Fitch Ratings has assigned an 'A+' rating to the following
Pennsylvania Commonwealth Financing Authority (CFA) bonds:
--$96 million CFA revenue bonds (tax-exempt) series A of
2015;
--$98.05 million CFA revenue refunding bonds (tax-exempt) series
B-1 of 2015;
--$3.565 million CFA revenue refunding bonds (taxable) series
B-2 of 2015.
The bonds are expected to be offered through negotiation the
week of April 6, 2015.
The Rating Outlook is Stable.
Concurrently, Fitch has withdrawn the 'A+' rating for the
following Pennsylvania CFA bonds as they were not sold:
--$96 million CFA revenue bonds (tax-exempt) series A of
2014;
--$96.865 million CFA revenue refunding bonds (tax-exempt)
series B-1 of 2014;
--$6.94 million CFA revenue refunding bonds (federally taxable)
series B-2 of 2014.
SECURITY
The bonds are paid from payments made by the commonwealth of
Pennsylvania pursuant to service agreements between the authority
and the commonwealth, subject to annual appropriation by the
Pennsylvania General Assembly.
KEY RATING DRIVERS
APPROPRIATION SECURITY: Bond payments require annual legislative
appropriation, resulting in a rating one-notch below Pennsylvania's
'AA-' GO rating.
FISCAL CHALLENGES: Pennsylvania's 'AA-' GO rating, below the
level of most states, reflects the commonwealth's continued
inability to address its fiscal challenges with structural and
recurring measures. After an unexpected revenue shortfall in fiscal
2014, the current year budget includes a substantial amount of
one-time revenue and expense items to achieve balance and continues
the deferral of statutory requirements to replenish reserves which
were utilized during the recession. The commonwealth's rapid growth
in fixed costs, particularly the escalating pension burden, poses a
key ongoing challenge, although Fitch expects budgetary planning
and management to mitigate these pressures in a manner consistent
with the 'AA-' rating.
PENSION FUNDING DEMANDS: The funding levels of the
commonwealth's pension systems have materially weakened as a result
of annual contribution levels that have been well below actuarially
determined annual required contribution (ARC) levels. Under current
law, contributions are projected to rise to the ARC for the two
primary pension systems by as soon as fiscal 2017, increasing the
budgetary burden and potentially crowding out other funding
priorities.
INCREASING BUT STILL MODERATE LONG-TERM LIABILITIES: The
commonwealth's debt ratios are in line with the median for U.S.
states. However, the commonwealth's combined debt plus
Fitch-adjusted pension liabilities is above average, and could
continue growing given the current statutory schedule of pension
underfunding for at least the next few years. Fitch views
Pennsylvania's long-term liability burden as manageable at the
'AA-' rating so long as the commonwealth adheres to its funding
schedule, or enacts reforms that do not materially increase its
liability or annual funding pressure.
SOLID ECONOMIC PROFILE: Employment growth continues for the
state's broad-based economy, but at a slower pace than the nation.
Below-average demographics represent a long-term drag on economic
growth, though potential development of the significant natural gas
reserves could mitigate that concern. Overall, the state's economy
provides a solid base for future potential revenue growth to help
manage ongoing expenditure pressures.
RATING SENSITIVITIES
ADDRESSING FIXED-COST PRESSURES: The 'AA-' rating is sensitive
to the commonwealth's continued ability to address increasing
fixed-cost pressures, particularly for pensions. Fitch anticipates
the commonwealth will meet at least its statutory obligations
through adequate funding in lieu of more discretionary budget
items, structural expenditure reform, or revenue increases; any
shift away from those commitments would be a credit negative.
MOVE TOWARD SUSTAINABLE BUDGETS: Given the magnitude of
Pennsylvania's structural budget gap, Fitch anticipates some
continued use of non-recurring items in upcoming budgets, but at a
declining rate. Failure to make progress toward structural balance
could trigger negative rating action.
