NEW YORK--(BUSINESS WIRE)--As part of its continuous surveillance effort, Fitch Ratings takes the following rating action on the City of Providence, RI's (the city) following general obligation (GO) bonds:
--$2.980 million GO bonds, series 2000, downgraded to 'A' from 'AA-';
--$1.340 million GO bonds, series 2001A, downgraded to 'A' from 'AA-';
--$11.090 million GO bonds, series 2001B, downgraded to 'A' from 'AA-';
--$3.770 million GO refunding bonds, series 2001C, downgraded to 'A' from 'AA-';
--$23.510 million GO refunding bonds, series 2004A, downgraded to 'A' from 'AA-';
--$8.475 million GO taxable refunding bonds, series 2004B, downgraded to 'A' from 'AA-'.
The Rating Outlook has been revised to Negative from Stable.
RATING RATIONALE:
--The two-notch downgrade is a result of the city's precipitous decline in financial flexibility over the last year compounded by significant structural deficits forecasted for fiscals 2011 and 2012.
--The Negative Outlook reflects Fitch's immediate concern about the city's ability to generate adequate cash flow to fully support current-year operations and the medium-term challenge of successfully closing large budget gaps given statutory revenue limitations.
--The new city administration has demonstrated its commitment to restoring balanced operations by coordinating a financial recovery review panel, and beginning to make difficult decisions that could affect city services.
--Reserve levels are very low and given the property tax levy limit, restoration of an adequate cushion seems possible only through spending reductions. Based on discussions with management, expenditure flexibility seems apparent but will require tough decisions and may be hard to implement.
--The city has severely under-funded and growing pension and other post-retirement benefit (OPEB) liabilities, although prudently funds at or near 100% of the annual required contribution for its pensions.
--As the capital of the state, long-term economic stability is provided from the large governmental, educational and healthcare institutional presence.
--Demographics are weak with low wealth levels, high unemployment and declining assessed values.
WHAT COULD TRIGGER A DOWNGRADE?
--Failure to provide for sufficient cash flow to support current fiscal year operations.
--Inability to satisfactorily implement budget stabilizing solutions amid increasing health and employee expenses, property tax limits and minimal reserve balances which could result in a multi-notch downgrade.
SECURITY:
The bonds are general obligations of the city and backed by its full faith and credit.
CREDIT SUMMARY:
Providence has experienced significant financial pressure as a result of imprudent budgeting decisions and failure to implement recurring budget solutions in the wake of the state's cut in education and municipal aid and a significant rise in employee pension, health and salary expenses. The city's revenue raising flexibility is limited due to state-wide annual limits on property tax levies, but such limit can be over-ridden with a 4/5ths approval from city council. The city's newly elected mayor, who took office in January, assembled a Municipal Finances Review Panel to perform a financial recovery review of the city. The results were published on March 3rd and show a $70 million structural deficit for the remainder of this fiscal year but the city has proposed solutions that bring the total down to a still challenging $29 million. The larger hurdle for the city to overcome is the projected $110 million structural deficit for fiscal 2012.
Revenues over the last two years have been pressured primarily due to state aid cuts and weakness in the economy resulting in a lack of new building activity and lower than projected local revenues. Expenditure growth has been rapid and is outpacing revenues due to the strong labor presence and onerous pension contracts indicating limited flexibility to make expenditure adjustments.
After two years of general fund operating deficits, the city's general unreserved fund has declined from $17.04 million in fiscal 2009 to $2.08 million for fiscal 2010, equivalent to a low 0.5% of spending. Results for fiscal 2010 were below expectations due to a decline in local revenues and a $2.7 million unanticipated cut in state motor vehicle reimbursements to the city. The deficit also includes a $6.9 million transfer to the school fund to cover a larger than expected deficit. In the same year, the city had relied on a number of one-time transfers from other special revenue funds to balance operations, including proceeds of $14.5 million from the sale/leaseback of city owned streetlights.
The city did not have an approved operating budget for fiscal 2011 until eight months into the fiscal year. The former mayor and his administration submitted a budget on time but the budget was not formally approved by the city council until February due to disagreements over spending line items. State law allows the city to operate based on the prior year's operating budget until a subsequent budget is approved. The city lost approximately $18 million in state motor vehicle excise tax reimbursement in 2011 due to the state's reduction in the deductible to $500 from $6,000. The city supplemented lost income with one-time revenue sources including the additional sale and leaseback of city-owned assets and use of special revenue fund reserves. Fiscal 2011 revenue projections are below expectations contributing to the projected general fund structural deficit of $70 million or 15% of spending. The city plans to close the gap with $30 million in proceeds from a sale-leaseback transaction scheduled for next month, employee terminations, an immediate review and freeze on all non-essential spending and hiring across city-departments, expected healthcare cost savings, additional distressed community state aid and use of remaining reserves.
