NEW YORK--(BUSINESS WIRE)--Fitch Ratings has downgraded to 'A+' from 'AA-' the rating for the State of New Jersey's approximately $2.4 billion in outstanding general obligation (GO) debt. The rating action also affects securities that are linked to the state GO, outstanding in the approximate amount of $32 billion that have been downgraded as detailed at the end of this release.
The Rating Outlook remains Negative.
SECURITY
General obligations of the state are secured by the full faith and credit of the state.
Appropriation bonds, certificates of participation, and Garden State Preservation Trust revenue bonds are secured by annual state legislative appropriations, and in some cases, certain defined pledged revenue streams.
KEY RATING DRIVERS
RATING DOWNGRADE: The downgrade to 'A+' of New Jersey's GO bonds incorporates both the scale and belatedness of the recently announced, preliminary fiscal 2014 revenue shortfall and the state's likely use of one-time measures to address the gap due to the maintenance of extremely narrow financial reserves. The downgrade also incorporates the state's ongoing budget strain created by overly optimistic revenue forecasts, a multitude of long-term spending pressures, and the state's repeated reliance on one-time solutions to achieve budgetary balance. The state's liquidity position is expected to remain tenuous.
NEGATIVE OUTLOOK: Maintenance of the Negative Rating Outlook incorporates Fitch's continuing concerns regarding the state's lagging economic performance, which is providing insufficient support to meet the growing demands of the state's high long-term liabilities, as well as the increased challenge in enacting a budget for fiscal 2015 that begins with a substantially lower revenue base than originally projected. Fitch believes these challenges are likely to persist over the next several fiscal years.
LONG-TERM LIABILITIES CONSIDERABLE: Above-average state debt obligations are compounded by significant and growing funding needs for the state's unfunded retirement liabilities. Continued pension funding-level deterioration is projected through the medium term as full actuarial funding of the required contributions is several years off.
WEALTHY ECONOMY AND LAGGING RECOVERY: New Jersey benefits from a wealthy populace and a broad and diverse economy. However, the state's economic performance has lagged the nation in recovery from the recent recession, with improvement in 2013 trailing off at the close of the year, and year over year (yoy) employment losses recorded in March 2014.
BUDGET REMAINS STRUCTURALLY IMBALANCED: The state relies on one-time measures to achieve budgetary balance, including in the current fiscal 2014, even though full funding of annual pension contributions remains several years off.
MINIMAL CASH BALANCES RESULT IN LIMITED OPERATING FLEXIBILITY: Minimal cash balances have been maintained in recent years, providing limited flexibility to absorb unforeseen needs or revenue under-performance.
BROAD EXPENDITURE REDUCTION AUTHORITY: The governor has strong executive powers to implement any necessary expenditure reductions to balance the budget and the state has a consistent history of doing so; however, options have become more limited as the state's fixed cost burden grows.
RATING SENSITIVITIES
The GO rating is sensitive to the state's economic and financial performance in the context of a high fixed cost burden and ongoing expenditure requirements. Continued under-performance of the state's economic base, an unwillingness to address or appropriate for its growing long-term liabilities, or continued deterioration in the state's budgetary flexibility or reserves, could lead to a downgrade.
The annual appropriation ratings and other ratings noted at the end of the release are sensitive to shifts in the state's GO credit rating to which they are linked.
CREDIT PROFILE
The downgrade of New Jersey's GO rating to 'A+' from 'AA-' incorporates financial operations that have been challenged by overly optimistic revenue projections, a multitude of long-term spending pressures including significant unfunded pension and employee benefit obligations, and an economy whose recovery has lagged the nation, hindering more robust revenue growth. The recent announcement of an estimated $807 million revenue shortfall from the February 2014 revised revenue estimate for fiscal 2014 and the state's likely use of stop-gap measures to close the gap prior to the fiscal year ending on June 30, 2014, exacerbates in Fitch's view, the strained financial environment in which the state operates. Additionally, the state's weak liquidity position, with an ending fund balance in fiscal 2013 of $313 million (less than 1% of operating revenues), provides little maneuverability in seeking budgetary solutions.
