Providence, Rhode Island; Appropriations; General Obligation; Moral Obligation

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1 Summary: Providence, Rhode Island; Appropriations; General Obligation; Moral Obligation Primary Credit Analyst: Victor M Medeiros, Boston (1) ; victor.medeiros@spglobal.com Secondary Contact: Christian Richards, Boston (1) ; christian.richards@spglobal.com Table Of Contents Rationale Outlook AUGUST 4,

2 Summary: Providence, Rhode Island; Appropriations; General Obligation; Moral Obligation Credit Profile Providence GO Long Term Rating BBB/Positive Outlook Revised Providence GO Unenhanced Rating BBB(SPUR)/Positive Outlook Revised Providence Pub Bldg Auth, Rhode Island Providence, Rhode Island Providence Pub Bldg Auth rev bnds (Schs & Pub Fac Proj) ser 2001A dtd 12/01/2001 due 12/15/ Rationale S&P Global Ratings revised its outlook to positive from stable and affirmed its 'BBB' long-term rating and underlying rating (SPUR) on Providence, R.I.'s general obligation (GO) debt. The outlook revision is based on the city's improved budgetary performance. Growth in taxable valuations (TVs), along with administrative changes and stronger operational controls, have contributed to improved budgetary results and substantially better general fund balances. The 'BBB' rating reflects the city's past fiscal imbalances and limited budgetary flexibility due to fixed costs and some historic economic volatility. While we believe the current administration's budgetary actions are producing favorable operating results, the rating remains constrained by our view of the city's weak operating environment, reflecting its significantly underfunded pension and other postemployment benefit (OPEB) liabilities. Over time, the city's ability to achieve and sustain balanced operations could become more difficult particularly given rising legacy costs and the limitations imposed by public-sector union contracts and other constraints in adjusting expenditures. In addition, its past vulnerability to adverse business or economic conditions and its ongoing need for new capital investments to address infrastructure and deferred maintenance are other factors that could challenge budgetary performance. Despite these weaknesses, we believe the city's finances should stay positive over our two-year outlook horizon. Management's commitment to deficit reduction and generally improving economic outlook will likely translate to positive general fund results and as a consequence, further strengthen budgetary flexibility over time. Among other factors, a low unemployment rate, growing TVs, steady operations, and stronger budgetary reserves are factors consistent with a higher rating, in our view. As such, we believe there is a one-in-three possibility we may raise the rating over our outlook period. AUGUST 4,

3 The city's full faith and credit secures the GO bonds. We also revised the outlook to positive from stable on the lease revenue debt issued by the Providence Public Building Authority (PPBA), Providence Redevelopment Agency, and Rhode Island Health & Educational Building Corp., supported by the city, while affirming our 'BBB-' long-term rating and SPUR on the bonds. These bonds are one notch down from the city's GO rating due to the risk of non-appropriation for the lease payments. In addition, we revised the outlook to stable from positive on Providence's moral obligation debt--including the redevelopment agency's certificates of participation, issued for the Port of Providence. We affirmed our 'BB' long-term rating on the debt. The rating is based on the moral obligation pledge made by the city to support the bonds. Pursuant to the bond indenture, the mayor will seek appropriation for any required replenishment of the debt service reserve fund. The GO debt rating reflects the following factors: An adequate economy with projected per capita effective buying income (EBI) at 72.6% and market value per capita of $67,745; the city participates in a broad and diverse metropolitan statistical area (MSA) that has seen underlying economic improvements over the last several years; A weak management environment, despite "good" financial policies and practices under our Financial Management Assessment (FMA) methodology; Weak debt and contingent liability position, with debt service carrying charges at 8.3% of expenditures and net direct debt that is 53% of total governmental fund revenue, and significantly underfunded pension and OPEB obligations with a limited ability adjust to rising legacy costs: Notably, the city is rapid in its debt amortization, with 82% of debt scheduled to be retired in 10 years, although we recognize it will issue $45 million of additional debt in the coming months, which will affect these figures; Very weak budgetary flexibility, with an available fund balance in fiscal 2016 of negative 0.4% of operating expenditures that is also low on a nominal basis at negative $3.2 million; and Adequate budgetary performance, with a slight operating surplus in the general fund and break-even operating results at the total governmental fund level in fiscal Very strong liquidity, with total government available cash at 13.7% of total governmental fund expenditures and 1.7x of governmental debt service, and access to external liquidity we consider strong; and Strong institutional framework score. Adequate economy We consider Providence's economy adequate. The city, the Rhode Island state capital, with a population of 179,001, is in Providence County in the Providence-Warwick MSA, which we consider to be broad and diverse. It has a projected per capita EBI of 72.6% of the national level and per capita market value of $67,745. Overall, market value grew by 2.2% over the past year to $12.1 billion in The county unemployment rate was 5.7% in Providence County's unemployment has declined as regional economic conditions have improved following the Great Recession. This has improved our view of the city's overall economic factors. Nevertheless, socioeconomic factors are below average, and despite the city being the primary economic center of the state--with significant higher education, health care, and business service sectors--we believe the local economy has shown itself to be vulnerable to deteriorating economic conditions. AUGUST 4,

