Fitch Affirms Pawtucket, RI's GOs at 'BBB-'; Outlook Stable

NEW YORK--()--Fitch Ratings affirms the following City of Pawtucket, Rhode Island's (the city) outstanding general obligation (GO) bonds:

$5.2 million, GO bonds, series 2001 at 'BBB-';

$1.8 million, GO refunding bonds, series 2002B at 'BBB-';

$9.9 million, GO bonds, series 2005 at 'BBB-'.

The Rating Outlook is Stable.

SECURITY

The bonds are an unlimited tax general obligation of the city backed by its full faith and credit.

KEY RATING DRIVERS

WEAK FINANCIALS; PROJECTED IMPROVEMENT: Tax increases coupled with departmental cost savings has helped stabilize city operations after deficit results in four of the last five years. Fitch views management projections for current positive general fund operating results and gradual improvement in reserves as reasonable given its effectiveness in cost cutting, efficiencies gained through attrition, and revenue improvement.

PERSISTENT SCHOOL DEFICIT TEMPERS CITY PROGRESS: The school department has implemented a plan to eliminate its cumulative deficit over the next four years but Fitch remains skeptical given historical setbacks. The city's audit shows positive fiscal 2011 school operating results negated by a projected fiscal 2012 deficit. Progress in balancing school operations is dependent on the accelerated payments of the state school funding formula as well as increased city contributions; a divergence from the deficit reduction plan will likely stall city general fund progress.

WEAK LIQUIDITY: The city's liquidity, although expected to improve, remains low requiring the continued usage of tax anticipation notes (TANs) to supplement cash flow.

WILLINGNESS TO RAISE REVENUES: The city has shown a willingness to raise revenues, in one year above the statewide tax cap, in an effort to stabilize financial operations at both the city and the school.

LARGE UNFUNDED BENEFIT LIABILITIES: The city's unfunded pension and other post-employment benefit (OPEB) liabilities are very high, but important to the rating is the city's progress in meeting its pension annual required contributions (ARC). Meaningful progress in funding levels will likely need to come with labor concessions and/or state legislation, the likelihood of which is unclear.

LOW DEBT LEVELS: The city's debt levels are low and are expected to remain manageable even with future planned debt issuances.

BELOW-AVERAGE SOCIO ECONOMIC INDICATORS: Wealth levels are relatively low and the city's unemployment rate exceeds state and national averages.

CREDIT PROFILE

The city, with a population of 71,148, is located just north of the capital city of Providence and 40 miles from Boston.

TAX BASE DECLINES; BELOW AVERAGE ECONOMY

The $3.6 billion tax base is primarily residential but declined 17% with the recent three year revaluation effective Dec. 31, 2011. The tax base has declined 30% since fiscal 2009 due primarily to lower real estate values, but management has adjusted tax rates upward to remain revenue neutral.

The largest employers are Memorial Hospital, Gateway Healthcare and Hasbro, the toy manufacturer, which maintains its headquarters in the city. The former mill town has seen a conversion of mills into residential condos and small retail businesses. Future residential housing development is slated for the next two years based on recent city approvals of plans which should help boost property tax revenues.

The city's wealth levels have historically been below state and national averages and unemployment rates continue to exceed the state and nation. Despite a slight uptick in employment and workforce participation in September 2012, the city's unemployment rate was 12.4% compared to 13.1% the year prior and above the state rate of 9.8%.

CITY FINANCES RECENTLY PRESSURED; PROJECTIONS ARE POSITIVE

The city experienced significant declines in reserves the last five years due to a combination of cuts in state aid, increased employee costs and recessionary conditions pressuring non-tax revenues. In fiscal 2011, the state removed a bulk of the motor vehicle reimbursement to local governments resulting in a $9.8 million (9%) structural imbalance. The city responded by lowering the motor vehicle exemption by about one-half and increasing the tax levy to just below the 4.5% maximum state-mandated total tax levy increase.

Fiscal 2011 midyear spending cuts and one-time transfers of reserves from other funds totaling roughly 3.5% of revenues, helped reduce the deficit further. Fiscal 2011 ended with a $1.4 million draw on reserves resulting in a low unrestricted general fund balance totaling 2.3% of spending.

In fiscal 2012, no new property tax increase was levied but the motor vehicle exemption was reduced from $3,400 to the state minimum of $500 resulting in $3.7 million of additional motor vehicle tax revenues. Officials approved an $876,000 appropriation towards fund balance and if successful, management's projection for a $1.89 million budgetary surplus would increase total fund balance to 4.8% of general fund spending. Supporting the projected positive results were revenues ahead of budget by $500,000 and lower expenses due to the administration's decision to privatize the city's waste transfer station, employee attrition and cuts in fire department spending.

The fiscal 2013 budget prudently included a 3% property tax increase, another year of not budgeting the use of fund balance and no one-time transfers. The budget includes a $500,000 appropriation to increase fund balance. According to management, the budget is tracking as expected with some savings realized due to some employee retirements.

