Fitch Rates Washington's $765MM GO Bonds 'AA+'; Outlook Stable

NEW YORK--()--Fitch Ratings has assigned an 'AA+' rating to the following state of Washington general obligation (GO) bonds:

--$526,060,000 various purpose GO refunding bonds, series R-2015C;

--$238,600,000 motor vehicle fuel tax GO refunding bonds, series R-2015D.

The bonds are expected to be sold on Oct. 15, 2014.

The Rating Outlook is Stable.

SECURITY

The bonds are GOs of the state to which its full faith, credit, and taxing power are pledged. Motor vehicle fuel tax GO bonds are first payable from state excise taxes on motor vehicle and special fuels.

KEY RATING DRIVERS

SOLID ECONOMY: Washington's economy is characterized by generally sound performance and increased diversification. The manufacturing sector remains concentrated in the cyclical aerospace industry, although this concentration is sharply reduced. Economic growth prior to the recession was primarily due to strength in construction, aerospace (Boeing), and technology (Microsoft), and these remain economic drivers.

RESPONSIVE FINANCIAL MANAGEMENT: Frequent reviews of economic and financial forecasts allow the state to react to changing conditions. As the economy and revenues repeatedly underperformed estimates in the recession, the state demonstrated its willingness and ability to take actions to maintain budget balance. The state has since experienced steady improvement in its economic and revenue results, and the budget for the current biennium continues to replenish a cushion against future underperformance.

CONCENTRATED REVENUE SYSTEM: The state, with no income tax, relies on consumption-based revenues. This makes Washington particularly vulnerable to reductions in consumer spending.

ABOVE-AVERAGE LIABILITY BURDEN: Debt ratios are in the upper moderate range and expected to remain so. This reflects funding of substantial capital needs, particularly for transportation. Although the state's unfunded pension liability is well below average, the combined burden of debt plus pensions is above the median for U.S. states.

INITIATIVES AND REFERENDA A LIMITED RISK: Washington's initiative and referendum environment creates a level of operating and financial uncertainty. However, any law approved by voters in this manner can be amended or repealed by the legislature by a two-thirds vote in the first two years after approval and by a simple majority thereafter.

RATING SENSITIVITIES

The 'AA+' rating and Stable Outlook assume the state's continued ability to maintain budget balance and an adequate reserve position in the face of funding demands presented by an education-funding court decision and transportation needs.

CREDIT PROFILE

Washington's 'AA+' GO bond rating reflects a generally solid economy and a demonstrated commitment to fiscal balance even as the state's financial position substantially weakened in the downturn. Credit strengths are offset by a concentrated revenue system that is reliant on the sales tax, with no income tax, as well as above-average debt levels. Economic and revenue growth in the recovery has allowed the state to begin to replenish its financial cushion, and the budget for the current fiscal 2013-2015 biennium continues to build reserves. Since the start of the biennium on July 1, 2013, the general fund revenue forecast has been raised repeatedly, 2% in aggregate, to $33.3 billion.

IMPROVING FISCAL POSITION

Washington's reliance on a broad-based sales tax makes it particularly vulnerable to reductions in consumer spending. State general fund revenue declines of 9.6% in fiscal 2009 and 4.1% in fiscal 2010 were followed by growth of 7.9% in fiscal 2011, reflecting in part tax increases enacted in April 2010, 1.5% in fiscal 2012, and 6.1% in fiscal 2013. The most recent forecast, from September 2014 and increased from levels assumed in the enacted budget, projects revenues up 3.8% in fiscal 2014 and 3.5% in 2015.

The state reviews its general fund revenue forecast quarterly. Actual revenue performance underperformed downwardly revised estimates in the recession repeatedly and significantly. Budget balance was maintained through a combination of ongoing and one-time actions, including a drawdown of reserves. More recent performance has been positive, with repeated modest forecast changes upward.

Despite continued revenue growth, budgeting for the current fiscal 2013-2015 biennium was challenging. Washington had already taken extensive spending control action in the downturn, and there was not sufficient support for significant revenue increases to support new spending demands. Adding to the challenge, a new statutory requirement mandated that the budget show projected balance over a four-year period rather than just the biennium.

The enacted budget was passed unusually close to the start of the new biennium and following preparation for a possible partial government shutdown. A key source of debate was the amount of additional money necessary to address a 2012 state Supreme Court decision that found state education funding inadequate. The court decision provided the state flexibility in terms of the timing and amount of remediation, although a goal of $3 billion-$3.5 billion in total incremental revenue by 2018, consistent with 2009 legislation, is often cited. The state calculated that $1 billion in additional funding was provided towards this goal with the budget, although that includes the continued suspension of a scheduled raise for teachers that was passed by voter initiative but has been repeatedly suspended.

