Fitch Rates $550MM Virginia Public Bldg Auth's 2016 Revs 'AA+'; Outlook Stable
--$197,755,000 public facilities revenue bonds, series 2016A;
--$188,160,000 public facilities revenue refunding bonds, series 2016B;
--$150,750,000 public facilities revenue bonds, series 2016C (AMT);
--$13,720,000 public facilities revenue bonds, series 2016D (Taxable).
The bonds are expected to sell via competitive bid on Sept. 14, 2016.
The Rating Outlook is Stable.
The bonds represent a limited obligation of the authority, payable from General Assembly appropriations.
KEY RATING DRIVERS
The 'AA+' rating on the VPBA bonds, one notch below the commonwealth's 'AAA' Fitch IDR, is based on debt service paid from direct payments made by the Commonwealth of Virginia, subject to legislative appropriation.
Economic Resource Base
Virginia's economic profile remains strong with a diverse mix of industries and high wealth levels, and Fitch expects the commonwealth to absorb the negative effects of federal contraction and maintain economic growth. Government and professional and business services are the leading sectors. Government employment has been flat to declining for the past several years, but professional and business services employment has grown rapidly since mid-2014 declines, driving overall gains in the Commonwealth's employment levels. Growth prospects are solid with above-average population growth and high education levels signaling a well-positioned workforce.
Revenue Framework: 'aa' factor assessment
Fitch expects that Virginia's revenues, primarily income and sales taxes, will continue to reflect the depth and breadth of the economy, but also its volatility. The Commonwealth has complete control over its revenues, with an unlimited legal ability to raise operating revenues as needed.
Expenditure Framework: 'aaa' factor assessment
The Commonwealth maintains ample expenditure flexibility with a low burden of carrying costs for liabilities and the broad expense-cutting ability common to most U. S. states. Also as with most states, Medicaid remains a key expense driver, but one that Fitch expects to remain manageable.
Long-Term Liability Burden: 'aaa' factor assessment
Virginia's long-term liability burden is low and well-managed. Debt issuance is carefully monitored through both constitutional limitations and more stringent policy and institutional practices. Despite a budget-driven deferral of pension contributions that weakened the funded position, the Commonwealth's unfunded obligations remain below those of most states.
Operating Performance: 'aaa' factor assessment
The Commonwealth remains extremely well-positioned to deal with economic downturns, with exceptionally strong gap-closing capacity in the form of its control over revenues and spending and a demonstrated willingness to restore financial flexibility at times of recovery.
IDR LINKAGE FOR APPROPRIATION BONDS: The rating on the bonds is sensitive to changes in the
Commonwealth's IDR, to which it is linked.
Virginia's income tax serves as the primary revenue source, accounting for nearly two-thirds of general fund revenues. The sales tax is the next largest component and together these economically sensitive taxes provide essentially the basis for the Commonwealth's revenue framework.
Historical revenue growth, adjusted for the estimated impact of policy changes, has been essentially flat on a real basis over the last 10 years. Robust growth in years of economic gains is offset by sometimes sharp declines when the economy contracts. The Commonwealth now caps estimated growth in the most volatile portion of its key tax revenues (non-withholding personal income taxes) to support budget stability, but Fitch anticipates the long-term trend for revenue growth will be in line with historical performance.
Virginia has no legal limitations on its ability to raise revenues through base broadenings, rate increases, or the assessment of new taxes or fees. As recently as 2013 the legislature and governor exercised this ability and made changes to the tax and fee structure supporting transportation to generate substantial new recurring revenues.
As in most states, education and health and human services spending are Virginia's largest operating expenses. Education is the larger line item, as the state provides significant funding for local school districts and an extensive public university and college system. Health and human services spending is the second largest area of spending, with Medicaid being the primary driver.
Spending growth, absent policy actions, will likely be slightly ahead of revenue growth driven primarily by Medicaid, requiring regular budget measures to ensure ongoing balance. The fiscal challenge of Medicaid is common to all U. S. states and the nature of the program as well as federal government rules limit the states' options in managing the pace of spending growth. In other major areas of spending such as education, Virginia is able to more easily adjust the trajectory of growth, since it does not retain responsibility for direct service delivery and there is no notable pressure for significant increases in state support. Overall, Virginia retains ample ability to adjust expenditures to meet changing fiscal circumstances.
Long-Term Liability Burden
Virginia maintains a modest long-term liability burden that should remain very manageable. Per Fitch's October 2015 State Pension Update report, the Commonwealth's total net tax-supported debt and unfunded pension liabilities of $20 billion made up just 4.8% of 2014 personal income compared to the 50-state median of 5.8%.
