Fitch Rates Virginia Public Bldg Auth's $480MM Revs 'AA+'; Outlook Stable
NEW YORK--(BUSINESS WIRE)--Fitch Ratings assigns an 'AA+' rating to the following Virginia Public Building Authority (VPBA) bonds:
--$117,940,000 public facilities revenue bonds, series 2014A;
--$44,615,000 public facilities revenue bonds, series 2014B (taxable);
--$317,135,000 public facilities revenue refunding bonds, series 2014C.
The bonds are expected to sell via competitive bid on August 27, 2014.
In addition, Fitch affirms the 'AAA' ratings on the Commonwealth of Virginia's $1.7 billion in outstanding general obligation (GO) bonds. Fitch also affirms the 'AA+' ratings on the commonwealth's appropriation-backed debt as detailed at the end of this release.
The Rating Outlook is Stable.
The bonds represent a limited obligation of the authority, payable from General Assembly appropriations.
KEY RATING DRIVERS
COMMONWEALTH APPROPRIATION OBLIGATION: The 'AA+' rating on the VPBA bonds, one notch below the commonwealth's 'AAA' Fitch GO rating, is based on debt service paid from direct payments made by the Commonwealth of Virginia, subject to legislative appropriation.
CONSERVATIVE FINANCIAL MANAGEMENT: The commonwealth's financial operations are conservatively managed with periodic revenue forecast updates and a constitutional revenue stabilization fund (RSF). The commonwealth has a history of making prompt adjustments to respond to fiscal uncertainties.
DIVERSE ECONOMY WITH HIGH WEALTH LEVELS: The commonwealth benefits from a diverse economy with relatively low unemployment and high wealth levels. As anticipated, federal government contraction weakened economic growth trends though Fitch still views Virginia's economic profile as strong.
MODERATE LIABILITY LEVELS: Virginia's debt ratios are in the moderate range, maintained through deliberate policy and above-average amortization. Capital needs for education and transportation improvements remain significant and issuance has accelerated in recent years. While the funded status of Virginia's retirement system declined in recent years, due in part to an underfunding of actuarially-calculated annual required contributions (ARC) to the system, unfunded liabilities as a percentage of personal income remain below average for U.S. states.
GO-LINKAGE FOR APPROPRIATION BONDS: The rating on the bonds is sensitive to changes in the commonwealth's GO rating, to which it is linked.
MANAGEMENT OF FISCAL PRESSURE: The GO rating is sensitive to Virginia's continued timely and responsive budgetary actions. The Stable Outlook assumes Virginia responds to an emerging budgetary imbalance in a manner consistent with past practice. Overreliance on nonrecurring measures or evidence of reduced budgetary flexibility could pressure the rating.
The 'AA+' rating is based on the pledge of appropriations by the commonwealth, whose GOs are rated 'AAA' by Fitch. Debt service for the bonds being offered derives from direct payments made by the commonwealth, subject to legislative appropriation. The bonds are issued under the 1997 master indenture and various supplemental indentures, which utilize a single payment agreement providing for bond debt service. There is no security interest in the projects financed under the master indenture. Proceeds from the current offering will be used to finance certain capital projects and to refinance certain outstanding VPBA bonds for debt service savings.
Authorization, oversight and management of appropriation-backed debt is centralized and well established in the commonwealth. Additionally, by practice, the legislature makes a single debt service appropriation for the bulk of the commonwealth's debt obligations, including its GO bonds and authority debt service. The authority's financings involve central commonwealth agencies, including the authority and the treasury board, which approves all bond issues payable from commonwealth appropriations. Appropriation-backed debt is an important element of the commonwealth's debt structure.
COMMONWEALTH FINANCES PRESSURED BUT EXPECTED TO BALANCE
Virginia's 'AAA' GO rating reflects its solid fiscal resources, conservative approach to financial operations which includes periodic revenue forecast updates, strong fundamental economic profile, and moderate liability levels. Economic and revenue performance underperformed notably in fiscal 2014 compared to earlier forecast expectations, the result both of the continuing timing impact of 2013 federal tax law changes on state tax filers and the commonwealth's exposure to ongoing federal contraction. Commonwealth fiscal 2014 general fund revenues declined 1.6% yoy versus the 1% forecasted gain. A pullback of non-withholding income tax revenues (following last year's over-performance due to federal tax law changes) accounted for 92% of the negative variance. The commonwealth was able to address the resulting $438 million revenue gap in fiscal 2014 largely through use of ending fund balances as the timing of the gap (opening up in May with final 2013 tax filings) precluded substantial expenditure reductions within the fiscal year. The commonwealth left its revenue stabilization fund (RSF) untapped in fiscal 2014, and instead made its constitutionally required deposit of $244.6 million, bringing its balance to $687.5 million (inclusive of projected interest earnings).
