MRO Magazine

Fitch Rates North Carolina’s $250MM GO Bonds ‘AAA’


March 27, 2015
By Business Wire News

NEW YORK

Fitch Ratings assigns an ‘AAA’ rating to the following general obligation (GO) bonds of the State of North Carolina:

–$250 million GO bonds, series 2015A

The bonds are expected to be sold via competitive bid April 8, 2015.

The Rating Outlook is Stable.

SECURITY

The bonds are a general obligation, full faith and credit pledge of the state of North Carolina.

KEY RATING DRIVERS

LOW LIABILITIES: The state has a low-to-moderate debt burden and strong debt management practices, including an affordability planning process. Over time the state has become more reliant on appropriation debt which now equals approximately 42% of total tax-supported debt. Pension funding is among the strongest of the states.

WELL-MANAGED FINANCIAL OPERATIONS: North Carolina has demonstrated the willingness and ability to take prompt action when necessary to maintain budget balance. This will be particularly important as the state continues to address the impact of a revised tax structure that is expected to lower tax revenues and absorb near-term revenue growth associated with economic expansion.

DIVERSE ECONOMY: The economy is expected to grow and diversify in the long run, but was severely affected by the recession. Although initial recovery was slow, recent growth trends have improved.

RATING SENSITIVITIES

The rating is sensitive to significant changes in the financial or debt profile or a fundamental change in the economy, inconsistent with maintenance of an ‘AAA’ rating.

CREDIT PROFILE

North Carolina’s ‘AAA’ GO bond rating reflects its moderate debt burden, conservative financial operations, and long-term prospects for continued economic expansion and diversification.

LOW DEBT LEVELS AND WELL-FUNDED PENSIONS

Tax-supported debt approximates $7.5 billion, as of June 30, 2014, 48% of which is general obligation. The state’s debt burden remains on the low end of the moderate range, at 2% of 2013 personal income. Amortization is above average with 78% of GO and appropriation debt due in 10 years. The current offering essentially completes the existing GO authorization. The governor’s proposed budget for the fiscal 2015-2017 biennium includes proposals for two large-scale bond programs for transportation and general infrastructure.

The state’s pension systems are well funded. As reported under the new reporting requirements of GASB 67, the fiduciary net position as a percentage of the total pension liability for the Teachers’ and State Employees’ system was 98.2% as of June 30, 2014. The combined ratio of debt and unfunded pension liability, using Fitch’s more conservative 7% discount rate assumption and Dec. 31, 2013 figures for comparative purposes, is well below average at 3.7% of personal income. This compares favorably to the 6.1% median for U.S. states, ranking North Carolina 12th among the states.

CHANGE IN TAX STRUCTURE AFFECTING REVENUES

Financial operations have historically been conservative, with the governor empowered to unilaterally reduce spending to maintain budget balance, after making provision for debt service. Fitch expects the state to continue to take appropriate action as it addresses funding gaps that developed after incorporating significant tax reform into the current fiscal 2013-2015 biennial budget.

The most significant of the changes to the tax structure was the shift from a progressive income tax structure to a flat tax of 5.8% effective Jan. 1, 2014, which was further reduced to 5.75% on Jan. 1, 2015. In addition, the corporate income tax was reduced from 6.9% to 6% effective Jan. 1, 2014 and to 5% on Jan. 1, 2015, and the estate tax was repealed. The sales tax base was expanded to include some services to partially offset the expected reduction in income tax revenues.

These tax changes, in combination with lingering effects of federal tax policy changes that shifted capital gains revenue between fiscal years, contributed to tax receipts underperformance in fiscal 2014, with total taxes declining 1.6% year-over-year and falling 2.5% short of estimate. Personal income tax (PIT) receipts were $724 million (6.6%) below estimate; although, as anticipated, this was somewhat offset by stronger corporate income and sales tax receipts. The state had been expecting stronger PIT performance in the second half of the biennium (the current fiscal year 2015), as tax revenues shifted between fiscal years due to changes in withholding tables; however, year-to-date personal income tax revenues are below forecast. Given the significant changes in tax policy and ongoing revenue underperformance, Fitch believes downside risk to the forecast for the current fiscal year remains.

The governor’s proposed budget for the fiscal 2015-2017 assumes stronger revenue growth in each of the next two years (3.9% in fiscal 2016 followed by 4.1% in fiscal 2017), based on continued slow but steady economic growth. The budget would increase funding for education, including raising teacher salaries and funding enrollment growth. North Carolina did not choose to expand Medicaid under the Affordable Care Act, but did experience a significant ‘woodwork’ effect. The budget proposes a $748 million increase in Medicaid spending over the biennium. The state is funding a Medicaid Risk Reserve to address a history of under-forecasting in the Medicaid program.

REBUILDING RESERVES

North Carolina has made steady progress rebuilding its rainy day fund, which it drew upon during the recession. The balance was $652 million as of the end of fiscal 2014, or 3.2% of general fund revenues. It does not anticipate a draw on the rainy day fund in the current fiscal year despite revenue underperformance. The state maintains other reserves as well, totaling $693 million in special and trust funds as well as approximately $868 million in the Golden Leaf trust, funded from tobacco settlement monies and used primarily for economic development in tobacco growing regions.

TRANSITION TO SERVICE-BASED ECONOMY

The transition of the economy away from manufacturing toward services continues. Although manufacturing employment remains a larger part of the North Carolina base than the U.S. average, it is now half of what it was in the 1990s. Employment in manufacturing grew for the first time in more than 15 years in January 2011, and has demonstrated year-over-year gains in every month but one since. Professional and business service employment is one of the faster growing sectors, increasing 5.4% on a year-over-year basis in January 2015. Measured by per capita personal income, North Carolina is below average at 86.4% of the U.S. level, ranking 39th among the states.

Prior to the recession, North Carolina’s economy had been growing significantly in terms of both size and diversity, but its contraction over the course of the recession was severe. Employment fell 5.5% during calendar 2009, notably worse than the national decline of 4.3%, with all sectors other than education and health services showing declines. Job losses began to abate toward the end of 2010 but employment overall fell 0.9% in 2010, again higher than the national decline of 0.7%.

Economic growth had been somewhat slow emerging from the recession, although it has accelerated recently and future growth is expected to be stronger as the now smaller manufacturing sector begins to recover and business and professional service sectors grow with the overall economy. Employment growth began to match the U.S. rate in 2011 but is now growing faster at 2.7% as of January 2015, relative to the U.S. rate of 2.3%. The state’s unemployment rate has dropped considerably, to 5.4% in January, atypically below the U.S. rate of 5.7%.

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

In addition to the sources of information identified in the 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. Local Government Tax-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=685314

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=982066

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY’S PUBLIC WEBSITE ‘WWW.FITCHRATINGS.COM‘. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH’S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE ‘CODE OF CONDUCT’ SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

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