Fitch Rates Rhode Island Convention Center Authority's $31MM Rfdg Rev Bonds 'AA-'; Outlook Stable
The bonds are expected to sell via negotiation on or about April 1, 2015.
The Rating Outlook is Stable.
SECURITY
The bonds are special obligations of the Rhode Island Convention Center Authority and payable from lease rental payments to be made by the state subject to annual legislative appropriation.
KEY RATING DRIVERS
APPROPRIATION SECURITY: Bond payment relies on annual legislative appropriations, resulting in a rating one notch below the state's general obligation (GO) bond rating. Appropriation risk is mitigated through a standard lease and agreement structure and the state's close oversight of the Convention Center Authority's budgeting and operations.
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.
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.
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.
MORAL OBLIGATION COMMITMENT: The governor's fiscal 2016 executive budget includes an appropriation for state moral obligation debt previously issued for a now-bankrupt video game company. The 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 November 2014 revenue update forecast 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.
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 annual 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 January 2015, Rhode Island had regained just 64.6% of the lost jobs, while national employment (and for most states) has already exceeded its pre-recession peak.
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 February 2015, Rhode Island's three month average yoy growth was 1.1% versus the national rate of 2.3%, while one year earlier the gap was 1.3% for Rhode Island versus 1.7% for the U.S. The gap between Rhode Island's and the nation's unemployment rate has slightly narrowed. Rhode Island's February 2015 unemployment rate of 6.3% improved notably from 8.4% the prior year, and is now 115% of the national level versus 125% in February 2014.
The state's consensus economic forecast (last updated in November 2014) forecasts modest employment growth of 1.4% for fiscal 2015, with the recovery accelerating in fiscal 2016 (2.4% employment growth). The fiscal 2015 estimate remained essentially unchanged versus the May 2014 estimates. 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, signaling a modest but continuing fiscal recovery and allowing Rhode Island to maintain its budget reserve at the full 5% requirement of general revenues (\$177 million at June 30, 2014). 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, but at a lesser pace, with continued full funding of the statutory reserve. The enacted fiscal 2015 budget, using the May 2014 revenue estimating conference forecast, relied on 2.2% GRF tax revenues (and 1.7% total GRF revenues) growth. The governor's revised fiscal 2015 estimate (released with the fiscal 2016 executive budget and based on the November 2014 revenue conference estimate) is for slightly more robust growth of 3.1% on GRF tax revenues and 2.3% on total GRF revenues. The governor's revised projection of a \$3.1 million GRF free surplus is a notable improvement from the \$575 thousand in the enacted budget.
The ending fiscal 2015 surplus would still be a sharp decline from the prior year, reflecting fiscal pressures in the current year including \$37 million in unanticipated Medicaid costs and \$25 million for employee contract raises which the enacted budget did not account for. In order to maintain balance, the governor's proposal includes additional revenues from the November revenue estimate (\$15.8 million) and a statutory change to allow for use of fiscal 2014 revenue growth in excess of the enacted budget (\$14.2 million). Under current law, those excess revenues would go towards pension funding. Fitch notes the state's narrowed fiscal position this year, but anticipates the state will manage the challenges in a manner commensurate with its 'AA' rating.
The fiscal 2016 executive budget addresses a \$190.4 million current services gap, which is somewhat higher than in recent years, primarily through expenditure reductions (\$118.1 million) and fund transfers or other largely one-time measures (\$58.4 million). The most significant expenditure reductions will come in Medicaid (\$93.8 million) with half in identified measures such as provider rate cuts, and half to be developed by an independent commission by April. 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 proposals in the executive budget are relatively modest and include some business tax reductions and a statewide property tax on second homes valued over \$1 million.
Rhode Island's multiyear budget outlook shows challenges, but structural budgetary protections mitigate associated risks. The governor forecasts 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
2011 pension reforms mitigated the ongoing credit pressure from the state's long-term liability levels which Fitch now views as manageable for the state. The state's debt ratios are moderate, with pro forma 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.
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%, respectively, at the end of fiscal 2014. 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.
Recently, the judge presiding over the cases in state court consolidated eight of the lawsuits into a single jury trial scheduled to begin on April 20. There have been recent media reports regarding a potential settlement covering some portion of plaintiffs in the litigation. In the preliminary offering statement for this transaction, the state notes that all parties are under a court-directed confidentiality order regarding settlement negotiations, and no official details have been released. Fitch will monitor any settlement regarding its effect on the unfunded liability and annual funding requirements.
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 executive budget also includes a full appropriation for expected debt service needs. As in the current year, 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.
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