Fitch Ratings has assigned a 'AA-' rating to $211.995 million of state
of Louisiana general obligation (GO) bonds, series 2016-A. The bonds are
scheduled to be sold via negotiation on Sept. 15, 2016.
The Rating Outlook is Stable.
SECURITY
The bonds are general obligations of the state of Louisiana, whose full
faith and credit are pledged. The bonds are payable from the bond
security and redemption fund, on parity with outstanding GO debt, and
have a first lien on the fund, which receives all money deposited in the
state treasury not otherwise dedicated.
KEY RATING DRIVERS
Louisiana's 'AA-' IDR reflects the state's broad though somewhat
concentrated economic base, strong ability to control revenue and
spending policy, and above average but still moderate liability burden.
The rating also reflects the state's persistently imbalanced financial
operations, and a reliance on one-time measures for immediate
gap-closing, which along with overly optimistic revenue projections have
resulted in the need for successive years of mid-year budget
corrections. Although the state recently approved recurring measures in
the 2016 legislative session to close identified budget gaps in fiscal
years 2016 and 2017, a large portion of the newly enacted revenue rolls
off after fiscal 2018. Absent substantially improved economic growth,
replacement revenues, additional expenditure controls, or other
proactive measures, the state is likely to be confronted with a large
structural gap in fiscal 2019, in Fitch's view.
Economic Resource Base
Louisiana's economy is resource-based as a major producer of oil and
gas, and much of its manufacturing is dominated by petroleum and
chemical production; combined, the state's mining, petroleum and coal
products manufacturing, and chemical products manufacturing contributed
$57.7 billion (23.5%) to the state's GDP in 2014. Given the
concentration in the development and processing of crude oil, the
state's economy is particularly exposed to the impact of a long-term
downward price trend. Tourism is also important, and the port system is
among the largest in the world.
Revenue Framework: 'aa' factor assessment
Fitch expects Louisiana's revenues, which are supported by broad-based
sources, to continue to reflect the economic volatility tied to the
extensive natural resources sector. The current economic slowdown is
expected to extend over the medium term and will continue to challenge
revenue growth. The state has complete control over its revenues, with
an unlimited legal ability to raise operating revenues as needed.
Expenditure Framework: 'aa' factor assessment
The state has a low burden of carrying costs for liabilities and
maintains the broad expense-cutting ability common to most U.S. states;
however, state actions over the past several years, such as
under-appropriating for formula expenditures such as Medicaid, have
somewhat reduced the state's budgetary flexibility in responding to
revenue shortfalls. Given continued, expected challenges in the state's
economy, expenditure growth is expected to be ahead of future revenues,
requiring ongoing active budget management.
Long-Term Liability Burden: 'aa' factor assessment
Louisiana's overall liabilities represent a moderate burden on resources
but are well above the U.S. state median. The burden of the state's
unfunded pension obligations is particularly high for a state,
incorporating 100% of the liability for the state employee and teachers'
pension systems.
Operating Performance: 'aa' factor assessment
Louisiana's financial operations have been characterized by continual
budget stress in the last decade, with recurring budget gaps that the
state has closed through both structural and non-recurring actions.
While the state has recently enacted recurring measures to close
identified budget gaps, a large portion of the new revenue rolls off
after fiscal 2018 and many solutions remain one-time in nature.
Nevertheless, Fitch believes that the state retains very strong
gap-closing capacity as a result of the flexibility inherent in a
state's powers. In addition, the state's financial operations benefit
from the maintenance of a separate rainy day fund despite a sizable
appropriation from this resource in fiscal 2016.
RATING SENSITIVITIES
Movement in the state's IDR is sensitive to shifts in key fundamental
credit characteristics including continued proactive management of its
challenged financial operations. The Stable Outlook incorporates Fitch's
expectation that the state will proactively respond to its fiscal and
economic challenges.
CREDIT PROFILE
Energy production and processing dominate Louisiana's economy. In 2015
the state was ranked ninth highest for crude oil production excluding
federal offshore production and fourth for natural gas production and
the state's 19 operating refineries process 20% of the nation's crude.
The state's economy has suffered from the downward energy price trend
that began in 2014. Baker Hughes, a large oilfield service company,
reports an average of 42 rotary rigs in the state in August 2016, down
from a peak average of 115 in September 2014 and continuing to trend
lower in recent months. The cutbacks have significantly dampened
employment gains while the unemployment rate, at 6.3% in July 2016,
approximates 129% of the nation's.
Beyond the energy sector, tourism in New Orleans remains a significant
sector, and that city's port system is among the largest in the world.
Flood protection in the New Orleans area has been enhanced since the
hurricanes in 2005, but Louisiana remains vulnerable to severe storm
activity, as recently demonstrated by the severe floods in the state's
capital region in August 2016.
