Fitch Rates MO Development Finance Board's $88MM Annual Appropriation Bonds 'AA+'; Outlook Stable

NEW YORK--()--Fitch Ratings assigns an 'AA+' rating to the $88.1 million Missouri Development Finance Board (MDFB), state of Missouri annual appropriation bonds (Fulton State Hospital project) series 2014.

The bonds are expected to be sold through competitive bid on or about November 19.

The Rating Outlook is Stable.

SECURITY

The bonds are special obligations of the MDFB, payable from annual state general assembly appropriations.

KEY RATING DRIVERS

APPROPRIATION SECURITY: Bond payments require annual state legislative appropriation, resulting in a rating one notch below the state of Missouri's 'AAA' GO rating. The state, acting through its Office of Administration, covenants to request annually an appropriation from the Missouri legislature to fund payments sufficient to pay debt service on the bonds.

CONSERVATIVE FINANCIAL MANAGEMENT: Missouri has a long record of conservative operations and has consistently displayed a willingness and ability to support fiscal balance including recently following tax changes and a revenue shortfall in fiscal 2014. The state's financial flexibility and healthy liquidity position provide cushion in the event of additional volatility. Missouri's rainy day fund remained fully funded through the recession.

LOW DEBT LEVELS: The state's debt burden is low with minimal GO debt. Bonds issued for transportation needs represent just over 70% of total state net tax-supported debt.

STABLE ECONOMIC PROFILE: While the state's economy generally tracks in a similar direction as the nation, employment gains since the recession trough have been somewhat less robust than the U.S. experience. Positively, recent employment growth has been widespread covering nearly all of Missouri's metro areas and industrial sectors. Missouri's economy remains broad and diverse, with overall sector distribution very similar to the national distribution.

RATING SENSITIVITIES

FUNDAMENTAL CREDIT CHARACTERISTICS: The rating is sensitive to shifts in fundamental credit characteristics, including the state's stable economic profile, proactive and conservative financial management, and very manageable long-term liabilities.

IMPLEMENTATION OF TAX CUTS: Given the state's constrained revenue-raising ability under the Hancock Amendment, Fitch will closely monitor the state's ability to manage the revenue implications of a significant multi-year income tax reduction planned for implementation during fiscal 2017 while maintaining fiscal balance and a stable reserve position. Further, any indication that the governor's concerns about the statutory ambiguity of the legislation are valid would trigger negative rating pressure.

CREDIT PROFILE

The Fulton State Hospital project has been a key executive and legislative priority and won authorization for $200 million in appropriation-supported bonds in the 2014 legislative session. Missouri anticipates issuing the remaining authorization over the next several years to complete the project. The bonds will be issued pursuant to a finance agreement between MDFB, the state's Department of Mental Health and Missouri's Office of Administration (OA). OA covenants to request appropriations in the Governor's annual executive budgets sufficient to pay debt service on the bonds.

Missouri's 'AAA' GO rating reflects a low debt burden, historically conservative financial operations, and a broad and diverse economy. The state has a long record of maintaining fiscal balance through spending restraint. The budget must be balanced, and the governor has strong constitutional authority to withhold funds as needed which he recently utilized. Additional financial flexibility is provided by a budget reserve fund (BRF) equal to 7.5% of net general revenues; notably, reserve funds were not drawn on in the recession.

PRUDENT FINANCIAL MANAGEMENT

Although state revenues were negatively affected during the recession, the state consistently acted to maintain balance. In both fiscal 2009 and 2010, the state revised revenue forecasts downward mid-year, and concurrently implemented multiple rounds of spending cuts. As Missouri climbed out of the recession in fiscal 2011 and 2012, the state maintained tight expenditure controls even as revenues recovered and the state benefited from the tail-end of federal stimulus funds distributions. Fiscal 2012 ended with net general revenues up 3.2% year-over-year, versus a budgeted forecast of 4%. The ending cash balance for fiscal 2012 was $205 million.

