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MOODY'S DOWNGRADES TO Aa3 FROM Aa2 NEW JERSEY'S OUTSTANDING G.O. BONDS AND DOWNGRADES TO A1 FROM Aa3 ALL APPROPRIATION-BACKED DEBT; OUTLOOK REVISED TO STABLE FROM NEGATIVE

27 Apr 2011

MOODY'S ASSIGNS A1 RATING TO NJ TRANSPORTATION TRUST FUND AUTHORITY'S $600 MILLION TRANSPORTATION SYSTEM BONDS, 2011 SERIES A

New Jersey (State of)
State
NJ

Moody's Rating

ISSUE

RATING

Transportation System Bonds, 2011 Series A

A1

  Sale Amount

$600,000,000

  Expected Sale Date

05/02/11

  Rating Description

Lease Revenue

 

Opinion

NEW YORK, Apr 27, 2011 -- Moody's Investors Service has assigned an A1 rating to the New Jersey Transportation Trust Fund Authority's ("TTFA") $600 million Transportation System Bonds, 2011 Series A. At this time, Moody's has also downgraded $12.1 billion of outstanding parity debt and revised the outlook to stable from negative, in conjunction with our downgrade of the state's general obligation rating to Aa3 from Aa2. Moody's has also downgraded the ratings and revised the outlook to stable from negative on $32.9 billion of state annual appropriation and moral obligation-backed- bonds payable from the General Fund as well as on the enhanced ratings assigned to the state's intercept programs (detailed below). The 2011 Series A bonds will fund transportation-related capital projects.

RATINGS RATIONALE

The downgrade of the state's general obligation rating to Aa3 from Aa2 reflects the state's weakened financial position and the expectation that recovery will be unlikely in the medium-term due to rapidly rising fixed costs, relatively slow economic recovery, and a lack of specified plan to rebuild fund balances. In addition, pension and other post-employment benefit (OPEB) liabilities will continue to grow rapidly, further pressuring the already high-debt state. According to Moody's estimates, fixed costs (debt service, pension contributions, and OPEB pay-go expenditure) could grow to 30% of the state's revenues within eight years (up from 13% in FY2010), leaving substantially less flexibility to manage discretionary expenditures. These rising costs have been exacerbated by the state's long-history of underfunding its pension contributions, and most recently, cutting all or nearly-all contributions in FY2009 through FY2011. In addition, revenue growth will be moderate as employment continued to decline through March 2011 and economic recovery is projected to lag the nation. There is no specific plan to rebuild liquidity and fund balance. The Aa3 rating also incorporates the state's broad, diverse economy and high resident wealth levels, as well as the governor's broad powers to reduce expenditures, which were implemented most recently in the 2011 budget.

The outlook is stable reflecting recent revenue growth that signals some economic stabilization; a decreased reliance on one-time resources to balance the proposed FY2012 budget; and the state's proactive measures to curb long-term liability growth, including proposed pension and OPEB reforms and a proposed increase in TTFA pay-go capital funding to reduce long-term borrowing needs.

The 2011 Series A bonds are special obligations of the authority, payable from anticipated contract payments to be made by the State of New Jersey from its general fund. The A1 rating reflects the need for annual legislative appropriation of the contract payments and is notched off of the state's general obligation bond rating of Aa3. Contract Payments to TTFA are also supported by specific state revenues, which are all dedicated to the state's transportation capital program, in some cases by statute, and in others by the constitution. There are no remedies in the event of a non-appropriation, and due to the risk of non-appropriation, we rate these bonds one notch below the state's general obligation rating. However, almost 90% of the debt service on net tax-supported debt in New Jersey is subject to appropriation. The essentiality of the authority's transportation financing program, support by dedicated revenues restricted to transportation purposes, and importance of maintaining access to the capital markets provides strong incentive for the state to make these appropriations.