Weaker spring 2014 revenue collections also affected the baseline revenue forecast for the fiscal 2015 and 2016 biennium. In total, the adopted biennial budget for fiscal 2015 and 2016, reflecting the underperforming spring 2014 revenue collections, closed gaps totaling $1.6 billion arising from lowered forecast revenues, consisting of a $350 million in fiscal 2014 and $600 million in fiscal 2015 and 2016. The adopted plan closed the then-expected cumulative gap through a planned $705 million RSF draw and an $846.1 million 'revenue reserve,' the latter consisting of reductions to recurring expenditures from executive budget baseline levels.
In August, the commonwealth refined its revenue forecast further, lowering forecast baseline revenues during the fiscal 2015-2016 biennium further from the reduced levels already assumed in the adopted budget. The August 2014 forecast revision anticipates revenue growth at 2.7% both years, well below the earlier forecast of 5.2% and 4.1% growth in fiscal 2015 and 2016, respectively. Consequently, budgetary gaps have reopened, with the commonwealth now estimating a remaining cumulative budget gap of $881.8 million ($346 million in fiscal 2015 and $536 million in fiscal 2016).
Fitch anticipates the commonwealth will address the new $881.8 million biennial revenue gap in a structurally sound manner, largely weighted towards expenditure reductions, particularly given that the adopted budget already incorporates sizable RSF draws. The governor will develop a plan to address the fiscal 2015 gap within the next weeks or months, with recommendations for fiscal 2016 to follow in December before the next legislative session. Within the budget appropriation act, the governor retains authority to withhold up to 15% of general fund agency appropriations to maintain fiscal balance.
The 'revenue reserve' spending actions incorporated in the enacted biennial budget mitigated the need for more substantial budget balancing actions after the start of the biennium. Fitch views the legislature's quick incorporation into the budget of the expenditure reductions in form of a revenue reserve following indications of a revenue shortfall in fiscal 2014 as reflective of the state's commitment to timely and forward-looking budgetary actions.
Planned draws on the RSF during the current biennium will reduce the flexibility provided by the fund, but constitutional provisions requiring deposits to the RSF based on past strong revenue performance should allow the state to maintain a modest reserve and allow for timely restoration as revenues recover. The biennial budget includes $705 million in draws, with $470 million planned for fiscal 2015 and $235 million planned for fiscal 2016. As of June 30, 2014, the RSF balance stood at $687.5 billion, inclusive of a $244.6 million deposit made during fiscal 2014. In fiscal 2015, the budget includes a $243.2 million deposit to the RSF, resulting in net use of $226.8 million during the current fiscal year and a projected ending RSF balance of $470.1 million (inclusive of interest earnings). Following the budgeted fiscal 2016 draw, Fitch anticipates a RSF balance of $238.1 million at the end of the current biennium, or a low 1.5% of fiscal 2014 general fund revenues.
POLITICALLY CHARGED BUDGET ADOPTION PROCESS
The budget adoption process for the current biennial budget was colored with significant political challenges that delayed final enactment well past Virginia's historical practice, though the commonwealth enacted a budget before the start of the biennium. Fitch anticipates some level of continued partisan disputes, particularly over the governor's desire to expand health insurance access under the federal Affordable Care Act.
ECONOMIC GROWTH SLOWING
In addition to the unexpectedly large pullback in non-withholding income, a small portion of the fiscal 2014 revenue weakness likely reflects effects of federal sequestration, as well as last year's federal shutdown, which Fitch anticipated would both negatively affect the commonwealth's general fund tax revenues given Virginia's exposure to federal government and government-related employment. Withholding tax revenues and sales and use tax revenues (on an economic basis, excluding statutory changes) both fell short of the official forecast although they were up yoy. Personal income tax withholding revenues increased 2.3% yoy to $10.5 billion versus the forecasted 2.9% growth (a $66 million negative variance), and sales and use tax revenues increased 0.8% on an economic basis (excluding statutory changes) versus the 1.6% forecast increase (a $12.9 million negative variance).
Fitch anticipates ongoing federal contraction to remain a headwind to economic and revenue growth in the commonwealth. The commonwealth's August economic forecast assumes continued below-national trends growth in employment and income due to ongoing effects of federal contraction, particularly in defense spending, to which Virginia is particularly exposed. For fiscal 2015, the August revenue forecast update assumes a modest 2.7% growth in personal income tax withholding revenues, reflecting this persistent drag.
Overall, Virginia's economic profile remains strong with a diverse mix of industries and high wealth levels and Fitch expects the commonwealth to absorb the negative effects of federal contraction and maintain economic growth, albeit reduced from prior years. Government and professional and business services are the leading industrial sectors, accounting for 17.9% and 17.8% of the June 2014 employment base, versus 14.9% and 14% for US respectively. Virginia's recent employment growth rates lag the national trend with annual growth of 1.1% and 0.7% in 2012 and 2013, respectively, versus a national rate of 1.7% in both years. The commonwealth's July employment increased a weak 0.8% versus 1.9% for the nation, and overall levels for Virginia were still just short of its pre-recession peak (99.9%) while the nation exceeded its pre-recession peak that same month. The commonwealth's unemployment rate (5.4%) remains below the national rate (6.2%) but the spread has narrowed over the past year.
