Fitch Rates Connecticut's $400MM GO Bonds 'AA'; Outlook Stable
Fitch Ratings assigns an 'AA' rating to $400 million in general obligation (GO) bonds of the State of Connecticut, consisting of:
--$180 million GO bonds (2012 series G);
--$220 million taxable GO bonds (2012 series B).
The bonds are expected to sell via negotiated sale the week of Oct. 29, 2012.
In addition, Fitch affirms the following outstanding ratings:
--Approximately $13.5 billion GO bonds and notes at 'AA'.
The Rating Outlook is Stable.
GO bonds to which the full faith and credit of the state will be pledged for payment of principal and interest.
KEY RATING DRIVERS
HIGH WEALTH LEVELS: Connecticut is the nation's wealthiest state as measured by per capita personal income. Economic performance has stabilized following the recession, but the recovery has been slow and uneven.
CONSERVATIVE FORECASTING OFFSETS SPENDING PRESSURE: State finances are marked by conservatively forecast, though cyclical, revenue performance and persistent spending pressure, including for labor and Medicaid.
SLOW RECOVERY DELAYING FISCAL IMPROVEMENT: In the past, the state has used revenue recovery to rapidly repay budget borrowing from recessionary periods and rebuild rainy day balances, a practice more recently hampered by the slow, uneven recovery now underway.
HIGH DEBT: Tax-supported debt is high for a U.S. state. Most GO bonds, excluding GO bonds issued to fund the teachers' retirement system, amortize rapidly.
SIGNIFICANT PENSION OBLIGATIONS: Unfunded liabilities for employees are significant, including for state employee and teacher pensions.
The state's 'AA' GO rating reflects its vast wealth and income resources, tempered by a relatively high burden of debt and retirement liabilities. The slow and uneven pace of the economic recovery is affecting the pace of revenue growth and the state's ability to quickly recover from the downturn.
The enacted budget for the fiscal 2012 - 2013 biennium, which began July 1, 2011, implemented various recurring solutions, including tax rate increases, spending cuts and labor savings to achieve balance, a notable departure from recent biennial budgets that had relied largely on one-time resources. Revenue underperformance since budget adoption was offset by prompt state balancing actions, although the previously sizable projected ending balance anticipated at June 30, 2013 has been eliminated. The state's executive budget for fiscal 2014 - 2015 will be released in February 2013.
Connecticut has a wealthy, diverse economy anchored by a large finance sector and important manufacturing, education and health sectors. The state entered the recession later than the U.S. as a whole, with employment growth stalling in 2008 before falling 4.3% in 2009 and 1.1% in 2010. Employment rose 1% in 2011 as the state bounced back from recessionary declines, although growth during 2012 has been slower. September 2012 employment rose 0.2% over September 2011, well below the 1.4% growth rate recorded nationally. Unemployment has fallen from its 2010 peak of 9.3%, but remains elevated at 8.9% as of September 2012, compared to a 7.8% rate reported nationally. The state remains the wealthiest as measured by personal income per capita, at 139% of the national average in 2011; second quarter 2012 personal income was up 1.8% year-over-year.
The state has a history of conservative revenue forecasting and a practice of accumulating excess revenues in its budget reserve fund (BRF). Prior to the onset of the recession, the BRF balance had risen to $1.38 billion in fiscal 2007, equal to 8.5% of appropriations; the statutory maximum is 10%. The balance was fully drawn in the fiscal 2010-2011 biennium. Fiscal performance was strained through the recession, with the state relying on non-recurring resources to close persistent budgetary gaps, including use of BRF balances, federal stimulus funds and borrowing $916 million in GO economic recovery notes (ERNs).
The enacted budget for the fiscal 2012 - 2013 biennium anticipated modest revenue recovery, with surpluses directed toward early repayment of ERNs and transitioning the state to GAAP budgeting. The adopted budget closed gaps of approximately $3 billion in each year, equivalent to 19.3% and 17% of baseline projected revenues, respectively. Projected gaps were addressed primarily through recurring actions, including new tax revenues ($1.5 billion annually), labor concessions ($1.6 billion through the biennium), and spending cuts ($758 million).
The slow pace of economic recovery and persistent spending needs weighed on state performance through fiscal 2012, eroding a fiscal year-end balance originally forecast at $80.9 million. Fiscal 2012 actual revenues fell short of the original budget estimate by 1.2% ($227 million), largely due to lagging personal income tax receipts. In response, the state undertook mid-year spending reductions ($78.7 million) and transferred a portion of the fiscal 2011 surplus ($143.6 million) that was originally intended for early repayment of the ERNs. A total of $93.4 million remains in the BRF.
The state also made various mid-biennium adjustments to the fiscal 2013 budget, including additional funds for K-12 schools ($93.8 million) and increasing the state's pension contribution ($85.3 million). The impact of weaker revenue trends was incorporated into the state's April 2012 consensus forecast and subsequent estimates from the controller. Including mid-biennium adjustments, a fiscal 2013 year-end deficit is now forecast by the state's budget office at $60.1 million on a budgetary basis, compared to a $488.5 million surplus when the biennium budget was adopted. The state continues to expect to transition to GAAP-based budgeting in fiscal 2014.
The state's debt burden is high compared to other states, with net tax-supported debt as of September 2012 at almost $18.2 billion, or 8.8% of 2011 personal income. Three-quarters of net tax-supported debt is GO, a large share of which is issued for local school capital needs.
Funding levels for the state's major pension systems remain a concern. As of June 30, 2012, the state employees' retirement system (SERS) was funded at 42.3%, and the teachers retirement fund (TRF) was funded at 55.2%, with the latter having benefited from the 2008 issuance of pension bonds. Using Fitch's more conservative 7% investment return assumption (instead of the 8% rate assumed by SERS and the 8.5% rate assumed by TRF) reduces funding levels to 38.1% and 47.4%, respectively. The investment return assumption of SERS was lowered to 8% as of its 2012 valuation, from 8.25%.
On a combined basis, the burden of net tax-supported debt and adjusted unfunded pension obligations equals 21.7% of 2011 personal income, well above the 6.5% median for U.S. states rated by Fitch. The state fully funds an actuarially required contribution (ARC) to the TRF under a covenant linked to the pension obligation bonds, and the SERS ARC is again fully funded in the budget. The state's mid-biennium budget revision increased the state's contributions to SERS to accelerate improvements to the funded ratio, among other reforms.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
In addition to the sources of information identified in Fitch's Tax-Supported Rating Criteria, this action was additionally informed by information from IHS Global Insight.
Applicable Criteria and Related Research:
--'Tax-Supported Rating Criteria' (Aug. 14, 2012);
--'U.S. State Government Tax-Supported Rating Criteria' (Aug. 14, 2012).
Applicable Criteria and Related Research:
Tax-Supported Rating Criteria
U.S. State Government Tax-Supported Rating Criteria
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