Fitch Affirms Providence RI's GO Bonds at 'BBB'; Outlook Remains Negative

NEW YORK--()--Fitch Ratings affirms the 'BBB' rating on the City of Providence, RI's (the city) following outstanding general obligation (GO) bonds:

--$1.3 million GO bonds, series 2000;

--$11.1 million GO bonds, series 2001B;

--$18.0 million GO refunding bonds, series 2004A;

--$6.1 million GO taxable refunding bonds, series 2004B;

--$37.8 million GO bonds series 2013A.

The Rating Outlook is maintained at Negative.

SECURITY

The bonds are general obligations of the city and backed by its full faith and credit and unlimited taxing authority.

KEY RATING DRIVERS

FINANCIAL PRESSURE STILL EXISTS: Despite indications of more balanced financial operations, the maintenance of the Negative Outlook reflects 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.

NEGATIVE GENERAL FUND BALANCE: The city's cash position and operating performance have improved with the establishment of new recurring revenue sources, but the city's cumulative general fund balance remains negative.

EFFECTIVE MANAGEMENT TEAM: Management has made notable progress in reducing prior year structural deficits and was successful in achieving savings from pension reform efforts. During the last two fiscal years, management has prudently budgeted 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%. Approved changes to retiree benefits should control growth in both near term costs and future liabilities.

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, improved but still high unemployment and slow growing assessed values.

RATING SENSITIVITIES

RESTORATION OF RESERVES: The rating is sensitive to management's ability to maintain stabilized operations with recurring budget solutions and a restoration of satisfactory reserves.

CREDIT PROFILE

FINANCIAL CONDITION SHOWING IMPROVEMENT

Providence's management has made significant progress in restoring stability to financial operations but the city's cumulative general fund balance remains negative. Revenue raising flexibility to meet growing expenditures is constrained by slow tax base growth and statutory levy restrictions, compounding the potential difficulty for a timely restoration of reserves.

The financial condition has improved markedly from fiscal 2012 when the city faced a sizable structural imbalance of $110 million (17% of fiscal 2012 city and school spending). Significant cost cutting measures, implementation of new recurring revenues, and a property tax increase helped the city restore some stability. Nevertheless, the city ended the fiscal year with a negative unrestricted general fund balance of $11.4 million (-2.5% of general fund spending).

Beginning in fiscal 2013, management took steps to partially restore fund balance by including a $5.7 million appropriation in its fiscal 2013 budget. The budget also assumed projected annual savings of $23 million from its pension reform efforts. Actual annual savings amounted to a still impressive $18 million annually due to agreements amongst its employees, retirees and management to changes in pension benefits, including the suspension of cost of living adjustments for a ten year period.

With better than anticipated tax collections and state aid combined with continued monitoring of expenditures the city was able to achieve a modest net operating surplus (after transfers) in fiscal 2013 of $1.6 million. Unrestricted fund balance improved to a still negative $9.8 million or a negative 2.2% of general fund spending. This addition to fund balance reversed a four year trend of general fund operating deficits and declines in cash balances.

CASH FLOW PRESSURES SUBSIDE

Beginning in fiscal 2012, management prudently implemented both increased budget monitoring, with monthly cash-flow reports provided to city council, and multi-year financial forecasting.

Fitch has reviewed fiscal 2014 cash flow projections which appear reasonable, and once again show adequate cash flow throughout the fiscal year. No cash flow borrowing is anticipated.

BALANCED BUDGET FOR FISCAL 2014

The fiscal 2014 general fund budget of $450 million is balanced and was up 3% compared to the fiscal 2013 budget. The property tax levy was increased by 2.4% (well below the 4% tax levy cap) and state aid for city and school operations was up. Public safety expenses, including pension costs of $62 million (up from $58 million) were the primary expenditure drivers for the city. The budget includes a $3.9 million appropriation, to be funded from surplus operations, for reduction of the general fund accumulated deficit as part of its continued plan to eliminate the deficit over five years.

According to management, general and school fund operations are ahead of budget expectations by $1.5 million through Dec. 31, 2013.

LOW DEBT LEVELS; HIGH FUTURE RETIREE COSTS

The city's debt ratios, net of the state's reimbursement for school projects, are below average with debt to market value at 2.4% and debt per capita at $1,467. Amortization is rapid at 70% of principal in ten years.

The city's pension and OPEB costs continue to be a concern to Fitch as their unfunded levels are very high. Based on the most recent valuation report for the city-managed employee retirement system, dated July 1, 2013, the pension changes agreed to amongst the city and its active employees and retirees helped reduce the unfunded liability by $69.5 million from $901 million as of July 1, 2011 to $831.5 million as of July 1, 2013. The unfunded liability was projected to increase to $965 million. Additionally, the city's normal annual cost for its pension declined by $2.3 million.

However, the decline in the actuarial value of assets of $35.5 million (due to a five year smoothing of 2009 investment losses) and an experience loss of $15.3 million kept the funded ratio relatively flat at 31% compared to the prior valuation. This calculation assumes the city's liberal 8.25% rate of return. The funded ratio declines to a Fitch-estimated 28% using a 7% rate of return, and the unfunded liability using that calculation represents a high 9% of fiscal 2014 taxable assessed value (AV) of $10.7 billion.

The city's pension contributions were $58 million in fiscal 2013, up from $48 million in fiscal 2012, and equal to 100% of its annual required contribution (ARC). These costs represent a moderate 7.7% of total governmental spending. Pension contributions for fiscal 2014 were budgeted at $62 million for fiscal 2014 (101% of ARC) and are projected to increase by 8% to $66.5 million for fiscal 2015 and $71.6 million for fiscal 2016 (up 7.7%). Prior to pension reform efforts the growth in these costs was projected to be higher.

OPEB contributions were $36 million for fiscal 2013, equivalent to 49% of the ARC. The city's OPEB liability was a very high $1.2 billion (11% of AV) as of July 1, 2012, based on a 4% rate of return. Combined debt service, pension, and OPEB pay-as-you-go payments made up a slightly high 24% of total governmental spending.

BELOW AVERAGE SOCIOECONOMIC INDICATORS

The city, with a 2011 population of 178,316, 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 low 5% of the tax base.

Management reports that new development and the opening of new retail stores continues to occur, but overall economic growth is expected by Fitch to lag that of other major metropolitan areas in the northeast.

Helped in part by a reduction in labor force, unemployment levels have improved slightly but continue to exceed state and national averages with the city rate at 9.9% in November 2013 compared to 11.1% a year ago. Wealth and income levels are lower than state and national levels with the large student population a contributing factor.

Additional information is available at 'www.fitchratings.com'.

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 2012);

--'U.S. Local Government Tax-Supported Rating Criteria' (Aug. 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

Additional Disclosure

Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=820271

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Contacts

Fitch Ratings
Primary Analyst
Kevin Dolan, +1-212-908-0538
Director
Fitch Ratings, Inc.
One State Street Plaza
New York, NY 10004
or
Secondary Analyst
Michael Rinaldi, +1-212-908-0833
Senior Director
or
Committee Chairperson
Amy Laskey, +1-212-908-0568
Managing Director
or
Media Relations, New York
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com

Sharing

Contacts

Fitch Ratings
Primary Analyst
Kevin Dolan, +1-212-908-0538
Director
Fitch Ratings, Inc.
One State Street Plaza
New York, NY 10004
or
Secondary Analyst
Michael Rinaldi, +1-212-908-0833
Senior Director
or
Committee Chairperson
Amy Laskey, +1-212-908-0568
Managing Director
or
Media Relations, New York
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com