Credit strengths:

-- High resident wealth levels and diversified economy

-- Recent revenue growth, although modest, suggests that economic stability is near

-- Administration is taking a proactive approach to managing future liabilities and cost growth

-- Broad executive powers to reduce expenditures

-- The state's high reliance on access to appropriation-backed debt, and the established history of appropriating for these bonds significantly reduce appropriation risk

Credit challenges:

-- Narrowed reserves and weakened liquidity with no specified plans to rebuild balances

-- Positive GAAP fund balances have been overstated by incorporating savings from underfunding pensions and historic use of bond proceeds to fund operations

-- Future budgetary pressure driven by rapid growth in pension and OPEB costs and already-high debt service costs

-- Revenue growth will not keep pace with expenditures as economic recovery lags the nation

-- State has 4th highest debt per capita and above-average pension and retiree health benefit liabilities

-- Structural imbalance remains although reliance on one-time resources has declined

-- Absence of certain best practices for governance

AUTHORITY HAS $12 BILLION OF DEBT OUTSTANDING; PROPOSED FY2012 DEDICATED APPROPRIATIONS INCREASED AND EQUAL 1.12 TIMES DEBT SERVICE

The authority was created as a financing and payment vehicle for the New Jersey Department of Transportation, which oversees a system of more than 13,059 lane miles of state highways and 2,388 state-owned bridges, as well as the nation's third-largest commuter rail and bus operation. In addition to conducting the overall planning and coordination of the state transportation system, the department provides transportation assistance to counties and municipalities.

The bonds are secured by state contract payments to the authority, on parity with previous and future issuances under the authority's 1995 transportation system bond resolution. The state's obligation to make contract payments is absolute, once the legislature has made the necessary annual appropriations. Although the appropriation made to the Department of Transportation includes funds for capital projects and maintenance, authority debt service has a first claim on contract revenue. While stress on the state's general fund has caused fluctuations in the amount of the state's appropriations (and thus the amount of funds available for purposes other than debt service), funding has always been sufficient to meet obligations to bondholders.

The state makes contract payments to the authority from the Transportation Trust Fund (TTF) account of the general fund, and if necessary from additional general fund revenues, subject to appropriation. Once funds are appropriated, the state treasurer is required to make payment to the authority no later than the fifth business day of the month following the month in which a credit has been made to the TTF. The TTF also funds debt service on certain bonds issued by the state for New Jersey Transit projects and vehicles, subject to the prior funding of authority contract payments. The TTF receives revenues from the following transportation-dedicated sources, under constitutional amendments approved by voters:

-- an amount equivalent to the revenue derived from 10.5 cents per gallon of motor fuel tax revenue, but not less than $483 million per year;

-- at least $200 million annually from the state's gross receipts tax on petroleum products, and

-- at least $200 million annually from the state's automobile sales and use tax collections; and if automobile sales and use tax collections are insufficient, then from the state's other sales and use tax.

In addition, certain revenues have been statutorily dedicated to the TTF, including the remainder of the state's motor fuel tax. Bondholders have no direct lien on any of the dedicated revenues, and the legislature has no legal obligation to appropriate funds to the authority. In the event of a failure by the legislature to appropriate sufficient funds for debt service, bondholders have no substantive remedies. On the other hand, the constitutionally dedicated revenues are available for transportation purposes only, and the financing activities of the authority are essential to the state, making an event of non-appropriation of debt service highly unlikely. The bond resolution does not require funding of a debt service reserve.

While the state has historically targeted appropriating the minimum dedicated revenues ($895 million) to TTFA, the Governor's proposed FY2012 budget appropriates the total projected collections from dedicated revenues ($1.035 billion). This offers additional financing flexibility, and as a result, the current offering will increase annual TTFA debt service to approximately $926 million in FY2012 (net of BABs subsidy receipts) from $857 million in FY2011. The $140 million of additional dedicated revenues are currently supporting General Fund operations, therefore while this transfer will provide necessary transportation funding, it will also further pressure the General Fund.

Adherence to the $895 million appropriation target has resulted in the authority utilizing capitalized interest and debt structures that are concentrated in longer maturities. Importantly, the state may increase the appropriation for debt service if needed, such as in the event that interest costs on variable rate debt exceeds budget.