GO debt constitutes only approximately 15% of the Commonwealth's net tax-supported debt, with the remainder principally represented by various appropriation credits. Capital needs for higher education and transportation improvements remain large, with substantial authorized but unissued bonds. Virginia uses a statutorily-established joint executive-legislative committee to annually assess the Commonwealth's debt capacity. The committee's findings are recommendations but the governor and legislature typically abide by them.
In recent years, the Commonwealth enacted pension reforms affecting required contributions and plan design, all expected to limit further growth in the Commonwealth's pension liabilities in the coming years. Systemwide funding of the primary state retirement system (Virginia Retirement Systems, or VRS) declined in recent years in part due to underfunding of actuarial contributions (partially used as a budget balancing measure). Positively, the biennial budget plan for fiscal 2017 - 2018 accelerates the phase-in for full ADEC payments by one year to fiscal 2018. The use of a 7% investment return assumption is notably conservative relative to other major state systems.
Virginia's ability to respond to cyclical downturns rests with its superior budget flexibility, and the underlying strength of its broad economic profile allows it to restore that flexibility quickly once utilized. The general strength of Virginia's economy means these revenue sources will generally grow solidly during economic recoveries. However, during even modest downturns, declines can be abrupt and material. The Commonwealth has implemented some policy measures in its revenue forecasting process to mitigate fluctuations, but Fitch expects volatility to remain a feature of Virginia's revenue profile.
Virginia is generally able to reduce direct spending by shifting responsibilities down to lower levels of government or deferring expenditures. Such measures are generally temporary ensuring flexibility in future downturns. Similarly, Virginia has been able to take short-term revenue measures to address short-term fiscal distress, such as accelerating sales tax collections - while not sustainable, Fitch views these as reasonable one-time measures at times of revenue decline.
The Commonwealth also maintains a constitutionally-supported revenue stabilization fund (RSF) that provides another often utilized source of material, short-term budget relief. While downturns can hit Virginia hard because of its revenue volatility, sometimes triggering short-term and unsustainable measures, recoveries generally are quickly reflected in tax revenues and allow the Commonwealth to resume its more typical practice of structurally sound budget management.
Virginia's typically conservative and prudent financial management leads it to restore budgetary flexibility in times of economic recovery. The RSF has strict constitutional limitations on its usage and requirements for timely repayment of withdrawals. Just as important, the approach is institutionalized, as reflected most recently in the governor and legislature's joint commitment to accelerating the phase-in to full actuarial pension contributions when the state deferred funding during the Great Recession.
Economic and revenue performance underperformed in fiscal 2016 compared to earlier forecast expectations. Commonwealth fiscal 2016 general fund revenues increased modestly but fell 1.5% ($268.9 million) short of the forecast. Weakness in personal income tax (PIT) withholding and sales and use tax revenues accounted for nearly the entire shortfall - both sources increased but well below forecast levels. The Commonwealth attributed the performance to federal sequestration's continued dampening effect on Virginia's broad industry of federal contractors, and more rapid growth in lower-wage versus higher-wage jobs.
Unlike in other PIT-dependent states, nonwithholding revenues were not a driver of the revenue shortfall. After a fiscal 2014 revenue shortfall, Virginia implemented measures to limit the budget forecast's exposure to nonwithholding PIT revenues. Absent those measures, the revenue shortfall would have been nearly $200 million larger in fiscal 2016.
The weaker fiscal 2016 revenue collections triggered a reforecast and downward adjustment of revenue for the current fiscal 2017-2018 biennium. In August, the state estimated a 3.1% shortfall ($1.2 billion) versus the official revenue estimate used for the enacted biennial budget. The governor has already directed state agencies to develop spending reduction plans and the administration and legislative leadership have begun efforts to jointly develop budget changes.
Fitch anticipates the commonwealth will address the new $1.2 billion biennial revenue gap in a structurally sound manner, largely weighted towards expenditure reductions. The enacted biennial budget funds substantial growth in operations, implying areas for possible cuts. Budget balancing could also include draws on the RSF - inclusive of a required deposit in the current year, the RSF balance will be $845.3 million at the end of fiscal 2017 (4.6% of revised revenues). The governor will propose a plan to address the fiscal 2017 gap within the next weeks, with recommendations for fiscal 2018 to follow in December before the next legislative session. Within the budget appropriation act, the governor retains authority to withhold up to 15% of general fund agency appropriations to maintain fiscal balance.