Fitch Affirms Alabama at AA+; Outlook Stable

Fitch Ratings affirms the following ratings of the State of Alabama:

The Rating Outlook is Stable.

The appropriation backed bonds are a 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 annual appropriation.

KEY RATING DRIVERS

Alabama’s ‘AA+’ GO rating and IDR reflect the longer-term trend toward a more diversified economy even with continued reliance on manufacturing, strong spending controls that contribute to balanced operations, and manageable debt levels.

CREDIT PROFILE

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 to the automotive sector. Aerospace manufacturing is also growing in the state with Airbus investing $600 million in an assembly plant in Mobile that began operation in 2015 and is expected to employ 1,000 as well as a $200 million investment by GE Aviation in Huntsville.

Alabama’s labor market has been slowly expanding since the recession and, even with the positive investments noted above, has been lagging the nation in job creation. 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 44th among the states. The poverty level is still among the highest of the states.

Historical tax revenue growth, adjusted for the estimated impact of policy changes, has been essentially flat on a real basis over the last 10 years, lagging GDP growth and below median growth for states. Year-over-year changes vary widely, indicating some volatility in the revenue stream and a revenue system that responds fairly quickly to economic changes. Fitch anticipates the long-term trend for revenue growth will be in line with historical performance.

Alabama has no legal limitations on its ability to raise revenues through base broadenings, rate increases, or the assessment of new taxes or fees.

As with most states, spending growth, absent policy actions, is expected to be slightly ahead of revenue growth, driven primarily by education and Medicaid spending. Education spending growth is capped according to statute at the rolling 15-year average annual revenue growth rate in order to control spending and avoid proration. Excess revenues are transferred to a budget stabilization fund to be used only to avoid proration in the ETF.

Alabama retains ample expenditure flexibility. General fund operations are relatively small and limited to general government functions, health, and police/corrections. The state has significant responsibility for education with operations funded through the ETF. Carrying costs for debt service and pensions are slightly above the state median but still quite low.

A longer-term concern is the deterioration in pension funded ratios despite full actuarial contribution: 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 67% and 67.5% respectively as of Sept. 30, 2014. These ratios, as adjusted by Fitch to a 7% return assumption, are 60.3% and 60.8% respectively. Both systems assume relatively high 8% discount rates, with annual contributions calculated on an open amortization basis. Reforms adopted in 2012 established a new tier with lower benefits and lower required contributions.

A constitutional amendment (from 1933) prohibits the issuance of debt except by constitutional amendment, which requires a three-fifths vote by each house of the legislature and voter approval. The authorization under which most GO debt is issued has a rolling $750 million limit, which allows the state to have outstanding at any time $750 million in GO bonds without an additional vote. Other constitutional amendments have authorized GO debt.

During times of economic recovery, Alabama rebuilds its financial flexibility including restoring draws on its rainy day funds and reducing the use of non-recurring budget items. During this post-recessionary period, the state also passed the Rolling Reserve Act, which allows it to smooth spending for education and creates an additional budget stabilization fund specifically designed to reduce the occurrence of proration in education spending.

The adopted general fund budget for fiscal 2016, which began Oct. 1, 2015, assumed modest revenue growth and closed a $200 million forecast gap with an increase in the cigarette tax and modest budget cuts. With growth in recurring revenues, the budget relies only minimally on one-time revenues, an improvement over recent budgets. Through April, general fund revenues are 3.6% above forecast, reflecting stronger than anticipated sales tax collections.

In addition to the sources of information identified in Fitch’s applicable criteria specified below, this action was informed by information from Lumesis and InvestorTools.