FUND BALANCE DECLINED SHARPLY BUT REMAINED POSITIVE; POSITIVE BALANCES BOLSTERED BY DEFICIT FINANCING AND PENSION UNDERFUNDING OVER PAST DECADE

The budgetary pressure of the recession and resulting 15% decrease in tax revenue from FY2008 to FY2010 is illustrated by the decline in GAAP fund balance, depletion of the Surplus Revenue Fund, weaker liquidity requiring increases in short-term note borrowings, and greater reliance on non-recurring actions. However, despite the fund balance declines of the past few years, the state's fiscal 2010 GAAP-basis unreserved, undesignated fund balance (General Fund and Property Tax Relief Fund) increased by $190 million and remained positive at $804 million (2.8% of revenues). Unreserved, undesignated fund balance is projected to decrease further in FY2011 and FY2012 but remain positive at a low 1% of revenues. The state's positive balances have been sustained, however, through a history of using bond proceeds for operations (no longer permitted in the constitution) and underfunding annual pension contributions. From FY2003 to FY2005, the state issued nearly $5 billion of deficit financing bonds, and in the past five fiscal years, aggregate unfunded pension contributions have amounted to $9.1 billion.

The state's liquidity position has also weakened, with GAAP basis net cash decreasing to 3.6% of revenues in FY2010 from 12% in FY2007. The state has not specified plans to rebuild cash or fund balances. Annual cash flow borrowings have increased steadily, reaching $2.25 billion in FY2011, and are expected to increase significantly in FY2012. Favorably, operating liquidity is bolstered by approximately $1.0 billion of cash available for interfund borrowing (as of April 12, 2011) despite a recent constitutional amendment limiting the state's ability to borrow from certain funds for cash flow relief.

SLIGHT REVENUE GROWTH IN FISCAL 2011; 2012 PROPOSED BUDGET INCORPORATES SPENDING REDUCTIONS, ONE-TIME RESOURCES AND UNCERTAIN SOLUTIONS

New Jersey faced a substantial $10.7 billion gap at the outset of the fiscal 2011 budget process. The most significant solutions included eliminating the pension contribution ($3 billion), reducing school aid ($1.7 billion), converting the homeowner's rebates to a tax credit ($850 million of one-time savings), and reducing the inflationary increases for rebates ($1.2 billion). Based on year-to-date performance, fiscal 2011 revenues are exceeding budget by $100 million, and projected available fund balance will be in line with the budget ($349 million).

The fiscal 2012 budget message did not publish a funding gap, but previous reports had estimated a budget gap of approximately $4 billion. The proposed budget includes the statutory 1/7 pension contribution ($506 million; may be paid early in FY2011) and continues to reduce the state's reliance on one-time resources, which is down to 2% of budget from 13% in FY2010. However, the budget is balanced with approximately $2.15 billion (7% of budget) of solutions that will either require Federal approval, or may be open to legal challenge. These solutions include $426 million of Medicaid savings that will require a Federal waiver, $321 million of savings from the Governor's proposed health care reform (discussed below), and $1.4 billion of savings from underfunding the state's K-12 funding formula. A Special Master appointed by the state Supreme Court has ruled that underfunding the formula violates the constitution, and there is uncertainty whether the appropriation will have to be increased. The proposed budget also utilizes $496 million of one-time resources in FY2012, including using $46 million of fund balance. The budget would also fund the $506 million pension contribution with higher-than-expected fund balance carried over from FY2010.

SUBSTANTIAL LONG-TERM PENSION AND OPEB OBLIGATIONS; FUTURE FINANCIAL FLEXIBILITY WILL BE DRIVEN BY MANAGEMENT OF PENSION AND OPEB

New Jersey's long-term liabilities related to pension and retiree health benefits are among the highest of all states and represent a significant budget pressure, as the fiscal 2011 pension ARC and pay-go OPEB cost comprise nearly 17% of the state's operating budget. Persistent underfunding of annual contributions, investment losses, and granting of benefit enhancements have resulted in a high $37 billion unfunded pension liability and low 56% funded ratio (as of June 30, 2010). Pension reform passed in 2010 will increase pension funding by 1/7 of the ARC over the next seven years and require full funding thereafter. Combined with projected growth in OPEB costs, and projected debt service costs (excluding new borrowing), Moody's estimates that total budgeted fixed costs will increase to 30% of revenues over the next seven years, compared to 15% in FY2011. With economic recovery projected to lag the nation, expenditure growth will be difficult to balance and financial flexibility could deteriorate - a key consideration in the current rating action. In addition, due to the phased in approach to pension funding, the funded ratio is expected to decline dramatically before the state begins to make full contributions.

