CHICAGO — Ohio will kick off the New Year with a pair of borrowings that will total $360 million.
The Buckeye State will bring $180.2 million of general obligation bonds the week of Jan. 5, following the week of Jan. 12 with $180.1 million of capital facilities appropriation-backed bonds.
The general obligation bonds will refund outstanding bonds to generate debt service savings. Ahead of the deal, the ratings agencies affirmed their double-A-plus ratings on Ohio's GO bonds.
The appropriation backed bonds, which will raise money for various capital projects, are rated one notch lower, reflecting the need for legislative approval to appropriate the money that will pay the bonds.
Credit analysts praise Ohio for conservative fiscal management and other strengths, including moderate liabilities and strong liquidity. But the deals come as the state is in the midst of a major tax overhaul that analysts warn could derail the state's structural balance.
Gov. John Kasich, who won a second term in November, has enacted more than $3 billion in income-tax cuts since taking office four years ago. The current two-year budget features the largest income-tax cut in the state's history, and lawmakers accelerated the cuts earlier this year after revenues beat projections.
The Republican governor is also expected to unveil a new tax package with a deeper income-tax reduction in early 2015.
To help offset losses from the income-tax cuts, Kasich wants to raise taxes on oil and gas producers. A higher tax could generate significant revenue as the state builds on a nascent oil boom driven by hydraulic fracturing, or fracking, in the Marcellus and Utica shale formations.
The state is now in the second year of its 2014-2015 budget, which began in July 2013 and enacted a 10% personal income-tax cut, phased in over three years, and reduced income taxes for small business owners. The tax cut was offset in part with a 0.25% increase in the sales tax rate.
In 2014, the mid-biennium budget review included an additional $402 million in tax cuts, according to according to Ohio Budget and Management spokesman Dave Pagnard.
The revenue losses tied to the tax cuts could threaten Ohio's structural balance, warned Fitch Ratings and Moody's Investors Service.
"The [personal income tax] rate reductions and tax modifications for small business owners are expected to result in a sizable amount of foregone revenue over the biennium and are only partly offset by the sales tax rate increase, some PIT index and exemption freezes, and other tax reform measures," Fitch analyst Karen Krop wrote in a ratings report on the state's upcoming general obligation bond deal. "Even with sound revenue performance in fiscal 2014 and fiscal 2015 revenue performance through December that is above forecast, Fitch believes there is downside risk to the state's expectation of future PIT growth given slower employment growth.
"In the event of economic and revenue underperformance, the state may face structural imbalance beyond the current 2014-2015 biennium, in part due to its reliance on use of fund balance in the current operating budget, but also due to further reductions in tax rates" Krop wrote.
Like Fitch, Moody's warns that tax cuts could pressure the state's budget. "Potential revenue reductions from tax reform could threaten the state's balanced financial operations," Moody's said in its ratings report.
Responding to analysts' concerns, state officials noted that Ohio's current forecast shows structurally balanced operations in fiscal 2015, with year-to-date revenues coming in above forecasts and spending coming in below forecasts.
"It is noteworthy that Ohio has outperformed its tax revenue and spending estimates in each of the prior four fiscal years and has used those surpluses to fully replenish its rainy-day fund," state debt manager Kurt Kauffman said in an email. Kauffman added that the rainy-day fund currently stands at its "statutory maximum" of $1.5 billion, or 5% of the budget based on prior-year revenue.
Kasich will present a new executive 2016-2017 budget on Feb. 2. He's expected to preview the tax reforms that will part of that budget in a state of the state address scheduled for late January.
In end-of-the-year interviews with Ohio papers, the GOP governor indicated that he was in favor of deeper income tax cuts and that he wants to raise taxes on oil and gas producers and tobacco.
Kasich originally called for increasing oil and gas production taxes in 2013 as part of the current two-year budget, but the provision was later dropped.
With income taxes the state's top revenue source, reductions also have an impact on local governments, according to the Ohio Municipal League, which advocates for local governments in the General Assembly.
Local governments, especially cities and villages, have big stakes in the discussions on income tax cuts and new taxes on oil and gas production, said Kent Scarrett, the league's spokesman.
"Some legislators acknowledge that local governments are affected by state revenues going down but it doesn't get a lot of attention," Scarrett said. "The aggressive changes the governor has enacted and has talked about for the upcoming year will directly affect the revenue that local governments receive."
Kasich, in his first year in office, eliminated the state's estate tax, which meant the loss of $300 million to local governments, according to the league.
"It's coming from every direction," said Scarrett.
Local governments are also bracing for losses tied to a bill that Kasich signed into law on Dec. 19.
After years of debate, House Bill 5 will launch a major overhaul of Ohio's notoriously complex income-tax system.
The bill establishes a common tax base by defining what kinds of income local governments can tax and what kinds they can't. In a letter to Kasich urging him to veto the measure, the municipal league warned the law will mean "deep and consequential revenue" losses for nearly 600 Ohio municipalities.
Scarrett said it's difficult to predict how much revenue will be lost from the new law but that it will be at least $85 million annually, and likely higher.
Income taxes are a key revenue source for most of Ohio's local governments, accounting for an average of 60% of total general fund revenue. With less revenue, municipalities will face new limits on their ability to borrow, and could see a drop in debt service coverage for existing debt, according to local government advocates.
"It will also affect rainy day funds and surpluses; they will be used up and that will affect bond ratings," said Scarrett.
Ohio is one of only 17 states that allows all of its municipalities to impose income taxes. Without a uniform local income tax policy, the state has hundreds of different local income tax systems. Of the state's 943 local governments, 592 levy an income tax, with roughly 300 different structures.
The $180 million GO bond deal set for the week of Jan. 7 will be sold through a competitive process, with Acacia Financial Group Inc. as the state's advisor.
The lease-appropriation deal the following week will be divided into three series: $100 million of tax-exempt bonds for the Ohio Department of Transportation, $62 million of tax-exempt bonds for the Department of Administrative Services and $18.1 million of taxable bonds for the D.A.S.
PNC Capital Markets is the senior manager on the negotiated deal.
