NEW YORK–(BUSINESS WIRE)–Fitch Ratings assigns an ‘A+’ to the following general obligation (GO)
bonds of the state of California:
–$105.355 million federally taxable various purpose GO bonds;
–$996.2 million tax-exempt various purpose GO refunding bonds.
The bonds will be sold via competitive bid on April 21, 2015.
The Rating Outlook is Stable.
General obligations, for which the state pledges its full faith and
credit, subject to the prior application of moneys to the support of
public education; funds for education represent approximately half of
KEY RATING DRIVERS
IMPROVED FISCAL FUNDAMENTALS: The rating reflects continued improvement
in the state’s fundamental fiscal position. Institutionalized changes to
fiscal operations in recent years, when combined with the ongoing
economic and revenue recovery, have enabled the state to materially
improve its financial position, enhancing its ability to address future
fiscal challenges. Progress includes timely, more structurally sound
budgets, spending restraint, continued sizable reductions in budgetary
debt, and initial funding of reserves.
WEALTHY, DIVERSE ECONOMY: The economy is wealthy and unmatched among
U.S. states in its size and diversity. After severe, widespread
recessionary conditions, growth has resumed, including in California’s
MODERATE DEBT BURDEN: Tax-supported debt is moderate, although combined
debt and pension liabilities are above the median for states. Pension
funded ratios declined following the downturn and there is a history of
inadequate contributions to the teachers’ system; however, the state has
instituted some benefit reforms and the fiscal 2015 enacted budget
provides the first installment of a long-term plan to increase
contributions to the teacher’s system.
CYCLICAL REVENUES AND CASH FLOWS: With economic recovery and associated
revenue growth, liquidity has improved significantly and no cash-flow
issuance is currently expected for fiscal 2016. State finances have been
subject to periodic, severe budget and cash flow crises due to economic
and revenue cyclicality and historical institutional inflexibility. The
state expanded its ability to manage cash flow weakness during the last
downturn, which can be expected to make the effects of future downturns
TANGIBLE STRUCTURAL PROGRESS: Deep recurring spending cuts in recent
adopted budgets, a restrained approach to restoring past cuts, and
healthy revenue growth have eliminated the state’s structural imbalance.
Further, the state is applying revenue growth to eliminating the heavy
burden of budgetary borrowing from the last two fiscal crises, enhancing
its fundamental financial flexibility.
INITIATIVES LIMIT FLEXIBILITY: Voter initiatives have reduced the
state’s discretion to effectively manage budgetary challenges over time.
However, more recent initiatives authorizing a simple legislative
majority to approve spending and temporarily raising tax revenues have
been instrumental to current fiscal progress.
CONTINUED FISCAL DISCIPLINE: The rating is sensitive to the continuation
of the state’s recent budgetary discipline and its ability and
willingness to continue progress on reducing budgetary borrowing and
maintaining structural balance.
Fitch’s ‘A+’ rating on California’s GO bonds reflects the institutional
improvements made by the state in recent years, its disciplined approach
to achieving and maintaining structural balance in recent budgets, and
the consequent fiscal progress made to date by the state as it recovers
from the severe budgetary and cash flow crisis of 2008-2009.
Recent fiscal management improvements remain untested by a severe
recessionary event, but in Fitch’s view the state is in a materially
improved position to address future economic and revenue cyclicality,
and the state’s finances are likely to further strengthen assuming the
current expansion and budgetary discipline continue. However,
California’s credit standing is likely to remain lower than most states
given its comparatively lower fiscal flexibility, driven by revenue
limitations, the initiative process, spending formulas for education,
and other factors that remain unchanged. Key credit strengths include
the state’s massive, diverse economy and tax base.