4 We acknowledge, however, that market values have recently shown stability or have improved, which we consider a positive credit attribute. We expect the New England region to see normal GDP growth of about 2% for the year, which is slower that the average for most of the country. We note Rhode Island has yet to fully recover from the Great Recession, but it is close to surpassing its pre-recession peak (late 2017). Regarding Providence, there appears to be new momentum and construction that could benefit the city. Building permit activity has virtually doubled in fiscal years 2016 and 2017 to just under $400 million compared to 2015 levels. In addition, there are increases, albeit modest, in existing median home prices that should keep values steady over the next few years. We believe these factors are important given that the city will be seeking continued tax levy increases to fund expenditures and rebuild and sustain its reserves to a positive level. Weak management environment We view the city's management environment as weak, despite "good" financial policies and practices under our FMA methodology, indicating financial practices exist in most areas, but that governance officials might not formalize or monitor all of them on a regular basis. Performance for fiscal 2016 has improved measurably as deficit reduction remains a key priority for the current administration. For the fiscal 2016 year and into fiscal 2017, the city has done markedly well achieving strong results due in large part to its better, more realistic budgetary assumptions. The administration has implemented several process and administrative changes that have provided savings through efficiencies, and has also done well maintaining budgetary discipline in spending. While we acknowledge the current administration has put stronger financial controls and oversight into place and is improving administrative processes and achieving efficiency gains, we believe overall management conditions remain challenging and tenuous due to past deficits, weak budgetary flexibility, and sizable long-term liabilities. Following the Great Recession, Providence's general fund balance deteriorated significantly between fiscal years 2009 and 2012; it culminated in a deficit of $11.3 million, or a negative 1.7% of general and school funds operating expenditures, at fiscal year-end Through substantial reforms and budgetary changes of the previous administration, the overall deficit was reduced in fiscal 2014 to just $8.6 million, or a negative 1.3% of general and school fund operating expenditures. However, in fiscal 2015, the city realized an operating deficit of $5 million, reversing those positive gains, suggesting the budgetary environment remains a challenge. The city maintains policies and practices in several areas that we consider positive under our FMA methodology. It maintains strong budget monitoring practices, does five-year budget forecasts that it submits annually to city council annually, and has a comprehensive rolling five-year capital improvement plan. In addition, the city maintains an investment management policy and basic debt policies. Weakening factors, however, have been its revenue expenditure assumptions and lack of formalized financial policies. In the past, the city's revenue and expenditure assumptions have shown to be optimistic but supportable. Very weak budgetary flexibility Providence's budgetary flexibility is very weak, in our view, with an available fund balance in fiscal 2016 of negative 0.4% of operating expenditures. In addition, its reserves are low on a nominal basis at negative $3.2 million, which we AUGUST 4,

