Fitch Ratings has assigned an 'AA+' rating to the following general obligation (GO) bonds issued by the state of West Virginia:
--$65.705 million infrastructure GO refunding bonds, 2015 series A (tax-exempt);
--$5.74 million infrastructure GO refunding bonds, 2015 series B (taxable).
The bonds are expected to sell via competitive bid on an as yet to be determined date at the end of January 2015.
In addition, Fitch affirms the following ratings:
--$460.4 million outstanding state of West Virginia general obligation (GO) bonds at 'AA+';
--$400.2 million outstanding appropriation-backed debt of the Economic Development Authority (EDA) and School Building Authority (SBA) at 'AA'.
The Rating Outlook is Stable.
SECURITY
GO bonds are secured by the state's full faith and credit. Special limited obligations of the EDA and SBA are payable from lease revenue payments from the state of West Virginia, subject to annual appropriation.
KEY RATING DRIVERS
WELL-MANAGED FINANCIAL OPERATIONS: The state has been challenged in recent fiscal years by underperformance in key revenue sources, necessitating expenditure cuts and modest use of fund balances to steady operations. The state expects budgetary imbalance to continue through fiscal years 2015 and 2016 and has focused its efforts on identifying expenditure solutions in concert with planned, limited use of its rainy day fund (RDF). Fitch expects the state to maintain strong control over appropriations as it adheres to its financial plan.
SIZABLE RESERVES: Despite the expected use of $100 million of the RDF in fiscal 2015, the state's reserve balances are expected to remain considerable, at over 20% of general fund revenues. The governor is expected to propose a further, $85 million use of the RDF in fiscal 2016, lowering reserves to a still solid 18% of general fund revenues. Fitch expects the state to maintain significant reserves given the economic and financial reliance on natural resource development.
WEAK DEMOGRAPHICS ALTHOUGH ECONOMY HAS DIVERSIFIED: West Virginia's economic base has diversified, though significant exposure to the cyclical natural resources industry remains, particularly the troubled coal industry. Wealth and other demographic indicators are weak for a U.S. state.
MANAGEABLE DEBT AND LIABILITY POSITION: Tax-supported debt levels are moderate and amortization is above average. The state has made significant progress in reducing a sizable liability situation although the combined burden of debt and pensions remains well above average.
RATING SENSITIVITIES
The ratings are sensitive to shifts in the state's fundamental credit characteristics, particularly its economic, liability, and financial profiles. The ratings assume the state's continued maintenance of high reserve balances while making progress toward restoring fiscal balance and reducing its long-term liability burden.
CREDIT PROFILE
GO bonds are supported by a full faith and credit pledge of the state and are rated 'AA+', reflecting the state's strong financial management, sound reserve position, and the substantial progress made in reducing its liabilities for the teachers' pensions and workers' compensation systems, as well as the liability for other post-employment benefits (OPEB). The state's economy has experienced a shift in recent years from increased development of its natural gas reserves in the Marcellus Shale while production of the state's coal resources has declined, spurred by low natural gas prices, decreasing export markets for its coal, and more stringent environmental regulations that have negatively impacted coal production.
This shift has also impacted the state's financial resources as the less labor-intensive gas development contributed to marginal to declining personal income tax (PIT) and sales tax collections, furthered by the cost of a meaningful but now reduced alternate vehicle fuel PIT credit. A concurrent reform of its business-related taxes and decline in lottery revenues due to increasing competition also reduced the revenues available to the state. This revenue weakness has resulted in recent and projected budget gaps that the state has solved through expenditure reductions, one-time actions, and the planned use of its RDF. Debt levels are moderate although the state's long-term liabilities remain high.
The lease revenue bonds are limited obligations of the state, with lease payments subject to annual appropriation; as such, the 'AA' rating is one notch below the GO rating of the state of West Virginia. The state has covenanted to include lease payments in its budget requests and lease payments are not subject to abatement.
