News Column

Fitch Rates Oregon's $19MM GOs 'AA+'; Outlook Stable

June 2, 2014

NEW YORK--(BUSINESS WIRE)-- Fitch Ratings has assigned an 'AA+' rating to the state of Oregon's general obligation (GO) bonds (Alternate Energy Projects), consisting of the following:

-- $16.66 million 2014 series E (tax-exempt);

-- $2.14 million 2014 series F (federally taxable qualified energy conservation bonds).

The bonds are expected to sell via competitive bid on June 12, 2014.

Additionally, Fitch affirms the following ratings:

-- $5.2 billion in outstanding state GO bonds at 'AA+';

-- $782 million in outstanding state appropriation-backed bonds at 'AA'.

The Rating Outlook is Stable.

SECURITY

The bonds are general obligations of the state of Oregon, with the full faith and credit of the state pledged to bond repayment.

KEY RATING DRIVERS

STRONG FINANCIAL MANAGEMENT OFFSETS REVENUE VOLATILITY: State finances are heavily dependent on the personal income tax, a volatile revenue source which declined sharply during the recession. The state's management reviews revenue and economic forecasts quarterly and takes measures as necessary to maintain balance. State reserve levels were drawn upon among balancing measures in the downturn, but the state is committed to rebuilding reserves in the current, and future, biennia.

DIVERSE ECONOMY WITH SELECT CONCENTRATIONS: Oregon's economy, which was historically based on its natural resources, has diversified. The computer and manufacturing sectors play an above-average role, and the state's economy is especially influenced by international trade patterns. Recent economic growth has been well above the national average, and unemployment rates, while modestly above average, have moderated.

MODERATE LIABILITY BURDEN: Debt levels are above average for a U.S. state but are only a moderate burden on resources. On a combined basis, the burden of the state's net tax-supported debt and unfunded pension obligations is in line with the median for U.S. states. OPEB obligations are small.

RATING SENSITIVITIES

The rating is sensitive to shifts in fundamental credit characteristics, including the state's proactive financial management and commitment to reserve funding.

CREDIT PROFILE

Oregon's 'AA+' GO bond rating reflects a diverse economy with some concentration in computer and electronic manufacturing and agricultural products, moderate debt levels, and the state's record of prompt actions to maintain financial flexibility in a challenging revenue environment. Strong financial management is critical to the rating given a revenue structure largely dependent on the cyclical personal income tax, exposure to voter initiatives that can have negative fiscal impacts, and constitutional 'kicker' provisions that require the return of surplus personal income tax (PIT) revenues to taxpayers. Corporate revenue in excess of the revenue forecast is now directed to elementary and secondary education per approval of a 2012 voter initiative.

While reserve levels decreased during the recession, strong growth in PIT collections aided in increasing reserves at the close of the biennium ending June 30, 2013. The state has also forecast increased long-range reserve levels through fiscal 2023. The 'AA+' rating and Stable Outlook reflect Fitch's expectation that the state will continue to promptly address budgetary gaps as they arise and maintain such cushion against revenue volatility.

The state's debt levels are above average but remain a moderate burden on resources. The current issue will fund various energy capital improvements and energy conservation and renewable energy projects across the state. The state intends to apply the Oregon Department of Energy's small-scale energy loan program revenues toward the payment of debt service on this obligation and similar state energy GO bonds.

RELIANCE ON PERSONAL INCOME TAX FOR OPERATIONS

Oregon's general fund (GF) is largely dependent on the PIT, which made up 86% of the biennial (BY) 2011-2013 GF revenues. PIT collections have been volatile, rising by 22% in BY 2005-2007 and just modestly at 1.2% during BY 2007-2009. PIT revenues for BY 2009-2011 fell by over 6.3%, reflecting the recession and uneven economic recovery, and then rebounded by 15.8% in BY 2011-2013, reflecting both the push forward of income into calendar year (CY) 2012 due to uncertainty over federal tax law changes as well as the beginning of a stronger economic recovery in the state.

