Fitch Upgrades Pawtucket, RI's IDR to 'A-' & GO Bonds to 'A+'; Outlook Stable

NEW YORK--()--Fitch Ratings has upgraded the following Pawtucket, Rhode Island (the city) ratings:

--Long-Term Issuer Default Rating (IDR) to 'A-' from 'BBB+';

--$3.4 million GO bonds, series 2005 to 'A+' from 'BBB+'.

The GO bond rating at two notches above the city's IDR reflects application of Fitch's revised criteria for U.S. state and local government credits, which was released on April 18, 2016. The revised criteria give GO bonds rating credit up to two notches above the IDR in the limited circumstances, including for statutory liens, where Fitch believes there are distinct and significantly superior prospects for ultimate recovery in the event of a municipal bankruptcy.

SECURITY

The bonds are general obligations (GOs) of the city backed by its full faith and credit and unlimited taxing authority. The Rhode Island State General Assembly enacted amendments to Section 45-12-1 of the General Laws to provide GO bondholders with priority over creditors in the event of a bankruptcy of the issuer by attaching a statutory lien on ad valorem taxes and general fund revenues of cities and towns. Fitch believes that this provides bondholders a substantial preferential right in a bankruptcy proceeding.

KEY RATING DRIVERS

ISSUER DEFAULT RATING: The upgrade of the city's IDR to 'A-' from 'BBB+' reflects the implementation of Fitch's revised criteria. The city has achieved positive operations in both the general and school funds and eliminated the accumulated deficit in the school fund, resulting in a solid reserve safety margin. Management's willingness and ability to raise revenues and reduce expenses underscores the city's financial flexibility. A notable pension liability in two of the city's pension plans coupled with a hefty OPEB liability offsets the low debt burden.

GENERAL OBLIGATION BOND RATING: Pawtucket's GO rating of 'A+' is two notches above the city's IDR. The two-notch uplift reflects the statutory lien security attached to GO bonds issued in Rhode Island and the resulting enhanced recovery considerations.

Economic Resource Base

The city, with a stable population of 71,600, benefits from its location just north of the capital city of Providence and approximately 40 miles from Boston. Healthcare, manufacturing, and retail comprise the largest components of the employment. Taxbase recovery has been sluggish, with the fiscal 2017 estimated valuation increase unable to offset recent multi-year declines. Socio-economic and labor indicators compare unfavorably with those of the nation.

Revenue Framework: 'a' factor assessment

Fitch expects revenue growth to approximate inflation in the absence of tax increases. Property taxes make up the bulk of the city's revenues providing for predictability and stability, but tend to grow more slowly. Statutory tax levy restrictions limit annual tax levy increases to 4% with some exceptions permitted, which, coupled with allowable increases in other locally-controlled revenues provides for a strong amount of tax revenue raising flexibility.

Expenditure Framework: 'a' factor assessment

Expenditures are expected to rise at a rate that exceeds slow-growing revenues. Moderate carrying costs and a number of limitations on the city's ability to control its work force contribute to the 'a' assessment of this key rating factor.

Long-Term Liability Burden: 'a' factor assessment

The overall debt and pension liability is moderate despite the low funded ratio for a couple of the city's pension plans. Limited financial resources are available to the city to permit a reduction in its high OPEB liability.

Operating Performance: 'a' factor assessment

Implementing expenditure controls and revenue increases has enabled the city to regain financial resilience and reserve levels that can withstand some economic stress. Nevertheless, Fitch could foresee budgetary challenges during a downturn and a notable lead time until the city would achieve a full recovery, based on the city's experiences in closing a deficit in the school fund a couple of years ago.

RATING SENSITIVITIES

FINANCIAL MANAGEMENT: The IDR and GO rating are sensitive to the city's ability to address its increasing retirees benefit costs, inclusive of both pensions and OPEB, while maintaining sufficient reserve levels and expenditure flexibility.

CREDIT PROFILE

The city's largest employers are Memorial Hospital (1,500 employees) and the toy manufacturer Hasbro (650), which maintains its headquarters in the city. Per capita personal income is around two-thirds of the nation's, and the poverty rate surpasses the state and national averages. The 6% May unemployment rate has decreased from the prior year, but remains well-above national levels.

Revenue Framework

The city's primary revenue source is property taxes, which represent about 88% of general fund revenues. The next largest revenue source, state and federal revenues provided to the city (exclusive of school aid) comprise 6% of revenues in fiscal 2015.

Historical revenue growth has trailed the growth in national GDP and approximated the rate of inflation during the decade spanning 2004 - 2014. Modest expectations for tax base and population growth likely will contribute to a relatively flat economy and consequently anemic revenue performance.

State statute limits annual increases in the property tax levy to 4% above the prior year's levy while insulating the city from loss of revenues from decreases in the property tax base. Certain exceptions exist in the law to exceed the 4% limit but require a 4/5ths approval from the city's council, and in certain instances, the state auditor general. Debt service costs are not restricted by this levy cap.

Expenditure Framework

City financial operations include responsibility for school finances. Personnel costs are the largest component of the city's general fund budget, representing about one-half of expenditures, while the contribution towards the schools represents about one-quarter of expenditures.

Future spending growth is not expected to be out of the norm but Fitch expects the natural pace of spending growth to be above that of the flat revenue growth.

