Fitch Rates Oregon’s $29MM GO Bonds ‘AA+’; Outlook Stable

NEW YORK

Fitch Ratings has assigned an ‘AA+’ rating to $29.14 million state of Oregon general obligation (GO) bonds 2015 series Q (veterans’ welfare bonds series 96) (fixed rate).

In addition, Fitch affirms the following ratings:

–$5.56 billion in outstanding state GO bonds at ‘AA+’;

–$518 million outstanding state appropriation-backed bonds at ‘AA’.

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 population and labor force has profited from strong recent employment gains 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 periods, 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 provide funding to the Oregon department of veterans’ affairs to fund first lien mortgage loans to qualifying veterans.

RELIANCE ON PERSONAL INCOME TAX FOR OPERATIONS

Oregon’s general fund (GF) is largely dependent on the PIT, which made up 88% of the biennial (BY) 2013 – 2015 GF revenues. PIT collections are volatile and increases more than 2% above the state’s close of session (COS) forecasts are subject to ‘kicker’ requirements, whereby excess revenue is returned to taxpayers. For BY 2015, actual PIT revenue was 3% above the projection for the biennium; requiring the excess to be returned to taxpayers as a PIT credit in tax year 2016, reducing PIT collections in fiscal 2016 by $402 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.

Corporate income taxes (CIT) were also above the 2% forecast threshold for BY 2015, providing for a $59 million CIT kicker; however, excess CIT collections are now directed to education and have no impact on the state’s GF revenues in fiscal 2016. These strong revenue results allowed the state to increase its rainy day (RDF) and education stability (ESF) funds’ reserves to a combined balance of $391.2 million, equivalent to 4.6% of fiscal 2015 net revenue.

The enacted budget for the 2015 – 2017 biennium (BY 2017) includes almost $18 billion in GF expenditures, supported by 12% growth in projected revenues at COS to $17.96 billion. The forecast is inclusive of 12.6% expected growth in the PIT over the biennium and a one-time transfer of $120 million from the public employees benefits board stabilization fund to the GF, offset by an expectation of a 1.5% decline in the CIT. The expected decline incorporates various tax law changes as well as a recent move to a new computer system for tracking CIT receipts that may have temporarily bolstered BY 2015 receipts. A September 2015 forecast left the state’s revenue expectations largely unchanged from COS although the expected decline in the CIT from BY 2015 increased modestly to 1.9%.

In support of the revenue projections, the September forecast estimates annual employment growth of 3.4% in 2015, 3.1% in 2016 and 2017, and 2.2% in 2018. The personal income forecast is also for continued strong growth, with growth of 5.3%, 6.1%, 6.8%, and 6.2% 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 state expects to make additional deposits to the RDF and ESF in BY 2017 of $169.8 million and $183.8 million, respectively. The reserve balances are expected to total $753.7 million at the end of fiscal 2017, or 8.1% of fiscal 2017 GF revenues, up substantially from the $391.2 million in fiscal 2015.

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, natural resources, and recently, because of its large high-tech sector and international trade activities which 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 131% of the jobs that were lost at the trough of the recession (January 2010 for Oregon) as compared to a current 145% 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 August 2015, state employment is up 3.5% year-over-year (yoy) as compared to the nation at 2% 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 CY 2015 as more workers seek employment. That trend eased in August 2015 with a 0.8% decline in the labor force that allowed the state’s unemployment rate to fall to 6.1% (down from 6.9% recorded in August 2014) compared to the national average of 5.1%.

In 2014, Oregon’s personal income (PI) growth of 5.7% was better than the 4.4% U.S. rate of growth, and recent quarterly trends have been robust: 5.5% yoy growth in the second quarter of 2015 as compared to 4.1% for the U.S. and 5.4% for the region. Per capita personal income (PCPI) in 2014 totaled $41,220, representing 89.5% 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’s robust forecast for PI growth through the forecast period could shrink the difference.

MODERATE DEBT BURDEN

As of June 30, 2015, the state’s debt at 4.8% of 2014 PI is above average but still a moderate burden on resources. Principal amortizes at an improved 57% 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, intended to reduce the system’s liability, provide for sizable system savings for all employers, and reduce employer contribution rates. These reforms included: 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.

A legal challenge to the benefit changes was partly upheld by the state’s Supreme Court, restoring the 2% COLA for service performed before the reform law; the court permitted the COLA reduction for service performed after the reform law, as well as all other reforms. 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 restored COLAs through BY 2015 – 2017 as employer contribution rates for the next biennium were set prior to the court ruling.

The PERS board has also implemented several rounds of changes to actuarial assumptions, including lowering investment returns in two steps, to 7.5% as of the Dec. 31, 2014 valuation (expected sometime in 2015). The additional lowering of its return assumption rate is expected to increase the unfunded actuarial accrued liability (UAAL) of the system and be partly offset by the additional assumption changes. The updated system valuation is expected sometime in 2015.

Under prior GASB standards and incorporating the some of 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 have resulted 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 5.7% of 2014 PI. The calculations include $1.46 billion of the adjusted 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‘.

Fitch recently published an exposure draft of state and local government tax-supported criteria (Exposure Draft: U.S. Tax-Supported Rating Criteria, dated Sept. 10, 2015). The draft includes a number of proposed revisions to existing criteria. If applied in the proposed form, Fitch estimates the revised criteria would result in changes to fewer than 10% of existing tax-supported ratings. Fitch expects that final criteria will be approved and published by Jan. 20, 2016. Once approved, the criteria will be applied immediately to any new issue and surveillance rating review. Fitch anticipates the criteria to be applied to all ratings that fall under the criteria within a 12-month period from the final approval date.

Applicable Criteria

Exposure Draft: U.S. Tax-Supported Rating Criteria (pub. 10 Sep 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869942

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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