5 view as vulnerably low and a negative credit factor. Since 2012, progress toward eliminating the accumulated deficit has been slow. However, due to the strong general fund surplus result in fiscal 2016 and estimated results in fiscal 2017, the city is projected to close the audited fiscal year with a positive fund balance of roughly $7 million, several years ahead of projections. The expected general fund result at the close of fiscal 2017, while positive, is projected to remain very weak relative budgetary expenditures. The city is expecting to continue to strengthen the general fund balance over the next several years, but we believe it will take some time before balances improve to adequate levels. Adequate budgetary performance Providence's budgetary performance is adequate, in our opinion. The city had slight surplus operating results in the general fund of 1.4% of expenditures, and balanced results across all governmental funds of 1.1% in fiscal Affecting our view of Providence's budgetary performance is its weak operating environment and the expectation of escalating pension costs due to its weak funded levels, along with ongoing need to address infrastructure and deferred maintenance. In calculating the budgetary performance measure, we have adjusted out any one-time capital expenditures paid for by bond proceeds to reflect base-line operating expenditures in the total governmental funds. Performance has generally been positive over the last several years, but we note that the fiscal 2015 deficit reversed the city's previous momentum. However, the 2016 result was much stronger and the city is anticipating a similar result in fiscal 2017 as the budget was built on realistic assumptions and sound principals, in our view. The city's 2018 operating budget of $736.8 million (including schools) is balanced, and includes a roughly $3.5 million appropriation to rainy day reserves. The budget is 3% higher or about $19 million more than the 2017 budget. It assumes an increase in tax revenues due to the continued growth in values of $3.1 million, and an increase in state pilots $2.1 million, and $14 million in a school funding formula increase. With the recent announcement of a budget agreement at the state level, we would not anticipate any deviations from what the city budgeted for state aid. Property taxes constitute 48% of general fund and school fund revenues, while state aid and federal grants largely make up the balance. Property tax collections have been generally favorable at a 96% collection rate. Moreover, the city has seen a reduction in back tax collections, which again signals a stronger economy and stronger collection procedures. We expect budgetary performance to remain adequate, but there are challenges looming. The city will begin re-investing in capital and issuing bonds to address long-standing capital and deferred maintenance. To some extent, we recognize that past general fund surpluses and the city's ability to cure its accumulated general fund deficit have partly reflected deferred capital maintenance. In addition, we believe ongoing fixed costs will continue to escalate because of Providence's sizable pension and OPEB liabilities and very low funded ratios. The city is funding the actuarially determined contributions for pensions and funding OPEBs on a pay-as-you-go basis. It has had to execute structural reforms to lower costs and is currently seeking ways to make further inroads with the liabilities. However, as currently constructed, these liabilities will AUGUST 4,

6 continue to strain future operations, particularly if economic or business conditions worsen and actuary assumptions are not met, revised, or found to be inadequate at current levels. Very strong liquidity In our opinion, Providence's liquidity is very strong, with total government available cash at 13.7% of total governmental fund expenditures and 1.7x governmental debt service in In our view, the city has strong access to external liquidity if necessary. Despite very weak budgetary flexibility, the city maintains very strong liquidity. Through strong cash collections, changes in property tax billing dates, and efforts to curb costs, cash flow pressure has lessened from a few years ago. Currently, we expect Providence will maintain current cash balances based on projected stable budgetary performance. Weak debt and contingent liability profile In our view, Providence's debt and contingent liability profile is weak. Total governmental fund debt service is 8.3% of total governmental fund expenditures, and net direct debt is 53.1% of total governmental fund revenue. Approximately 82.6% of the direct debt is scheduled to be repaid within 10 years, which is, in our view, a positive credit factor. The city's debt burden has remained stable, and looking ahead, while it anticipates issuing additional debt, we believe debt factors will remain stable overall. We calculate total direct debt to be roughly $516 million; of that amount, roughly $99.6 million is self-supported enterprise debt. Providence will be issuing roughly $45 million in the October timeframe, to fund the first two years of its capital improvement program. The city is expected to issue through the PPBA, through an annual appropriation lease structure. This bond offering will increase the net direct debt ratio to 59%. Debt service carrying charges would likely remain at current levels. In our opinion, a credit weakness is Providence's large pension and OPEB obligation, without a plan in place that we think will sufficiently address it. Providence's combined required pension and actual OPEB contributions totaled 12.7% of total governmental fund expenditures in Of that amount, $70.7 million, or 8.9% represented required contributions to pension obligations, and $30 million, or 3.8% represented OPEB payments. The city made its full annual required pension contribution in The funded ratio of the largest pension plan is 25.2%. In our opinion, while Providence has proactively managed long-term liabilities, they remain large and a credit constraint. The net pension liability was $1.2 billion in 2016; of this, roughly $985 million was associated with the employees' retirement system (ERS) of Providence and the remainder with the proportionate share of the ERS of the state. The net pension position funding ratio for the city's locally administered plan is very low at 25%. Moreover, although recently reduced from 8.25%, this still assumes a fairly optimistic 8% investment rate of return. The city continues to examine reductions in the assumed rate of return with the eventual goal of reducing the figure to near 7%, which is closer to industry standards, although doing so would result in higher annual costs. The city is exploring the creation of a regional water authority that would enable the Providence Water Supply Board to join and negotiate the terms and conditions of a potential sale, lease, or other agreement, which could yield a projected $300 million to $400 million to the city. The administration has stated that, if approved, proceeds from the AUGUST 4,

