Fitch Rates $300MM VA Commonwealth Transportation Board Revs 'AA+'; Affirms 'AAA' Commonwealth GOs

NEW YORK--()--Fitch Ratings has assigned a 'AA+' rating to $300 million in Commonwealth Transportation Board (CTB), Commonwealth of Virginia, Transportation Capital Projects Revenue Bonds, Series 2016.

The bonds are expected to price through competitive bid on May 4, 2016.

In addition, Fitch has affirmed the 'AAA' ratings on the Commonwealth of Virginia's outstanding general obligation (GO) bonds and the 'AA+' ratings on the Commonwealth's appropriation-backed debt as detailed at the end of this release.

Fitch has also assigned an Issuer Default Rating (IDR) of 'AAA' to the state. The IDR reflects application of Fitch's revised criteria for U.S. state and local government credits, which was released on April 18, 2016. The IDR equals the GO debt rating, as GO pledges reflect the unsecured general credit quality of the issuer.

The Rating Outlook is Stable.

SECURITY

The bonds are limited obligations of the CTB, secured by and payable from general assembly appropriations or CTB allocations from general assembly appropriations. The rating is based on ultimate access to general assembly appropriations, not limited to transportation revenues; as such, the bonds are rated one notch below the state's IDR.

Despite the access to Commonwealth appropriations at large, the bonds are expected to be paid from the Priority Transportation Fund (within the broad Transportation Trust Fund [TTF]), backstopped by access to the TTF. The TTF's revenue composition can be altered by the legislature.

KEY RATING DRIVERS

Analytical Conclusion:

Virginia's 'AAA' IDR rating reflects its solid fiscal resources, conservative approach to financial operations, and exceptional financial flexibility. The state's strong fundamental economic profile provides a stable revenue base and indicates solid growth prospects. Low long-term liability levels indicate the Commonwealth retains ample capacity.

Economic Resource Base:

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. Government and professional and business services are the leading sectors. Government employment has been flat to declining for the past several years, but professional and business services employment has grown rapidly since mid-2014 declines, driving overall gains in the Commonwealth's employment levels. Growth prospects are solid with above-average population growth and high education levels signaling a well-positioned workforce.

Revenue Framework: 'aa' factor assessment

Fitch expects that Virginia's revenues, primarily income and sales taxes, will continue to reflect the depth and breadth of the economy, but also its volatility. The Commonwealth has complete control over its revenues, with an unlimited legal ability to raise operating revenues as needed.

Expenditure Framework: 'aaa' factor assessment

The Commonwealth maintains ample expenditure flexibility with a low 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: 'aaa' factor assessment

Virginia's long-term liability burden is low and well-managed. Debt issuance is carefully monitored through both constitutional limitations and more stringent policy and institutional practices. Despite a budget-driven deferral of pension contributions that weakened the funded position, the Commonwealth's unfunded obligations remain below those of most states.

Operating Performance: 'aaa' factor assessment

The Commonwealth remains extremely well-positioned to deal with economic downturns, with exceptionally strong gap-closing capacity in the form of its control over revenues and spending and a demonstrated willingness to restore financial flexibility at times of recovery.

RATING SENSITIVITIES

SOLID FINANCIAL MANAGEMENT: The rating is sensitive to shifts in Virginia's fundamental credit characteristics including its history of timely action to address budgetary challenges, as demonstrated most recently in the response to the 2014 revenue shortfall.

CTB BONDS: The rating for the CTB bonds is sensitive to changes in the Commonwealth's 'AAA' IDR, to which it is linked.

CREDIT PROFILE

Revenue Framework

Virginia's income tax serves as the primary revenue source, accounting for nearly two-thirds of general fund revenues. The sales tax is the next largest component and together these economically sensitive taxes provide essentially the basis for the Commonwealth's revenue framework.