Missouri ended fiscal 2013 on a strong note, with surpluses adding to reserve balances. The fiscal year 2013 budget included several minor one-time budget solutions, including $45 million from debt restructuring and use of $40 million in monies from the national mortgage settlement to fund higher education. Final results for the year were strong with net general revenues growing 10.1% year-over-year to $8.08 billion, well ahead of the budgeted 4.8% growth. Personal income tax revenues led the way, up 9% for the year (gross basis), while sales and use tax revenues underperformed by increasing just 1.3% (also gross basis). The state ended the year with reserves in its general fund balance and BRF totaling $951 million, covering a solid 11.7% of final fiscal 2013 net general revenues.

Fiscal 2014 (ended June 30) performance trailed the state's January 2014 revenue estimate with weakness in the key revenue sources of personal income and sales taxes. Revenues were in line with the originally enacted budget, thereby mitigating any need for significant balancing actions, and the state's reserve remains fully funded. Missouri currently estimates fiscal 2014 gross general revenue collections increased a weak 0.2% year over year (yoy) to $9.3 billion versus the January revised revenue estimate of 3.3% growth and the enacted budget estimate of a 0.2% decline. Net of refunds, fiscal 2014 general revenues declined a slight 1% yoy versus the Governor's 2.8% January growth estimate, a shortfall of $307 million.

Gross personal income tax revenues (usually between 55-60% of general revenues) declined 0.2% in fiscal 2014 versus the January estimate of 3.2% growth. The state attributes the weakness primarily to a much sharper than anticipated decline in capital gains related collections after last fiscal year's acceleration of income due to federal tax increases. Gross sales tax revenues (generally 17-18% of general revenue funds revenues) increased 3.8% yoy, which was slightly below the January estimate of 4.2%. The ending general fund balance of $222 million is down from $447.1 million the prior year, but the budget reserve fund remains fully funded at $557.2 million, or 7.5% of prior year net general revenue collections.

The shortfall in fiscal 2014 pressures the fiscal 2015 budget which the state built on a legislative estimate of 2% yoy growth in fiscal 2014. The enacted fiscal 2015 budget assumed 4.2% growth on the legislature's estimate for fiscal 2014 net general revenues, and increased spending in key categories including K-12 and higher education. Given the yoy revenue decline in fiscal 2014, the 2015 budget now requires robust and likely unrealistic 11% yoy growth. The administration's internal estimate is for 5.2% yoy growth in fiscal 2015. To address this revenue gap, the governor implemented $641.6 million in spending restrictions ($136.8 million of which was technically for fiscal 2014 capital spending) and $144.6 million in vetoes on the fiscal 2015 budget. The administration reports that spending cuts primarily address several deficiencies including a series of unfunded statutory tax changes. After the legislature sustained the majority of the vetoes in September, the governor released $166 million in restricted spending.

Revenue growth through the first quarter has been modest at 3.8% yoy versus the administration's 5.2% updated estimate. The state monitors reports revenues on a monthly basis and Fitch anticipates the governor will take timely action, including additional expenditure reductions to ensure structural balance, if revenue growth continues to lag estimates into the latter half of the year.

INCOME TAX CUT COULD REDUCE OUT-YEAR REVENUES

A significant income tax reduction package enacted this year (over a gubernatorial veto) could reduce out-year revenues absent economic growth, and Fitch expects the state will take appropriate action to maintain fiscal balance largely through expenditure management. Under Missouri's Hancock Amendment constitutional provision, the state's ability to raise revenues beyond a generally narrow limit is subject to voter approval or a gubernatorial emergency declaration and approval by two-thirds of the each house of the legislature. The tax cut legislation reduces income tax rates beginning Jan. 1, 2017 with full implementation over five years, with the legislative goal of spurring economic growth. A revenue trigger requiring $150 million in revenue growth in the prior fiscal year to implement each phase of the tax cuts, provides a measure of budgetary protection, but would not account for a rapid current year revenue decline as occurred during the last recession. The legislature estimates that once fully implemented, the tax cut package will cut $620 million from net general revenues on a baseline basis.