New Jersey's other post-employment benefits (OPEB) liability is higher than most peers as the state is liable for teachers' benefits as well as state retirees. The state's FY2010 accrued OPEB liability is $56.8 billion, and the ARC for OPEB is $4.9 billion. Like most states, New Jersey funds its OPEB liabilities on a pay-go basis, which is budgeted at $1.65 billion in FY2012.

To address the substantial and growing funding need, the governor has proposed an aggressive set of reforms designed to bolster the pension funded status and control the growth in OPEB costs. Proposed pension reforms include rolling back a 9% benefit increase granted in 2001, eliminating automatic cost of living adjustments, raising the retirement age and increasing employee contributions into the system. The governor is also proposing decreasing the assumed discount rate to 7.5% from 8.25%. Proposed reforms to health benefits would increase employee contributions to cover 30% of the cost of benefits (current contributions cover approximately 8%) and incorporate increased employee co-pays and deductibles. The proposal has been incorporated into the FY2012 budget proposal and requires legislative approval. The reform is likely to face legal challenges from the state's unions. If passed, the reform would provide the state with significant savings - both in total liability and annual budgetary savings - however these would not have any notable positive impact for at least the next seven years.

STATE'S ECONOMY IS BEGINNING TO STABILIZE BUT RECOVERY WILL LAG THE NATION

The state's March 2011 non-farm employment level (seasonally adjusted) declined a modest 0.04% over the prior year, marking the 35th consecutive quarter of job losses. In comparison, both New York and Connecticut have seen job growth for the past seven and five quarters, respectively. Moody's Analytics projects that New Jersey's job growth will average 1% through 2014, compared to 1.5% and 1.1% for New York and Connecticut. The 9.3% unemployment rate for March was above the 8.8% national rate. Ongoing contraction in government employment, reflecting pressure on state and local government budgets, may dampen improvement in the state's labor market somewhat.

In contrast to employment, aggregate personal income levels have been growing since mid-2009, which bodes well for revenue growth in this high income state. Approximately 40% of personal income taxes are typically derived from only 1.5% of individual tax filers, therefore growth in personal income may be a stronger indicator of future growth than employment levels. State per capita personal income in 2009 ($49,980) ranked second in the nation and was 126% of the national average. With its mature economy, New Jersey is expected to lag the nation as a whole in the recovery, according to Moody's Analytics. Downside risk also includes the continuing stagnation of healthcare employment and the high cost of living and doing business in the Garden State.

STATE HAS 4TH HIGHEST DEBT PER CAPITA; PROACTIVE MANAGEMENT TO CONTROL FUTURE BORROWING

Net tax-supported debt as of December 2010, was approximately $34 billion, among the highest nationwide. Net tax-supported debt has increased nearly 20% since 2006 and has doubled since 2001 due to debt issuance for the state's court-ordered school construction program, transportation, the issuance of debt for operating purposes in fiscal years 2003 through 2005. Despite the significant capital and infrastructure needs of this densely-populated state, the administration is proactively working to reduce reliance on borrowing going forward. The governor has recommended a transportation capital plan that increases pay-as-you go funding and reduces borrowing relative to the prior five year plan. In addition, the state adopted a Debt Limitation Clause in 2008 that requires voter approval of new laws authorizing borrowing through authorities. This limitation does not apply to TTFA borrowing.

Outlook

New Jersey's credit outlook is stable, reflecting our expectation that recent revenue growth signals some economic stabilization; a decreased reliance on one-time resources to balance the proposed FY2012 budget; and the state's proactive measures to curb long-term liability growth, including proposed pension and OPEB reforms and a proposed increase in TTFA pay-go capital funding to reduce long-term borrowing needs.

What could change the state's rating -- UP?