WELL-MANAGED FINANCIAL OPERATIONS
West Virginia's institutionalized fiscal and management practices, highlighted by the governor's broad power to cut spending and the consolidated executive control of debt issuance, are also reflected in its proactive approach to addressing long-term liabilities and maintenance of sizable reserve balances. While reserves are expected to decline in fiscal years 2015 and 2016 due to revenue weakness and increased funding needs for its Medicaid program, Fitch expects these practices to aid the state as it navigates forecast budgetary imbalance through fiscal 2018.
The state emerged from the recession in a strong financial position, managing through revenue declines with the use of federal stimulus funds and expenditure reductions. The state continued to generate budgetary-basis surpluses and additions to the RDF in each of the recessionary years and through fiscal 2012. For fiscal 2013, actual revenues were essentially flat to fiscal 2012 due to contractions in the coal and natural gas industries and the reverberating effects on the state's economically sensitive revenue sources, offset by 3.4% year over year (yoy) growth in PIT collections that was 1.4% above expectations for the year. The state addressed negative variances in severance, sales, and corporate income tax collections through a mid-year reduction in expenditures and the use of the state's $45 million income tax refund reserve. The rainy day fund was not tapped, however, and total reserves equaled a sizable 24% of revenues including the tax reduction reserve of $75.7 million. The rainy day funds cannot be spent without legislative appropriation.
The enacted $4.1 billion fiscal 2014 general fund budget forecast a 0.3% decline in revenue sources, integrating legislated reductions in the state's corporate income tax rate and business franchise tax (which has now expired). Actual revenues were 0.7% below forecast and incorporated more substantial losses in business-related taxes, PIT receipts that were 5.8% below forecast, and sales tax revenue that was 2.6% below forecast. The state responded to the reduced revenues through mid-year state agency reductions and the transfer of special revenue fund cash balances to the general fund, and benefited from a timing adjustment to the revenue sharing of local severance tax. The state also applied available cash balances in the general fund to operations and appropriated almost $55 million from the tax reduction reserve. Combined, one-time revenues applied to support the general and lottery fund budgets totaled $209 million; 4.5% of general fund revenues. The RDF was not tapped in this fiscal year and total reserves were maintained at 24% of revenues.
For fiscal 2015, the enacted $4.25 billion general fund budget forecast more robust growth in revenue sources; 3.6% from fiscal 2014, which incorporated expected 8.7% growth in the PIT, partly attributable to the repeal of a PIT credit for alternative-fuel motor vehicles, and 6.9% growth in sales tax revenue, offset by expected declines in corporate and severance tax revenue as well as declines in transfers from the excess lottery fund that has been impacted by increased competition in neighboring states. Fitch believed the forecast to be aggressive, and the state now expects a $64 million revenue shortfall.
Sizable 7.3% growth in enacted fiscal 2015 general fund appropriations includes double-digit growth in general funds for Medicaid and social service expense as well as public safety. The state has applied $100 million from its RDF to reduce base appropriations in the Medicaid program through a transfer to the state's Medical Services Trust Fund; the state's share of Medicaid costs has grown significantly in recent fiscal years due to a declining federal match rate and Medicaid inflation. Given the planned application of the RDF in fiscal 2015 and potential use of $11 million in the income tax refund reserve, reserves at the end of fiscal 2015 are expected to equal a still strong 20.6% of revenues at year-end.
The state's six-year financial plan contemplates the use of an additional $85 million of the RDF in fiscal 2016 as well as other budgetary actions to achieve balanced operations. The use of the RDF in fiscal 2016 at the currently contemplated amount would bring the RDF to 18% of general fund revenues, not inclusive of potential interest earnings on the reserve, a level that Fitch believes provides sufficient cushion for the state. Given the state's continued reliance on natural resources production for support of its economy and financial operations, however, a more sizable reduction in fiscal 2016 or continued use of reserves beyond fiscal 2016 would be a negative rating factor.
MODESTLY DIVERSIFIED ECONOMY WITH BELOW AVERAGE DEMOGRAPHICS
West Virginia's economic profile has evolved to more closely resemble that of the nation with increases in the service sectors. However, its economy remains relatively narrow with a still important presence of cyclical natural resource industries. The state only modestly participated in the national recession, recording one year of employment decline at 2.2% in 2009 compared to a 4.3% decline for the U.S.; the aggregate employment change from 2008 to 2010 was a decline of 1.3% compared to a 5.6% decline for the nation. More recent comparative trends have not been as favorable, however, largely reflecting weak markets for coal and lower employment demand in the natural gas industry.