Historical revenue growth, adjusted for the estimated impact of policy changes, has been essentially flat on a real basis over the last ten years. Robust growth in years of economic gains is offset by sometimes sharp declines when the economy contracts. The Commonwealth now caps estimated growth in the most volatile portion of its key tax revenues (non-withholding personal income taxes) to support budget stability, but Fitch anticipates the long-term trend for revenue growth will be in line with historical performance.

Virginia has no legal limitations on its ability to raise revenues through base broadenings, rate increases, or the assessment of new taxes or fees. As recently as 2013 the legislature and governor exercised this ability and made changes to the tax and fee structure supporting transportation to generate substantial new recurring revenues.

Expenditure Framework

As in most states, education and health and human services spending are Virginia's largest operating expenses. Education is the larger line item, as the state provides significant funding for local school districts and an extensive public university and college system. Health and human services spending is the second largest area of spending, with Medicaid being the primary driver.

Spending growth, absent policy actions, will likely be slightly ahead of revenue growth driven primarily by Medicaid, requiring regular budget measures to ensure ongoing balance. The fiscal challenge of Medicaid is common to all U.S. states and the nature of the program as well as federal government rules limit the states' options in managing the pace of spending growth. In other major areas of spending such as education, Virginia is able to more easily adjust the trajectory of growth since it does not retain responsibility for direct service delivery and there is no notable pressure for significant increases in state support. Overall, Virginia retains ample ability to adjust expenditures to meet changing fiscal circumstances.

Long-Term Liability Burden

Virginia maintains a modest long-term liability burden that should remain very manageable. Per Fitch's October 2015 State Pension Update report, the Commonwealth's total net tax-supported debt and unfunded pension liabilities of $20 billion made up just 4.8% of 2014 personal income compared to the 50-state median of 5.8%.

GO debt constitutes only approximately 15% of the Commonwealth's net tax-supported debt, with the remainder principally represented by various appropriation credits. Capital needs for higher education and transportation improvements remain large, with substantial authorized but unissued bonds. Virginia uses a statutorily-established joint executive-legislative committee to annually assess the Commonwealth's debt capacity. The committee's findings are recommendations but the governor and legislature typically abide by them.

In recent years, the Commonwealth enacted pension reforms affecting required contributions and plan design, all expected to limit further growth in the Commonwealth's pension liabilities in the coming years. Systemwide funding of the primary state retirement system (Virginia Retirement Systems, or VRS) declined in recent years in part due to underfunding of actuarial contributions (partially used as a budget balancing measure). Positively, the biennial budget plan for fiscal 2017 - 2018 accelerates the phase-in for full ADEC payments by one year to fiscal 2018. The use of a 7% investment return assumption is notably conservative relative to other major state systems.

Operating Performance

Virginia's ability to respond to cyclical downturns rests with its superior budget flexibility, and the underlying strength of its broad economic profile allows it to restore that flexibility quickly once utilized. The general strength of Virginia's economy means these revenue sources will generally grow solidly during economic recoveries. However, during even modest downturns, declines can be abrupt and material. The Commonwealth has implemented some policy measures in its revenue forecasting process to mitigate fluctuations, but Fitch expects volatility to remain a feature of Virginia's revenue profile.

Virginia is generally able to reduce direct spending by shifting responsibilities down to lower levels of government or deferring expenditures. Such measures are generally temporary ensuring flexibility in future downturns. Similarly, Virginia has been able to take short-term revenue measures to address short-term fiscal distress, such as accelerating sales tax collections - while not sustainable, Fitch views these as reasonable one-time measures at times of revenue decline.

The Commonwealth also maintains a constitutionally-supported revenue stabilization fund (RSF) that provides another often utilized source of material, short-term budget relief. While downturns can hit Virginia hard because of its revenue volatility, sometimes triggering short-term and unsustainable measures, recoveries generally are quickly reflected in tax revenues and allow the Commonwealth to resume its more typical practice of structurally sound budget management.

