NEW YORK--(BUSINESS WIRE)--Fitch Ratings assigns an 'AA' rating to the State of Rhode Island and Providence Plantations $145.725 million general obligation (GO) bonds, consolidated capital development loan of 2015, refunding series A.
The bonds are expected to sell via negotiation on or about the week of July 20, 2015.
The Rating Outlook is Stable.
SECURITY
The state's GO bonds are backed by a pledge of the state's full faith and credit.
KEY RATING DRIVERS
STRONG FISCAL MANAGEMENT: The state's financial operations are conservatively managed and the state acts proactively to close budget gaps. A constitutionally mandated limit on budget appropriations to 97% of estimated revenue and 5% budget reserve contribute to fiscal stability.
FINANCIAL PERFORMANCE STABILIZED: Following a period of persistent weakening during the recession, the state's fiscal performance has steadily recovered. In fiscal 2014, tax revenues grew for the fifth consecutive year and Rhode Island also ended the year with a fifth consecutive general revenue operating surplus. Fitch anticipates final fiscal 2015 results will continue this trend.
MODERATED LIABILITY POSITION: The state's debt position has moderated, with 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, comprehensive 2011 pension reform significantly reduced the unfunded liability and lowered annual required contributions. Recent settlement of pension litigation preserves the vast majority of the savings and removes uncertainty.
LAGGING ECONOMIC INDICES: Rhode Island's economic performance continues to trail national trends with slower jobs growth and a relatively high unemployment rate. The state's economic decline was among the worst of the states during the downturn and the pace of recovery has lagged. Fitch anticipates continued below-average economic growth.
RATING SENSITIVITIES
FUNDAMENTAL CHARACTERISTICS: The rating is sensitive to changes in the state's fundamental credit characteristics, particularly its fiscal discipline.
MORAL OBLIGATION COMMITMENT: The fiscal 2016 budget includes an appropriation for state moral obligation debt previously issued for a now-bankrupt video game company. This is the third consecutive enacted budget including the debt service appropriation. Rhode Island's GO rating incorporates Fitch's expectation that the state will sustain its full support of these bonds through final maturity. 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, stable 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. But since fiscal 2011, Rhode Island's general revenue taxes have increased every year, allowing the state to add to its rainy day fund and meet a higher statutory requirement. Fiscal 2014 results and the May 2015 revenue update indicate continued growth. Rhode Island's enacted fiscal 2015 budget includes maintenance of the rainy day fund at the statutory 5% of revenues, which the governor's fiscal 2016 executive budget continues. While Fitch anticipates modest revenue growth, Rhode Island's budget outlook assumes manageable structural gaps in the current and future years that will require continued fiscal discipline.
Rhode Island's fiscal 2016 enacted budget relies on $64.5 million in savings from this GO refunding transaction to support one-time expenditures for economic development initiatives and a one-time allocation to support K-12 school construction. The transaction shifts debt service to the out-years to generate savings this year and next, but does not extend final maturity of the refunded bonds and results in net present value savings.
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 losses during the recession of 8% exceeded the national decline of 6.3%. The state's employment recovery has been weak as well. Through May 2015, Rhode Island had regained just 72.4% of the lost jobs, ranking 40th amongst states. National employment exceeded its pre-recession peak one year ago.
In recent months, the state's pace of jobs growth has proved relatively volatile with a high of 1.8% year-over-year (yoy) in May 2014 versus a low of 0.6% in November 2014. The three-month moving average indicates a modestly widening gap with the national trend - in May 2015, Rhode Island's three-month average yoy growth was 1.1% versus the national rate of 2.2%, while one year earlier the gap was 1.5% for Rhode Island versus 1.8% for the U.S. The gap between Rhode Island's and the nation's unemployment rate has slightly narrowed. Rhode Island's May 2015 unemployment rate of 5.9% improved notably from 7.9% the prior year, and is now 107% of the national level versus 125% in May 2014.