Employment in 2013 was a decline of 0.3% from 2012 as compared to 1.7% national growth. Yoy through November 2014, employment has demonstrated more positive trends with yoy growth of 1.6% in November compared to 2% for the nation. Mining employment was up a significant 7.7% yoy while both professional business services and financial activities are showing strong growth; 7.9% and 6.3% yoy growth respectively. While the state reports improving natural gas production, coal demand remains low, suppressing both price and employment. Fitch expects the state's coal industry to continue to contract, incorporating export markets for coal that have weakened over the past year and new and proposed federal emissions standards that would have a detrimental impact on the state's coal industry.
West Virginia's economy had generally been marked by low and generally slow-growing personal income but performance through the recessionary years was notably stronger than that of the nation; in 2008 state personal income growth was 139% of that of the nation, and in 2009 it fell 0.6% over the prior year while nationally a decline of 4.8% was realized. The more robust income performance has continued in recent years, although growth has not been as strong as regional and national trends; 1% personal income growth in 2013 compared to 2% for the nation. Recent quarterly income trends are stronger, with 3.1% yoy growth in the third quarter of 2014 compared to 3.9% for the nation. As a result of the improved performance, West Virginia's per capita personal income now ranks 47th of the states, at 79.4% of the U.S. rate, an improvement from 72.2% in 2000. Unemployment rates have been below national averages for several consecutive years although the recent November rate of 6.5% was above the national rate of 5.8%, largely reflecting the solid decline in the national rate.
MODERATE DEBT AND LIABILITY POSITION
Overall, tax-supported debt has been declining as a percentage of personal income and represents a moderate burden on resources, as the state funds most of its capital needs on a pay-go basis, enhancing its budgetary flexibility. As of June 30, 2014, net tax-supported debt approximated $1.7 billion, or 2.6% of 2013 personal income.
West Virginia's pension funding levels, in particular, those of the teachers' retirement system (TRS) had been amongst the worst of the states, but have shown significant improvement. The state had made a concerted effort to not only fund the actuarially calculated annually required contribution (ARC) but to add assets in excess of the ARC to the pension systems. The state deposited $1.6 billion from budget surpluses and a tobacco securitization into the teachers' plan in addition to paying the ARC in recent years. As a result, the funded ratio of TRS, which is fully paid by the state, has increased from less than 20% in 2002 to 53% in 2012. Adjusting the funded ratio to incorporate Fitch's more conservative 7% return rate assumption, the funded ratio in 2012 was 50.9%. The state currently projects the funded ratio to be 64.4% based on a July 1, 2014 valuation.
The funded ratio for the state employees' retirement system (PERS) has historically been better than that of TRS. The system reported a 77.6% funded ratio for fiscal 2012. Adjusting the ratio with Fitch's return rate assumption produces a funded ratio of 74.3%. When the adjusted unfunded pension liabilities are added to debt burden, debt and liabilities as a percentage of personal income equal approximately 12.4% compared to a median of 6.1% for the states.
In keeping with its efforts to reduce its long-term liabilities, West Virginia has undertaken several efforts to address its OPEB liability. In December 2011, the state's public employee insurance agency (PEIA) took action to reduce liabilities related to OPEB. By cutting health benefits, capping subsidies to retirees, and limiting growth in such subsidies, the OPEB liability dropped from approximately $10 billion to approximately $5 billion. The state legislature took additional action to eliminate the remaining liability by 2037 by allocating $30 million per year from income tax collections to the OPEB trust fund and $5 million per year to the health care subsidy for employees hired on or after July 1, 2010. The legislature also transferred the county school boards' OPEB liabilities to the state to include this liability in their reform efforts. As of June 30, 2014, the accrued liability is estimated at $2.8 billion and the OPEB trust totaled $685 million.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Tax-Supported Rating Criteria', Aug. 14, 2012;
--'U.S. State Government Tax-Supported Rating Criteria', 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=963915
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