NEW YORK--()--Fitch Ratings assigns an 'AA' rating to $400 million in general obligation (GO) bonds of the state of Connecticut, consisting of:
--$170 million GO bonds (2013 series A) SIFMA index bonds;
--$230 million GO bonds (2013 series B).
The bonds are expected to sell via negotiated sale the week of March 4.
In addition, Fitch affirms the ratings of GO and other related bonds of the state as detailed at the end of this release.
The Rating Outlook is Stable.
GO bonds to which the full faith and credit of the state will be pledged for payment of principal and interest.
KEY RATING DRIVERS
HIGH WEALTH LEVELS: Connecticut is the nation's wealthiest state as measured by per capita personal income. Economic recovery has been slow and uneven since the recession.
CYCLICAL REVENUES AND SPENDING PRESSURE: State revenue performance is cyclical, while high fixed costs limit its ability to respond during revenue downturns. The state's practice of borrowing to close deficits further limits flexibility.
HISTORICAL WILLINGNESS TO BUILD BALANCES: During past economic recoveries the state has demonstrated a willingness to rapidly repay deficit borrowing and rebuild its rainy day balance, although this has not been possible in the current recovery.
HIGH DEBT: Tax-supported debt is high for a U.S. state. Most GO bonds, excluding GO bonds issued to fund the teachers' retirement system, amortize rapidly.
SIGNIFICANT PENSION OBLIGATIONS: Unfunded liabilities for employees are significant, including for state employee and teacher pensions. The state has taken steps to reform retiree pension and health liabilities.
Connecticut's rating is sensitive to how the state manages its near-term financial standing given its high liabilities and limited operating flexibility. Further reliance on borrowing for operations in the context of an uncertain economic and revenue environment could weigh on the state's rating.
Connecticut's 'AA' GO rating reflects its vast wealth and income resources, tempered by a comparatively high burden of debt, retirement liabilities and other fixed costs. Despite a diverse and wealthy economy, the state's economic recovery has been slow, and revenue collections have materially underperformed forecast even as Medicaid and other costs exceed budget. In the current biennium ending June 30, the state has repeatedly taken quick balancing actions, most recently through spending cuts, but the general fund remains only narrowly balanced through the forecast period.
By practice, the state issues GO deficit notes following depletion of budget reserves, and repays them rapidly when the economy recovers. Reflecting the lack of a stronger revenue recovery and higher spending needs in the current cycle, there has been no acceleration of repayment. Additionally, the governor's biennial budget proposal for fiscal years 2014-2015 includes a restructuring of outstanding GO deficit notes for budget relief and issuing additional GO bonds to augment the state's cash balance while transitioning into GAAP-based budgeting. In Fitch's view, this proposal is a form of borrowing for operations that would further elevate state debt and fixed costs and could signal a degree of operating inflexibility inconsistent with the current rating. Longer term challenges include high unfunded pension and OPEB liabilities, although the state has achieved reforms in both and has demonstrated a commitment to fully fund annual pension contributions.
Connecticut has a wealthy, diverse economy anchored by large finance sectors and important manufacturing, education and health sectors. Employment rose 1% in 2011 as the state bounced back from recessionary declines, although growth during 2012 slowed through the course of the year. December 2012 employment fell 0.1% from December 2011, compared to growth of 1.7% reported nationally. Unemployment has fallen from its 2010 peak of 9.3%, but remains elevated at 8.6% as of December 2012, compared to a 7.8% rate reported nationally. The key professional and business services and finance activities sectors continue to show sizable job losses. The state remains the wealthiest as measured by personal income per capita, at 139% of the national average in 2011. Third quarter 2012 personal income rose 2% year-over-year, compared to 3.2% nationally. The state's forecast assumes 2013 will have the weakest economic performance since the downturn, with personal income up only 1.6%, flat employment, and an elevated unemployment rate at 8.5%; growth is expected to accelerate in 2014 and beyond.
Connecticut has a cyclical revenue system, with strong growth in some years enabling the state to build considerable balances in its budget reserve fund (BRF). Prior to the recession, the BRF balance had risen to $1.38 billion in fiscal 2007, equal to 8.5% of appropriations; the statutory maximum is 10%. During recessionary periods, the state relies on the BRF to cover revenue declines, and bonding in the form of GO economic recovery notes (ERNs) to cover year-end deficits. To close persistent budgetary gaps in the fiscal 2008-2009 and 2010-2011 biennia, the state relied on spending cuts, tax rate changes and non-recurring resources, including federal stimulus funds and $916 million in ERNs; the BRF was depleted in fiscal 2010 and fiscal 2011, and the forecast anticipates only small increases from unappropriated surpluses in the near term.