Significant additional education funding in future biennia is believed necessary to satisfy the court mandate, and this will be a key source of pressure in the budget for the next biennium. Last month, the state supreme court found the state in contempt over its failure to provide a detailed long-term funding plan to meet the 2018 goal, but gave the state time to respond in the 2015 legislative session before taking any further action. In addition, a voter initiative on the November ballot would require significant funding for class size reduction; Fitch notes that even if approved by voters such requirement could be amended or repealed by the legislature by a two-thirds vote, and the legislature has suspended and repealed such measures repeatedly in the past.

The ending balance and reserve total for the biennium that closed on June 30, 2013 totaled $438 million, 2.7% of fiscal 2013 revenues. This is projected to rise to $1.2 billion, 7% of fiscal 2015 revenues, by the end of the current biennium. Fitch views positively the replenishment of reserves and the state's reserve funding provisions. In November 2007, voters approved a constitutional budget stabilization account that receives 1% of revenues off the top every year, capped at 10% of annual general revenues. Although there are restrictions on use, these monies were depleted during the recession. In 2011, voters approved another constitutional amendment that requires that any extraordinary growth in state revenue (defined as growth in general state revenues that exceeds by one-third the average biennial growth of the prior five biennia) shall be transferred to the budget stabilization account on top of the 1%.

Although budget balancing solutions for the current biennium did not include significant revenue-raising actions, a 2013 court decision declared unconstitutional a voter initiative-based requirement that tax increases be passed with a supermajority legislative vote. This provides some increased flexibility in this area as the state confronts funding pressures in future biennia.

SOLID ECONOMIC PROFILE

Washington State's economy, historically reliant on manufacturing supplemented by regional and international trade and tourism, has broadened. Areas of concentration (Boeing and Microsoft) offer relatively high-wage employment, and the population is well educated. In addition, population growth has far exceeded that of the U.S. as a whole. Following a vote by the machinists union in early 2014 and a state incentive package passed by the legislature last year, Boeing will manufacture its new 777X jetliner in the state. This was positive news for the Washington economy, as the company had been considering production in other states.

Washington's economy entered the recession later than the U.S. overall following a period when it performed much more strongly than the nation. Peak-to-trough, the state's non-farm employment decline was slightly lower than that of the nation (down 5.2% vs. 5.6%), and the recovery has been stronger (up 5.3% through 2013, compared to the nation's 4.7%). In August 2014, Washington's year-over-year job growth of 2.2% compared to the 1.8% rate for the nation. The state's unemployment rate in August was 5.6%, 92% of the U.S. rate.

Per capita personal income is above average, at 107% of the U.S. in 2013, 12th highest of the states. Recent personal income growth has been comparatively strong.

WELL ABOVE-AVERAGE DEBT LEVELS; NEAR MEDIAN WHEN PENSIONS ADDED

Washington's debt levels are in the upper moderate range and well above average for a U.S. state, with net tax-supported debt equal to 6% of personal income. Debt is primarily GO. Capital needs are substantial, particularly for transportation, and tolling is part of the funding solution. Positively, the state has increased its focus on debt affordability. In November 2012, voters approved a constitutional amendment that tightened the constitutional debt limit.

The state administers 13 defined benefit retirement plans, three of which have hybrid defined benefit/defined contribution options. The closed public employees and teachers plans (PERS1 and TRS1), which have been closed since 1977, are underfunded. However, Fitch believes that the unfunded liability is manageable. The state supreme court recently upheld pension reforms that had been subject to longstanding legal challenge.

On a combined basis, Washington's burden of net tax-supported debt and adjusted unfunded pension obligations, at 7.9%, is above the 6.1% of personal income median for U.S. states. OPEB benefits are limited and funded on a pay-as-you-go basis.

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

In addition to the sources of information identified in Fitch's report 'Tax-Supported Rating Criteria', this action was additionally informed by information from IHS Global Insight.

Applicable Criteria and Related Research:

--'Tax-Supported Rating Criteria', dated Aug. 14, 2012;

--'U.S. State Government Tax-Supported Rating Criteria', dated Aug. 14, 2012.

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

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=890414

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Contacts

Fitch Ratings, New York
Media Relations
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com
or
Primary Analyst
Managing Director
Laura Porter, +1-212-908-0575
or
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Director
Eric Kim, +1-212-908-0241
or
Committee Chairperson
Senior Director
Karen Krop, +1-212-908-0661

Contacts

Fitch Ratings, New York
Media Relations
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com
or
Primary Analyst
Managing Director
Laura Porter, +1-212-908-0575
or
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Director
Eric Kim, +1-212-908-0241
or
Committee Chairperson
Senior Director
Karen Krop, +1-212-908-0661