Oregon's BY 2011-2013 GF budget of $13.7 billion has projected PIT receipts in anticipation of recovery, with 16% growth projected over the two-year period. Expectations for the PIT varied, with final estimated growth of 15.8% for the biennium, down by less than 1% from the enacted budget. The corporate income tax (CIT) accounted for just over 6% of BYs 2011-2013 GF revenues and ended below the close-of-session (COS) forecast by 1.2%; 6.8% is estimated as the final growth over the biennium. The budget did not contain revenue-raising measures, although one-time measures were included for programmatic funding. The ending GF balance of $472.9 million has been applied to appropriations in the current biennium while the state deposited a combined $52.7 million to its rainy day fund (RDF) and educational stability fund (ESF), increasing reserves to $69.4 million or 0.5% of biennial GF revenue.

The COS forecast for the current 2013 2015 biennium that began on July 1, 2013 included an 11.7% baseline growth assumption in PIT revenue, although the baseline growth was expected to be offset by a falloff of one-time revenues, some related to the federal tax law changes. Overall, GF revenues were forecast to grow 9.5% from the 2011-2013 biennium and total $15.6 billion. The enacted budget for the biennium incorporated estimated savings from program changes to the public employees' retirement system (PERS), including limiting cost of living increases and eliminating a tax benefit for out-of-state retirees. The budget also included savings related to changes in sentencing requirements for the prison population and increased funding to K-12 education, human services, and transportation. Per typical expenditure patterns, the state estimated 52% of the enacted budget would be spent in the first year of the biennium and the balance spent in the second year.

The most recent quarterly economic and revenue forecast, dated June 2014, updated the state's expectations for the current biennium, projecting GF revenues at $15.8 billion; a modest increase from the March 2014 forecast of $15.78 billion. Appropriations have increased to $15.9 billion from $15.8 billion, reflecting legislative approval for selective restoration of appropriation holdbacks, increased firefighting costs, and potential increased costs for the Oregon Health Authority and Department of Human Services. The forecast projects a $165 million ending balance for the biennium in the GF, down from $473 million at the end of the last biennium. The forecast anticipates deposits of $147.3 million to the RDF and $170.3 million to the ESF. The reserve balances are expected to total $388.4 million at the end of fiscal 2015, or 2.5% of biennial GF revenues, and the state forecasts an additional deposit in the 2015-2017 biennium.

CYCLICAL ECONOMY WITH SLOW EMPLOYMENT GAINS

Oregon's economy tends to be more cyclical than the nation's due historically to its reliance on agriculture and natural resources and today because of its large high-tech sector and international trade activities. The state's largest exports are computer and electronics products (35.1%) and agricultural products (14.1%) and the largest destinations are Canada (16.3%), China (14.5%), and Malaysia (10.7%).

Following 7.6% total job loss in CYs 2008 through 2010 as compared to 5.6% for the nation, the state added jobs in CYs 2011 and 2012 at rates of 1.1% and 1.3%, respectively, compared to 1.2% and 1.7% for the nation. Employment growth in CY 2013 was a solid 2%; above the national average of 1.7%, as the state's economic recovery progressed. As of April 2014, year over year (yoy) employment growth is 2.8% compared to 1.7% for the nation. The largest positive growth sectors by number of employees were construction at 8.4% yoy, trade, transportation, and utilities at 2.3% yoy, and professional and business services at 4.8% yoy.

The June 2014 forecast estimates annual employment growth of 2.2% in CY 2014, 2.5% in 2015, and 2.2% in 2016. Overall, the state estimates slow but steady recovery of jobs lost in the recession. State unemployment, typically above the national level, was 7.7% in 2013 against a national rate of 7.4%; a much closer margin as compared to the peak of the recession in 2009 when state unemployment was 120% of the national rate. For April 2014, the state unemployment rate of 6.9% continued the trend above the national average of 6.3%.

In 2013, Oregon's personal income (PI) growth of 3.5% was better than the 2.6% U.S. rate of growth, and recent quarterly trends have been robust: 3.1% yoy growth in the fourth quarter of 2013 as compared to 1.4% for the U.S. and 1.1% for the region. Per capita personal income in 2013 totaled $40,233, representing 90.3% of the U.S. level and ranking Oregon 32nd among the states. The state estimates 4% growth in PI in 2014 with robust 5.5% growth forecast in both 2015 and 2016.