Carrying costs for debt service, required pension contributions, and actual OPEB payments equal a moderate 18% of fiscal 2015 governmental expenditures. For the primary pension plans to which the city contributes, pension contributions have generally risen over the past few years and Fitch expects the pattern to continue going forward. In addition, the city has only moderate control over its workforce.

The city benefitted when in 2009 and 2010 the state changed the two state cost-sharing pension plans in which the city participates by reclassifying the plans as hybrid plans, including a defined contribution component in addition to the traditional defined benefit calculation. There were numerous legal challenges. Some of the challenges have been settled, while others are being appealed. Current estimates indicate that the city will be able to retain a majority of the savings that it garnered from the original pension reforms. Fitch's assessment of the expenditure framework assumes that city will be able to fund fully any increased pension obligations.

Fitch posits that the city has adequate ability to reduce expenditures if needed, despite some limitations in labor force control. About half of the employees belong to public safety unions, which cannot strike but are subject to binding arbitration for contract negotiations. Currently, the city is meeting the minimum staffing requirements in these areas. General employees typically have short or intermediate term contracts that usually do not include the city's ability to reopen negotiations due to adverse economic conditions, although they do allow the city to control headcount through lay-offs and furloughs.

Long-Term Liability Burden

City general employees and teachers participate in two state pension plans, while public safety employees are members of city-run plans. The largest city plan for police and firefighters accounts for over-half of the city's unfunded pension liability is poorly funded, as is the city's portion of one of the state plans. In addition, there are limited financial options for the city to address in full its high OPEB liability, which weakens the overall assessment of this key rating factor. Low debt levels, with rapid amortization creating capacity for the city's modest issuance plans, are a credit positive.

City employees primarily participate in one of the following pension plans: the city's new Police and Firefighters Pension Plan, the Municipal Employees' Retirement System of the State of Rhode Island (Municipal Plan), or the Employees' Retirement System of the State of Rhode Island (Teachers' Plan). The public safety plan is poorly funded at around 40%, assuming the rate of return to be 7%. The Municipal Plan and Teacher's Plan, which together account for less than half of the city's unfunded pension liability, have funded ratios, respectively, of an adequate 76% and a low 58%, after adjusting for Fitch's assumed rate of return. For all three plans, actuarial projections indicate that the fiduciary net position would allow the plan to make all projected future benefit payments to current members.

The city's OPEB position is weak. The city contributed about half of its OPEB actuarially determined contribution in fiscal 2015, below the two-thirds it contributed the prior year. City out-year budget projections show that the city cannot attain structural balance should it significantly increase its annual OPEB contribution. For the fiscal 2017 budget, the city has inserted a small amount to establish an OPEB trust. The city is considering how to address this liability sustainably.

The city's ability to navigate successfully the pension and OPEB liabilities without compromising either its expenditure flexibility or its reserve levels will be a key rating consideration going forward and could result in upward rating potential.

Operating Performance

The city's general fund reserves have only recently recovered sufficiently from the Great Recession to surpass the reserve safety margin that Fitch expects to see throughout an entire rating cycle. While a moderate economic downturn would not necessarily decrease reserves by an equal margin, Fitch expects to see available fund balance above the 'aa' or 'aaa' reserve safety margin though any future stress prior to reconsidering the 'a' assessment of financial resilience. Positively, the city possesses a strong revenue raising capacity coupled with the willingness to use it along with reasonable expenditure flexibility.

Fitch expects the city will continue its past practice of increasing reserves during an economic recovery and managing expenditures to address any shortfalls in intergovernmental funding for education. Recovery from the Great Recession, though, was a bit sluggish compared to that of other municipalities. The school fund deficit stood at $9 million at the beginning of fiscal 2012 and still equaled $1.5 million at the end of fiscal 2013. The city has faced liquidity challenges, with the fiscal 2015 days cash on hand of 62 days nearly double the low 34 days cash on hand of fiscal 2013.

Recent financial performance has been positive, strengthening the city's financial flexibility. Fiscal 2015 concluded with a $1.7 million surplus, equal to 1.5% of spending, adjusted for bond proceeds. General fund reserves rose to 14.5% of spending, with available fund balance adjusted for bond proceeds equal to 17.7% of spending.

The fiscal 2016 budget included a tax rate increase, the first in three years. Management projects that fiscal 2016 final results will show revenues and expenditures both out-performed the budget, which Fitch sees as consistent with recent financial performance.

The balanced fiscal 2017 budget does not appropriate reserves nor does it incorporate a tax increase. Out-year projections indicate that the city has sufficient revenue raising capacity to maintain consistently positive financial operations for baseline expenditures.

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

In addition to the sources of information identified in the 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

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Contacts

Fitch Ratings
Primary Analyst:
Barbara Ruth Rosenberg, +1-212-908-0731
Senior Director
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst:
Kevin Dolan, +1-212-908-0538
Director
or
Committee Chairperson:
Karen Ribble, +1-415-732-5611
Senior Director
or
Media Relations:
Elizabeth Fogerty, +1-212-908-0526
New York
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst:
Barbara Ruth Rosenberg, +1-212-908-0731
Senior Director
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst:
Kevin Dolan, +1-212-908-0538
Director
or
Committee Chairperson:
Karen Ribble, +1-415-732-5611
Senior Director
or
Media Relations:
Elizabeth Fogerty, +1-212-908-0526
New York
elizabeth.fogerty@fitchratings.com