Fitch Rates Oregon’s $115MM GOs ‘AA+’; Outlook Stable

NEW YORK

Fitch Ratings has assigned an ‘AA+’ rating to the state of Oregon’s $115.405 million general obligation (GO) bonds (higher education), consisting of the following:

–$11.995 million 2015 series M (Article XI-F(1) tax-exempt);

–$2 million 2015 series N (Article XI-F(1) federally taxable);

–$101.41 million 2015 series O (Article XI-G tax-exempt).

The bonds are expected to sell via negotiation the week of June 1, 2015.

The Rating Outlook is Stable.

SECURITY

The bonds are general obligations of the state of Oregon, with the full faith and credit of the state pledged to bond repayment.

KEY RATING DRIVERS

STRONG FINANCIAL MANAGEMENT OFFSETS REVENUE VOLATILITY: State finances are heavily dependent on the personal income tax (PIT), a volatile revenue source that declined sharply during the recession, and has since shown steady growth. The state’s management reviews revenue and economic forecasts quarterly and takes measures as necessary to maintain balance. State reserve levels were drawn upon among balancing measures in the downturn, but the state is committed to rebuilding reserves in the current, and future, biennia.

DIVERSE ECONOMY WITH SELECT CONCENTRATIONS: The computer and manufacturing sectors play an above-average role in Oregon’s economy, which is especially influenced by international trade patterns. The state’s growing labor force has profited from employment opportunities in the state.

MODERATE LIABILITY BURDEN: Debt levels are above average for a U.S. state but are only a moderate burden on resources. On a combined basis, the burden of the state’s net tax-supported debt and unfunded pension obligations approximates the median for U.S. states. Other post-employment benefit (OPEB) obligations are small.

VOTER INITIATIVES CAN LIMIT FLEXIBILITY: A dynamic voter initiative process can have an impact on state finances.

RATING SENSITIVITIES

The rating is sensitive to shifts in fundamental credit characteristics, including the state’s proactive financial management and commitment to reserve funding.

CREDIT PROFILE

Oregon’s ‘AA+’ GO bond rating reflects a diverse economy with some concentration in computer and electronic manufacturing and agricultural products, moderate debt levels, the state’s record of prompt actions to maintain financial flexibility in challenging revenue environments, and the maintenance of financial cushion to provide protection from revenue volatility. Strong financial management is critical to the rating given a revenue structure largely dependent on the cyclical PIT, exposure to voter initiatives that can have negative fiscal impacts, and constitutional ‘kicker’ provisions that require the return of surplus revenues to taxpayers. Corporate revenue in excess of the revenue forecast is now directed to elementary and secondary education per approval of a 2012 voter initiative.

The state’s debt levels are above average but pensions are well funded, despite a recent court decision to restore cost of living (COLA) increases to retirees and current employees that is expected to modestly lower funded ratios. These obligations remain a moderate burden on resources. The currently offered bonds are being issued to fund various capital improvements at five state universities located across the state.

RELIANCE ON PERSONAL INCOME TAX FOR OPERATIONS

Oregon’s general fund (GF) is largely dependent on the PIT, which made up 86% of the biennial (BY) 2011 – 2013 GF revenues. PIT collections are volatile. The close-of-session (COS) forecast for the current 2013-2015 biennium that began on July 1, 2013 included an 11.7% baseline growth assumption in PIT revenue, although the baseline growth was expected to be offset by a falloff of one-time revenues, some related to the federal tax law changes. Overall, GF revenues were forecast to grow 9.5% from the 2011-2013 biennium and total $15.6 billion. Strong revenues from the tax in the current biennium, which ends on June 30, are expected to exceed the state’s forecast for the biennium by over 2%, triggering a credit for taxpayers in the 2016 tax year.

The most recent quarterly forecast completed in May 2015, which incorporates revenue initiatives passed in a 2013 special legislative session, updated GF revenue projections to 13.6% growth from the prior biennium; 3.6% above the forecast the state used when enacting the BY 2013-2015 budget. The PIT is forecast to grow by 15.9% over the biennium and the CIT is expected to grow by 24.2%. Due to the effects of the additional revenue initiatives as well as strong PIT collections in April 2015, the May forecast projects GF revenues exceeding the constitutional PIT kicker threshold by $182 million, triggering a PIT credit to be issued to taxpayers in the 2016 tax year of approximately $473 million. The kicker credit is expected to have only a modest impact on revenues in the next biennium as the state’s economic forecast for the next two years has strengthened, a positive credit factor in Fitch’s view.