Notable improvements since the fiscal crisis of 2008 – 2009 have
included a voter-approved change that allows simple majority budget
approval, various cash flow management tools that contribute to enhanced
liquidity, and the passage of a constitutional amendment in November
2014 that strengthens the funding mechanism of the budget stabilization
account (BSA) and provides the state with a means to better manage
revenue cyclicality. Successive years of timely budgets that have
achieved and maintained structural gains primarily through deep,
recurring spending cuts as well as voter-approved temporary taxes have
positioned the state to make steady progress repaying past budgetary
borrowing. Fitch believes that these improvements, supported by an
expanding economy that is generating revenues at a pace that is
exceeding the state’s forecasts, have strengthened California’s
fundamental credit profile.
A key element that will provide future flexibility is the significant
reduction in budgetary borrowing that accumulated as the state worked to
balance the budget over the course of the two most recent recessions. At
its peak, the state’s budgetary borrowing totaled approximately $35
billion, including outstanding debt in the form of the Economic Recovery
Bonds (ERBs), payment deferrals to schools and local governments,
payroll shifts between fiscal years, and interfund borrowing.
The temporarily higher personal income tax (PIT) and sales tax rate
changes approved by voters in November 2012, while exposing the state to
sharper revenue volatility, provide the state with a margin of cash and
revenue flexibility to sustain recent progress, assuming the state
continues to exercise spending restraint. The state has utilized these
additional revenues to rapidly repay budgetary borrowing, including
effectively retiring the ERBs at the beginning of the next fiscal year
(fiscal 2016). It is important to note that by focusing the use of
temporary taxes on debt reduction, the state is better positioned to
maintain budgetary balance as the tax increases expire.
Another source of financial flexibility is expected to come from the
improved mechanism for funding the BSA. Voters approved a constitutional
amendment in November 2014 that requires 1.5% of general fund revenues,
plus the excess of capital gains tax receipts above 8% of general fund
tax revenue, not necessary to fund Proposition 98, be set aside at the
beginning of each fiscal year in the BSA. Half of each year’s deposit
for the next 15 years will be used for supplemental payments toward
budgetary debt or other long-term liabilities, with the balance retained
in the BSA. This latter provision covering capital gains revenue is
likely to contain one of the key drivers of general fund revenue
volatility during the last two fiscal crises. The state deposited $1.6
billion in the BSA at the beginning of the current fiscal year, based on
the then existing provisions of Proposition 58.
ECONOMIC RECOVERY GAINING MOMENTUM
California’s economy is unmatched in size and diversity, and the economy
is gaining momentum across most sectors and regions. Although
California’s job losses during the recession exceeded the U.S. median,
its recovery has exceeded the U.S. as well.
As of February, non-farm employment had reached 103.2% of its
pre-recession peak, above the U.S. median of 102%. Employment growth has
been outpacing the nation’s during the current expansion with non-farm
employment up 3.2% year-over-year in February 2015, well above the 2.3%
national rate. Employment gains are widespread, particularly in key
service sectors, and construction employment is expanding (+6.5% in
February) as the housing sector recovers.
California’s unemployment rate has fallen considerably, to 6.7% in
February 2015 vs. 8.0% one year earlier, although it remains elevated
relative to the nation’s 5.5% unemployment rate; this is consistent with
historical trend. Personal income growth has generally matched the
national and regional averages over the past year and California ranks
11th among the states in terms of per capita personal income at 108.2%
of the national average.
The state’s latest economic outlook, released with the governor’s budget
proposal in January 2015, foresees continued moderate improvement in the
economy; unemployment declining but still higher than the national rate;
and continued recovery in the housing market. Personal income is
forecast to grow 5.3% in 2016.
IMPROVED BUDGET OUTLOOK
The state has adopted four consecutive budgets on a timely basis, a
marked contrast to historical behavior, and one that reflects the
benefit of the change to requiring a simple majority to enact a budget.
Recent budgets have prioritized shoring up finances, including through
prudent control of spending and budgetary debt repayment. Only four
years ago, the state faced a cumulative operating gap of $26.6 billion,
equivalent to 15.3% of baseline fiscal 2011 and 2012 general fund
revenues. Since then, economic and revenue gains, the state’s
disciplined approach to limiting spending growth, and voter approval in
2012 of temporary personal income and sales tax increases have enabled
the state to move to structural budget balance while repaying billions
in past budgetary borrowing.