Liquidity is a concern. If the aforementioned sale-leaseback is unsuccessful, the city will have to resort to alternative solutions to firm up liquidity. Fitch will reevaluate the city's liquidity position prior to the close of the fiscal year. Failure to stabilize liquidity and rectify the current year deficit would likely result in a multi-notch downgrade.
The city's projected $110 million structural deficit for fiscal 2012 is due primarily to the city's reliance on one-time revenue sources ($48 million in 2011) and its reluctance to raise revenues. Reserves have been diminished and the property tax levy is limited per state law to 4.25% for fiscal 2012 unless a larger increase is approved by a 4/5ths vote of town council and approval by the state general auditor. A 4.25% increase results in only $12 million additional revenue (assuming a 95% collection rate). As a result, the mayor and his administration have been taking strong actions to begin cost-cutting to reduce expenditures, including the planned closing of four schools and termination of teachers and other city employees.
The Municipal Finance Review Panel's report has identified a large number of options for the city to consider in order to not only cut expenditures but to bring in new revenues. A majority of these solutions require cooperation not only from collective bargaining units, but from city hospitals and colleges who face new fees for city services. The city has identified a number of operational efficiencies and department restructurings and consolidations which will help save costs but must decide how to implement them expeditiously. It is Fitch's opinion that these options are viable but may take some time to implement and may not be sufficient in the short term to alleviate the full structural deficit. City officials have stressed that they will reduce headcount as needed, negotiate concessions with bargaining units and continue cost containment efforts to limit the amount of property tax increases necessary, but may ultimately have to raise taxes.
Included in the projected $110 million structural deficit for 2012 is the school department's projected $28 million fiscal 2012 structural deficit which follows projected break-even results for fiscal 2011. Approximately $20 million of the deficit is attributable to the loss of federal jobs and stimulus funding for salaries and benefits with the remainder reflecting salary and general increases in operating expenses. The suggested school closures that have been announced by the mayor and job terminations should help to reduce this deficit by an estimated $12 million annually. Additional cost cutting measures combined with potential union concessions are anticipated to help balance next year's budget.
The city, with a population of 172,519, is the capital of Rhode Island and continues to be a major economic and employment center for the state. The numerous government offices and healthcare and higher education institutions including Brown University, Providence College and Johnson & Wales, provide stability to the region's economy. The city's top 10 taxpayers represent a moderate 7.4% of the tax base with no individual taxpayer concentration. Unemployment levels have improved, but continue to exceed state and national averages with the city rate at 13% in December 2010 compared to 14.1% a year ago. Historically, wealth and income levels have been lower than state and national levels with the large student population a contributing factor.
The city's debt ratios, net of the state's reimbursement for school projects, are moderate with debt to market value at 3.3% and debt per capita at $1,941 including the Providence Public Building Authority debt.
The city's pension and OPEB costs continue to be a concern to Fitch as their unfunded levels are very high. Pension contributions to the city-managed employee retirement system were $51 million in 2010, equivalent to 11% of general fund spending and 97.7% of the annual required contribution amount. An additional $39 million was paid for retiree health claims on a pay-as-you-go-basis. The city defined benefit plan is funded at a low 34% with an unfunded liability of $828 million as of June 30, 2010 assuming a 8.5% rate of return. The funded ratio declines even further to 29% with the Fitch-adjusted 7% rate of return. The city's OPEB liability was a very high $1.5 billion as of July 1, 2009, based on a 4% rate of return. The city has determined a number of options that could achieve lower annual contribution amounts, but many of these changes require agreement from bargaining units which may be difficult to achieve. The city was able to renegotiate its contract with firefighters last year resulting in increased contributions from the employees for healthcare and higher co-pays resulting in significant long term savings for the city. Negotiations with other labor groups are currently ongoing.
Additional information is available at 'www.fitchratings.com'
In addition to the sources of information identified in the Tax-Supported Rating Criteria, this action was additionally informed by information from Creditscope, LoanPerformance, Inc., and IHS Global Insight.
Applicable Criteria and Related Research:
--'Tax-Supported Rating Criteria', dated Aug. 16, 2010.
--'U.S. Local Government Tax-Supported Rating Criteria', dated Oct. 8, 2010.
Applicable Criteria and Related Research:
Tax-Supported Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=548605
U.S. Local Government Tax-Supported Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=564566
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