Fitch Rates Connecticut’s GO 2016C Bank Bonds ‘AA-‘; Outlook Stable

NEW YORK

Fitch Ratings has assigned a ‘AA-‘ rating to bank bonds corresponding to the following GO bonds of the State of Connecticut:

–$300,000,000 GO bonds (2016 series C variable rate demand bonds).

The bank bond ratings have been assigned in conjunction with the expected sale, on June 13, 2016, of the variable rate bonds, which will carry liquidity support provided by Bank of America, N.A. in the form of a Standby Bond Purchase Agreement.

Based on a review of the terms governing the bank bonds, it is Fitch’s opinion that the incremental risk associated with bank bonds does not have a material impact on the long-term credit rating of the GO bonds.

The Rating Outlook is Stable.

SECURITY

The bonds are general obligations to which the full faith and credit of the state will be pledged for payment of principal and interest.

KEY RATING DRIVERS

Fitch rates the State of Connecticut ‘AA-‘ with a Stable Outlook. The rating was downgraded on May 19, 2016 from ‘AA’ based on underlying credit trends and the application of the of Fitch’s revised “U.S. Tax-Supported Rating Criteria”, released April 18, 2016. The state has experienced chronic economic and fiscal challenges during the current expansion and consequently its scope of flexibility to address future cyclicality, in Fitch’s view, has been reduced. Despite repeated, and generally structural, responses to bring the current biennial budget into balance, it remains unclear whether the state has succeeded in fully aligning its budget to potential future economic and revenue performance. The Stable Outlook at the ‘AA-‘ rating level reflects Fitch’s view that, despite its high fixed-cost burden and ongoing economic uncertainty, recent state corrective actions have primarily been structural in nature, and state managers continue to pursue fiscal management changes to improve the state’s longer term prospects.

Economic Resource Base: Connecticut has a mature and diverse economy anchored by a large finance sector and important manufacturing and education and health sectors. The last downturn in the state was severe, and the recovery has been very slow compared to previous economic cycles. Over the 2012 – 2015 period, employment in the state rose at roughly half of the pace enjoyed by the nation, and current employment remains below the pre-recession peak. The state is the wealthiest in the U.S. as measured by per capita personal income, although aggregate personal income gains have trailed the nation’s and key finance and manufacturing sectors are experiencing only modest growth after the retrenchment of recent years.

Revenue Framework: ‘aa’ factor assessment

Tax revenues are diverse, with the largest tax source, personal income tax (PIT), subject to considerable cyclicality, particularly the component derived from capital gains. Sales, corporate income, transportation and gaming taxes serve to further diversify the tax base. Baseline growth prospects for taxes are limited given the state’s mature, slowly growing economy. The state has unlimited legal ability to levy taxes.

Expenditure Framework: ‘aa’ factor assessment

As with most states, Connecticut’s pace of spending growth is expected to be higher than that of revenues in the absence of policy action given the prominence of Medicaid; other social services, education, municipal aid, debt service and pension contributions add further to spending pressure. The state has consistently demonstrated the ability to manage its high fixed-cost burden, including making full actuarial contributions.

Long-Term Liability Burden: ‘a’ factor assessment

The burden of debt and unfunded pension liabilities in relation to resources is elevated and among the highest for a U.S. state. Net tax-supported debt consists primarily of GO and transportation borrowings, with much of GO borrowing undertaken on behalf of local schools. Unfunded pensions, including for local teachers, are more significant, with high discount rates suggesting that future funded ratio erosion and higher contribution needs are a risk, despite an otherwise very conservative amortization policy.

Operating Performance: ‘aa’ factor assessment

Frequent revenue reforecasting allows the state to identify revenue underperformance and quickly implement corrective actions. Gap-closing capacity remains strong but is less robust than during past expansions given that the state has been unable to quickly rebuild reserve balances and it already has implemented tax increases and spending cuts in the course of the current expansion. Further expenditure adjustments remain a source of additional flexibility, although high fixed costs limit the state’s scope of action.

RATING SENSITIVITIES

MAINTAINING FISCAL RESILIENCE: The rating is sensitive to the state’s continued ability to manage comparatively weak economic recovery conditions and future economic and revenue downturns while maintaining an operating profile consistent with the current rating level. This is particularly important given that reserve balances are likely to remain low relative to history and potential budgetary needs. Evidence that through-the-cycle fiscal flexibility has deteriorated further could lead to a downgrade.

For further information on the bonds, see Fitch’s press release “Fitch Rates Connecticut GO VRDBs, Series 2016C ‘AA-/F1′” dated May 27, 2016.

For further information on the State of Connecticut, please see Fitch’s press release dated May 19, 2016, “Fitch Downgrades Connecticut’s Rating to ‘AA-‘; Outlook Stable,” at ‘www.fitchratings.com‘.

Date of Relevant Rating Committee: May 19, 2016.

Additional information is available at ‘www.fitchratings.com‘.

In addition to the sources of information identified in the applicable criteria specified below, this action was informed by information from CreditScope and Lumesis.

Applicable Criteria

U.S. Tax-Supported Rating Criteria (pub. 18 Apr 2016)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=879478

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