
Pennsylvania's broad-based economy is growing, but at a slower pace than the nation. Below-average demographics, including population growth that has lagged the nation's for several decades, represent a long-term drag on economic growth. Ongoing development of Pennsylvania's significant natural gas reserves could mitigate that concern, but a weakened market tempers that potential. Overall, the state's economy provides a solid base for future potential revenue growth to help manage ongoing expenditure pressures.
Revenue Framework: 'aa' factor assessment
Fitch expects Pennsylvania's revenues, primarily income and sales taxes, will continue to reflect the depth and breadth of the economy, but also its slower pace of growth. The commonwealth has complete legal control over its revenues.
Expenditure Framework: 'aa' factor assessment
The commonwealth maintains solid expenditure flexibility with a moderate burden of carrying costs for liabilities and the broad expense-cutting ability common to most U.S. states. Also, as with most states, Medicaid remains a key expense driver but one that Fitch expects to remain manageable.
Long-Term Liability Burden: 'aa' factor assessment
Pennsylvania's long-term liability burden is moderate but above average for a state driven by unfunded pensions. Net tax-supported debt is low. Pension funded ratios have eroded with contributions long below actuarial levels, but the commonwealth is nearing full funding of its contributions following a multiyear ramp up, which may help stabilize ratios.
Operating Performance: 'aa' factor assessment
The commonwealth retains very strong gap-closing capacity to deal with a cyclical downturn given its general budgetary flexibility. Pennsylvania is somewhat less exposed to revenue volatility due to economic declines than most states. Pennsylvania continues to utilize material nonrecurring budgetary measures during the economic recovery, with recent efforts towards reducing the reliance stymied by as-yet unresolved differences between executive and legislative branch approaches.
RATING SENSITIVITIES
IDR LINKAGE: The rating on the bonds is sensitive to changes in the state's IDR, to which it is linked.
CREDIT PROFILE
The 'A+' rating on the CFA revenue bonds reflects the credit of the commonwealth (IDR of 'AA-' with a Stable Outlook) and the state appropriation commitment. The bonds are special obligations of the CFA, which was created in 2004. Debt service is now derived first from a statutory continuing appropriation of Article II revenues (the statewide 6% sales tax and 6% hotel tax) to a restricted account within the commonwealth's general fund. This account can only be applied toward payments of CFA debt service. The monthly Article II transfers by the state treasurer are made pursuant to a letter agreement with the treasurer and equal one-sixth of biannual interest payments and 1/12th of annual principal payments. Under the agreement, the payments are timed to be fully accumulated 30 days prior to debt service due dates. Article II revenues provide ample coverage of the monthly transfers.
The continuous appropriation of Article II revenues for debt service was enacted by the 2016 legislature and remains effective unless the legislature affirmatively chooses to amend or repeal it. The appropriation continues in the event of a budget impasse, such as the nine-month delay in enacting the fiscal 2016 budget.
In the event the Article II transfers are insufficient, the bonds are also secured by payments from the commonwealth to the CFA under multiple service agreements, subject to annual legislative appropriation. The secretary of the Department of Community and Economic Development (DCED) and the secretary of the budget have covenanted to seek such appropriations for prior CFA issuances. The secretary of education and the secretary of the budget have made similar covenants for the series 2016A bonds.
The 2016 bonds were authorized under Act 25 of 2016 and will finance the commonwealth's partial reimbursement of debt service paid by local school districts under the Planning and Construction Workbook program (PlanCon). Act 25 authorized up to $2.5 billion in CFA revenue bonds for PlanCon, subject to certain increases. Proceeds of the series 2016A bonds will fund the fiscal 2017 reimbursements and outstanding amounts owed to school districts. Act 25 also halted the department of education's approval of additional PlanCon reimbursement requests after May 16, 2016 and established an advisory committee to study the structure of future commonwealth reimbursements for school districts' debt service.
The CFA is staffed through DCED and is governed by a seven member board including both executive and legislative appointees. The CFA and DCED have regularly met their covenants to request full appropriation of debt service from the general fund in annual budget requests. Partially as a budget management tool in fiscal 2015 (and also in fiscal 2011), Pennsylvania's budget relied on the CFA's use of available interest earnings, in addition to state appropriations, to fund CFA debt service. Interest earnings are pledged to bondholders.
CFA has also issued debt under three additional, separate programs; the original programs primarily for economic development, the alternative energy program, and the H2O PA program for water and sewer infrastructure. All CFA revenue bond programs benefit from the continuous appropriation of Article II revenues and the service fee agreements for the payment of debt service.
COMMONWEALTH OF PENNSYLVANIA IDR
Pennsylvania faces fiscal pressures in the form of a structurally unbalanced budget, brought on by a combination of rising fixed costs, modest baseline revenue growth, and a particularly contentious decision-making environment. The 'AA-' IDR reflects those limiting factors, as well as Fitch's expectation that the commonwealth will utilize the significant budgetary flexibility available to most states to respond to those pressures adequately, while also making progress toward structural budgetary balance. Pennsylvania benefits from a large, diversified and expanding, albeit slowly, economic base which is expected to provide adequate revenue capacity to match expenditure growth.
Current Developments
Pennsylvania's fiscal 2017 budget makes progress on, but does not fully resolve the commonwealth's sizable structural budget gap. The budget increases funding for policy areas including K-12 education while meeting Pennsylvania's statutory commitment toward full actuarial pension funding. However, it relies on a mix of recurring and non-recurring measures to achieve balance. Last December, the commonwealth's Independent Fiscal Office (IFO) estimated a nearly $2 billion fiscal 2017 structural gap for the general fund (6% of then projected revenues). Fitch anticipated gradual progress towards structural balance, which this budget achieves. Pennsylvania still faces obstacles and difficult decisions before it can fully align recurring revenues and expenditures.
For further information on the state, please see 'Fitch Rates Commonwealth of Pennsylvania's $990.55MM GOS 'AA-'; Outlook Stable' dated May 20, 2016, available at 'www.fitchratings.com'.
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.
Applicable Criteria
U.S. Tax-Supported Rating Criteria (pub. 18 Apr 2016)
https://www.fitchratings.com/site/re/879478
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Dodd-Frank Rating Information Disclosure Form
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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1012815
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