The state also forecasts the CIT coming in above the COS forecast, by about $41 million. Prior to the 2012 law change, these additional revenues would have resulted in a $92 million CIT kicker payment. Due to the law change, should these funds be realized, they will be directed to education programs.

The kicker-related revenue loss in the 2015-2017 biennium is expected to be offset by an increase in beginning cash balance that may be applied to expenditures, from $260 million expected in December 2014 to $503 million now anticipated. The state has increased its expected deposits to the rainy day fund (RDF) and educational stability fund (ESF) at June 30, 2015 to $148.8 million and $171.9 million, respectively. The reserve balances are expected to total $391.3 million at the end of fiscal 2015, or 4.7% of fiscal 2015 GF revenues, up modestly from the $387 million expected in December.

The governor’s budget for the 2015-2017 biennium proposed $17.7 billion in GF expenditures, supported by 12% growth in projected revenues to $17.8 billion, inclusive of proposed revenue revisions that would maintain 18 current PIT and CIT tax credits, add a new PIT tax credit for working families, and transfer $120 million from the public employees benefits board stabilization fund to the GF. The May 2015 forecast updated revenue expectations, including revisions, to $17.76 billion, reflecting the impact of an expected kicker credit for the 2016 tax year. Including the proposed revenue revisions, the PIT is projected to grow by 12.1% over the biennium and the CIT is forecast to be down by 1.5% from the current biennium, incorporating various tax law changes as well as a recent move to a new computer system for tracking CIT receipts that may have temporarily bolstered current biennium receipts.

In support of the revenue projection, the forecast estimates annual employment growth of 3.3% in 2015, 2.9% in 2016 and 3% in 2017, all improved estimates from March. The personal income forecast was also enhanced, with growth of 5.5%, 6.1%, and 6.8% in those respective years, which is a fairly robust forecast, in Fitch’s view. Overall, the state continues to project steady job growth that ranges well above the national growth rate in each year of the forecast.

The legislature has approved the K-12 education budget for the next biennium, totaling $7.2 billion, while debate continues on the remaining components of the budget. Fitch expects budget enactment and session conclusion to be timely.

CYCLICAL ECONOMY WITH STEADY EMPLOYMENT GAINS

Oregon’s economy tends to be more cyclical than the nation’s due historically to its reliance on agriculture and natural resources and today because of its large high-tech sector and international trade activities that expose the state to global economic cycles. The state’s largest exports are computer and electronics products (36%) and agricultural products (13%) and the largest destinations are China (18%), Canada (17%), and Malaysia (10%).

Following 7.6% total job loss in CYs 2008 through 2010 as compared to 5.6% for the nation, the state has recovered 115% of the jobs that were lost at the trough of the recession (January 2010 for Oregon) as compared to a current 132% recovery rate for the nation. The state reports that employment in five major industries; education, health care, food manufacturing, professional and business services, and leisure and hospitality, which account for 40% of statewide jobs, are currently at all-time highs. As of March 2015, state employment is up 3.4% year-over-year (yoy) as compared to the nation at 2.3% yoy.

State unemployment, typically above the national level, was 7% in CY 2014 against a national rate of 6.2%. Sizable growth in the state’s labor force, up by 1.6% yoy in CY 2014 compared to a 0.3% national growth rate, has pressured the state’s unemployment rate in recent months as more workers seek employment. That trend abated in March 2015 with the sizable yoy job growth that allowed the state’s unemployment rate to fall to 5.4% (down substantially from 7.1% recorded in March 2014) compared to the national average of 5.5%.

In 2014, Oregon’s personal income (PI) growth of 5.7% was better than the 3.9% U.S. rate of growth, and recent quarterly trends have been robust: 6.4% yoy growth in the fourth quarter of 2014 as compared to 4.5% for the U.S. and 5% for the region. Per capita personal income (PCPI) in 2014 totaled $41,681, representing 90.4% of the U.S. level and ranking Oregon 32nd among the states. PCPI still falls below the high ratio of 94% of the U.S. in 2000 but the state estimate of 5.7% growth in PI in 2014 (revised upward from an earlier 4.9% growth estimate) and continued robust growth projected through the forecast period could shrink the difference.