CREDIT PROFILE
The 'A+' rating on the CFA revenue bonds reflects the credit of
the commonwealth (GOs rated 'AA-' with a Stable Outlook by Fitch)
and covenants to seek state appropriations. The bonds are special
obligations of the CFA, which was created in 2004 to stimulate and
diversify the state's economy through the use of
appropriation-backed debt. Debt service is derived from payments
from the commonwealth to the CFA under multiple service agreements,
subject to appropriation. The secretary of the Department of
Community and Economic Development (DCED) and the secretary of the
budget have covenanted to seek such appropriations. The CFA is
staffed through DCED and is governed by a seven-member board
including both executive and legislative appointees. The CFA and
DCED have regularly met their covenants to request full
appropriation of debt service from the general fund in annual
budget requests. Partially as a budget management tool in fiscal
2015 (and also in fiscal 2011), Pennsylvania's enacted budget
relies on the CFA's use of available interest earnings, in addition
to state appropriations. Interest earnings are pledged to
bondholders.
CFA was granted bonding authority for up to $1.135 billion in
debt, of which $500 million is for alternative energy projects and
the remainder for other programs including economic development
initiatives (the original programs authorization). The series 2015A
bonds are being issued under the alternative energy authorization,
and the 2015B bonds are being issued under the original programs
authorization. Following these issuances, Fitch estimates CFA will
have issued $461 million of the $500 million in authorized
alternative energy programs debt.
Pennsylvania faces fiscal pressures in the form of a
structurally unbalanced budget, depleted reserves, and a rapidly
growing pension contribution burden following years of contribution
underfunding and market-driven investment declines. The 'AA-'
rating reflects those issues, as well as Fitch's expectation that
the commonwealth will respond to those pressures adequately, while
also beginning to make progress toward structural budgetary
balance. Pennsylvania benefits from a large, diversified and
expanding, albeit slowly, economic base and moderate tax burden
which provides some capacity to match expenditure growth.
STRUCTURAL IMBALANCE; ONGOING BUDGETARY RISK
The commonwealth's tax revenues continue their slow recovery,
though fiscal 2014 ended well short of budgeted expectations (0.1%
actual growth versus 2% budgeted), adding to the state's fiscal
pressures. As in several other states, Pennsylvania's fiscal 2014
personal income tax revenues grew at a much slower rate than
anticipated, largely due to the acceleration of income into fiscal
2013 attributable to a federal income tax increase. Sales tax
revenues also came in below the enacted budget, but to a lesser
degree. The revenue shortfall totaled just over $500 million, which
the commonwealth responded to primarily through broad-based
expenditure reductions, reflecting positively on Pennsylvania's
proactive budgetary management.
Pennsylvania's enacted budget for fiscal 2015, which ends on
June 30, relies heavily on one-time items to achieve balance. In
total, the budget includes a significant $2 billion in one-time
items on a $29 billion budget, or approximately 7%. Through the
first eight months of fiscal 2015, general fund revenues were
tracking ahead (2.2%) of the budgeted estimate. Fitch notes the
enacted budget includes $2 billion in one-time, non-recurring items
to achieve balance creating a substantial budget challenge for
fiscal 2016. In November, the state legislature's independent
fiscal office (IFO) projected a significant structural budget gap
of $1.7 billion for fiscal 2016, escalating steadily in the years
thereafter. Fitch anticipates Pennsylvania will take necessary
budgetary actions to move towards structural balance over the next
several years.
Several one-time sources included in the current budget may not
be realized, but revenue over-performance to date appears
sufficient to offset the loss of these items. Fitch does not
currently anticipate any need for intra-year balancing actions in
order to maintain balance, a notable improvement from last year.
However, budgetary pressure for future years remains substantial,
evidenced by the extensive use of one-time items in the current
year and ongoing statutory increases in pension contributions noted
earlier. The potential for a moderate level of added budgetary
stress and continued, though declining, use of one-time items in
upcoming budgets is incorporated into the 'AA-' rating.
