Fitch Ratings assigns an ‘AA+’ rating to the following general obligation (GO) bonds of the State of Alabama:
–$186.505MM GO Refunding Bonds series 2014-A.
The bonds are scheduled to sell via competitive bid on July 24, 2014.
Fitch Ratings also affirms the ‘AA+’ rating on $618.9 million in outstanding GO bonds and the ‘AA’ rating on $22.3 million of series 2010 appropriation backed bonds issued by the Building Renovation Finance Authority (BRFA).
The Rating Outlook is Stable.
GO bonds: General obligation, full faith and credit of the state of Alabama. Although not pledged, 28% of oil and gas royalty payments received in the Capital Improvement Trust Fund are appropriated for debt service on up to $750 million of GO bonds.
BRFA bonds: Special obligation of the Alabama Building Renovation Finance Authority, payable solely from rental payments to be received by the Authority from the State of Alabama, pursuant to a master lease agreement. Rental payments are subject to appropriation.
KEY RATING DRIVERS
SLOW GROWTH AND DIVERSIFICATION: The trend in Alabama’s economy is toward more diversification although it retains a sizeable manufacturing base. There is an on-going positive shift from low paying textile and apparel jobs to higher paying durable subsectors including automobile and aerospace manufacturing.
MODERATE DEBT POSITION: Debt levels are moderate with most debt issued by a variety of authorities. However, pension funding has weakened in recent years.
SPENDING CONTROLS: Strong spending controls include a statutory requirement to make across-the-board appropriation reductions to maintain budgetary balance. Recent financial performance has been stable.
SIGNIFICANT TRUST FUND BALANCE: The state benefits from the maintenance of sizeable reserves in the Alabama Trust Fund, which is protected from the operating funds. The fund’s corpus cannot be used without constitutional amendment.
The rating is sensitive to material deviation from historically prudent financial practices, a change in policy or statute regarding use of the Alabama Trust Fund, significant weakness in the economy that deviates from national economic trends.
The rating reflects the state’s longer term trend toward a more diversified economy even with continued reliance on manufacturing, strong spending controls which contribute to balanced operations, and manageable debt levels.
MANUFACTURING BASED ECONOMY
Alabama’s economy was historically dominated by agriculture, natural resource extraction, and manufacturing, including textiles and iron and steel production. Today, the state still depends more heavily on manufacturing relative to the national average, but manufacturing has shifted away from textiles and apparel, in particular, to the automotive sector. This sector was hard hit in the recession, but the foreign owned automakers in the state, including Honda, Hyundai, and Daimler AG, continue to invest and produce in Alabama. Aerospace manufacturing is also growing in the state with Airbus investing $600 million in an assembly plant in Mobile that is expected to employ 1,000.
Alabama’s labor market has been slow to emerge from the recession and has lagged the nation since in job creation. Following several years of strong job growth prior to the recession, job losses during the recession were significant with weakness evident across all areas of the state and all employment sectors. Year-over-year employment declined 5.3% during 2009 and 0.8% in 2010, worse than the U.S. average of 4.3% and 0.7% respectively. Alabama experienced no growth in non-farm employment in 2011 while employment growth resumed nationwide at 1.2% and although Alabama employment grew 0.8% in 2012 and 1% in 2013, the U.S. grew 1.7% in both of these years. Most recently, non-farm employment grew just 0.6% in May 2014, while employment nationally grew 1.7%. The unemployment rate, which is typically lower than the U.S. rate, has recently jumped above the national rate at 6.8% in May 2014, higher than the U.S. rate of 6.3%.
Wealth indicators have typically been well below national averages, but show improvement in recent years. Personal income per capita is just 82% of the U.S. average, ranking it 42nd among the states. Quarterly personal income returned to growth in the first quarter of 2010 at a pace higher than that of the US or southeast region. More recently, personal income, while still growing, has lagged the growth of the US and southeast region. The poverty level is still among the highest of the states.
BUDGET BALANCE THROUGH SPENDING REDUCTIONS
State financial operations are dispersed among a variety of funds, supported by a diverse revenue stream. General fund operations are relatively small, limited to general government functions, health, and police/corrections, and supported by a variety of taxes and fees, including a portion of the sales and use tax and earnings on the Alabama Trust Fund. The state has significant responsibility for education with operations funded through the Education Trust Fund (ETF), which receives the state income tax, sales and use tax, and utility taxes.
Financial operations benefit from strong spending controls, with a constitutional requirement to make across-the-board appropriation reductions, called “proration,” when a deficit is projected in one of several funds; debt service is not subject to proration. This device has been implemented several times, especially in the education trust fund, but also in the general fund. The state depleted cash balances in the general and education funds, utilized rainy day fund borrowing from the Alabama Trust Fund, discussed below, and still required proration in fiscal years 2009 through 2012.
Financial operations have improved after several years of recession related revenue declines that required multiple rounds of budget reductions. With fiscal 2014 general fund revenues largely on target, the state will be able to make a sizeable repayment of the ETF rainy day fund draw at the end of the fiscal year as anticipated. The adopted budget for fiscal 2015, which begins October 1, assumes only modest revenue growth and keeps general fund spending essentially flat.
SIZEABLE RESERVES SUPPORT OPERATIONS
The state maintains a sizeable balance in the Alabama Trust Fund, which was initially capitalized with proceeds from off-shore lease sales in 1981 and still receives portions of oil and gas royalty payments to the state. Earnings from the fund, which has a balance of approximately $2.9 billion, support the general fund, a land trust, and a variety of state and local capital projects. It also is the source of the general fund and ETF rainy day funds, which, when used, must be repaid over a specified time period. The ETF rainy day fund balance of $437 million was depleted in fiscal 2009; the general fund rainy day fund balance, which varies according to a number of factors and is limited to 10% of prior year appropriations, was utilized in fiscal 2010. As part of fiscal 2013 budget balancing measures, the general fund was allocated $437 million in additional transfers from the Alabama Trust Fund, to be distributed over three fiscal years.
LOW DEBT BUT WEAK PENSION FUNDING
With a constitutional prohibition against issuing debt, except by a constitutional amendment, state debt issuance is diffuse, issued by a variety of authorities, with less than 20% of debt general obligation. Debt levels are moderate at 2.2% of 2013 personal income. However, a longer term concern is the deterioration in pension funding levels: the two largest systems, covering general employees and public education, were over-funded as recently as 2001 but are now funded on a reported basis at 65.8% and 66.5% respectively as of September 30, 2013. When liabilities are adjusted to reflect a 7% return assumption (compared to the plans’ 8% assumption), the funded ratios fall to 29.2% and 59.9% respectively. On a combined basis, the burden of net tax-supported debt and adjusted unfunded pension obligations that are attributable to the state equals 18.5% of 2013 personal income, above the 6.1% median for U.S. states.
In addition to the sources of information identified in the report ‘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