Fitch Rates Texas $200MM GO Water Bonds 'AAA'; Outlook Stable

Fitch Ratings has assigned a 'AAA' rating to approx. $200 million in State of Texas general obligation (GO) water financial assistance bonds, series 2015D.

The bonds are expected to sell via negotiated sale the week of March 30, 2015.

The Rating Outlook is Stable.

SECURITY

The bonds are general obligations to which the state pledges its full faith and credit.

KEY RATING DRIVERS

LOW DEBT: The state's debt burden remains low despite significant growth-related capital needs, especially for transportation. Amounts for debt service are constitutionally dedicated.

GROWTH-ORIENTED ECONOMY: The state's economy is large, diverse, and is growing rapidly relative to national averages. The state's energy industry remains a significant source of economic activity and continues to be subject to volatility.

SIGNIFICANT RESERVE BALANCES: Financial operations are generally conservative. The state has built a sizable budget reserve, with a portion of natural resource receipts dedicated to funding it.

SALES TAX DEPENDENCE: Finances are dependent on consumption-based (primarily sales) taxes; volatile energy taxes are also important.

GROWTH-RELATED SPENDING PRESSURES: Longer term fiscal pressures stem from having to adequately fund the state's rapid growth. This includes expanded transportation needs, school funding, and water needs.

RATING SENSITIVITIES

ECONOMIC GROWTH AND HIGH RESERVES: The state's GO rating and Stable Rating Outlook assume the maintenance of high reserve balances and continued economic growth. The rating could be pressured in the event of severe revenue weakness, including stemming from cyclicality in the state's large energy sector, or unwillingness to address potential fiscal challenges in an effective and timely manner.

CREDIT PROFILE

The state's long-term 'AAA' GO rating reflects its low debt burden, conservative financial operations and a growth-oriented economy that continues to outpace national averages. Financial pressures arise from the demands placed on the state's consumption-based tax system by its rapid growth, including addressing transportation, education and water needs.

Texas' GO bonds are payable from a constitutional appropriation out of the first moneys coming into the state treasury not otherwise appropriated. This unrestricted balance equaled nearly $48 billion as of Aug. 31, 2014, the fiscal year-end.

The Texas Water Development Board issues financial assistance bonds under a 1997 constitutional amendment that consolidated the board's various authorizations, with proceeds supporting water conservation and infrastructure projects throughout the state. As of Aug. 31, 2014, the board has over $6.5 billion in unissued GO bond authorization available for various board programs.

By policy, most water financial assistance program bonds, including the current series, are self-supporting from repayments of loans made to local entities for water development projects and income received from investments. Certain water financial assistance program bonds receive general fund support.

The board's resources and responsibilities for managing water projects have been expanded under a constitutional provision approved in November 2013 which included the transfer of $2 billion from the state's rainy day fund, the Economic Stabilization Fund (ESF), to establish a loan program for water-related projects. Water infrastructure remains a perennial need in the state given its high growth and scarce water resources.

LOW BONDED DEBT

Texas' net tax-supported debt burden is low, with approximately $15.1 billion as of Aug. 31, 2014 equal to 1.3% of 2013 personal income. This figure includes $10.3 billion in GO bonds supported by tax revenues of the general revenue fund (GRF) or the mobility fund, and $4.3 billion in state highway fund bonds to which constitutionally-dedicated transportation receipts are pledged. Net tax-supported debt has risen with issuance over the last decade for transportation needs, but remains low measured against personal income.

On a combined basis, net tax-supported debt and pension liabilities attributable to the state as of Fitch's May 2014 state pension update report equaled 6.1% of personal income, roughly in line with the median for U.S. states.

SOME PENSION REFORMS IMPLEMENTED

Funded ratios for the state's two major pension systems, covering state employees and teachers, declined given investment losses in the last downturn, and annual contributions have been consistently below actuarially calculated levels.

In its 2013 session, the state legislature adopted teacher plan reforms, including a higher retirement age and phased increases in member, state and district contribution rates. The changes bring amortization of the teachers system to below 30 years on an actuarial basis, although actual contributions remain below the actuarially calculated level (the state reports the teacher system liability as a state obligation). The legislature simultaneously implemented minor employer contribution increases for the employees' system, although as of its Aug. 31, 2014 valuation, contributions remain inadequate to pay down the obligation.

As of Aug. 31, 2014, the reported funded ratio for the state employees' system was 63.4% (under GASB 67); the system reports a depletion date in 2041, underscoring the inadequate funding of contributions noted earlier. The teachers system's reported funded ratio was 83.2%. Using Fitch's more conservative 7% discount rate assumption would lower the funded ratio to 57.1% for the employees' system and 75% for the teachers' system.

RESERVES PROVIDE LARGE CUSHION

Finances are generally conservatively managed, though challenges include sustainably addressing long-term growth needs and managing the cyclicality inherent in the state's energy-dominated economy. The state has also faced longer term challenges in addressing key spending needs, including in sustainably funding rapidly growing education needs.

The state maintains fiscal flexibility both in the form of its ESF, as well as in its demonstrated willingness to make deep spending cuts to maintain budget balance. The ESF benefits from the constitutional dedication of a share of oil and gas production taxes, as well as unencumbered balances at fiscal year-end.

As of January 2015, the ESF balance was nearly $8.46 billion, equal to 16% of estimated fiscal 2015 general revenue-related revenues. The current balance reflects several notable draws during the fiscal 2014-2015 biennium to address key state needs. These include the one-time, $2 billion draw noted earlier to establish a new loan program for water-related projects and a second, permanent diversion of half of future dedicated oil and gas taxes to support highway capital funding. Both measures were ratified by voters.

