Fitch Rates North Carolina's $330MM GO Bonds 'AAA'
OREANDA-NEWS. Fitch Ratings has assigned an 'AAA' rating to the following general obligation (GO) bonds of the State of North Carolina:
--$330 million GO refunding bonds, series 2016A
The bonds are expected to be sold via competitive bid Feb. 24, 2016.
Fitch has also affirmed the 'AAA' rating on $3.5 billion of outstanding North Carolina general obligation (GO) debt and the 'AA+' rating on $2.3 billion in appropriation backed debt issued by the state and its Infrastructure Finance Corp.
The Rating Outlook is Stable.
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 debt burden and strong debt management practices, including an affordability planning process. 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 remain important as the state continues to address the impact of a revised tax structure that is expected to lower tax revenues and absorb some 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 are stronger.
The rating is sensitive to significant changes in the financial or debt profile or a fundamental change in the economy.
North Carolina's 'AAA' GO bond rating reflects its moderate liabilities, conservative financial operations and long-term prospects for continued economic expansion and diversification. The governor is empowered to unilaterally reduce spending to maintain budget balance, after making provision for debt service. Other sources of financial flexibility include maintenance of sound budgetary reserves and occasional revenue increases to balance operations.
LOW DEBT LEVELS AND WELL FUNDED PENSIONS
North Carolina's liabilities are relatively low, with a debt burden that is low at 1.9% of 2015 personal income. Tax-supported debt approximates $7.5 billion, as of June 30, 2015, about half of which is general obligation. There is a $2 billion GO bond authorization, proposed by the governor and authorized by the legislature, on the state ballot scheduled for March 2016, coinciding with the state's presidential primary. Given rapid amortization of outstanding debt (80% of GO and appropriation debt is retired within ten years), debt levels are expected to remain low to moderate even with additional borrowing. The current offering is a refunding for debt service savings.
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 94.6% as of June 30, 2015. The state is responsible for the pension obligation of teachers as well as state employees. The combined ratio of debt and unfunded pension liability, using Fitch's more conservative 7% discount rate assumption, is well below average at 3.3% of personal income. This compares favorably to the 5.8% median for U.S. states, ranking North Carolina 11th among the states.
CHANGE IN TAX STRUCTURE AFFECTING REVENUES
Financial performance was challenged during the fiscal
2013 - 2015 biennium, as the state contended with revenue underperformance caused primarily by changes in its tax structure. Tax revenues were significantly below estimate in the first year of the biennium, 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 partly offset by stronger corporate income and sales tax receipts.
Recent stronger economic growth contributed to revenue growth that exceeded forecast in the second half of fiscal 2015, leading to a sizeable operating surplus despite a gap being forecast midway through the fiscal year. Tax revenue increased 7.1% in fiscal 2015, led by strong personal income and sales tax growth. Corporate income taxes, while down on a year-over-year basis, were also well above the very conservative forecast.
The enacted budget for the fiscal 2015 - 2017 biennium is based on continued slow but steady economic growth and requires modest revenue growth of 1.3% annually. The budget continues tax code adjustments, including lowering the PIT rate (to 5.499% from 5.75%) and further expanding the sales tax base. These tax changes are expected to reduce biennial revenues by approximately $384 million, primarily in fiscal 2017.
Spending pressure in two key areas, Medicaid and education, appears to be reduced. The state is transitioning to a managed care model for Medicaid over three to four years, which is expected to stabilize Medicaid spending as a portion of the budget. Although North Carolina did not choose to expand Medicaid under the Affordable Care Act, it did experience a significant "woodwork" effect of new enrollments under preexisting eligibility guidelines. The budget includes a $333 million increase in Medicaid spending over the biennium as well as funding a Medicaid Risk Reserve ($186 million) to address volatility in the program. The budget provided teacher salary increases but some budget flexibility may materialize as enrollment growth is lower than anticipated.
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. With positive year-end revenue performance, the state increased reserves by $200 million, bringing the total to $852 million, or 3.8% of general fund revenues at the end of fiscal 2015. The current biennial budget would further increase reserves to $1.1 billion, or 5.1% of expected general fund revenues.
The state maintains other reserves as well, totaling $637 million in special and trust funds as well as approximately $844 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 and has shown steady growth since 2011, it remains half of what it was in the 1990s. Professional and business service employment is one of the faster growing sectors, increasing 3.6% on a year-over-year basis in December 2015. Measured by per capita personal income, North Carolina is below average at 85.1% 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.
Economic growth was originally slow emerging from the recession, although it has accelerated in recent years 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 and has been growing faster since. Most recently, non-farm employment increased 2.1% in December 2015, relative to the U.S. rate of 1.9%. The state's unemployment rate has dropped considerably, to 5.6% in December 2015, and as is typical, remains above the U.S. rate (5.0% in December).