City of Providence, RI

Transcription

1 CREDIT OPINION City of Providence, RI Update - Moody's Downgrades RIHEBC's Providence (PPBA) Bonds to Baa2; Affirms Baa1 on GOs; Outlook is Negative Update Summary Rating Rationale Analyst Contacts Robert Azrin VP-Senior Analyst robert.azrin@moodys.com Heather Guss Analyst heather.guss@moodys.com Nicholas Lehman AVP-Analyst nicholas.lehman@moodys.com Moody's Investor Service downgrades Rhode Island Health & Educational Building Corporation's (RI) Providence Public Schools Revenue Bond Financing Program, Series' 2007 A, 2007 B, 2007 C, 2009 A, 2010 A, and 2010 B to Baa2 from Baa1. The rating was previously on review for downgrade and concludes a review undertaken in conjunction with the publication on July 26, 2016 of the Lease, Appropriation, Moral Obligation, and Comparable Debt of US State and Local Governments Methodology. Concurrently, Moody's has affirmed the Baa1 rating on the city's outstanding general obligation (GO) debt; the Baa2 rating on the lease appropriation revenue bonds issued by the Providence Redevelopment Agency; the Baa2 lease appropriation revenue bonds issued by the Providence Public Buildings Authority (PPBA) ;and Series 2015 A & B, and 2013A PPBA bonds issued through RIHEBC. The outlook is negative. The rating action affects approximately $446 million in outstanding debt. The Baa2 rating on the RIHEBC bonds is one notch lower than the Baa1 general obligation rating on the city. The notching reflects the appropriation requirement, as well as the more essential nature of the projects financed and the moderate legal structure. The Baa1 general obligation rating reflects the city's sizeable and diverse tax base anchored by a significant institutional presence and an improving unemployment rate and high poverty levels. The rating also factors the city's weak financial position including a negative fund balance.the rating also incorporates a high debt burden that is partially supported by state school building aid, and a very high fixed cost burden with large unfunded pension and OPEB liabilities. The Baa2 PPBA and PRA lease revenue bond ratings reflect the city's general credit quality as well as the risk of non-appropriation, as outlined in the Master Trust Indentures and lease agreements between the city and the authorities. The rating also factors the essential nature of the leased assets. Credit Strengths Sizeable tax base with stabilizing presence of higher education and health care institutions Close proximity to economically vibrant Boston metro region Declining unemployment rates

2 Credit Challenges Negative accumulated fund balance position and weak liquidity Historically inconsistent financial performance High fixed costs (pension, OPEB and debt payments) Limited budgetary flexibility Weak socioeconomic indicators Lack of multiyear capital plan however initiative underway to implement Rating Outlook The negative outlook reflects the continued fiscal challenges the city faces including a very weak reserve position and rising pension and healthcare costs. Factors that Could Lead to an Upgrade Continued reduction in accumulated operating fund deficit Ability to achieve and maintain structurally balanced operations Significant tax base expansion and improvement in socioeconomic metrics Reduction in unfunded pension and OPEB liabilities Factors that Could Lead to a Downgrade Further weakening of reserve levels Inability to achieve and maintain structurally balance operations Increase in debt burden Lack of progress in funding long-term liabilities This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on for the most updated credit rating action information and rating history. 2

3 Key Indicators Exhibit 1 Notes: June 30th year end; Finances section reflect the General Fund and School Unrestricted Funds Source: City's financial statement, Moody's Investors Service Detailed Rating Considerations Economy and Tax Base: State Capital With Education and Health Care Sector Presence As the state capital, Providence's sizable $11.7 billion full value derives stability from its large government, health care and higher education presence, and remains a major center for employment in the region. The city remains well positioned for future growth given continued ongoing development stemming from many of the stable institutions located in the city. In addition to Brown University (Aa1 stable), the city's numerous hospital facilities and academic institutions include Johnson & Wales University (A2 negative), Rhode Island School of Design (A1 stable), Providence College (A2 stable), Rhode Island Hospital, Life Span, Women and Infants Hospital, and Hasbro Children's Hospital. As of July 2016, the city's unemployment rate remained elevated at 7.0%, and while that is an improvement from its peak of 15.5% in July of 2011, it remains above that of the state (5.6%) and nation (5.1%). Wealth and income levels in Providence remain below the state median, and poverty is a very high 29%, although this is partially reflective of a large student population. Full value per capita is a below average $65,454 (or 53% of the state median), which does not account for large amounts of tax exempt property in the city including higher education, health care, and state government. Financial Operations and Reserves: Weak Reserves; Adherence to Deficit Reduction Plan is Positive The city's financial position remains weak, with a negative General Fund balance position since fiscal Operating performance has been inconsistent with five operating deficits in the last seven audited fiscal years through Although the city is making strides to address its weak reserves, going forward, the city will remain challenged to reach and maintain structural balance due to growing pension and healthcare expenditures. Any further reductions in reserves or failure to adhere to the deficit reduction plan will result in strong downward rating pressure. The fiscal 2015 budget was adopted with a 1.66% levy increase to offset a 2% increase in expenditures. Primary budget drivers were public safety expenditures and pension costs. To manage the structural imbalance, the budget included the use of one-time revenue and expenditure saving measures including asset sales and debt service savings on debt refundings. Per the city's multi-year deficit reduction plan to address the negative fund balance, the city budgeted to increase reserves. However, due to unfavorable variances, the city experienced a $5 million decline in its General Fund balance. Contributing factors to the deficit were: city real estate sales that did not materialize, higher than expected public safety overtime, lower than expected state aid and back tax revenue and unanticipated growth in medical claims expenditures. The deficit increased the accumulated fund balance deficit to $13.7 million (or -3% of budgeted General Fund revenues), requiring the creation of a 2nd deficit reduction plan to address the fiscal 2015 $5 million deficit. Favorable 3