MODERATE DEBT BURDEN

As of June 30, 2013, the state's debt at 4.9% of 2013 PI is above average but still a moderate burden on resources. Principal amortizes at a below-average pace but amortization has improved from fiscal 2011. In contrast to the prior downturn, the state did not undertake any deficit borrowing in the recent recession.

Two rounds of pension reform occurred in 2013; the first in the regular legislative session and the second as part of a special fall legislative session. Reforms enacted in the regular session included: changes to the public employees' retirement system (PERS) to provide annual savings to employers, including limiting COLAs, and eliminating a benefit increase for out-of-state retirees based on the Oregon income tax, reducing employer contribution rates in the coming biennium. This legislation (SB 822) reduced the total system liability by approximately $2.6 billion (4.6%), providing $460 million in total system savings over the coming biennium to all employers, which included approximately $131 million in PERS contribution reductions for state agencies.

SB 822 contained a budget note that directed the PERS board to recalculate employer contribution rates, expected to provide an additional $350 million in total system savings over the 2013-2015 biennium. In May, 2013, the PERS board provided for a reduction of up to 4.4% of covered payroll for employer contribution rates; however, the board required that no employer pay less than the rate that was paid in the 2011-2013 biennium. Implementation of the directions in the budget note was expected to result in the full actuarially-calculated annual required contribution (ARC) not being met by employers for the two years in the current biennium. The legislation required contribution rates to increase in future biennia to offset the rate increase deferral.

The fall 2013 special legislative session implemented additional reforms to PERS. The enacted legislation (SBs 861 and 862) adjusted and further limited COLA benefits to retirees, redefined salaries used in calculating benefits, and reduced legislators' participation in PERS. These changes provided for an additional reduction of the PERS accrued liability of about $2 billion, improved the funded ratio, and alleviated the need for rates to increase in future biennia solely based on the implemented payroll contribution rate change. After enactment of the 2013 PERS bills, the PERS board reduced employer contribution rates by 4.28% of payroll on a system-wide average basis for the 2013-2015 biennium.

Also in 2013, the PERS board lowered its investment return assumption from 8% to 7.75%, effective Jan. 1, 2014, thereby increasing the calculated actuarial accrued liability. The board also implemented additional changes to its actuarial methods and assumptions including moving to entry age normal and providing for a 20-year re-amortization of the unfunded actuarial liability. Incorporating the legislative and assumption changes in 2013 as well as the employer contribution rate deferral and re-amortization, the unfunded actuarial liability (UAAL) of the PERS system decreased from $11.03 billion as of Dec. 31, 2011 to $5.621 billion as of Dec. 31, 2012. PERS' reported funded ratio improved from 82% as of Dec. 31, 2011 to 90.7% as of Dec. 31, 2012 (the Dec. 31, 2012 PERS valuation was issued after reform passage.) Using Fitch's more conservative 7% discount rate assumption, the funded ratio for the plan declines to 83.8% as of Dec. 31, 2012.

Several legal cases have been filed in regard to the earlier 2013 legislative changes to benefits, citing breach of contract and taking of property rights. Fitch will monitor the status of all legal challenges to these reforms as to impact on the financial and liability position of the state.

On a combined basis, the burden of the state's net tax-supported debt and adjusted UAAL obligations equals about 6.3% of 2013 PI; down from 7.9% in 2012. This is in line with the 6.1% state median. The calculations include 21.4% of the liability of PERS that Fitch estimates to be attributable to the state; the state reported their portion to be 93% funded as of Dec. 31, 2012.

The state's share of other-post employment health benefits is small and funded at 62%, with a 7% funded ratio for the much smaller premium account, which provides monthly subsidies to pre-Medicare-age state retirees.

Additional information is available at 'www.fitchratings.com'.

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

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=686015

U.S. Local Government Tax-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=685314

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=832634

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.



Fitch Ratings, Inc.

Primary Analyst, +1-212-908-0239

Marcy Block

Senior Director

33 Whitehall Street

New York, NY 10004

or

Secondary Analyst

Karen Krop, +1-212-908-0661

Senior Director

or

Committee Chairperson

Laura Porter, +1-212-908-0575

Managing Director

or

Media Relations, New York

Elizabeth Fogerty, +1-212-908-0526

elizabeth.fogerty@fitchratings.com

Source: Fitch Ratings


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