New Jersey records high wealth levels and benefits from a broad economy; these positives are offset, however, by a high debt burden and sizable unfunded liabilities. Despite passage of pension and benefits reform legislation in 2011 which restrained future growth in the state's accumulated liabilities, continued pension funding-level deterioration is projected through the medium term as full funding of the actuarially required contributions is phased in over seven years. This schedule also results in sizeable, planned increases in annual pension contributions. Fitch believes that meeting the requisite increases in pension contributions will continue to be challenging and is likely to conflict with other long-term demands, such as infrastructure needs, property tax relief, and school funding.
FINANCIAL OPERATIONS ARE STRUCTURALLY IMBALANCED
Projected revenues assumed in the enacted budget for fiscal 2014 totaled $32.8 billion and incorporated growth from actual 2013 results; 7.7% projected growth in the personal income tax (PIT), 5.4% growth in the sales tax, 2.2% growth in the corporate income tax (CIT), and 76% ($166 million) growth in casino revenue resulting from the introduction of internet gaming tied to Atlantic City casinos. Reflecting fiscal 2014 revenue underperformance through January 2014, the governor's proposed fiscal 2015 budget, released in February 2014, included a net $251 million negative revision to the fiscal 2014 revenue forecast. Factored into the revision was the expected receipt of one-time proceeds from a securitization of the state's remaining tobacco settlement revenues; the transaction brought a net $91.6 million into the general fund; without this transaction the revenue gap would have been $342.7 million.
In addition to this revenue gap, in February the state incorporated $694 million of appropriation lapses from unexpended items, including about $94 million in pension savings from the combined effect of incorporating salary scale changes from recently adopted experience studies and a changed method of calculating the state's normal cost pension contributions.
The change in calculating the state's normal cost pension contribution, effective for fiscal 2015 and applied retroactively to fiscal 2014, allows increased employee contributions pursuant to pension reform to be used as an offset in developing the state's normal cost pension contribution rather than serving to reduce the unfunded actuarially accrued liability (UAAL) as originally planned. The lapses also included $40 million in expected debt service savings from a refunding currently being undertaken through the Economic Development Authority (EDA). These lapses allowed the state to fund an increase in appropriations of $292 million for fiscal 2014.
The addition of the pension savings and EDA refunding to the aforementioned $342.7 million revenue gap increases the revenue gap prior to the current announcement to almost $477 million. The addition of the preliminary, estimated $807 million revenue gap, which the state treasurer is expected to update on May 21 and May 22, 2014 in testimony before the state legislature's budget committees, increases the size of the revenue shortfall for fiscal 2014 compared to the enacted budget to almost $1.3 billion; approximately 3.9% of the state's operating budget. The state reports the shortfall is largely due to a $700 million preliminary, estimated shortfall in PIT receipts for fiscal 2014. In his appearances before the state legislature's budget committees, the treasurer is expected to detail solutions for closing the estimated $807 million gap prior to the close of fiscal 2014 as the state is precluded by law from carrying a deficit over to the next fiscal year. At that time, the state treasurer is also expected to provide specific recommendations with respect to the proposed state budget for fiscal 2015 that now begins with a substantially lower revenue base than had been previously estimated.
The state has indicated its intent to maintain the current target of a $300.7 million ending fund balance in fiscal 2014 and a $313 million ending fund balance for fiscal 2015 as the state grapples with closing the new revenue gap. Should the state achieve this target on a budgetary basis, Fitch believes it would be relatively inconsequential as due to the late point in the fiscal year, closing the revenue gap would likely largely be achieved through stop-gap actions on the part of the state, such as potentially moving fiscal 2014 payments into fiscal 2015, creating further budgetary imbalance in fiscal 2015.