Revenue Framework
Sales taxes and personal income taxes (PIT) have provided almost equal
support of GF operations, together totaling about 70% of fiscal 2016 GF
revenues, with additional revenue flowing from lottery and gaming,
reflecting the sizable casino and riverboat gaming presence in the
state, as well as corporate income and severance taxes. A temporary
boost in the sales tax rate to close a fiscal 2017 budget gap is
expected to increase the share of sales taxes support to 37% of GF
revenue. The state is directed by its constitution and statutes to
dedicate certain revenues for specific purposes, such as transportation
revenues, lottery revenue, and tobacco settlement monies. Dedications
diverted approximately 30% of revenues from the GF in fiscal 2016
although the proportion is expected to drop to 23% in fiscal 2017
following the expected increase in gross revenues that year.
Historical growth in revenues, after adjusting for the estimated impact
of tax policy changes, was below the pace of national GDP growth over
the 10 years through 2014 and essentially matched inflation. Over that
period, modest growth was notable in sales and income taxes, as well as
in severance taxes from natural resource development, despite the robust
growth in crude oil and natural gas markets during this time; trends
were affected by the devastating impacts of Hurricanes Katrina and Rita
as well as the national recession despite solid economic growth as the
state recovered from the hurricanes. The slump in crude oil prices,
beginning in late 2014, was a primary contributor to significant revenue
underperformance relative to forecast in fiscal years 2015 and 2016 and
as projected for fiscal 2017. Fitch believes slow revenue growth will
continue over the medium term as crude oil and natural gas prices are
expected to remain subdued and affect overall economic performance.
The state has no legal limitations on its independent ability to raise
revenues through base broadenings, rate increases, or the assessment of
new taxes or fees. A two-thirds vote of each house of the legislature is
required to impose a law that levies a new tax or increases an existing
tax, but a majority vote is sufficient to suspend an existing tax
exemption.
Expenditure Framework
As in most states, education and health and human services are
Louisiana's largest operating expenditures. Education is the larger line
item, including for higher education, as the state provides significant
funding for local school districts and the public university and college
system. Health and human services is the second largest area of
spending, with Medicaid being the primary driver.
Fitch expects that spending growth, absent policy actions, will be ahead
of natural revenue growth, driven primarily by Medicaid, and require
regular budget adjustments to ensure ongoing balance. The fiscal
challenge of Medicaid is common to all U.S. states and the nature of the
program as well as federal government rules that limit the states'
options in managing the pace of spending growth. However, Fitch expects
Louisiana to be particularly challenged as the state has reduced many
programs over the past several years, shrinking its cost-cutting
options. The state anticipates that its recent expansion of Medicaid
under ACA will reduce some of the state's financial burden in upcoming
years. In other major areas of spending such as education, Louisiana is
able to more easily adjust the trajectory of growth.
Overall, Louisiana retains ample ability to adjust expenditures to meet
changing fiscal circumstances. While Medicaid remains a notable cost
pressure, fixed spending requirements for debt service, pension (ARC),
and OPEB (actual) are low; carrying costs accounted for only 5.9% of
governmental expenditures in fiscal 2015 as compared to the 5.8% U.S.
state median. Pension contributions over the past several years have
generally fallen below the ARC as state contributions are based on
statutory guidelines, although the state has made recent contributions
above the ARC. The pensions' funded ratio has remained fairly constant
as a result of successful reforms on cost of living increases.
Long-Term Liability Burden
As of June 30, 2016, the state's debt burden at 3.5% of 2015 personal
income remains a low, but above average burden on the state's resources
and debt issuance is well controlled by policy measures. Funding of the
two largest pension systems is below average and the state has initiated
various reform measures to improve their sustainability. Under GASB 67
standards for pension systems, the state employees' retirement system
(LASERS) reported a 62.7% ratio of pension assets to liabilities in
fiscal 2015; the teachers' retirement system (TRS) reported a ratio of
62.5%.
Reform efforts in 2014 included changing how cost of living increases
are granted and how excess investment earnings are applied to address
the unfunded liabilities, as well as re-amortizing unfunded liabilities.
The reforms modestly improved the systems' ratios in fiscal 2015.
Pension and OPEB benefits for state employees and teachers are otherwise
constitutionally protected, reducing the state's flexibility to make
benefit changes.
On a combined basis, the burden of the state's net tax-supported debt
and adjusted unfunded pension (UAAL) obligations approximates 16% of
2015 personal income, well above the 5.8% median for U.S. states as
calculated by Fitch in its October 2015 pension report. The calculations
include 100% of the liability for both LASERS and TRS, which are both
the responsibility of the state although it is not required to make 100%
of the annual payments. The state's accrued OPEB obligations are
guaranteed by its constitution, similar to accrued pension benefits, and
the state made 44% of the ARC payment for OPEB in fiscal 2016. The OPEB
UAAL stood at $5 billion as of the end of fiscal 2015.