4 factors that partially offset these negative variances were debt restructuring savings, higher than forecasted state and local PILOT funding and grant revenue. The School Unrestricted Fund had slightly positive operations, achieving a $282,000 surplus. The Operating Fund (combined General Fund and School Unrestricted Fund) balance was -$13.4 million or a very weak -1.9% of revenues. The city's fiscal 2016 budget grew 2% and did not include an increase in the property tax rate, although it did include a 1.8% increase in the property tax levy. The city appropriated $4.3 million for deficit reduction, up from $3.3 million in fiscal The fiscal 2016 budget continued to utilize one-time revenues and expenditure savings, but to a lesser extent than in fiscal Favorably, the city increased appropriations to expenditure areas that have historically had unfavorable variances, including to public safety overtime, self-insured medical costs and snow removal. Management's estimated fiscal 2016 results are positive with a $6.3 million surplus expected. This surplus includes the $4.3 million budgeted contribution to fund balance per its Deficit Reduction Plan (consisting of four quarterly $1.1 million payments). Although the city received less state aid (including housing aid) and had expenditure overruns in the fire department, it offset these unfavorable variances with higher than forecasted property tax collections and building inspection fees and utility savings. The fiscal 2017 adopted budgets increases 3% and included a 4% increase in property taxes and $6.1 allocation to fund balance to address its accumulated General Fund deficit. Favorably, the budget includes an additional $800,000 appropriation over what is required under the Deficit Reduction Plan. The city's state-mandated deficit reduction plan is schedule to eliminate the operating fund shortfall in fiscal With the surplus in 2016 and the additional payment $800,000 payment in fiscal 2017, the city believes it is can potentially eliminate the deficit in fiscal 2018 with a $3 million contribution. Even if the negative fund balance is eliminated, significant improvement in the fiscal position will be challenging due to rising public safety, pension and health care costs. The city's ability to achieve structural balance and replenish reserves to adequate levels and address unfunded pension liabilities will be the focus of future reviews. Further erosion from current reserve levels will likely result in a downward rating action. LIQUIDITY The city's net operating funds cash position was adequate at the close of fiscal 2015 at $43.7 million, or 6.3% of revenues. The city has not issued cash flow notes since fiscal 2011, when it entered into a $31 million lease financing which was used for operational expenses. Management's estimates for operating fund cash (General Fund and School Unrestricted Fund) for the end of fiscal 2016 are similar to the fiscal 2015 ending cash balance. Debt and Pensions: High Debt and Pension Burdens; Elevated Fixed Costs The city's debt burden at 4.4% will remain elevated over the next few years as tax base growth will likely be modest and the city has plans to issue bonds for school capital projects as existing debt matures. Debt service costs as a percentage of expenditures are moderate 8.3% in The elevated debt burden is partially mitigated by the high state aid reimbursement for RIHEBC debt service at approximately 82% of debt service. Moving forward, the city has identified approximately $50 million in capital needs and will place a $40 million road bond on the ballot for approval in November. Notably, the city has not had a multi-year capital plan (on the city side) and has accumulated an estimated $800 million in deferred maintenance. The current administration established a capital planning work group that is expected to address this deficiency in the current fiscal year. Total fixed costs for the city in fiscal 2015, including debt service, required pension payments and current year OPEB contribution totaled a significant 25.6% of Operating Fund expenditures. Increases in fixed costs, resulting in reduced operating flexibility, would put downward pressure on the rating. DEBT STRUCTURE All of Providence's debt is fixed rate and amortizes at an average pace, with 85% of principal retired within 10 years. DEBT-RELATED DERIVATIVES Providence is not party to any derivative transactions. PENSIONS AND OPEB Providence's unfunded pension obligations are large and are a material weakness in the city's credit profile. Providence contributes to two defined benefit-pension plans. One is a multi-employer cost sharing plan for teachers and the other is a locally administered 4