The state originally forecasted modestly higher revenues in the fiscal 2012-2013 biennium, which began July 1, 2011, with anticipated surpluses directed toward early repayment of ERNs and transitioning the state to GAAP budgeting. However, persistent revenue underperformance and higher spending needs eroded forecast surpluses despite mid-year cuts and other balancing actions. Ultimately, fiscal 2012 general fund net tax revenues fell short of the adopted budget forecast by 1.5% ($215 million). The fiscal year-end, originally forecast to have a surplus of $80.9 million, ended with a deficit of $143.5 million, which was closed using fiscal 2011 surplus originally intended for early repayment of ERNs.
Revenue underperformance and higher spending needs have continued in fiscal 2013, which ends on June 30. The state forecasts general fund net tax revenues of $14.1 billion, 2.1% below the revised budget forecast. During the first half of fiscal 2013 the state implemented rescissions and a deficit mitigation plan totaling $422.7 million to return to forecast balance. The fiscal year is currently forecast to end with a deficit at $55.7 million. A total of $93.4 million remains in the BRF from fiscal 2011's surplus.
The governor's proposed budget for fiscal 2014 and 2015 forecasts small surpluses in both years. General fund net tax revenues, including several tax law changes, rise 3.6% and 4.3% in fiscal 2014 and 2015, respectively. Proposed spending includes actions to begin implementing health care expansion under the Affordable Care Act, offset by various health care spending cuts. The budget also benefits from $150 million in annual savings from a proposed restructuring of the $573 million in outstanding GO ERNs.
As noted earlier, a separate GO borrowing proposed in the governor's plan, for up to $750 million, would cover a portion of the costs for transitioning to GAAP-based budgeting, which the state is implementing on July 1, 2013. The GO GAAP bonds would enhance the state's cash flow position while covering a portion of the $1.2 billion GAAP deficit the state estimates it will have as of June 30, 2013; proceeds could not be general fund resources. Instead of amortizing the GAAP deficit over time using planned surpluses, as is the state's plan under current statute, the changes would require amortization of the GAAP deficit as expenditures and free any future surpluses for deposit to the BRF. Nonetheless, Fitch would view the bonds as a borrowing for operations, and thus a credit negative.
DEBT AND OTHER LIABILITIES
The state's burden of debt and other liabilities is high compared to other states. Net tax-supported debt as of February 2013 totals $18.9 billion, including the new bonds, or 9.1% of 2011 personal income. Three-quarters of net tax-supported debt is GO, a large share of which has been issued for local school capital needs. Borrowing also includes $573 million in remaining ERNs.
Funding levels for the state's major pension systems remain a concern. As of June 30, 2012, the state employees' retirement system (SERS) was funded at 42.3% on a reported basis, and the teachers retirement fund (TRF) was funded at 55.2%, the latter having benefited from the 2008 issuance of pension bonds. Using Fitch's more conservative 7% investment return assumption (instead of the 8% rate assumed by SERS and the 8.5% rate assumed by TRF) reduces funded ratios to 38.1% and 47.4%, respectively. On a combined basis, the burden of net tax-supported debt and adjusted unfunded pension obligations equals 24.1% of 2011 personal income, among the highest for U.S. states rated by Fitch.
Connecticut has continued to demonstrate the ability and willingness to absorb the comparatively high fixed costs posed by its liabilities. The state fully funds an actuarially required contribution (ARC) to the TRF under a covenant linked to the pension bonds, and the SERS ARC is likewise fully funded. Several rounds of pension reforms have been implemented which in some cases elevate near-term contributions to accelerate funded ratio improvement over time.
Fitch also affirms the ratings on the following outstanding bonds of the state of Connecticut and related entities:
--State of Connecticut GO bonds and notes at 'AA';
--University of Connecticut GO state debt service commitment bonds, at 'AA-';
--Capital City Economic Development Authority parking and energy fee revenue bonds, series 2004A, 2004B, and 2008D, affirmed at 'AA-';
--Connecticut Development Authority general fund obligation bonds, series 2004A, 2004B, 2004C, and 2006A, affirmed at 'AA-';
--Connecticut Health and Educational Facilities Authority (CHEFA) revenue bonds (child care facilities program) series G, affirmed at 'A+'.
The Rating Outlook is Stable.
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' (Aug. 14, 2012);
--'U.S. State Government Tax-Supported Rating Criteria' (Aug. 14, 2012).
Applicable Criteria and Related Research
Tax-Supported Rating Considerations for 2010
U.S. State Government Tax-Supported Rating Criteria