Fitch Rates Rhode Island's $118MM GOs 'AA'; Outlook Stable

NEW YORK--()--Fitch Ratings assigns an 'AA' rating to the following State of Rhode Island and Providence Plantations general obligation (GO) bonds, consolidated capital development loans:

--$59.8 million 2016, series A (tax-exempt);

--$3.2 million 2016, series B (federally taxable);

--$55 million 2016, refunding series C (tax-exempt).

The bonds are expected to sell via competitive sale on or about the week of April 25, 2016.

In addition, Fitch affirms the following ratings:

--$1 billion in outstanding state GO bonds at 'AA';

--$508.67 million in outstanding state appropriation-backed debt at 'AA-'.

The Rating Outlook is Stable.

SECURITY

The state's GO bonds are supported by a pledge of the state's full faith and credit. Appropriation-backed debt of the state is supported 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. A constitutionally mandated limit on budget appropriations to 97% of estimated revenue and 5% budget reserve contribute to fiscal stability.

FINANCIAL PERFORMANCE STABILIZED: The state's fiscal performance steadily recovered following a period of persistent weakening during the recession. In fiscal 2015, tax revenues grew for the sixth consecutive year and Rhode Island also ended the year with a sixth consecutive general revenue operating surplus.

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.

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.

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.

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. 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 2015 results indicate continued growth. Rhode Island continues to maintain its rainy day fund at the statutory 5% of revenues. While Fitch anticipates modest revenue growth, Rhode Island's budget outlook assumes manageable structural gaps in future 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 losses during the recession of 8% exceeded the national decline of 6.3%. The state's employment recovery has been weak as well. Through February 2016, Rhode Island had regained just 81.2% of the lost jobs, ranking it 41st amongst states. National employment exceeded its pre-recession peak in May 2014.

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 below average economic performance, general revenues increased for the fifth and sixth consecutive years in fiscal 2014 and 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 ($185 million at June 30, 2015).

Performance in fiscal 2015 continued the recent trend of fiscal improvement, with the largest general fund ending balance ($168 million) since before the Great Recession. General revenues were up 6.1% yoy ($210 million), led by robust personal income tax revenue yoy growth of 10% ($112 million). Volatile capital gains tax revenue played a key role in the growth, but importantly, withholding revenue growth also picked up, rising 4.6% in fiscal 2015 from 3.9% the prior year. Fitch views growth in withholding revenues as a more reliable and sustainable indicator of fundamental economic growth.

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 had not accounted for.

CURRENT YEAR BUDGET INCLUDES MEDICAID CHANGES

The fiscal 2016 enacted budget addressed 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. The Act incorporated recommendations from a gubernatorially-appointed commission with representatives from the healthcare industry, unions, advocacy groups, and the legislature that developed proposals to address Medicaid spending trends and health outcomes.

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. Despite early challenges, the administration reports the Executive Office of Health and Human Services is on track to achieve the vast majority of the projected $75 million in recurring savings beginning this fiscal year. By next year's, the administration anticipates annual recurring savings could reach$120 million versus the pre-reform cost trajectory.

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 $192.6 million and $233.6 million in fiscal years 2018 and 2019, respectively, based on the enactment of the fiscal 2017 executive budget proposals. In addition to lackluster economic growth, a key driver of the forecast 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 preserved nearly all of the originally expected savings and removed a negative credit risk. The state's debt ratios are moderate, with net tax-supported debt of $2.1 billion (as of Fitch's October 2015 State Pension Update Report) equal to 4% of 2014 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 $243 million in additional GO bonds. The governor's fiscal 2017 capital budget proposes an additional $257.5 million in GO bonds for legislative and voter approval. Voters previously approved $33.5 million for the Veterans Home project included in the FY 2017 proposal so on a net basis, the amount of new proposed debt is $230.5 million. This is the third consecutive bond election with more than $200 million in GO proposals. In Fitch's view, the state retains sufficient debt capacity for this additional projected issuance. Given the state's high unfunded pension liability, careful long-term liability management remains an important credit factor for Rhode Island.

On a combined basis, the burden of the state's net tax-supported debt and Fitch-adjusted unfunded pension obligations equals 10.6% of personal income, well above the median of 5.8% for U.S. states (as reported in Fitch's 2015 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 reforms, the state's liability position was characterized by notably low funded ratios (48.4% for ERS as of June 30, 2010) and high unfunded liabilities. The state undertook two rounds of pension reform in 2011; the first focused on actuarial adjustments while the second focused on benefit changes. For fiscal 2015, the state reported system-wide funded ratios for the state employees' and teachers' portion of ERS of 56.6% and 58.8%, respectively. Under the new GASB 67 reporting standard, the ratios of pension assets to liabilities for the state employees' and teachers' portion of ERS are 55% and 57.6%, respectively, at the end of fiscal 2015. Under current actuarial assumptions, the state's actuary projects ERS to reach full funding in 2036. Rhode Island has consistently contributed for its pension obligations at actuarially recommended levels.

Last spring, the state reached a settlement agreement with unions challenging the 2011 reforms 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, with a $14.7 million increase in fiscal 2017. Under the settlement, the reported June 30, 2014 UAAL for all affected plans (including those for local governments) increased 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, which carry a moral obligation commitment from the state, and were issued on behalf of a now bankrupt video game company are an important credit consideration for Fitch. Despite significant public debate about the state's commitment, the fiscal 2014, 2015, and 2016 enacted budgets included the full debt service appropriations. Actual expenditures 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.

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

Fitch recently published exposure drafts of state and local government tax-supported criteria (Exposure Draft: U.S. Tax-Supported Rating Criteria, dated Sept. 10, 2015 and Exposure Draft: Incorporating Enhanced Recovery Prospects into U.S. Local Tax-Supported Ratings). The drafts include a number of proposed revisions to existing criteria. If applied in the proposed form, Fitch estimates the revised criteria would result in changes to less than 10% of existing tax-supported ratings. Fitch expects that final criteria will be approved and published in the beginning of the second quarter of 2016. Once approved, the criteria will be applied immediately to any new issue and surveillance rating review. Fitch anticipates the criteria to be applied to all ratings that fall under the criteria within a 12-month period from the final approval date.

In addition to the sources of information identified in the applicable criteria specified below, this action was informed by information from CreditScope, and IHS.

Applicable Criteria

Exposure Draft: U.S. Tax-Supported Rating Criteria (pub. 10 Sep 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869942

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

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Contacts

Fitch Ratings
Primary Analyst
Eric Kim
Director
+1-212-908-0241
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Marcy Block
Senior Director
+1-212-908-0239
or
Committee Chairperson
Douglas Offerman
Senior Director
+1-212-908-0889
or
Media Relations:
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Eric Kim
Director
+1-212-908-0241
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Marcy Block
Senior Director
+1-212-908-0239
or
Committee Chairperson
Douglas Offerman
Senior Director
+1-212-908-0889
or
Media Relations:
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com