NEW YORK--()--Fitch Ratings takes the following rating action on the City of Providence, RI's (the city) general obligation (GO) bonds:
$40,000,000 GO bonds series 2013A at 'BBB'.
The bonds are scheduled to price via negotiation the week of March 4. Proceeds will be used for road improvements.
In addition, Fitch affirms the 'BBB' rating on the city's following outstanding bonds:
--$1.9 million GO bonds, series 2000;
--$11.1 million GO bonds, series 2001B;
--$19.1 million GO refunding bonds, series 2004A;
--$6.9 million GO taxable refunding bonds, series 2004B.
The Rating Outlook is Negative.
The bonds are general obligations of the city and backed by its full faith and credit and unlimited taxing authority.
KEY RATING DRIVERS
FINANCIAL CONDITION STILL PRESSURED: Despite indications of substantial improvement to its structural imbalance, the maintenance of the Negative Outlook reflects remaining uncertainty and Fitch's view that the city still faces financial pressure and limited flexibility. Challenges include statutory revenue limitations, a shortage of additional cost cutting solutions, and increasing employee benefit costs.
IMPROVED BUT LIMITED LIQUIDITY: The city's cash position has improved with the establishment of new recurring revenue sources, but liquidity is still weak. Challenges include the negative general fund balance and forward year budget gap projections.
EFFECTIVE MANAGEMENT TEAM: Management has made notable progress in reducing its structural deficit for fiscal 2012. The fiscal 2013 budget is balanced and includes an appropriation for partial replenishment of general fund reserves.
HIGH FUTURE RETIREE COSTS: The city has growing and severely under-funded pension and other post-employment benefit (OPEB) liabilities, although funding of the annual required contribution for its pensions is at or near 100%. If approved, changes to retiree benefits are expected to reduce both near term costs and future liabilities. Overall debt levels are moderate.
ECONOMIC STABILITY FROM INSTITUTIONAL PRESENCE: Long-term economic stability is derived from the city's position as the capital of the state and its large educational and healthcare institutional presence.
WEAK DEMOGRAPHICS: Demographics are weak with low wealth levels, high unemployment and declining assessed values.
AGREEMENT WITH RETIREES: Formalization of the tentative agreement with retirees would ensure immediate and long term pension and healthcare cost savings. Inability to obtain formal approval could cause significant budget pressure and a downward change in the rating.
FINANCIAL PRESSURES: The rating is sensitive to management's ability to stabilize operations with recurring budget solutions and a restoration of satisfactory reserves and liquidity.
FINANCIAL CONDITION STILL WEAK
Providence has made significant progress in eliminating its structural imbalance, but financial pressure still exists. After passing a fiscal 2012 budget that eliminated a $110 million structural deficit, the city ended the fiscal year with a $15.1 million general fund operating deficit after transfers (3% of general fund spending). The fiscal year-end unrestricted general fund balance was a negative $11.4 million (-2.5% of spending). This was the fourth year of operating deficits and declines in cash balances. Much of this weak performance was due to cumulative loss of $123 million in state aid since fiscal 2009, weakness in the economy that resulted in a lack of new building activity, and lower than projected local revenues.
Cash flow pressures are less acute than they were a year ago, when depletion of cash was a real concern. Through management of payables/receivables, moving up the property tax billing date, and negotiation of new payment-in-lieu-of-tax (PILOT) payments from its local universities and hospitals, the city was able to retain adequate cash and avoid short-term borrowing.
The primary drivers of the reduction in the structural imbalance were a 5.14% property tax increase, a reduction in staff by 200 (approx. 10% of staff), salary freezes, and the new or increased PILOT payments ($6.25 million). No one-time revenues were included in the budget. A budgeted reduction in retiree healthcare payments for Medicare-eligible retirees was delayed, accounting for approximately $11 million of the $15.1 million fiscal 2012 deficit.
Management has prudently implemented both increased budget monitoring, with monthly cash-flow reports provided to city council, and multi-year financial forecasting.
In April 2012, city council passed an ordinance (the Pension Protection Act) for pension reform including eliminating and partially freezing certain cost of living adjustments. The city expects a formal agreement and signoff by the state superior court to occur within the next two months. Included in the tentative agreement is the transfer to Medicare for eligible employees. Annual combined savings are estimated at $18.5 million.
