Fitch Rates Rhode Island's $79.45MM GO Rfdg Bonds 'AA'; Outlook Stable

NEW YORK--()--Fitch Ratings assigns an 'AA' rating to the State of Rhode Island and Providence Plantations' $79.45 million of general obligation (GO), consolidated capital development loan of 2014, refunding series A.

The bonds are expected to sell via negotiation the week of April 21, 2014.

In addition, Fitch affirms the following ratings:

--$1.157 billion in outstanding state GO bonds at 'AA';

--$556.6 million in outstanding state appropriation-backed debt at 'AA-'.

The Rating Outlook is Stable.

SECURITY

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. Appropriation-backed debt of the state is secured by payments from the state subject to annual legislative appropriation.

KEY RATING DRIVERS

STRONG FISCAL MANAGEMENT: The state's financial operations are conservatively managed and the state acts proactively to close budget gaps. Management oversight is strong and the constitutionally mandated limit on budget appropriations to 97% of estimated revenue and required 5% budget reserve contribute to fiscal stability.

FINANCIAL PERFORMANCE STABILIZING: Following a period of persistent weakening during the recession, the state's revenue performance shows signs of recovery. Revised fiscal 2014 general revenue fund tax revenues indicate a fourth consecutive year of growth and are slightly ahead of the enacted budget. The governor's proposed fiscal 2015 budget projects further growth, though at a modest rate.

MODERATED LIABILITY POSITION: The state's debt position has moderated due to more disciplined debt issuance policies and cash funding of capital projects. While the state's combined burden of debt and unfunded pension liabilities is well above average, the state's 2011 comprehensive reform of its pension systems significantly improved funded ratios while lowering annual required contributions.

WEAK ECONOMIC INDICES: The state's economic performance was among the worst of the states in the downturn and the pace of recovery has lagged national trends. Going forward, Fitch anticipates continued below average economic growth.

APPROPRIATION SECURITY: Bond payments for appropriation-backed debt rely on annual legislative appropriations, resulting in a rating one notch below the state's GO rating.

RATING SENSITIVITIES

FUNDAMENTAL CHARACTERISTICS: The rating is sensitive to changes in the state's fundamental credit characteristics, particularly its fiscal discipline.

PENSION REFORM LEGAL CHALLENGE: Litigation around recent pension reforms is ongoing, and a resolution that substantively reduces the enacted savings for the state could trigger rating concern. The state and labor unions recently re-entered settlement talks after one employee group rejected a proposed settlement agreement.

MORAL OBLIGATION COMMITMENT: The enacted fiscal 2014 budget included an appropriation for state moral obligation debt previously issued for a now-bankrupt video game company. The governor's proposed fiscal 2015 budget includes the next payment on the debt, which is significantly higher than the fiscal 2014 payment which the legislature approved despite some political opposition. Failure to meet that commitment going forward would exert negative rating pressure.

CREDIT PROFILE

The state's 'AA' GO bond rating is based on conservative fiscal management, improved financial performance and a manageable debt position, offset by below-average economic growth. A deep recession and fragile recovery severely strained the state's financial position. Despite this, Rhode Island saw growth in economically sensitive revenue sources in fiscal 2011, 2012, and 2013, allowing the state to add to its rainy day fund in those years and maintain the required level. The revised fiscal 2014 budget and proposed fiscal 2015 budget forecast continued growth and maintenance of the rainy day fund at the statutory 5% of revenues. While Fitch anticipates modest revenue growth going forward, Rhode Island's budget outlook assumes manageable structural gaps in the out-years that will require continued fiscal discipline.

SLUGGISH ECONOMIC PERFORMANCE

Current economic indicators point to an economy that will be very slow to recapture employment lost in the recession. Rhode Island's peak-to-trough nonfarm employment loss of 11.5% notably exceeds the national loss of 8.4% (both not seasonally adjusted). Employment stabilized in 2011 and began to pick up modestly in 2012 with growth of 0.5% and 1.1%, respectively. The trend continued in 2013 with annual growth of 1.2%. Despite the positive momentum, the state's growth lags the national rates of 1.2%, 1.7% and 1.7% over the last three years. In February 2014, Rhode Island's year-over-year (YOY) payrolls growth rate of 1.6% actually slightly exceeded the national rate of 1.5%, but the three-month moving average of 1.1% still trails the national average of 1.7%. The state has only recovered 92.8% of its pre-recession peak employment levels, while through February, the nation recovered 97.7%. Similarly, Rhode Island's February 2014 unemployment rate of 9% improved notably from 9.5% the prior year, but remains well above the national rate of 6.7%.

The state's consensus economic forecast (last updated in November 2013) forecasts modest employment growth of just 0.9% for fiscal 2014, with the recovery picking up pace in fiscal 2015 (1.9% employment growth). Fitch anticipates the state's growth will remain below national levels over at least the medium term.

IMPROVED FINANCIAL POSITION

Despite the weak economic performance, general revenues increased for the third consecutive year in fiscal 2013, signaling a modest fiscal recovery and allowing Rhode Island to maintain its budget reserve at the full 5% requirement of general revenues ($173.7 million at June 30, 2013). Fiscal 2013 ended with a general revenue fund free surplus of $104.1 million (inclusive of all transfers and adjustments). Revenue from the personal income tax (PIT, 32.7% of general revenues) increased 2.4% YOY, while sales tax revenue (26.4% of general revenues) increased 3.3%. Overall, general revenue fund (GRF) revenue of $3.3 billion was up 1.6% YOY, essentially in line with the final forecast.