In his veto message, the governor raised concerns regarding the statutory language in the tax cut package which could significantly weaken Missouri's fiscal flexibility. Based on an independent legal opinion, the governor asserts the language of the legislation could be interpreted to eliminate all income taxes on incomes above $9,000. If confirmed, that language could jeopardize $4.8 billion, or 97%, of personal income tax revenues. The legislature, citing its own independent legal analysis, disputes that claim. The governor's veto letter further states that a legislative attempt to modify the statutory language could be subject to the state's Hancock Amendment requiring voter approval. Fitch's analysis relies on the official legislative estimate of a $620 million revenue effect, but the agency will closely monitor any developments regarding interpretation of the language cited in the veto letter. Validation of the governor's concerns could trigger negative rating pressure.

BROAD, GROWING ECONOMY

Missouri's economy is broad based and similar in makeup to that of the nation, with recent state employment growth nearing national rates. The state's economic trends have historically moved in line with U.S., though usually at a lesser pace. Missouri's recession recovery has been slower than the U.S., though recent trends indicate some improvement. While the nation saw annual employment gains of 1.2% and 1.7% in 2011 and 2012, respectively, state employment grew just 0.2% and 0.5% in those years. In fiscal 2013 that gap narrowed with state gaining 1.5% versus the national rate of 1.7%. Monthly yoy data for 2014 indicates that Missouri's performance is now on par with the nation. In September, the state's yoy gain of 1.2% matched the national gain, and the same was true for Missouri's three-month moving average of 1.9%. Missouri's unemployment rate has historically been in line with the national rate but recently is trending higher than the U.S. rate reaching 6.3% in September versus the nation's 5.9% rate. Part of the increase could be attributed Missouri's more rapid labor force growth of 1% yoy in September versus the national rate of just 0.3%.

LOW LONG-TERM LIABILITIES BURDEN

The state's debt burden is low, with net tax-supported debt equal to 1.4% of 2013 personal income. Debt levels reflect borrowing for transportation needs, including bonds issued under voter-approved Amendment 3 and grant anticipation revenue vehicle (GARVEE) bonds. Approximately 70% of outstanding tax-supported debt has been issued for transportation purposes. GO bonds constitute only 8.5% of outstanding debt, with the remainder consisting of appropriation-supported issues. Given the state's currently low debt burden, Fitch views the effect of the additional issuance for the Fulton State Hospital project as very manageable.

As of June 30, 2013, the reported funded ratio of the state's largest pension system was 72.7%. Using Fitch's more conservative 7% discount rate assumption rather than the system's 8%, the funded ratio falls to 65.5%. The state has consistently funded its actuarially calculated required contributions to the system with the declining funded ratio due mainly to market volatility which is smoothed in over five years. On a combined basis, the burden of net tax-supported debt and the state's adjusted unfunded pension obligations of 4.5% is well below the 6.1% of personal income median for U.S. states.

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

In addition to the sources of information identified in Fitch's report 'U.S. State Government 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

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

Additional Disclosure

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Contacts

Fitch Ratings
Primary Analyst
Eric Kim
Director
+1 212-908-0241
Fitch Ratings, Inc.
33 Whitehall St.
New York, NY 10004
or
Secondary Analyst
Douglas Offerman
Senior Director
+1 212-908-0889
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
Eric Kim
Director
+1 212-908-0241
Fitch Ratings, Inc.
33 Whitehall St.
New York, NY 10004
or
Secondary Analyst
Douglas Offerman
Senior Director
+1 212-908-0889
or
Committee Chairperson
Karen Krop
Senior Director
+1 212-908-0661
or
Media Relations
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com