Fitch Ratings assigns an 'AA' rating to the State of Rhode Island and Providence Plantations' general obligation (GO) bonds consisting of:
--$81.4 million consolidated capital development loan of 2012, series B.
The bonds are expected to sell via negotiation on Oct. 10, 2012.
In addition, Fitch affirms the following ratings:
--$1.11 billion in outstanding state GO bonds at 'AA';
--$647.6 million in outstanding appropriation-backed debt at 'AA-'.
The Rating Outlook is Stable.
The bonds are general obligations of the State of Rhode Island and Providence Plantations, secured by a pledge of the state's full faith and credit.
KEY RATING DRIVERS
IMPROVED FINANCIAL PERFORMANCE: The state's financial position has improved after a period of significant budget deficits and the state has demonstrated a willingness to adjust revenues and expenditures to achieve balanced operations. State-source revenues, particularly sales and personal income taxes, showed notable improvement in fiscal years 2011 and 2012 and the state added to its rainy day fund in those years.
STRONG FISCAL MANAGEMENT: The state's financial operations are conservatively managed and the state acts proactively to close budget gaps through structural solutions. Management oversight is strong and the constitutionally mandated limit on budget appropriations to 97% of estimated revenue and required 5% budget reserve ensures fiscal stability.
MODERATED LIABILITY POSITION: The state's debt position has moderated through the application of more disciplined debt issuance policies and the use of cash funding for capital projects. While the state's combined burden of debt and unfunded pension liabilities is well above average, the state's comprehensive reform of its pension systems significantly improved funded ratios while lowering annually required contributions.
WEAK ECONOMIC INDICES: The state's economic performance was among the worst of the states in the downturn and continuing job loss contrasts to modest growth across the nation. The state's unemployment rate remains high at 10.7% in August 2012 compared to a national rate of 8.1% but has improved year over year. Employment gains are expected to be slow over the next several years.
The state's 'AA' GO bond rating is based on improved financial performance, conservative fiscal management, and a manageable debt position, offset by economic performance that continues to be among the weakest in the nation. After adding jobs every year from 1992 through 2006, the state fell into the recession early, with YOY job losses beginning in August 2007 and continuing through April 2010. After showing improvement in 2010, employment returned to year-over-year losses beginning in January 2011. Rhode Island's unemployment rate reached 11.9% in January 2010; the rate in August 2012 was 10.7% (132% of the national rate), pointing to continued economic weakness.
These fragile economic conditions and a struggling real estate market pressured state revenues in the recession and challenged fiscal health and stability, severely straining the state's financial position. Despite continued economic weakness, the state's financial position improved in fiscal years 2011 and 2012, boosted by growth in economically sensitive revenue sources, allowing the state to add to its rainy day fund in those years. Fiscal 2013 revenues to date are below forecast, incorporating disappointing results in these same revenue sources due to weak economic performance; personal income and sales taxes.
SLUGGISH ECONOMIC PERFORMANCE
While the state's economy has stabilized, current economic indicators point to an economy that will be very slow to recapture employment lost in the recession. The 10.7% unemployment rate in August 2012 was the second highest in the nation and notably higher than the 8.1% national average. The state's annual unemployment rate in has grown relative to the national rate, from 117% in 2009 to 127% in 2011, and given current employment trends, Fitch expects the proportion to increase still further in 2012.
The state recorded YOY employment loss of 0.6% in August 2012 as compared to 1.4% growth for the U.S. Job losses were fairly wide-spread, occurring in other services (down 3.4%); retail trade (down 3.7%); government (down 2.3%); non-durable goods manufacturing (down 2%); professional and business services (down 2.4%); trade, transportation and utilities (down 2.5%); as well as education and health services (1.8%). These losses were somewhat offset by improvements in construction (7.9%); information (8.3%); and leisure and hospitality (3.8%) sectors.
Global Insights' economic forecast does not predict a return to pre-recession state employment levels until after 2020, the slowest of the states, although the state consensus economic forecast sees a quicker return to pre-recession employment, in 2015, based on state-sourced data. The state's department of labor and training (DLT) estimates actual YOY employment gains from March 2011 to March 2012. Given the large revision to BLS data earlier this year for the state, Fitch believes there could be potential for improved economic performance.
IMPROVED FINANCIAL POSITION
Despite the weak economic performance, economically sensitive revenue sources rebounded in fiscal years 2011 and 2012, improving financial margins and providing the state the opportunity to add to its reserves. The state added over $80 million to its budget reserve (BRF) in fiscal 2011 and preliminarily estimates a $93 million addition in fiscal 2012, bringing the BRF to over $153 million; maintaining the reserve at its full 5% required funding level.
An early, estimated budget gap of $295 million was identified for fiscal 2012; the gap was later reduced by improved revenue estimates. The budget gap was addressed in the enacted budget through structural budget solutions, encompassing both revenue enhancements and expenditure modifications, consistent with the state's well managed financial operations. The state extended the sales tax to additional items, increased various user fees, increased the hospital licensing fee, and cut social services spending and spending in other departments. The state also planned for a further addition to its rainy day fund at fiscal year-end.
