NEW YORK--(BUSINESS WIRE)--Fitch Ratings has assigned an 'AAA' rating to approximately $600 million in Texas Transportation Commission (TTC) State of Texas highway improvement general obligation (GO) bonds, series 2016A.
The bonds are expected to be offered by negotiated sale during the week of Oct. 17, 2016.
The Rating Outlook is Stable.
The bonds are general obligations to which the state pledges its full faith and credit.
KEY RATING DRIVERS
Texas' long-term 'AAA' Issuer Default Rating (IDR) reflects an economy that continues to grow despite the severe contraction in the state's globally important energy sector, its conservative financial operations and manageable liability burden. The oil price plunge that began in late 2014 interrupted a long period of economic and revenue growth, but diversification over time leaves the state better positioned relative to past cycles to weather the energy sector downturn.
Economic Resource Base
Texas' economic resource base is large and diverse, although oil and gas remain significant and are subject to volatility. The state has been a population magnet and economic growth leader for decades, resulting in a degree of diversification well beyond the resource sectors that were dominant during the last severe oil price shock, in the 1980s. Service sectors in particular have grown in size and importance. The current energy sector downturn has slowed, but not halted, economic momentum, and Fitch views the state's longer-term economic prospects as strong. Overall employment gains continue, albeit now below national averages, and the unemployment rate remains well below U.S. levels.
Revenue Framework: 'aaa' factor assessment
Texas' revenue growth is expected to be in line with or above the level of U.S. economic growth, driven by rapid population and economic growth over time. Like most states, Texas retains nearly unlimited ability to raise operating revenues. Sales tax is the dominant source of revenue, although transportation, energy and other levies are also important.
Expenditure Framework: 'aa' factor assessment
Similar to other states, Texas retains ample flexibility to cut spending throughout the economic cycle, an attribute that the state relies on if needed to maintain fiscal equilibrium. Spending pressures from education, Medicaid, transportation, water and other growth-related needs are notable, and litigation has often been a source of uncertainty.
Long-Term Liability Burden: 'aaa' factor assessment
The combined burden of Texas' debt and unfunded liabilities is low relative to its resource base. A reluctance to borrow results in a low burden of net tax-supported debt. Unfunded pensions are a larger but thus far manageable burden. Progress lowering pension liabilities is unlikely given several factors including higher than average discount rates and contributions that are statutorily fixed instead of shifting with actuarially-calculated needs.
Operating Performance: 'aaa' factor assessment
Financial resilience is strong, with exceptional gap-closing capacity stemming from a willingness to cut even high priority spending and a very well-funded budgetary reserve which receives constitutionally dedicated oil and gas tax revenues. The state has a high level of fundamental financial flexibility despite a historical reluctance to raise operating revenues. To a limited degree, there is some deferral of required spending, notably pension contributions.
Economic Growth and Ample Flexibility: Texas' 'AAA' IDR and Stable Outlook assume continued strong prospects for economic gains and the maintenance of ample fiscal flexibility both in its conservative approach to budget management and its high reserve balances. The rating could be pressured in the event of the state's unwillingness to address potential fiscal challenges in an effective and timely manner.
GO bonds are issued by various state agencies, with TTC authorized to issue transportation-related GO bonds administered by the Texas Department of Transportation. Transportation needs, driven by the rapid population growth and economic expansion of the last decade, have been funded by the TTC via multiple bond programs, including the highway improvement GO bonds, GO mobility fund bonds, state highway fund (SHF) revenue bonds, and various toll road borrowings. Highway improvement GO bonds are issued under a 2007 constitutional amendment which authorized $5 billion of such debt. Debt service for highway improvement GO bonds is supported from state general revenue fund (GRF) resources, with current proceeds intended for capital projects to relieve congestion, among other priorities.
Fitch believes the state has ample fiscal flexibility to absorb near-term economic and revenue volatility, both in the form of its very large budgetary reserve, the $9.7 billion economic stabilization fund (ESF), and a practice of taking budgetary actions to maintain balance. Although sales tax collections, the state's primary source of revenues, are trending below prior year figures, liquidity remains ample. In fiscal 2016, for the first time in decades, it was unnecessary for the state to undertake cash flow borrowing for intra-year cash needs, and no such borrowing is planned in fiscal 2017, which began on Sept. 1. However, rapid growth and the concomitant demand for public services, including for transportation, education and water, continue to pressure spending, and unresolved litigation has periodically posed further uncertainty.
Fitch expects the downturn in the state's oil and gas sector to continue to weigh on overall state economic performance, but the degree to which this will happen remains to be seen. Job gains continue, albeit now at levels below U.S. averages, while the unemployment rate remains well under the national rate. Employment losses to date are concentrated in natural resources and manufacturing, as well as in geographic regions of the state with significant energy sector concentration.
