Fitch Rates Commonwealth of PA's $1B GOs 'AA-'; Outlook Stable

Fitch Ratings has assigned an 'AA-' rating to the Commonwealth of Pennsylvania's $1 billion general obligation (GO) bonds, first series of 2015.

The bonds are expected to be offered through negotiation the week of Jan. 26, 2015.

The Rating Outlook is Stable.

SECURITY

The GO bonds are direct and general obligations of the commonwealth of Pennsylvania, with full faith and credit pledged.

KEY RATING DRIVERS

FISCAL CHALLENGES: Pennsylvania's 'AA-' GO rating, below the level of most states, reflects the commonwealth's continued inability to address its fiscal challenges with structural and recurring measures. After an unexpected revenue shortfall in fiscal 2014, the current year budget includes a substantial amount of one-time revenue and expense items to achieve balance and continues the deferral of statutory requirements to replenish reserves which were utilized during the recession. The commonwealth's rapid growth in fixed costs, particularly the escalating pension burden, poses a key ongoing challenge, although Fitch expects budgetary planning and management to mitigate these pressures in a manner consistent with the 'AA-' rating.

PENSION FUNDING DEMANDS: The funding levels of the commonwealth's pension systems have materially weakened as a result of annual contribution levels that have been well below actuarially determined annual required contribution (ARC) levels. Under current law, contributions are projected to rise to the ARC for the two primary pension systems by as soon as fiscal 2017, increasing the budgetary burden and potentially crowding out other funding priorities.

INCREASING BUT STILL MODERATE LONG-TERM LIABILITIES: The commonwealth's debt ratios are in line with the median for U.S. states. However, the commonwealth's combined debt plus Fitch-adjusted pension liabilities is above-average, and will likely continue growing given the current statutory schedule of pension underfunding for at least the next few years. Fitch views Pennsylvania's long-term liability burden as manageable at the 'AA-' rating so long as the commonwealth adheres to its funding schedule, or enacts reforms that do not materially increase its liability or annual funding pressure.

SOLID ECONOMIC PROFILE: Employment growth continues for the state's broad-based economy, but at a slower pace than the nation. Below-average demographics represent a long-term drag on economic growth, though potential development of the significant natural gas reserves could mitigate that concern. Overall, the state's economy provides a solid base for future potential revenue growth to help manage ongoing expenditure pressures.

RATING SENSITIVITIES

ADDRESSING FIXED-COST PRESSURES: The 'AA-' rating is sensitive to the commonwealth's continued ability to address increasing fixed-cost pressures, particularly for pensions. Fitch anticipates the commonwealth will meet at least its statutory obligations through some combination of adequate funding at the expense of more discretionary budget items, structural expenditure reform, or revenue increases, and any movement away from those commitments would be a credit negative.

MOVE TOWARD SUSTAINABLE BUDGETS: Given the magnitude of Pennsylvania's structural budget gap, Fitch anticipates some continued use of non-recurring items in upcoming budgets, but at a declining rate. Failure to make progress toward structural balance could trigger negative rating action.

CREDIT PROFILE

Pennsylvania faces fiscal pressures in the form of a structurally unbalanced budget, depleted reserves, and a rapidly growing pension cost burden following years of contribution underfunding and market-driven investment declines. The 'AA-' rating reflects those issues, as well as Fitch's expectation that the commonwealth will respond to those pressures adequately, while also beginning to make progress toward structural budgetary balance. Pennsylvania benefits from a large, diversified and expanding, albeit slowly, economic base and moderate tax burden which provides some capacity to match expenditure growth.

Through the first six months of fiscal 2015 (which began on July 1), general fund revenues were tracking ahead (2.1%) of the budgeted estimate. Fitch notes the enacted budget included $2 billion in one-time, non-recurring items to achieve balance creating a substantial budget challenge for fiscal 2016. In November, the state legislature's independent fiscal office (IFO) projected a significant structural budget gap of $1.7 billion for fiscal 2016, escalating steadily in the years thereafter. Fitch anticipates Pennsylvania will take necessary budgetary actions to move towards structural balance over the next several years. The newly-elected Governor takes office on Jan. 20 and will present his executive budget in March.

For more information on the commonwealth of Pennsylvania's general credit quality, see 'Fitch Downgrades Commonwealth of Pennsylvania's GOs to 'AA-'; Outlook Stable' dated Sept. 23, 2014 and available at 'www.fitchratings.com'.

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

Applicable Criteria and Related Research:

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

Applicable Criteria and Related Research:

U.S. State Government Tax-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=686033

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=971875

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