MODERATE DEBT BURDEN

As of June 30, 2014, the state’s debt at 5% of 2013 PI is above average but still a moderate burden on resources. Principal amortizes at an improved 52% pace in 10 years from a prior slower trend. In contrast to the prior downturn, the state did not undertake any deficit borrowing in the most recent recession.

Two rounds of pension reform occurred in 2013; the first in the regular legislative session and the second as part of a special fall legislative session. The reforms were enacted to reduce the system’s liability, provide for sizable system savings for all employers, and reduce employer contribution rates. These reforms included: adjusting and limiting COLAs, eliminating a benefit increase for out-of-state retirees based on the Oregon income tax, redefining salaries used in calculating benefits, and reducing legislators’ participation in PERS.

Legal challenges were filed in regard to the 2013 legislative changes to benefits, citing breach of contract and taking of property rights. On April 30, 2015, the state’s Supreme Court ruled in favor of the plaintiffs in regard to the COLA reforms while upholding other reform measures, resulting in the restoration of a 2% COLA to retirees and employees for services provided prior to the 2013 law change. The court ruled that it was legal to reduce COLAs for services accrued after the 2013 reforms were enacted. The ruling is expected to lower PERS’ funded ratio and raise ongoing required contributions. PERS is expected to apply a portion of its reserve funds for the retroactive payment of COLAs earned from the 2013 law change through BY 2015-2017 as employer contribution rates for the next biennium were set prior to the court ruling. The board is expected to soon announce the impact to the funded ratio and the amount of the retroactive payment from the litigation loss.

Also in 2013, the PERS board lowered its investment return assumption from 8% to 7.75%, effective Jan. 1, 2014, thereby increasing the calculated actuarial accrued liability. Historically, the system has not smoothed the return on its investments. The board also implemented additional changes to its actuarial methods and assumptions including moving to entry age normal and providing for a 20-year re-amortization of the unfunded actuarial liability. At its next meeting, the board is expected to consider further lowering its return assumption rate, which would also increase the unfunded actuarial accrued liability (UAAL).

Incorporating the legislative and assumption changes in 2013 as well as an employer contribution rate deferral and re-amortization, the UAAL of the PERS system decreased from $11.03 billion as of Dec. 31, 2011 to $5.621 billion as of Dec. 31, 2012. Under prior GASB standards and incorporating the above mentioned reforms as well as sizable investment earnings, PERS’ UAAL decreased to $2.58 billion as of Dec. 31, 2013, and the reported funded ratio improved to 95.9% from 90.7% in 2012. Beginning in fiscal 2014, the state’s pension systems issued financial statements under new GASB statement 67 reporting standards. Based on the new standards, OPERS reports assets equaling 103.6% of liabilities.

Despite the outcome of the litigation, Fitch expects system funding to remain solid, albeit at a lower level, than it was before the court decision. The state legislative fiscal office (LFO) had previously indicated that a total loss in the lawsuits would result in an increase of the system UAAL from $2.6 billion as of Dec. 31, 2013 to about $8.7 billion or an 89% funded level. The state anticipates that a substantial portion of the increase in the UAAL estimated by the LFO will be realized from the partial litigation loss. Contribution rates beginning in the 2017-2019 biennium will be set at a level corresponding with amortization of this higher UAAL.

On a combined basis, the burden of the state’s net tax-supported debt and adjusted UAAL obligations approximates 5.3% of 2013 PI. The calculations include 21.4% of the liability of OPERS that Fitch estimates to be attributable to the state. The state had reported their portion to be 97% funded as of Dec. 31, 2013 inclusive of the reform measures, and Fitch expects that funded level to decline due to the recent court ruling although remain sound.

The state’s share of other-post employment health benefits is small and funded at 75%, with a 9% funded ratio for the much smaller premium account, which provides monthly subsidies to pre-Medicare-age state retirees.

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);

–Fitch: Oregon Pension Fund Will Manage Court Decision (May 6, 2015).

Applicable Criteria

Tax-Supported Rating Criteria (pub. 14 Aug 2012)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=686015

U.S. State Government Tax-Supported Rating Criteria (pub. 14 Aug 2012)

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

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Fitch Ratings
Elizabeth Fogerty, +1-212-908-0526
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elizabeth.fogerty@fitchratings.com
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Fitch Ratings, Inc.
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