The state's consensus economic forecast (last updated in May 2015) calls for modest employment growth of 1% for fiscal 2015, with the recovery improving modestly in fiscal 2016 (1.5% employment growth). The fiscal 2015 and 2016 estimates are down from the May 2014 estimates of 1.4% and 2.4%, respectively. Fitch anticipates the state's growth will remain below national levels over at least the medium term, particularly given its weaker demographic profile of very slow population growth and a slightly older population.
IMPROVED FINANCIAL POSITION
Despite the weak economic performance, general revenues increased for the fifth consecutive year in fiscal 2014 with continued growth estimated for fiscal 2015, signaling a modest but continuing fiscal recovery and allowing Rhode Island to maintain its budget reserve at the full 5% requirement of general revenues (estimated $185 million at June 30, 2015). Fiscal 2014 ended with a general revenue fund free surplus of $67.8 million (inclusive of all transfers and adjustments). Revenue from the personal income tax (PIT; 32.5% of general revenues) increased 2.7% yoy, while sales tax revenue (26.7% of general revenues) increased 4.2%. The PIT growth came despite the lingering effects of income acceleration in the prior year which held back PIT growth in other states. Overall, general revenue fund (GRF) tax revenues increased 3.7% and total GRF revenues increased 3.2% yoy, essentially in line with the final forecast. The $3.4 billion in total revenues was the first time GRF revenues exceeded the pre-recession peak.
Fitch anticipates continued revenue growth in fiscal 2015 with continued full funding of the statutory reserve. The enacted fiscal 2015 budget, using the May 2014 revenue estimating conference (REC) forecast, relied on 2.2% GRF tax revenues (and 1.7% total GRF revenues) growth. The May 2015 REC forecast for fiscal 2015 is for more robust growth of 7.2% on GRF tax revenues and 5.4% on total GRF revenues. The revised projection of a $118.6 million GRF free surplus is a substantial improvement from the $575 thousand in the enacted budget.
For fiscal 2015, the estimated surplus is largely attributable to strong revenue over-performance in personal income and business taxes that the state prudently characterizes as largely non-recurring. PIT estimates in the May 2015 REC forecast are up $59.1 million versus the November 2014 estimate and $69.7 million from the enacted budget. REC analysis indicates the bulk of the gain is in capital gains related collections so the forecast does not assume similar growth in fiscal 2016. Business taxes, which are historically volatile, accounted for $46.4 million of the $108.4 million improvement in fiscal 2015 tax revenues per the May 2015 REC forecast versus the November 2014 forecast. The revenue gains allowed the state to address fiscal pressures including $20 million in unanticipated Medicaid costs and $25 million for employee contract raises which the enacted budget did not account for.
ENACTED BUDGET INCLUDES MEDICAID CHANGES
The fiscal 2016 enacted budget addresses a $190.4 million current services gap, which is somewhat higher than in recent years, primarily through expenditure reductions and use of the fiscal 2015 ending balance, partially offset with tax structure changes. The most significant expenditure reductions ($70 million) are in Medicaid via the Governor's Reinventing Medicaid Act. In February, the governor created an independent commission with representatives from the healthcare industry, unions, advocacy groups, and the legislature to develop proposals to address Medicaid spending and health outcomes. The legislature largely adopted the commission's recommendations for the fiscal 2016 budget. As with many states, Medicaid is a key cost driver and the state's efforts to control costs will be a factor in future budgetary flexibility. Revenue changes in the fiscal 2016 budget are relatively modest, totaling an estimated $35 million in net declines; $24 million is attributable to the elimination of sales and use tax levies on utility services for commercial users.