SCHOOL FUND STILL STRUGGLING

Fitch remains concerned that the apparent progress in the city's general fund could be stalled if school deficit elimination benchmarks are not met. Historic overspending and aggressive budgeting thwarted budget balancing solutions despite a willingness by the city to raise taxes to support school operations. The cumulative deficit stands at $2.7 million (2.7% of fiscal 2011 school spending) and both the city and state auditor general have approved a plan to eliminate the gap by fiscal 2016. Successful implementation relies both on closer expense management by the school and increased funding from the city.

The original school fund deficit for fiscal 2012 stood at $8.9 million due primarily to decreases in overall city funding and federal funding. Management reduced staffing by 22 positions, froze salaries for both fiscal 2012 and 2013 and continued reducing expenditures to help partially offset the imbalance. The projected school fund operating deficit for fiscal 2012 is $2 million (2% of spending).

For fiscal 2013, the state restored $3 million in school funding and accelerated an additional $1 million in school aid. As a result, school officials expect an operating surplus of $1.5 million for fiscal year end which if realized would help partially eliminate the fiscal 2012 deficit. City management expects the phase in of increased state funding for schools and other cost savings measures to continue to help stabilize school operations over the longer term. The risk associated with slow progress towards balanced operations is incorporated into the low 'BBB-' rating.

DEBT LEVELS REMAIN LOW

The city's debt levels are low with overall debt to market value at 1.4% and debt per capita at $726. GO debt amortization is above-average with 73% of par retired in 10 years. To accommodate cash flow needs the city resorted to the use of tax anticipation notes (TANs) beginning in fiscal 2010 and issued TANs in February 2012 in the amount of $12.6 million, up from $11.6 million in fiscal 2011. The TANs were paid off in July 30, 2012. Management has indicated to Fitch its need for TANs still exists due to the timing of tax collections but as another indication of slight improvement, the borrowing level should be lower.

The city issued $8.3 million in bond anticipation notes (BANs) on August 22, 2012 (not rated by Fitch) and plans to take out the BANs with a $12.3 million GO bond issue in fiscal 2014. To help fund planned capital improvements, future BAN issues in the amounts of $4 million, $7 million and $10 million are planned for fiscal years 2015, 2016 and 2017 respectively. Such issuances are not expected to materially increase debt ratios due to the phase in of the new debt over time and rapid amortization rate of existing debt. Debt service costs in fiscal 2011 were a manageable 6% of spending.

Fitch recognizes a certain level of market access risk associated with the city's reliance on short term financing (BANs and TANs) given the low rating level. Importantly, the city reports no issues to date in subscriptions to short-term debt offerings.

HIGH EMPLOYEE BENEFIT COSTS

The city-run pension has an unfunded liability of $149 million, or 34% funded, as of July 1, 2011, up from 30% the prior year and assuming the city's 7.875% investment rate. Using Fitch's more conservative 7% rate the funding level is 31%. The city has increased its contributions to meet 100% of the ARC starting in fiscal 2012. Contracts with the city's major bargaining units expired June 30, 2012 and the city plans to seek potential concessions which could help reduce its estimated future liability. No salary increases were included in the fiscal 2013 budget.

The city makes pay-as-you-go payments for its other post-employment benefits (OPEB) obligations. The unfunded OPEB liability as of July 1, 2009 is a very large $378 million using a 4.25% discount rate. The next OPEB actuarial valuation as of July 1, 2011 is nearing completion, according to city officials. The city and school fund contributed $12.5 million towards its OPEB costs (52% of the ARC) in fiscal 2011, 7% of total city and school spending.

Fiscal 2011 carrying costs for debt service, pensions and OPEB paygo are a high to moderate 20% of city general fund and school fund expenditures.

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 Creditscope, University Financial Associates, S&P/Case-Shiller Home Price Index, IHS Global Insight, Zillow.com, National Association of Realtors, and Stone Consulting, Inc. (city's pension actuary).

Applicable Criteria and Related Research:

--'Tax-Supported Rating Criteria' (Aug. 14, 2012);

--'U.S. Local Government Tax-Supported Rating Criteria' (Aug. 14, 2012).

Applicable Criteria and Related Research:

Tax-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=686015

U.S. Local Government Tax-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=685314

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Contacts

Fitch Ratings
Primary Analyst
Kevin Dolan, +1 212-908-0538
Director
Fitch, Inc.
One State Street Plaza
New York, NY 10004
or
Secondary Analyst
Michael Rinaldi, +1 212-908-0833
Senior Director
or
Committee Chairperson
Jessalynn Moro, +1 212-908-0608
Managing Director
or
Media Relations
Elizabeth Fogerty, +1 212-908-0526 (New York)
elizabeth.fogerty@fitchratings.com

Sharing

Contacts

Fitch Ratings
Primary Analyst
Kevin Dolan, +1 212-908-0538
Director
Fitch, Inc.
One State Street Plaza
New York, NY 10004
or
Secondary Analyst
Michael Rinaldi, +1 212-908-0833
Senior Director
or
Committee Chairperson
Jessalynn Moro, +1 212-908-0608
Managing Director
or
Media Relations
Elizabeth Fogerty, +1 212-908-0526 (New York)
elizabeth.fogerty@fitchratings.com