5 plan for city employees. During fiscal 2016, the city contributed the full required contributions to the plans, equal to a combined $88.3 million, or 12.8% of Operating Fund expenditures. Management indicated they contributed the full ARC in fiscal 2016 and has budgeted to do so again in fiscal As of July 1, 2015 the reported funding status of the city's locally-administered pension plan remains weak at a 27.8%, and the unfunded liability is sizable at $951.8 million. In 2012 and 2013, the city enacted significant pension reform which reduces the escalation of benefit payments. Even with reform, the city's contribution over the next five year is still projected to increase by over 26.5%, from $73.2 million in fiscal 2017 to $92.6 million in fiscal As of fiscal 2015, the combined adjusted net pension liability for both defined benefit plans, under Moody's methodology for adjusting reported pension data, was $1.9 billion, equivalent to a significantly above average 17% of full value or 2.8 times operating revenues. Moody's uses the adjusted net pension liability to improve comparability of reported pension liabilities. The adjustments are not intended to replace the city's reported liability information, but to improve comparability with other rated entities. The city has had success reducing its sizeable unfunded liability for post-employment health benefits (OPEB). The reported liability for OPEB in fiscal 2014 was a sizeable $981 million, although it has declined significantly from 2010 when the liability was reported at $1.5 billion. The liability was reduced through a number of measures, including shifting eligible retirees to Medicare. The city funded approximately 49% of the 2015 OPEB ARC, representing $30.7 million payment by the city. Management and Governance The city's management has focused on more realistic budgeting assumptions and less use of one-time measures. As indicated above, lack of formal capital planning on the city side has been a credit weakness. Rhode Island towns and cities have an institutional framework score of A, or moderate. Revenues, consisting mostly of property taxes and state aid, are moderately predictable with economically sensitive revenues accounting for a fairly small portion. Revenue raising flexibility is moderate; although there is a limit on annual property tax levy increases, the cap is a fairly generous 4%. Expenditures mostly consist of personnel costs which are moderately predictable. Expenditure reduction ability is also moderate given the presence of public sector unions in the state. Pension costs will continue to rise despite reform on the state level. Legal Security The Rhode Island Health and Educational Building Corporation (RIHEBC) bonds are secured solely by a pledge of payments made by the Providence Public Building Authority (PPBA or authority) under the financing agreement between the two parties. Loan payments to RIHEBC are scheduled to be sufficient to pay the principal, sinking fund installments and redemption price of and interest on the bonds. The PPBA's loan payments will be made from lease payments the PPBA receives from the City of Providence. Security for the lease obligation between the PPBA and the City of Providence is provided by a pledge of lease rental payments made by the city to the authority. Under the lease agreement, the lease rental payments by the city are subject to and dependent upon annual appropriation. The authority has no taxing power of its own. The authority is required to maintain a debt service reserve (except for Series 2010 A & B) equivalent to maximum annual lease payments, which can be tapped if the city fails to make a payment sufficient to cover its lease payment. Further, the RIHEBC bonds benefit from a monthly pay Intercept Program which is a state-backed enhancement program. The program allows RIHEBC to request an intercept of basic education aid from the General Treasurer of the state. Additionally, security is provided by direct payment of School Housing Aid (82% of debt service) directly to RIHEBC s trustee from the State. The PPBA and PRA bonds are secured by the agencies' respective pledges to annually appropriate lease payments equal to debt service on the bonds and by liens on pledged collateral, which is comprised of various city buildings, primarily schools and public safety facilities. Under the lease agreements, these lease rental payments by the city are subject to annual appropriation. The PPBA and PRA have no taxing powers of their own. These bonds are issued under Master Trust Indentures pursuant to separate lease agreements with the city. All outstanding PPBA and PRA debt is fully collateralized by city assets. In the event of default, the Trustee is granted power to sell such real property as may be allowed for cure. Debt service on the GO bonds is secured by the city's general obligation unlimited tax pledge, subject to the state levy cap. Use of Proceeds Not applicable. 5

6 Obligor Profile Providence is the third largest city in New England and the capital of Rhode Island. The city is home to several higher education and healthcare institutions and serves as a regional employment center. The city has an estimated population of 178,432. Methodology The principal methodology used in the lease rating was the Lease, Appropriation, Moral Obligation and Comparable Debt of US State and Local Governments published in July The principal methodology used in the general obligation rating was US Local Government General Obligation Debt published in January Please see the Rating Methodologies page on for a copy of these methodologies. 6

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8 Contacts 8 CLIENT SERVICES Robert Azrin VP-Senior Analyst robert.azrin@moodys.com Heather Guss Analyst heather.guss@moodys.com Nicholas Lehman AVP-Analyst nicholas.lehman@moodys.com Americas Asia Pacific Japan EMEA