Pennsylvania's newly inaugurated governor introduced his first
executive budget, for fiscal 2016, several weeks ago, focusing on
several substantial revenue changes and a multi-year plan to
restore education funding cuts made in recent years. Revenue
highlights include a severance tax on natural gas, increases in the
personal income and sales tax rates, broadening of the sales tax
base, and reduction in corporate tax rates and local school
district property taxes through increased state offsets for
property owners. The most significant spending growth is in K-12
education, particularly beyond the next fiscal year when full-year
effects of the proposed tax changes are realized. Pennsylvania has
a history of late budgets, particularly in situations where
political control is split between parties, and thus Fitch expects
that achieving consensus on a final fiscal 2016 budget may be
challenging. Importantly, debt service for GO and appropriation
debt has consistently been paid even when final budget enactment
was delayed several months.
PENSIONS PRESSURING FINANCIAL PROFILE
Growing statutory pension funding obligations are a main driver
of the structural imbalance in the state's budget and will require
either a growing commitment of state fiscal resources, or a
structural reform to drive down costs. Under the current statutory
framework, Fitch expects commonwealth general fund pension
contributions will increase significantly in fiscals 2016 and 2017
before growth rates ratchet down thereafter. Both of the state's
primary pension systems project Pennsylvania will contribute the
full ARC by fiscal 2017 following over a decade of underfunding. At
that point, Fitch expects growth in annual contribution increases
will slow to a level more in line with overall budgetary growth.
Similarly, projections provided by each of the systems for their
respective funded ratios (a proxy for unfunded liabilities) weaken
moderately over the next several years but begin improving by
fiscal 2019.
Without structural expense reform or broad revenue increases,
pension contributions will consume a larger share of state
resources and limit the commonwealth's overall fiscal flexibility.
In fiscal 2015, commonwealth contributions are increasing over $600
million from the prior year, to $2.7 billion on a $30 billion
general fund budget (9.1%). Based on the statutory framework and
the pension systems' historical data and actuarial projections for
contributions, Fitch anticipates increases for fiscal 2016 and 2017
will be similar though somewhat lower. While substantial, Fitch
views the anticipated contribution increases and unfunded
liabilities laid out in the current statutory framework as within
the commonwealth's capacity to absorb at the 'AA-' rating
level.
The governor's fiscal 2016 executive budget includes
pension-related measures focused on issuing a pension obligation
bond to reduce the unfunded liability, dedicating revenues to
ensure adequate annual contributions, and reducing investment
management fees. Several alternative legislative proposals appear
to focus instead on benefit reform, largely through switching to a
defined contribution plan for new employees. Fitch will evaluate
any enacted pension changes on their ability to improve the
commonwealth's fiscal capacity and long-term liability profile.
LONG-TERM LIABILITIES ABOVE AVERAGE
Pennsylvania's debt burden is moderate and at the median for
U.S. states rated by Fitch. The state issues primarily GO debt,
with over 60% retired within 10 years. Pro forma net tax-supported
debt (NTSD) ratios have risen but remain very manageable at
approximately 3% of 2014 personal income. Fitch's NTSD calculation
for Pennsylvania includes availability and milestone payment (AP
and MP) commitments for its rapid bridges replacement public
private partnership transportation project (P3), which Fitch views
as a long-term state obligation. Under terms of the AP and MP
agreements and related contracts, Pennsylvania pays a private
developer fees based on the successful completion and continued
operation of the bridge projects. The commonwealth anticipates
funding the payments largely from its Motor License Fund, though
Pennsylvania remains committed even if such revenues are
insufficient.
Unfunded pension obligations now represent the dominant share of
the state's long-term liabilities. Annual contributions have been
below actuarially required levels for many years and investment
performance lagged expectations during the recession, triggering
growth in unfunded liabilities. Pursuant to statute, sharp jumps in
required contributions began in fiscal 2011, with the goal of
phasing in full ARC funding over several years. Funded level ratios
for the primary pension systems, the State Employees' Retirement
System (SERS) and the Public School Employees' Retirement Systems
(PSERS), have declined in recent years, and continued declines are
likely at least for PSERS given that even the increased statutory
contributions will be below the ARC for several more years.
The most recent reported funded ratio for SERS (as of Dec. 31,
2013) is 59.2%, dropping to 56.1% using Fitch's more conservative
7% discount rate assumption - both ratios are actually up slightly
from the 2012 valuation (58.8% reported and 55.7% Fitch-adjusted).