-- Higher than projected, sustained revenue growth that materially eases the budgetary pressure of growing fixed costs

-- Sustained progress in structurally balancing the state's budget, including full funding of all non-discretionary obligations, together with restoration and maintenance of financial reserves and liquidity

-- Reduction in the state's debt burden, while addressing pension and retiree health benefit funding

-- Adoption and implementation of policies and practices generally embraced by higher level credits such as multi-year financial planning and debt affordability policy

What could change the state's rating -- DOWN?

-- Slower-than-projected revenue growth that increases budgetary pressure of growing fixed costs

-- Failure to restore operating reserves or GAAP fund balances and liquidity position

-- Failure to address growing pension and OPEB liabilities

-- Significant increase in the state's debt position

-- Growing dependence on nonrecurring budget solutions, particularly in light of uncertain solutions in FY2012 budget

-- Economic recovery that materially lags the nation

The principal methodology used in this rating was Moody's State Rating Methodology published in November 2004.

LIST OF RATINGS AFFECTED BY DOWNGRADE

State of New Jersey General Obligation Bonds (Aa3 from Aa2)

State of New Jersey Certificates of Participation (A1 from Aa3)

Appropriation-backed bonds issued by New Jersey Building Authority (A1 from Aa3)

Appropriation-backed bonds (essential asset) issued by New Jersey Economic Development Authority (NJEDA) (A1 from Aa3)

NJEDA Designated Industries Economic Growth and Development Bonds (A2 from A1)

NJEDA Business Employment Incentive Program Bonds (A2 from A1)

Appropriation-backed bonds issued by New Jersey Education Facilities Trust Fund (A1 from Aa3)

Appropriation-backed bonds issued by New Jersey Transportation Trust Fund Authority (A1 from Aa3)

Appropriation-backed bonds issued by South Jersey Port Corporation (A1 from Aa3)

Appropriation-backed bonds issued by Garden State Preservation Trust (Aa3 from Aa2)

Appropriation-backed bonds issued by New Jersey Health Care Facilities Financing Authority (A1 from Aa3)

Appropriation -backed bonds issued by New Jersey Sports and Exposition Authority (A2 from A1)

Local Government State Aid Intercept Programs:

-- New Jersey Municipal Qualified Bond Program (A1 from Aa3)

-- New Jersey Qualified School Bond Program (A1 from Aa3)

-- Chapter 12 County College Bond Program (A1 from Aa3)

REGULATORY DISCLOSURES

Information sources used to prepare the credit rating are the following: parties involved in the ratings, public information, confidential and proprietary Moody's Investors Service information, and confidential and proprietary Moody's Analytics information.

Moody's Investors Service considers the quality of information available on the credit satisfactory for the purposes of assigning a credit rating.

Moody's adopts all necessary measures so that the information it uses in assigning a credit rating is of sufficient quality and from sources Moody's considers to be reliable including, when appropriate, independent third-party sources. However, Moody's is not an auditor and cannot in every instance independently verify or validate information received in the rating process.

Please see ratings tab on the issuer/entity page on Moodys.com for the last rating action and the rating history.

The date on which some Credit Ratings were first released goes back to a time before Moody's Investors Service's Credit Ratings were fully digitized and accurate data may not be available. Consequently, Moody's Investors Service provides a date that it believes is the most reliable and accurate based on the information that is available to it. Please see the ratings disclosure page on our website www.moodys.com for further information.

Please see the Credit Policy page on Moodys.com for the methodologies used in determining ratings, further information on the meaning of each rating category and the definition of default and recovery.

Analysts

Baye B. Larsen
Analyst
Public Finance Group
Moody's Investors Service

Edward Hampton
Backup Analyst
Public Finance Group
Moody's Investors Service

Robert A. Kurtter
Senior Credit Officer
Public Finance Group
Moody's Investors Service

Contacts

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MOODY'S DOWNGRADES TO Aa3 FROM Aa2 NEW JERSEY'S OUTSTANDING G.O. BONDS AND DOWNGRADES TO A1 FROM Aa3 ALL APPROPRIATION-BACKED DEBT; OUTLOOK REVISED TO STABLE FROM NEGATIVE
No Related Data.
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