Operating Performance
The state's revenue monitoring and forecast updates are an important
tool that the state applies to monitor financial operations,
particularly given the stress under which operations have functioned
over the past several years, with consecutive years of recurring budget
gaps that the state has closed through both structural and non-recurring
actions. In the period following hurricanes Katrina and Rita, in 2005,
the state has been affected by steep cuts in its federal Medicaid
reimbursement rates given increases in the state's income and the ending
of disaster-related federal reimbursements.
The sharp drop in crude oil prices since late 2014 further affected
budgetary performance. Although the state's revenue estimating
conference (REC) repeatedly reduced GF revenue expectations for fiscal
years 2015 and 2016, actual collections underperformed even as higher
needs emerged in K-12 education, Medicaid, higher education tuition
assistance, and corrections. The state responded with reduced agency
expenditures, fund sweeps, revenue reallocations, a series of tax
increases and enhancements, an appropriation from the budget
stabilization fund (BSF), and an allocation from settlement proceeds
from BP.
The BSF continues to be an important backup resource for the state. The
state is able to access up to one-third of the balance for current
fiscal year operations or a prospective revenue shortfall. The state
estimates fiscal 2016 ended with a BSF balance of $358 million or 4.4%
of GF revenues.
Louisiana's budget management during the national economic recovery has
been influenced by the state-specific challenges discussed above. The
state's reliance on one-time measures for budget-balancing, along with
overly optimistic revenue projections and insufficient budgeting of
formulaic expenditures, have resulted in the need for successive years
of mid-year budget corrections during a period of economic growth.
GF cash position has narrowed in recent years and the state is currently
considering the issuance of cash flow notes to fund operations, although
accessible cash in other operating funds remains and the state's BSF,
expected to equal 4.4% of General Fund (GF) revenues at the end of
fiscal 2016, can be applied to financial shortfalls under certain
guidelines and with legislative consent.
Current Developments
The new administration which took office in January 2016 estimated a
$750 million current year budget gap for fiscal 2016, later expanded to
$940 million, with a $2 billion gap forecast for fiscal 2017. The
legislature responded in two special sessions to the forecast gaps
through the approval of a series of tax increases and enhancements and
changes to tax exemptions and credits. Actions included increasing taxes
on sales, tobacco, alcohol, and health maintenance organizations. While
most tax initiatives are permanent, the one-cent sales tax increase,
which provides $214 million in revenue in fiscal 2016 and $881 million
in fiscals 2017 and 2018, respectively, will sunset on June 30, 2018
after which the state will have to address the resulting structural gaps
in the absence of faster economic growth.
In addition to the tax increases, which are estimated to have
contributed $300 million to closing the fiscal 2016 gap and almost $1.4
billion to the closing of the fiscal 2017 gap, the state approved a
$128.5 million BSF draw for fiscal 2016, redirected $200 million of BP
settlement monies for economic damages to the GF, and authorized a debt
refunding to provide approximately $81.6 million in relief to the GF in
fiscal 2016 and about $30 million in relief for fiscal 2017.
The state still anticipates an ending deficit for fiscal 2016 despite
these actions. The amount of the deficit is uncertain, but Fitch
believes the state will proactively strive to reduce operations expense
in fiscal 2017 to eliminate it, as required by the state's constitution.
This task had been expected to be challenged by the need to trim
appropriations in fiscal 2017 from an already identified, estimated $300
million funding gap, and Fitch now expects this challenge will be
compounded by additional, unanticipated expenditures and possible
revenue losses related to the August 2016 floods.
The August floods resulted in considerable damage to homes and
businesses in nine parishes in the state's capital region. The ultimate
cost for damages in the state will take time to finalize, but
significant federal reimbursement through FEMA is already occurring;
through Aug. 31, 2016, $394 million had been approved by FEMA's
individual assistance program. The state currently estimates its direct
operating expense related to the floods at $52 million, an estimate that
Fitch believes could be augmented by flood-related infrastructure
requirements. How the state will fund these costs prior to receiving
FEMA reimbursements given its narrow cash balances is yet to be decided,
and already-contemplated cash flow borrowing this fiscal year, currently
authorized up to a maximum of $500 million, is now more likely, in
Fitch's view.
Fitch expects the state's financial position will deviate from earlier
forecasts due to the adverse economic and revenue impact of the floods
and increase in related expenditures, with offsets provided by the
gradual receipt of federal disaster reimbursement and rebuilding
efforts. Fitch expects the state will proactively respond to these
challenges and will continue to monitor the state's progress.
Date of Relevant Rating Committee: Aug. 15, 2016
Additional information is available at 'www.fitchratings.com'.
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.
Applicable Criteria
U.S. Tax-Supported Rating Criteria (pub. 18 Apr 2016)
https://www.fitchratings.com/site/re/879478
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