SERS has not yet issued a fiscal 2014 comprehensive annual
financial report. For PSERS, the reported funded ratio (as of June
30, 2013) is 63.8%, or a Fitch-adjusted 60.4% - PSERS reports 54.5%
GASB 67 ratio of pension assets to liabilities as of June 30, 2013.
The commonwealth is responsible for an estimated 59% of the PSERS
liability and 100% of SERS. The burden of the commonwealth's net
tax-supported debt and adjusted unfunded pension obligations equals
9.8% of 2013 personal income, above the median for U.S. states, as
reported by Fitch in its 2014 state pensions report.
Under current law, both pension systems project some weakening
of funded ratios, and growth in unfunded liabilities, until
commonwealth contributions reach the ARC. The 'AA-' rating
incorporates this projected growth, which Fitch anticipates will
keep the total long-term liability burden at an above-average
though manageable level for Pennsylvania.
Fitch notes that the state's OPEB liabilities are relatively
manageable, following several significant reforms in recent years.
As of June 30, 2013, the state's reported unfunded OPEB liability
for its two largest plans (for state employees and teachers, and
for state police) of $16.3 billion represented a moderate 2.8% of
2013 personal income. Those plans also have a modest amount of
pre-funding, with $153 million in actuarially valued assets.
BROAD-BASED ECONOMY A CREDIT STRENGTH
Pennsylvania's economy, historically dominated by manufacturing,
has diversified and is growing slowly as the state recovers from
the recession. Prior to the downturn, the economy posted consistent
annual employment growth despite continued manufacturing losses.
Employment in 2008 was flat as U.S. employment fell, and once the
recession hit it was less severe and shorter in Pennsylvania than
for the nation as a whole. The commonwealth's peak-to-trough
decline in seasonally adjusted monthly payrolls was just 4.4%, vs.
a national decline of 6.3%.
While Pennsylvania's non-farm payrolls grew every year since
2009, the trajectory has slowed. In 2014, non-farm employment grew
just 0.8%, down from 1.1% in 2011 and half the U.S. rate of 1.8%.
Pennsylvania's January 2015 year-over-year (YOY) employment growth
of 1.2% remains below the national YOY gain of 2.3%, but payrolls
in the state do appear to be gaining some modest momentum. The
three-month moving average for YOY employment growth in
Pennsylvania reached 1.1% in January, up from 0.4% one year
earlier.
Factors affecting the commonwealth's longer term economic
outlook include its relatively weak demographic profile as well as
the boost that development of abundant natural gas resources could
provide. The commonwealth is among the nation's oldest states, with
a median age of 40.5 versus the national median of 37.4. State
population growth has lagged the national trend for several
decades, indicating the potential for a smaller future workforce.
Offsetting these trends, the state could benefit from continued
development of the Marcellus Shale natural gas deposits, and
eventual development of the Utica Shale, which may bring additional
jobs in mining and related industries as well as attracting
industries focused on low-cost energy such as manufacturing. While
natural gas activity is subject to market-driven volatility, the
abundance of supplies still presents a significant economic
opportunity for the state.
Additional information is available at
'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'U.S. State Government Tax-Supported Rating Criteria' (Aug.
14, 2012)
--'Tax-Supported Rating Criteria' (Aug. 14, 2012)
Applicable Criteria and Related Research:
Pension Pressures Continue (2014 State Pension
Update)http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=747605
Tax-Supported Rating
Criteriahttp://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=686015
U.S. State Government Tax-Supported Rating
Criteriahttp://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=686033
Additional Disclosure
Solicitation
Statushttp://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=982084
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Fitch RatingsPrimary AnalystEric Kim,
+1-212-908-0241DirectorFitch Ratings, Inc.33 Whitehall StreetNew
York, NY 10004orSecondary AnalystLaura Porter,
+1-212-908-0575Managing DirectororCommittee ChairpersonDouglas
Offerman, +1-212-908-0889Senior DirectororMedia Relations, New
YorkElizabeth Fogerty,
+1-212-908-0526elizabeth.fogerty@fitchratings.com