Fiscal 2012 is preliminarily estimated to have ended with revenues over expenditures by about $153 million. Revenue from the personal income tax (PIT) is estimated to have increased 3.9% YOY and was 1.4% above the estimate. Sales tax revenue increased 3.5% YOY and essentially met forecast expectations. Overall, General Fund (GF) revenue of $3.27 billion was up 6% YOY and essentially met forecast expectations, which included the tax revisions.
The enacted budget for fiscal 2013 estimated revenue growth of 1.9% from the enacted fiscal 2012 budget, incorporating the forecast of the state Revenue Estimating Conference (REC) from May 2012. Based on the preliminary results for fiscal 2012, revenue is estimated to increase by 1.5% in fiscal 2013, incorporating various tax law changes. Based on the constitutional funding formula that calculates contributions to the BRF, which limits annual appropriations to 97% of estimated revenues in fiscal 2013, a deposit of $102 million is estimated to be made in fiscal 2013. The enacted budget for fiscal 2013 closed an estimated budget gap of $166 million through structural solutions including expenditure reductions, an expansion of the sales tax base, and other tax law changes.
Actual general revenue through August 2012 is running about 1.5% below the estimate and actual cash collections are essentially flat YOY as compared to fiscal 2012. PIT collections were 2.3% below the estimate through August; the state reports the withholding component was less than expected. Sales tax receipts were up YOY by 2.4%, however, actual receipts were 3.7% less than the estimate; the state reports a slower summer tourism season than expected. While these results demonstrate only two months of collections, the REC is scheduled to meet in November 2012 and Fitch believes the revenue forecast for fiscal 2013 could be revised should receipts continue to not meet expectations. The state has preliminarily identified a budget gap in fiscal 2014 of $130 million based on the maintenance of current service levels with no changes to current enacted revenues. Fitch believes the state will act proactively to eliminate any identified budget gaps.
ABOVE AVERAGE BUT STABILIZED LIABILITIES
Rhode Island's debt ratios are on the high end of the moderate range, with net tax-supported debt of $2.36 billion equal to about 5.1% of personal income compared to the 2.9% median for states rated by Fitch. The state has made a concerted effort to reduce debt levels through increased cash funding of capital projects through its Capital Fund. On a combined basis, the burden of the state's net tax-supported debt and adjusted unfunded pension obligations equals 11.7% of 2011 preliminary personal income, well above the 6.6% median for U.S. states rated by Fitch. The calculations include 100% of the liability of ERS and the 40% of the TRS liability for which the state is responsible.
Prior to significant recent reforms, the state's liability position was characterized by notably low pension funding levels (48.4% as of June 30, 2010). The state undertook two rounds of pension reform in 2011; in the first round, the state made a variety of conservative adjustments, including reducing the return assumption to 7.5% from 8.25%, reducing the rate of inflation, and increasing the life expectancy of retirees, which raised the state's unfunded actuarially accrued liability (UAAL). In late 2011, a second round of reform included establishing a hybrid defined benefit-defined contribution system and making future cost-of-living adjustments (COLAs) contingent on investment performance and the funded level of the plan.
The latter round of changes improved the funded ratios and lowered the plan's forecast contributions considerably. The UAAL for state employees (ERS) based on the June 30, 2010 valuation dropped to $1.7 billion from $2.7 billion; for teachers (TRS), the UAAL fell to $2.4 billion from $4.1 billion. For fiscal 2011, based on the noted pension reforms, the system-wide funded ratio for ERS and TRS increased to 61.1%. The Fitch-adjusted funded ratio for these systems is 57.9% for 2011. The systems are now expected to reach 80% funded in 2032 for ERS and 2020 for TRS with full funding of the systems expected in 2035.
There are several lawsuits currently outstanding challenging the pension reforms in 2011, as well as reforms promulgated in 2009 and 2010. As the judicial system did not stay the implementation of the reforms, should final, unfavorable outcomes be delivered to the state, Fitch believes there could be considerable financial loss to the state should retroactive payments to employees and retirees be required. Additionally, the state's liability position would be expected to weaken and additional budgetary allocations would be required to maintain pension funding levels.
Additional information is available at 'www.fitchratings.com'.
The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
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', dated Aug. 14, 2012;
--'U.S. State Government Tax-Supported Rating Criteria', dated Aug. 14, 2012;
--'Improving Comparability of State Liabilities' dated March 28, 2012;
--'Fitch: Effect of Sweeping Rhode Island Pension Reform May Be Felt Nationwide' dated Nov. 17, 2011.
Applicable Criteria and Related Research:
Tax-Supported Rating Criteria
U.S. State Government Tax-Supported Rating Criteria
Improving Comparability of State Liabilities
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