BALANCED BUDGET FOR FISCAL 2013
The fiscal 2013 budget is balanced and includes no significant expenditure adjustments and no property tax increase. The budget includes a $5.6 million reduction of the general fund accumulated deficit as part of a new ordinance requiring approximately 1% of general fund spending (including transfers to schools) to be budgeted each year to help replenish reserves. The budget funds 100% of its revised $58 million annual required contribution (ARC), assuming formalization of the pension reform discussed above. The budget includes $20 million in additional state aid for schools due to a change in the state's funding formula which Fitch expects will be ongoing.
According to management, operations are on target to meet budget expectations. The city has adequate liquidity as represented by its $42 million in general fund cash and $24 million in school fund cash as of Nov. 2012. No cash flow borrowing is anticipated.
FUTURE FISCAL YEAR PROJECTIONS SHOW MODERATE IMBALANCES
The city's internal auditor has prepared a three year budget forecast which shows annual budget gaps of between $30 million and $40 million (5%-7% of budget) for combined general and school funds. These projections assume no tax base growth, no increase in property taxes and no increase in state school aid. Additionally, management has indicated to Fitch that the additional health care savings realized during this fiscal year of approximately $4 million are not reflected in the projections. The projections account for negotiated salary increases for certain employee groups as well as projected increases in pension ARCs and healthcare costs. Although it has not always done so, the city will be required to fund at least 95% of the pension ARC if the pension reform agreement is approved.
MODERATE DEBT LEVELS; HIGH FUTURE RETIREE COSTS
The city's debt ratios, net of the state's reimbursement for school projects, are moderate with debt to market value at 3.2% and debt per capita at $1,700. Amortization is rapid at 69% of principal in ten years and debt service in fiscal 2012 represented a moderate 7.3% of spending.
The city's pension and OPEB costs continue to be a concern to Fitch as their unfunded levels are very high. Recent pension reform efforts and changes to employee healthcare contribution requirements stand to reduce the burden. Pension contributions to the city-managed employee retirement system were $48 million in fiscal 2012, equal to 90% of its adjusted ARC and a moderate 7.3% of general and school fund spending. An additional $34 million was paid for retiree health claims on a pay-as-you-go-basis. Combined debt service, pension, and OPEB payments made up 23% of combined general and school fund spending.
The city defined benefit plan is funded at a low 32% with an unfunded liability of $903 million as of June 30, 2011 assuming a liberal 8.25% rate of return (revised from 8.5% in 2011). The funded ratio declines to 28% using a Fitch-adjusted 7% rate of return, and the unfunded liability represents a high 9.7% of 2011 market value (MV) of $10.2 billion. Based on the preliminary pension reform settlement, the city's actuarial consultant has estimated that the unfunded pension liability will be reduced by approximately $170 to $200 million. The final actuarial study is expected in the next few months.
The city's OPEB liability was a very high $1.15 billion (11% of MV) as of July 1, 2011, based on a 4% rate of return. The coordination of employee benefits currently being implemented by management should result in additional cost savings and reduction in the actuarial liability.
BELOW AVERAGE SOCIOECONOMIC INDICATORS
The city, with a 2011 population of 178,053, is the capital of Rhode Island and continues to be a major economic and employment center for the state. The numerous government offices and healthcare and higher education institutions including Brown University, Providence College and Johnson & Wales, provide stability to the region's economy. The city's top 10 taxpayers represent a moderate 10% of the total taxes levied with Narragansett Electric the top payer at 4.3%.
Unemployment levels have improved slightly but continue to exceed state and national averages with the city rate at 11.8% in November 2012 compared to 12.6% a year ago. Wealth and income levels are lower than state and national levels with the large student population a contributing factor.
Evidence of increased economic development includes a 200% increase in building permits fiscal year-to-date relative to the budget. Commercial vacancy rates have declined to the lowest rates since 2004 and hotel occupancy and revenue per room are up. Management reports a 56% increase in exports from the Port of Providence. Additionally, the relocation of Interstate 195 through Providence has resulted in the creation of surplus parcels of lands available for sale which could result in notable new property tax revenues depending on the development.
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, S&P/Case-Shiller Home Price Index, IHS Global Insight, Zillow.com, and National Association of Realtors.
Applicable Criteria and Related Research:
--'Tax-Supported Rating Criteria' (Aug. 15, 2011);
--'U.S. Local Government Tax-Supported Rating Criteria' (Aug. 15, 2011).
--'Fitch Downgrades Providence, RI's GO Bonds to 'BBB'; Outlook Negative' (March 2012).
Applicable Criteria and Related Research:
Tax-Supported Rating Criteria
U.S. Local Government Tax-Supported Rating Criteria