The state is currently in the second year of its fiscal 2016-2017 biennium. Total general revenue (GR) and GR dedicated appropriations in the adopted budget equal $106.2 billion through the biennium, after adjustments including vetoes. This figure is approximately 12% higher than the comparable figure for the fiscal 2014 - 2015 biennium, based on the legislative budget board (LBB) analysis of the joint Senate-House budget bill.
Recent revenue collections have trended lower due to weakness in taxes affected by the oil and gas downturn. Fiscal year-to-date through Aug. 31, the end of fiscal 2016, total revenues excluding federal funds were 0.4% below the forecast level and 1.2% below the prior year's figure. Sales taxes are 4.7% below forecast and 2.3% below the prior year. The state's next revenue forecast is not expected until early 2017, before the next regular legislative session convenes.
Texas' main revenue source for funding expenditures is a statewide sales tax; there is no personal or corporate income tax. Other levies are important, including a franchise tax on businesses, various transportation taxes and fees, and oil and gas production taxes. The latter taxes in particular remain important, but volatile, and have fallen as a share of state revenues since the 1980s, the last time the state suffered through a severe energy sector downturn. Sales taxes are also affected by energy sector volatility, although to a lesser degree. The constitutional diversion of most oil and gas tax revenues into the budgetary reserve or for highways spares the general revenue fund from the most extreme energy sector volatility.
Texas' rapid population growth and generally strong labor market provide the basis for a revenue growth profile that Fitch expects to exceed the typical state's over time. This will likely continue even as the state once again faces near-term economic disruptions from low energy prices and slowing revenues. Dedication of revenues for specific needs (oil and gas production for budgetary reserves and highways, and sales taxes for highways beginning in the next biennium) may affect how closely economic trends align with revenue collection trends.
Texas has almost unlimited legal ability to raise revenues, with the exception of a constitutional restriction on levying a property tax.
Spending commitments are dominated by education and social services, particularly Medicaid. Education is the state's largest expenditure, and consists of formula spending for K-12 education distributed as intergovernmental aid to local school districts; public college and university funding are also significant line items.
Fitch has long noted the spending pressures arising from the state's rapid growth. Growth-related demands affect both operating and capital spending, including for education, transportation, water and social services. Education funding is provided through a combination of state resources and local property taxes and has been a longstanding policy flashpoint given rapid growth, limits on local property taxes, and the state's demonstrated willingness to change education funding based on state fiscal conditions. Transportation needs are also considerable, particularly within and between cities, with the state devoting a larger share of both transportation and general revenues to address congestion.
The state has not hesitated to make deep cuts even to core services in the face of projected revenue weakness. During the last downturn, these included deep cuts to education formula funding, deferrals of some education aid into later biennia, and underfunding of Medicaid. Texas' carrying cost for liabilities is low and only slightly above the median for states, driven primarily by pension contributions, which are statutorily set at a level that, of late, has been below the amount needed to make progress on amortizing the liability.
Long-Term Liability Burden
Texas' overall liability burden is just above the median for U.S. states but remains a low burden on resources. The net tax-supported debt burden is low, driven by a longstanding reluctance to pursue tax-supported borrowing at the state level, although self-supported borrowing is a significant source of capital spending and much of this debt carries a GO pledge. Pension liabilities are larger, given the state's responsibility both for its own retirees and for most of the cost of retired teachers. Despite some reforms including partial cost-shifting to local schools and higher employer contributions, challenges for the pensions include higher than average discount rates and contributions that are statutorily fixed below actuarial levels. These factors suggest progress toward full prefunding is unlikely absent additional reforms.
The state has significant internal liquidity, which it has used to a limited degree to provide self-support for variable rate borrowing or commercial paper (CP) programs. Liquidity is currently high enough that the state did not borrow for annual cash flow needs in fiscal year 2016, nor is it planning to do so in fiscal year 2017.
The state's financial resilience is high, driven both by an exceptional budget reserve balance and by a willingness to make deep spending cuts, including to core services, in the event of a revenue shortfall. As of August 2016, the ESF balance of $9.7 billion was equal to 18% of projected fiscal 2017 general revenues.
Constitutional provisions divide most oil and gas revenues between the ESF and for highways; these provisions have both spared the GRF from energy revenue-related volatility and resulted in very high ESF balances. The state has not been reluctant to tap reserves for other needs, such as water development; recent decisions to divert portions of the ESF balance and to divert revenues flowing to the ESF have generally been for functional spending needs that are urgent and growth-related.
Date of Relevant Rating Committee: April 27, 2016
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.
U.S. Tax-Supported Rating Criteria (pub. 18 Apr 2016)