Fitch Rates Commonwealth of Pennsylvania's $1.2BN GOs 'AA-'; Outlook Stable

NEW YORK--()--Fitch Ratings has assigned a 'AA-' rating to the Commonwealth of Pennsylvania's $1,208,725,000 general obligation (GO) bonds, second series of 2016.

The bonds are expected to sell on or about July 19, 2016 through competitive bid.

The Rating Outlook is Stable.

SECURITY

The GO bonds are direct and general obligations of the commonwealth of Pennsylvania, with its full faith and credit pledged.

KEY RATING DRIVERS

Pennsylvania faces fiscal pressures in the form of a structurally unbalanced budget, brought on by a combination of rising fixed costs, modest baseline revenue growth, and a particularly contentious decision-making environment. The commonwealth's 'AA-' Issuer Default Rating (IDR) and the rating on the bonds reflects those limiting factors, as well as Fitch's expectation that the commonwealth will utilize the significant budgetary flexibility available to most states to respond to those pressures adequately, while also making progress toward structural budgetary balance. Pennsylvania benefits from a large, diversified and expanding, albeit slowly, economic base which is expected to provide adequate revenue capacity to match expenditure growth.

Economic Resource Base

Pennsylvania's broad-based economy is growing but at a slower pace than the nation. Below-average demographics, including population growth that has lagged the nation's for several decades, represent a long-term drag on economic growth. Ongoing development of Pennsylvania's significant natural gas reserves could mitigate that concern, but a weakened market tempers that potential. Overall, the state's economy provides a solid base for future potential revenue growth to help manage ongoing expenditure pressures.

Revenue Framework: 'aa' factor assessment

Fitch expects Pennsylvania's revenues, primarily income and sales taxes, will continue to reflect

the depth and breadth of the economy, but also its slower pace of growth. The commonwealth has complete legal control over its revenues.

Expenditure Framework: 'aa' factor assessment

The commonwealth maintains solid expenditure flexibility with a moderate burden of carrying costs for liabilities and the broad expense-cutting ability common to most U.S. states. Also, as with most states, Medicaid remains a key expense driver

Long-Term Liability Burden: 'aa' factor assessment

Pennsylvania's long-term liability burden is moderate but above average for a state, driven by unfunded pensions as net tax-supported debt is low. Pension funded ratios have eroded with contributions long below actuarial levels, but the commonwealth is nearing full funding of its contributions following a multiyear ramp up.

Operating Performance: 'aa' factor assessment

The commonwealth retains very strong gap-closing capacity to deal with a cyclical downturn given its general budgetary flexibility. Pennsylvania is somewhat less exposed to revenue volatility due to economic declines than most states, but continues to utilize material nonrecurring budgetary measures during the economic recovery. Efforts toward reducing the reliance remain stymied by unresolved differences.

RATING SENSITIVITIES

ADDRESSING FIXED-COST PRESSURES: The 'AA-' rating is sensitive to Pennsylvania's ability to address fixed-cost pressures, particularly for pensions, without materially weakening its fiscal flexibility. Fitch anticipates the commonwealth will meet its statutory obligations through structural expenditure reform, or revenue increases; any shift away from those commitments would be a credit negative.

MOVE TOWARD SUSTAINABLE BUDGETS: Given the magnitude of Pennsylvania's structural budget gap, Fitch anticipates some continued use of non-recurring items in upcoming budgets. Material growth in the structural gap beyond this expectation could trigger negative rating action.

CREDIT PROFILE

In January, the commonwealth's Independent Fiscal Office estimated a $1.9 billion structural, or current services, general fund budget gap for fiscal 2017. The structural budget challenge remains significant for a roughly $30 billion overall general fund budget. In advance of the July 1 start to the new fiscal year, the legislature approved a fiscal 2017 appropriations bill that increases general fund spending approximately 5%, or $1.5 billion. Importantly, revenue measures to support the budget are yet to be finalized. Pennsylvania's current 'AA-' IDR incorporates an expectation of continued challenges in reaching political consensus on final fiscal measures. But the rating also anticipates the commonwealth will halt the growth in the fundamental mismatch between recurring revenues and recurring expenditures.

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

In addition to the sources of information identified in Fitch's applicable criteria specified below, this action was informed by information from Lumesis and InvestorTools.

Applicable Criteria

U.S. Tax-Supported Rating Criteria (pub. 18 Apr 2016)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=879478

Additional Disclosures

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1008347

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https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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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
Laura Porter
Managing Director
+1-212-908-0575
or
Committee Chairperson
Marcy Block
Senior Director
+1-212-908-0239
or
Media Relations:
Elizabeth Fogerty, New York, +1 212-908-0526
Email: 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
Laura Porter
Managing Director
+1-212-908-0575
or
Committee Chairperson
Marcy Block
Senior Director
+1-212-908-0239
or
Media Relations:
Elizabeth Fogerty, New York, +1 212-908-0526
Email: elizabeth.fogerty@fitchratings.com