Rhode Island's multiyear budget outlook shows challenges, but structural budgetary protections mitigate associated risks. In February the governor forecast current services general revenue fund deficits of $75.2 million and $211.8 million in fiscal years 2017 and 2018, based on the enactment of the executive budget proposals. 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 (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
Pension reforms of 2011 mitigated the ongoing credit pressure from the state's long-term liability levels, which Fitch now views as manageable for the state. Recent settlement of litigation regarding these, and earlier, pension changes preserves nearly all of the savings and removes a negative credit risk. The state's debt ratios are moderate, with net tax-supported debt of $2.1 billion equal to 4.3% 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. In November 2014, voters approved several GO bond referenda previously approved by the legislature, authorizing $248 million in additional GO bonds in the next several years. In Fitch's view, the state retains sufficient debt capacity for this additional projected issuance.
On a combined basis, the burden of the state's net tax-supported debt and Fitch-adjusted unfunded pension obligations equals 11% of personal income, well above the median of 6.1% for U.S. states (as reported in Fitch's 2014 pension update). The calculations include 100% of the liability for state employees in the employees' retirement system (ERS), 40% of the teachers' liability in ERS (the state share), and 100% of the liability for the judicial retirement benefit trusts and the state police retirement benefits trust. The ERS liabilities encompass over 97% of the unfunded liabilities attributed to the state by Fitch.
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) and high unfunded liabilities. 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 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. For fiscal 2014, the state reported system-wide funded ratios for the state employees' and teachers' portion of ERS of 57.4% and 59.6%, respectively. Under the new GASB 67 reporting standard, the system-wide ratios of pension assets to liabilities for the state employees' and teachers' portion of ERS are 58.6% and 61.4%, at the end of fiscal 2014. Under current actuarial assumptions, the state's actuary projects ERS to reach full funding in 2035.
Earlier this spring, the state reached a settlement agreement with unions challenging RIRSA and other recently enacted pension reforms that preserved 92% of the savings (based on an actuarial analysis provided by the state). By resolving the litigation on favorable terms, Rhode Island addressed a key downside credit risk. The state's actuary estimates the settlement will increase annual state contributions modestly, beginning with a $17.2 million increase in fiscal 2017. Under the settlement, the reported June 30, 2014 UAAL for all affected plans (including those for local governments) increases by a modest $290 million, or 6.3%.
EXPECTATION OF COMMITMENT TO MORAL OBLIGATION
The state's willingness to continue paying debt service on bonds issued in 2010, with a moral obligation commitment from the state, on behalf of a now bankrupt video game company are an important credit consideration for Fitch. While there has been significant public debate about the state's commitment, the fiscal 2014 and 2015 enacted budgets included the full debt service appropriations. The fiscal 2016 enacted budget also includes a full appropriation for expected debt service needs. As in prior years, the final appropriation will be net of any proceeds the bond trustee receives from related litigation.
Failure to fully appropriate for debt service on moral obligation bonds that were originally issued by a state agency would lead Fitch to reassess the state's commitment to bondholders and likely trigger negative rating action on the state's GO and appropriation-backed debt ratings. Consistent with Fitch's criteria for moral obligation pledges, Fitch does not anticipate moving those ratings below investment-grade as these moral obligation bonds were a project-specific commitment with limited direct state involvement in the company.
UNINTENTIONAL LATE COPS SINKING FUND PAYMENT NOT A CREDIT CONCERN
In April, the state unintentionally missed a $1.2 million required sinking fund principal payment on 2009 certificates of participation (COPs) issued for construction of a new School for the Deaf. Fitch does not view the missed payment as a credit concern as it reflects a minor administrative issue and does not indicate any diminished state commitment to the project or any fiscal stress. Rhode Island's fiscal 2015 budget included the required appropriation, but the trustee's invoice request for payment on related bonds did not include the sinking fund payment for the 2009 COPs. The state discovered the oversight during its year-end financial close-out process and began the payment process immediately.
Additional information is available at 'www.fitchratings.com'.
In addition to the source of information identified in the Tax-Supported Rating Criteria, this action was additionally informed by information from IHS.
Applicable Criteria
Tax-Supported Rating Criteria (pub. 14 Aug 2012)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=686015
U.S. State Government Tax-Supported Rating Criteria (pub. 14 Aug 2012)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=686033
Additional Disclosures
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