7 transaction would be deposited directly into the pension plan. In our view, if executed, this would substantially improve the funded ratio and reduce annual general fund costs. This proposal, however, would be fairly difficult to realize as there are several stakeholders needed for approval. Nevertheless, this proposal is both suggestive of the significance of the liability and its effects on the city's fiscal standing, but also the efforts by the administration to achieve a sustainable solution. Providence's OPEB liability is also large. The unfunded OPEB liability was $980 million, assuming a 4% discount rate, with an annual OPEB cost of $64.7 million. The city is currently funding OPEBs through pay-as-you-go financing, and contributed $30 million toward its OPEB obligation in fiscal Strong institutional framework The institutional framework score for Rhode Island local governments is strong. Outlook The positive outlook reflects our opinion that given Providence's improved operations, there is a one-in-three possibility that we could raise the rating over our outlook period by one notch if the city continues to perform well and available reserves improve further. Management's commitment to budgetary balance and the generally improving economic outlook will likely translate to positive general fund results and, as a consequence, further strengthen budgetary flexibility over time. We recognize that the management environment will likely remain weak due to the city's large pension and OPEB obligations and weak funded ratios. If general fund budgetary performance begins to weaken due to rising fixed costs and if the threat of a structural imbalance scenario heightens, we would likely not raise the rating. Ratings Detail (As Of August 4, 2017) Providence GO Unenhanced Rating BBB(SPUR)/Positive Outlook Revised Providence Pub Bldg Auth, Rhode Island Providence, Rhode Island Providence Pub Bldg Auth Providence APPROP (AGM) Providence Pub Bldg Auth rev bnds (1999 Sch & Pub Fac Proj) ser A dtd 07/01/1999 due 12/15/ Providence Pub Bldg Auth GO rev bnds ser 1998 A dtd 05/15/1998 due 12/15/ Providence Redev Agy, Rhode Island Providence, Rhode Island Providence Redev Agy (Providence) MORALOBLIG Long Term Rating BBB-/Positive Outlook Revised Providence Redev Agy (Providence) (Public Safety Proj) (AGM) AUGUST 4,

8 Ratings Detail (As Of August 4, 2017) (cont.) Providence Redev Agy certs of part Unenhanced Rating BB(SPUR)/Positive Outlook Revised Rhode Island Hlth & Educl Bldg Corp, Rhode Island Providence, Rhode Island Rhode Island Health & Educational Building Corporation (Providence) Long Term Rating BBB-/Positive Outlook Revised Rhode Island Hlth & Ed Bldg Corp (Providence Pub Schs Rev Bnd Fincg Prog) ser 2006A Many issues are enhanced by bond insurance. Certain terms used in this report, particularly certain adjectives used to express our view on rating relevant factors, have specific meanings ascribed to them in our criteria, and should therefore be read in conjunction with such criteria. Please see Ratings Criteria at for further information. Complete ratings information is available to subscribers of RatingsDirect at All ratings affected by this rating action can be found on the S&P Global Ratings' public website at Use the Ratings search box located in the left column. AUGUST 4,

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