RECENT FISCAL PERFORMANCE SOLID

The state's fiscal performance has been solid during the fiscal 2014-2015 biennium to date, which ends Aug. 31, 2015, despite more recent uncertainty arising from the oil price decline recorded in the latter half of 2014. The December 2013 revenue forecast for the fiscal 2014-2015 biennium assumed GRF net revenues rising a modest 1.5% in fiscal 2014 and 2% in fiscal 2015, with $99.4 billion in total net revenues during the biennium. GRF appropriations in the fiscal 2014-2015 budget totaled nearly $95 billion, about 10.4% ahead of fiscal 2012-2013 biennium appropriations. The adopted budget included significant spending increases for schools, pay raises for state employees, and the higher pension contributions noted earlier. Despite higher school formula funding, litigation regarding the constitutionality of school funding continued.

Actual revenue performance in the fiscal year ending August 2014 was strong, with total general revenue-related net revenues rising 6.9% from a year earlier; sales tax revenues rose 5.5%. Strength has continued into fiscal 2015 despite oil price declines. Total GRF cash receipts through January 2015 year-to-date are 11.1% higher than a year earlier and 4.8% over forecast. Sales taxes are 9.4% higher than a year earlier and 5.9% higher than forecast, while oil production taxes are 1.8% below the prior year and 13.7% below forecast.

COMPTROLLER'S FORECAST APPEARS CONSERVATIVE

The comptroller's biennial revenue estimate (BRE) released with the start of the 2015 legislative session incorporates a diminished outlook for energy-related receipts, while continuing to assume broader economic and revenue gains. Fiscal 2015 is forecast to end with GRF net revenues rising 1.8% from fiscal 2014 actuals; sales tax growth of 6.2% would be partly offset by an oil production tax decline of 28.7%. The certification balance at fiscal year-end before any legislative action is estimated at just over $7.5 billion, and the ESF balance is estimated at $8.48 billion.

For the fiscal 2016-2017 biennium, the comptroller is estimating revenues rising 2.3% in fiscal 2016 and 5.4% in fiscal 2017. Sales taxes are forecast to rise 2.5% in fiscal 2016 and 6.4% in fiscal 2017, while oil production taxes decline 0.8% in fiscal 2016 and rise 7.5% in fiscal 2017. Under the forecast, total biennium GRF net revenues equal $110.4 billion. The ESF balance, barring any legislative action during the session, is forecast at nearly $11.1 billion as of Aug. 31, 2017, equal to 10% of forecast biennium GRF net revenues.

FISCAL 2016-2017 BUDGET UNDER DELIBERATION

The legislature is currently considering the state's fiscal 2016-2017 biennial budget. Budget bills in the House and Senate include only $193 million in fiscal 2015 supplemental spending, the bulk of which covers Medicaid needs. For the upcoming biennium, the House's budget bill as introduced assumes 3.9% growth in general revenue-funded appropriations, at $98.8 billion. The Senate's budget bill assumes a 6.6% increase in general revenue-funded appropriations, totaling $101.5 billion. Fitch will continue to monitor the budget process through the session.

ROBUST ECONOMY DESPITE OIL PRICE SLUMP

The state's economy has expanded rapidly and diversified over the last two decades, although the cyclical energy sector still represents a large share of economic activity. Population growth is more than twice the national rate, rising 29.3% since 2000 (compared to 13.3% nationally). The state outperformed the nation into the last downturn given growth-related momentum and strong energy sector performance, and has continued to outpace the nation through the recovery. The oil price decline in the last six months has had a modest targeted impact on Texas to date, although overall state growth continues to exceed the nation. However, lingering lower energy prices may pose a drag on the state's continued high growth near term as repercussions spread beyond energy-specific sectors and regions.

Employment in 2012 and 2013 in Texas rose 2.9% in both years, compared to the 1.7% gains in both years reported nationally. Job growth accelerated in the second half of 2014 from already high levels, with December 2014 employment 4% higher than a year before; U.S. gains were 2.3% over the same period. Growth continues in the mining sector, although the pace of gains in oil and gas extraction slowed at year-end. Texas' large and growing service sector continued to post large gains as well. The unemployment rate, at 4.6% in December 2014, is well below the 5.6% rate reported nationally for the same period. Personal income has shown strong growth in recent quarters, rising 5.6% in the third quarter of 2014, compared to 3.9% nationally. Personal income per capita measured 98% of the nation's in 2013, ranking 25th among the states.

The comptroller's January 2015 economic outlook, extending through fiscal 2017, foresees continued robust economic gains. Oil prices are forecast at $64.35 per barrel in fiscal 2015, well under the $96.56 level reported in fiscal 2014; prices would remain near the fiscal 2015 level through fiscal 2017. After rising 5.9% in fiscal 2015, gross state product is forecast to rise only 2.5% in 2015 as the state adjusts to the energy slowdown, accelerating again in fiscal 2016-2017. Employment is likewise forecast to rise a slow 1.9% in fiscal 2015, well below the earlier pace of growth. Gains would accelerate thereafter.

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);

--'Pension Pressures Continue: 2014 State Pension Update' (May 14, 2014).

Applicable Criteria and Related Research:

Pension Pressures Continue (2014 State Pension Update)

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=747605

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

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=980456

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