Although New Jersey has a history of taking steps necessary to maintain budget balance, the state's ongoing reliance on one-time budget solutions to achieve and maintain balance and its insufficient annual pension contributions are evidence of a significant structural imbalance, in Fitch's view. Fitch estimates that one-time budgetary measures in fiscal 2014 could approach $2.2 billion (6.6% of the fiscal 2014 operating budget) should the entire $807 million shortfall materialize and be solved through one-time actions. These measures include actions enacted with the fiscal 2014 budget as well as the EDA refunding; securitization of the state's remaining tobacco settlement proceeds; and the changes to the state's calculation of its normal cost contribution to its pension systems. Of further concern is the current misalignment of revenues projected for fiscal 2015 with the governor's proposed operating budget.
The governor's budget proposal for fiscal 2015, introduced in February, called for appropriations of $34.4 billion. Notable expenditure recommendations include an approximate 4% increase in spending on grades PreK-12 education (to $12.9 billion), an approximate 7% increase in higher education spending (to $2.3 billion), and a 5.4% increase in state-funded Medicaid programmatic spending (just shy of $4.2 billion). The budget proposal includes a $2.25 billion appropriation for the state's pension systems, equal to four-sevenths of the ARC, as required by statute.
Anticipated revenue in the governor's fiscal 2015 budget was projected to total $34.4 billion; an increase of 5.8% from the February 2014 revised fiscal 2014 revenue estimate. Strong yoy revenue growth is factored into the forecast including 8.2% growth in the PIT, 6.1% growth in sales tax revenue, 6.7% growth in the corporate income tax, and 21% growth in casino revenue. Fitch considered the revenue forecast to be aggressive, as has been typical for the state over the past several fiscal years, particularly in regard to the PIT and casino revenues in light of year to date revenue and economic trends. In the state treasurer's appearance before the state legislature's budget committees later in May, revenue revisions for fiscal 2015 are expected to be delivered as the year will begin with a substantially lower revenue base than earlier projected.
RELATED DEBT
The ratings on the following credits, which are linked to the state GO rating, have been downgraded as indicated. The Rating Outlook on all the bonds remains Negative.
--Approximately $13.9 billion New Jersey Economic Development Authority annual appropriation bonds are downgraded to 'A' from 'A+';
--Approximately $14.35 billion New Jersey Transportation Trust Fund Authority annual appropriation bonds are downgraded to 'A' from 'A+';
--Approximately $992.7 million Garden State Preservation Trust revenue bonds are downgraded to 'A+' from 'AA-';
--Approximately $518.5 million New Jersey Building Authority annual appropriation bonds are downgraded to 'A' from 'A+';
--Approximately $404.9 million New Jersey Educational Facilities Authority annual appropriation bonds are downgraded to 'A' from 'A+';
--Approximately $712.2 million New Jersey Health Care Facilities Financing Authority annual appropriation bonds are downgraded to 'A' from 'A+';
--Approximately $486.8 million New Jersey Sports and Exposition Authority annual appropriation bonds are downgraded to 'A' from 'A+';
--Approximately $739.7 million of state of New Jersey certificates of participation are downgraded to 'A' from 'A+';
--The program ratings assigned to New Jersey Municipal Qualified Bonds and bonds secured by the New Jersey School Bond Reserve (New Jersey School Credit Enhancement Program) are downgraded to 'A' from 'A+'.
The 'A' ratings for the state's appropriation obligations, one notch below the state's GO rating, reflects the requirement of annual legislative appropriations for debt service. The 'A+' rating for the Garden State Preservation revenue bonds reflects that while annual legislative appropriation of dedicated sales tax revenue is necessary, the provision that if the legislature fails to make the appropriation, dedicated funds may not be for any other purpose, effectively eliminates the risk of non-appropriation in Fitch's opinion, allowing for a rating on par with the state's GO debt.
For additional information on the state, please see 'State of New Jersey Full Rating Report' dated March 28, 2014, located on our web site at www.fitchratings.com.
Additional information is available at 'www.fitchratings.com'.
In addition to the sources of information identified in Fitch's 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);
--'State of New Jersey Full Rating Report' (March 28, 2014).
--'Fitch Revises Outlook on New Jersey GO and Appropriation Bond Ratings to Negative' (March 21, 2014).
Applicable Criteria and Related Research:
Tax-Supported Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=686015
U.S. State Government Tax-Supported Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=686033
State of New Jersey
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=741256
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