The governor's revised fiscal 2014 budget (presented in January 2014) forecasts GRF revenue growth at a slightly accelerated YOY pace of 3%, with PIT revenues up 3.2% and sales tax up 2.9%. For fiscal 2015, the governor's proposed budget includes a more modest GRF revenues YOY growth rate of 2%. Continued PIT and sales tax growth is assumed at 3.4% and 3.7%, respectively. The budget addresses a $149.3 million current services gap primarily through expenditure proposals with no broad-based tax increases. Rhode Island's multi-year budget outlook poses challenges with increasing general revenue fund deficits of $151 million and $257 million projected in fiscal 2016 and 2017. Notably, these projected deficits are down from last year's estimates. In addition to lackluster economic growth, a key driver of the shortfalls is a reduction in lottery and gaming-related revenues due to the anticipated opening of gaming facilities in adjacent southeastern Massachusetts. The constitutional funding formula that calculates contributions to the budget reserve account (now capped at 5% of general revenues) limits annual appropriations to 97% of estimated revenues, providing an important fiscal cushion. With the rainy day fund at its statutory cap, excess revenues flow to a capital projects fund thereby reducing debt issuance.

ABOVE AVERAGE BUT STABILIZED LIABILITIES

Fitch views Rhode Island's long-term liability levels as a key credit risk, but 2011 pension reforms mitigated the ongoing pressure. The state's debt ratios are on moderate, with net tax-supported debt (as of June 30, 2013) of $2.2 billion equal to 4.5% of 2013 personal income. This is down from 5.3% of personal income at the end of fiscal 2009. The state continues to moderate debt levels through increased cash funding of capital projects.

On a combined basis, the burden of the state's net tax-supported debt and Fitch-adjusted unfunded pension obligations equals 11.3% of personal income, well above the median for U.S. states rated by Fitch. The calculations include 100% of the liability for state employees in the employees' retirement system (ERS), approximately 40% of teachers' liability in ERS (the state share), and 100% of the liability for the judicial retirement benefit trust and the state police retirement benefits trust. The ERS liabilities encompass over 97% of the unfunded liabilities.

Prior to significant recent reforms, the state's liability position was characterized by notably low funding levels (48.4% for ERS 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 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 actuarial accrued liability (UAAL). In late 2011, a second round of reform (Rhode Island Retirement and Security Act, or RIRSA) 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.

RIRSA improved the funded ratios and lowered the plan's forecast contributions considerably. The state-reported UAAL for state employees in ERS based on the June 30, 2010 valuation dropped to $1.7 billion from $2.7 billion; for teachers, the state-reported ERS UAAL fell to $2.4 billion from $4.1 billion. For fiscal 2013, based on the noted pension reforms, the state reported system-wide funded ratios for the state employees' and teachers' portion of ERS of 54.7% and 56.6%, respectively which Fitch views as relatively weak. On a consolidated basis, the total state-reported ERS funded ratio was 57.3%. The Fitch-adjusted system-wide funded ratio for ERS is 54.4% for 2013. Under current actuarial assumptions, the state's actuary projects ERS to reach full funding in 2035.

Fitch's rating on the state incorporates the benefits of RIRSA and other recently enacted pension reforms, therefore, legal challenges to the reforms pose a downside credit risk. There are several lawsuits currently outstanding challenging the pension reforms in 2011, as well as reforms promulgated in 2009 and 2010. The judicial system did not stay the implementation of the reforms so if the cases result in unfavorable outcomes for the state, Fitch believes there could be considerable financial loss if retroactive payments to employees and retirees were to be required. Additionally, Rhode Island's liability position would likely weaken and additional budgetary allocations would be required to maintain pension funding levels.

REJECTION OF POSSIBLE SETTLEMENT NOT A CREDIT DRIVER

The recent failure of a proposed settlement agreement to end the pension reform lawsuits does not trigger rating action by Fitch. The agreement won approval from five of the six employee groups voting on it last week, but municipal police officers rejected the agreement, thereby automatically nullifying it. The presiding judge in the case ordered all sides back into further settlement talks with a trial date set for Sept. 15 if the talks fail. Had it been approved, Fitch viewed the settlement agreement as a favorable means for the state to resolve a significant point of uncertainty while retaining the bulk of savings to the state from RIRSA. The agreement's failure maintains the status quo.

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 IHS Global Insight.

Applicable Criteria and Related Research:

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

Applicable Criteria and Related Research:

U.S. State Government Tax-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=686033

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=826530

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

Contacts

Fitch Ratings
Primary Analyst
Eric Kim, +1-212-908-0241
Director
Fitch Ratings, Inc.
One State Street Plaza
New York, NY 10004
or
Secondary Analyst
Marcy Block, +1-212-908-0239
Senior Director
or
Committee Chairperson
Laura Porter, +1-212-908-0575
Managing Director
or
Media Relations
Elizabeth Fogerty, +1-212-908-0526 (New York)
elizabeth.fogerty@fitchratings.com

Sharing

Contacts

Fitch Ratings
Primary Analyst
Eric Kim, +1-212-908-0241
Director
Fitch Ratings, Inc.
One State Street Plaza
New York, NY 10004
or
Secondary Analyst
Marcy Block, +1-212-908-0239
Senior Director
or
Committee Chairperson
Laura Porter, +1-212-908-0575
Managing Director
or
Media Relations
Elizabeth Fogerty, +1-212-908-0526 (New York)
elizabeth.fogerty@fitchratings.com