Virginia's above-average per capita personal income and below average poverty rate reflects its high wealth levels, though the rate of personal income growth in recent years trails national and regional trends. Federal contraction could be a driving factor here as multiple federal agencies and contractors based in Virginia, including the Department of Defense, implemented the first round of federal sequestration beginning in March 2013 primarily through furloughs, resulting in reduced personal income for employees.
Despite the pressures related to federal contraction, the commonwealth maintains other fundamental economic strengths that should support continued growth. High-tech employment (as defined by the federal Bureau of Labor Statistics) remains robust in Virginia. Between 2003 and 2013, average annual growth of 2.5% in the commonwealth significantly outpaced the national trend of just 1%. Virginia's educational attainment levels are significantly ahead of the national average with 34.7% of those 25 and older with a bachelors degree versus 28.5% nationally. Population growth has been above average in Virginia at 3.2% since 2010 versus 2.4% for the U.S.
WELL-MANAGED DEBT PROFILE
The commonwealth's debt ratios are in the moderate range and have grown in recent years, but remain manageable. As of June 30, 2013, net tax-supported debt totaled approximately $10.7 billion, equal to 2.7% of 2013 personal income. GO debt constitutes only approximately 15.5% of net tax-supported debt, with the remainder principally represented by various appropriation credits. Certain appropriation-linked debt is excluded from Fitch's calculation of state debt due to a track record of self-support. Capital needs for higher education and transportation improvements remain large with substantial authorized but unissued bonds.
Virginia's debt management practices should allow it to absorb continued issuance to meet capital demands without meaningfully changing debt ratios. The commonwealth manages its debt burden primarily through its Debt Capacity Advisory Committee, which provides annual guidance to the legislature and governor on Virginia's debt burden and ability to absorb additional issuance. The most recent report (issued in December 2013) projects additional capacity for authorization and issuance of $560 million in both fiscal 2014 and 2015, above the approximately $4 billion already authorized but not yet issued.
PENSION LIABILITIES UNDER CONTROL
On a combined basis, the burden of the commonwealth's net tax-supported debt and unfunded pension obligations equals 4.8% of 2013 personal income, below the median of 6.1% for U.S. states. The adjusted calculation includes the commonwealth's portion of the total unfunded liability of the Virginia Retirement System (VRS) covering only commonwealth employees, and the full liability for several much smaller systems where the commonwealth is the sole employer.
The system-wide funding of the VRS declined in recent years in part due to underfunding of contributions (partially used as a budget balancing measure), and as of the June 30, 2012 valuation the funded ratio on a reported basis was 65.8%, down from 84% funded on June 30, 2009. As of 2011, the system utilizes a 7% investment return assumption, in line with Fitch's standard adjustments to pension system liability calculations for other governments. In recent years, the commonwealth enacted pension reforms addressing required contribution levels and various plan design changes, all expected to limit further growth in the commonwealth's pension liabilities in the coming years.
Importantly, the commonwealth anticipates phasing back in full ARC payments by fiscal 2019. Funded ratios will likely weaken until then, though Fitch does not anticipate material reductions, absent significant investment market declines. Positively, the fiscal 2015-2016 biennial budget maintains the phase-in for full ARC payments despite the budgetary pressures noted earlier.
Virginia's OPEB liabilities remain very manageable. On a reported basis, the commonwealth's $5.1 billion in total OPEB liabilities as of June 30, 2013 represented only 1.3% of personal income. After adjusting for the portion directly attributable to the commonwealth, Fitch estimates Virginia's direct OPEB liabilities at approximately $3 billion, or just 0.7% of personal income.
As noted earlier in this release, Fitch also affirms the 'AA+' ratings and Stable Outlook on the following Commonwealth appropriation-backed credits:
--$2.5 billion VA Public Building Authority - Public Facilities Revenue Bonds;
--$3.5 billion VA Public School Authority - School Financing Bonds and School Educational Technology Notes;
--$1.8 billion VA College Building Authority - Public Higher Education Financing Program Bonds;
--$2.7 billion VA College Building Authority - 21st Century College & Equipment Program Bonds;
--$228.6 million VA Port Authority - Commonwealth Port Fund Revenue Bonds;
--$16.7 million Big Stone Gap Redevelopment and Housing Authority - Correctional Facilities Lease Revenue Bonds;
--$35.3 million Virginia Biotechnology Research Partnership Authority - Commonwealth of VA Lease Revenue Bonds;
--$77.5 million Fairfax County Economic Development Authority- Commonwealth of VA Lease Revenue Bonds.
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.
Applicable Criteria and Related Research:
--'U.S. State Government Tax-Supported Rating Criteria' (Aug. 14, 2012).
Applicable Criteria and Related Research:
U.S. State Government Tax-Supported Rating Criteria