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Fitch Ratings has assigned the following rating to the Philadelphia Authority for Industrial Development's (PAID) revenue bonds:

--$346.34 million city service agreement refunding revenue bonds (city of Philadelphia), series 2012 (federally taxable) at 'A-'.

The revenue refunding bonds are expected to sell through a negotiated sale the week of Dec 10. The purpose of the bonds is to refund certain of PAID's outstanding series 1999B pension funding bonds for interest savings.

At this time, Fitch also affirms the following:

--$1.3 billion in city of Philadelphia (the city) general obligation (GO) bonds at 'A-';

--$250 million in lease revenue bonds issued by the Philadelphia Municipal Authority (PMA) at 'A-';

--$1.5 billion in bonds issued by the PAID at 'A-';

--$228 million in bonds issued by the Philadelphia Redevelopment Authority (RDA) at 'A-';

--$15 million in bonds issued by the Philadelphia Parking Authority (PPA) at 'A-'.

The Rating Outlook is Stable.

SECURITY

The PAID bonds, as well as bonds issued by the PPA, RDA and PMA are secured by an annual service fee payable by the city under a non-cancelable service agreement with the city. The city's obligation to make payments required by the service agreements is absolute and unconditional. The city's GO bonds are secured by the city's full faith and credit general obligation and its ad valorem tax pledge, without limitation as to rate or amount.

RATING RATIONALE

LIMITED FINANCIAL FLEXIBILITY: Financial flexibility is constrained by a high overall tax burden, a minimal general fund balance position, and a high level of fixed costs. Fund balance has shown notable improvement over the past two years but is expected to decline again in fiscal 2013.

STRONG FINANCIAL MANAGEMENT: Fitch views positively management's efforts in recent years to contain costs and raise available revenues to address an ongoing budget imbalance, although significant budgetary pressures remain.

SIZEABLE DEBT BURDEN: Debt ratios are exceptionally high and, with limited growth prospects for the city's tax base and population, will remain elevated over the long term.

LARGE UNFUNDED PENSION LIABILITY: The city's pension fund is poorly funded, although Fitch views favorably the current administration's recent efforts to implement various pension reforms.

WEAK SOCIOECONOMIC PROFILE: Wealth levels remain notably low and above-average unemployment persists. Despite this weakness, Philadelphia remains an important center for healthcare and higher education with good prospects for long-term economic stability.

CREDIT PROFILE

IMPORTANT ECONOMIC CENTER TEMPERED BY CHALLENGING DEMOGRAPHICS

Philadelphia is both a city and county with an estimated population of slightly more than 1.5 million. The city serves as a regional economic center with a stable employment base weighted in the higher education and healthcare sectors. Led by the University of Pennsylvania, Jefferson Health System, and Temple University, the city is home to several large colleges and universities and is anchored by multiple hospitals and health systems.

Above average unemployment and weak income indicators persist, although current data suggests some recent improvement. Unemployment, measured at 10.8% in September 2012, remains elevated but is down from its recent high. The unemployment rates of the broader metropolitan statistical area (MSA) and state were appreciably lower at 8.4% and 7.5%, respectively. Income levels grew at a slightly better clip over the prior decade in comparison to the state and nation but continue to approximate just 65% of the MSA and 75% of the commonwealth and nation. The city's poverty rate stands at 25%, approximately twice the MSA, state and nation. The population has grown slightly over the last decade after nearly 50 years of population loss.

BUDGET BALANCING PLAN IMPLEMENTED AMID FALLING REVENUES

Recessionary pressure in recent years coupled with a depressed housing market prompted significant decline in tax revenues between fiscals 2008-2010 leading to multiple years of large operating deficits. Management responded favorably with a number of expenditure cuts. The city also suspended through fiscal 2014 long-running annual rate cuts in its wage and business privilege taxes as part of a comprehensive budget-balancing plan.

In fiscal 2010 the city implemented a temporary five-year sales tax increase and the partial deferral of annual pension costs over the ensuing two fiscal years. In total, the administration's efforts would have produced an operating surplus if not for a late state-aid payment that was received early in fiscal 2011. Instead, fiscal 2010 ended with a $54.7 million general fund deficit on a GAAP basis, although the unreserved fund balance improved slightly from negative $274.5 million to negative $251.8 million, still equal to an insufficient negative 6.8% of spending.

Results for fiscal 2011 were positive, driven primarily by a nearly 10% property tax increase, a full year of the sales tax increase, nominal growth in general fund expenditures, and receipt of a large state aid payment intended for the prior fiscal year. Fiscal 2011 ended with a sizeable $106.4 million general fund surplus on a GAAP basis as a result, which improved the unrestricted general fund balance (the sum of the unassigned, assigned and committed fund balance under GASB 54) to a still weak negative $46 million. On a budgetary basis, the city reported a minimal year-end general fund balance of $92,000.