Virginia's typically conservative and prudent financial management leads it to restore budgetary flexibility in times of economic recovery. The RSF has strict constitutional limitations on its usage and requirements for timely repayment of withdrawals. Just as important, the approach is institutionalized as reflected most recently in the governor and legislature's joint commitment to accelerating the phase-in to full actuarial pension contributions when the state deferred funding during the Great Recession.

Current Developments

Virginia's recent financial performance has been solid. Fiscal 2015 revenue collections outperformed notably compared to earlier forecast expectations, as the Commonwealth rebounded from a significant shortfall in fiscal 2014. Fiscal 2015 ended with a $538 million surplus, compared to a $438 million fiscal 2014 revenue gap that was addressed largely with its ending general fund balance.

In the current year, general fund revenues are tracking slightly below the forecast through March but Fitch notes that April and May are Virginia's most important revenue collection months. Recent economic indicators have been strong with both jobs growth and personal income growing ahead of the national pace, implying a positive trajectory for state revenues. Regardless, the Commonwealth retains ample flexibility to deal with any revenue shortfalls, including through its RSF. The robust surplus in fiscal 2015 triggered a constitutionally-mandated contribution to the RSF of $606 million in fiscal 2017. At the end of that year, Virginia projects the RSF will reach its highest level since before the Great Recession ($845 million, or 4.5% of projected general fund revenues).

The budget for the next biennium (fiscal 2017 - 2018), which begins on July 1, funds substantial growth in operations over the current biennium. General fund spending is up approximately 10% for the biennium in the budget enacted by the legislature to which the governor has proposed modest amendments. General fund revenues, including transfers, are projected to grow 6.2% over the biennium. The spending number includes required RSF restorations and Fitch views the budget as structurally balanced. The legislature will reconvene this week to consider the governor's proposed amendments. K-12 aid for school districts and Medicaid are two other key drivers of the increase, with both seeing substantial increases in the budget plan. The budget plan's significant increases in K-12 funding largely reflect the governor's proposals and include additional direct aid for school districts and funding for modest teacher pay and staffing increases. Most additional funding requires school districts to match Commonwealth appropriations. The official economic forecast continues to assume Virginia's economic performance will trail national trends, leaving some flexibility in revenue estimates that rely on the economic forecast.

RELATED CREDITS

As noted earlier in this release, Fitch has affirmed the 'AA+' rating and Stable Outlook on the following Commonwealth appropriation-backed credits, which are all rated one notch below the IDR:

--VA Public Building Authority - Public Facilities Revenue Bonds;

--VA Public School Authority - School Financing Bonds and School Educational Technology Notes;

--VA College Building Authority - Public Higher Education Financing Program Bonds;

--VA College Building Authority - 21st Century College & Equipment Program Bonds;

--VA Port Authority - Commonwealth Port Fund Revenue Bonds;

--Virginia Biotechnology Research Partnership Authority - Commonwealth of VA Lease Revenue Bonds;

--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 the applicable criteria specified below, this action was informed by information from CreditScope.

Applicable Criteria

U.S. Tax-Supported Rating Criteria (pub. 18 Apr 2016)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=879478

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1003008

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1003008

Endorsement Policy

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Contacts

Fitch Ratings
Primary Analyst:
Eric Kim, +1-212-908-0241
Director
Fitch Ratings
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Laura Porter, +1-212-908-0575
Managing Director
or
Committee Chairperson
Douglas Offerman, +1-212-908-0889
Senior Director
or
Media Relations:
Sandro Scenga, New York, +1-212-908-0278
sandro.scenga@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst:
Eric Kim, +1-212-908-0241
Director
Fitch Ratings
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Laura Porter, +1-212-908-0575
Managing Director
or
Committee Chairperson
Douglas Offerman, +1-212-908-0889
Senior Director
or
Media Relations:
Sandro Scenga, New York, +1-212-908-0278
sandro.scenga@fitchratings.com