The adopted budget for the current year, fiscal 2015, avoided restoring
the deep spending cuts, repaid an additional $10.4 billion of budgetary
debt, was expected to leave a $1.4 billion cumulative general fund
balance, and deposits $1.6 billion to the state’s rainy day fund, the
first deposit since fiscal 2008. Another $1.6 billion was expected to
further reduce budgetary borrowing, including deferred payments to
school districts and local governments.
Strong revenue performance is continuing in fiscal 2015, with general
fund revenues through February $633 million above even the upwardly
revised November 2014 forecast used for the governor’s fiscal 2016
budget proposal, although this is in part due to timing of receipt of
sales tax revenues. Strong PIT and corporate tax receipts offset
slightly weaker than anticipated sales and use tax revenues during the
first half of the fiscal year. The governor’s budget proposal for fiscal
2016 assumes that fiscal 2015 revenues will ultimately be $2.6 billion
higher than originally assumed in the fiscal 2015 adopted budget, with
these increased revenues absorbed by additional payments to schools and
higher costs of Medi-Cal.
The governor’s budget proposal for fiscal 2016 assumes continued
economic growth and steady revenue gains through fiscal 2016. The budget
as proposed is balanced and continues the emphasis on reducing
outstanding budgetary borrowing. It continues to restrain budgetary
growth, repays budgetary debt including making the final payment for the
economic recovery bonds (ERBs), and makes a second consecutive deposit
to the BSF. A revised budget proposal is expected in May.
DEBT AND PENSIONS
California has a moderate but above-average debt burden, with net
tax-supported debt of approximately $89 billion as of January 1, 2015
(not including the current issuance), equal to 4.9% of 2013 personal
income. Debt and pension liabilities combined at 8.3% are above the
state median of 6.1%, ranking the state 31st.
System-wide funded ratios on a reported basis for the state’s two main
pension systems, covering public employees and teachers, eroded due to
investment losses during the recession. Based on its June 30, 2013
financial report, the public employees’ plan reported an 83.1%
system-wide actuarial funded ratio. As of its June 30, 2014 financial
report, the teachers’ plan reported a 76.5% system-wide ratio of assets
to liabilities (reflecting GASB 67 requirements). Using Fitch’s more
conservative 7% discount rate assumption, the most recent ratios for the
two systems fall to 78.8% for public employees and 72.5% for teachers.
The state adopted a broad package of pension reforms in 2012 that affect
most state and local systems, including through benefit reductions for
new workers and higher contributions for employees. While changes are
expected to generate only modest near-term annual savings for the state
and for local governments whose pension plans are subject to the
reforms, annual savings are expected to grow considerably over time.
Full actuarial contributions to the public employees’ system are legally
required, but not for the teachers’ system, leading to persistent
underfunding of the latter. The state addressed teachers’ system funding
with legislation enacted in June 2014. The legislation gradually
increases contribution requirements, in particular from school
districts, with the first installment funded in the fiscal 2015 budget,
and expects that it will be fully funded by 2046.
Net tax-supported debt excludes cash flow borrowing; the state issued
$2.8 billion in revenue anticipation notes for fiscal 2015 cash flow
needs, well below that of prior years, reflecting the state’s
substantially improved fiscal position. The governor’s budget proposal
does not anticipate the need for cash flow issuance during fiscal 2016.
Additional information is available at ‘www.fitchratings.com‘.
In addition to the sources of information identified in the
Tax-Supported Rating Criteria, this action was additionally informed by
information from IHS Global Insight.
Applicable Criteria and Related Research:
–‘Tax-Supported Rating Criteria’ (Aug. 14, 2012);
–‘U.S. State Government Tax-Supported Rating Criteria’ (Aug. 14, 2012).
Applicable Criteria and Related Research:
Tax-Supported Rating Criteria
U.S. State Government Tax-Supported Rating Criteria
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