Fiscal 2012 looks to continue the improvement shown in fiscal 2011. Unaudited results indicate a $113 million surplus on a GAAP basis, bringing the unrestricted general fund balance to $71 million or 2% of expenditures. On a budgetary basis, the surplus is $147 million, notably better than the budgeted $60 million surplus. The surplus and outperformance of budget result from tax revenues growing 4.4% over fiscal 2011 and $34 million of one-time pension aid from the commonwealth.

The city relies on annual cash flow notes for liquidity. The $173 million note issuance for fiscal 2012 was well below historical borrowings and the fiscal 2013 borrowing is scheduled to be approximately $127 million, reflecting further improvement in the city's liquidity.

BUDGETARY PRESSURE REMAINS

The fiscal 2013 general fund budget raises spending by almost 3%, mostly due to the repayment of previously deferred pension costs. Through one quarter, total revenue is projected to be flat to unaudited fiscal 2012 revenue, with tax revenues expected to be $12 million ahead of budget. Expenditures are projected to be $35 million over budget as prison costs are $9 million over budget due to an increase in inmates. Expenditures were also increased from council actions restoring several items removed from initial drafts of the budget. The original budget included a $17 million deficit that has now grown to $29 million on a budgetary basis.

The city also faces several budgetary challenges in future years. The five-year increase in the sales tax ends after fiscal 2014, resulting in an expected decline of approximately $130 million of revenue. The city is also finalizing the implementation of a major revaluation of the city's entire property tax base, which has not been done in many years. The revaluation is planned to be revenue neutral and will be effective for fiscal 2014. However, the city faces significant risk regarding implementation of the revaluation and the expectation of a large number of appeals.

ELEVATED LONG-TERM LIABILITIES

The city's aggregate debt burden, which includes debt associated with the Philadelphia School District, remains notably high at over $4,600 per capita and 15% of market value, although Fitch notes that the market value ratio is somewhat overstated due to antiquated property assessment practices. As indicated above, the city expects to implement a more accurate assessment process based on full value in fiscal 2014.

The city's fiscal 2013 - 2018 government-wide capital improvement plan (CIP) totals $10 billion, of which about $6.7 billion is for the city's self-supporting airport and water and sewer utility system. Of the remaining $3.3 billion in capital projects, the city expects the state and federal government to fund about $2.4 billion while the balance, estimated at $923 million, will be derived almost entirely from city-supported annual debt issuance.

Pension funding continues to be a key credit concern for Fitch, despite the recent implementation of cost-saving changes to pension benefits for uniformed employees. The city funds on an annual basis the amount determined by the actuary to be required by state law , which is less than the amount the actuary determines is required by the pension board's funding policy. Full funding of the annual obligation resumed in fiscal 2012 following a partial deferral for budgetary relief in the previous two years. The five-year plan shows annual pension payments rising by 13% and 5% in fiscals 2013 and 2014, respectively, to meet the repayment obligation. Pension costs are forecast to consume an above average 17% of annual general fund spending in fiscal 2013. Savings from the current refunding will be contributed to the pension fund in addition to the required annual payment.

The most recent actuarial report shows a funded ratio of about 50% and an unfunded liability of about $4.7 billion. Using Fitch's more conservative 7% discount rate assumption, the city's pension plan would be 44% funded. The city's other post-employment benefit liability is also sizable at $1.2 billion based on the latest valuation available, although benefits are only provided for the first five years following retirement and the city's five-year financial plan consistently includes the annual pay-as-you-go amount.

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 Creditscope, University Financial Associates, S&P/Case-Shiller Home Price Index, IHS Global Insight, Zillow.com, and National Association of Realtors.

Applicable Criteria and Related Research:

--'Tax-Supported Rating Criteria' (Aug. 14, 2012);

--'U.S. Local Government Tax-Supported Rating Criteria' (Aug. 14, 2012).

Applicable Criteria and Related Research:

Tax-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=686015

U.S. Local Government Tax-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=685314

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Fitch Ratings
Primary Analyst
Eric Friedman
Director
+1-212-908-9181
Fitch, Inc.
One State Street Plaza
New York, NY 10004
or
Secondary Analyst
Karen Wagner
Director
+1-212-908-0230
or
Committee Chairperson
Doug Scott
Managing Director
+1-512-215-3725
or
Media Relations:
Elizabeth Fogerty, +1-212-908-0526 (New York)
elizabeth.fogerty@fitchratings.com

 

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