Fitch Lowers Philadelphia, PA GOs to 'BBB+' from 'A-'; Outlook Remains Negative.

WASHINGTON -- Fitch Ratings lowers its rating on the City of Philadelphia, PA's approximately $1.038 billion outstanding general obligation bonds to 'BBB+' from 'A-'. Additionally, the Rating Outlook remains Negative. The downgrade reflects poor revenue growth and significant increases in fixed costs and public safety spending, leading to the depletion of the city's reserve position.

Fitch expects that a delay in the receipt of state aid reimbursements of up to $90 million will contribute in fiscal 2004 to the city's second consecutive accumulated general fund deficit under generally accepted accounting principles. Fitch notes that had the reimbursements been received in fiscal 2004, the resulting general fund balance of about $60 million would still represent only 1.8% of expenditures, down significantly from reserves as high as 10% of spending in 2000. Moreover, liquidity is strained, as evidenced by a fourth straight increase in the proportion of cash flow borrowing relative to general fund revenue. Note proceeds are budgeted at 13.3% of general fund revenue in fiscal 2005.

The Rating Outlook remains Negative continues due to Fitch's concerns that the fiscal 2005 and the next succeeding fiscal years are overly reliant on economic improvement and speculative operating efficiencies to offset already enacted tax cuts and rising benefit costs. Moreover, the cost of new labor contracts is not yet included in the city's five year plan and such costs could be significant. Upon ratification of the contracts, a revised multi-year budget plan must be approved by the Pennsylvania Intergovernmental Cooperation Authority (PICA), a state authority that oversees Philadelphia's finances.

Budget estimates for fiscal 2005 highlight the recent structural budgetary imbalance. Payroll and benefits, equal to two-thirds of general fund spending, grew at twice the pace of local tax revenues (two-thirds of revenue) over the past five years. The weak revenue reflects not only a sluggish local economy and a stubbornly high 7.6% unemployment rate, but also the city's long-running program of incremental annual wage and business tax reductions. Fitch notes that while the tax reductions may be of long-term benefit to the city's competitiveness, they have had a dampening effect on revenues that has not been offset by spending reductions.

The current five-year plan calls for a budget basis fund balance of $100,000 at the close of fiscal 2005. However, allowing for the timing of fiscal 2004 state receipts, opening balance for fiscal 2005 could be as high as $60 million. Assuming realization of the $15 million drawdown budgeted in fiscal 2005, the city would have $45 million in reserve at year-end, a margin Fitch does not believe provides adequate flexibility on a $3.4 billion operating budget. The fund balance would grow to $120 million by fiscal 2009, but Fitch notes that this figure assumes $60 million in unidentified operating efficiencies and also assumes that the city-owned gas utility will repay a $45 million loan and resume its $18 million return-on-investment payment in that year. Fitch rates the gas utility's senior lien revenue bonds 'BBB-' with a Negative Outlook.

More favorably, the national and regional economy is gaining momentum, which may improve prospects for Philadelphia. No job growth is included in the financial forecast, although wage growth begins to accelerate in the later years of the plan. Excluded also from the five-year plan are new revenues from casino gaming, potentially allowing for further tax reductions as required by statute and additional unencumbered general fund revenue to the city. However, Fitch views this revenue stream as less stable than taxes and not a sound footing for future city operating budgets.

The rating and Outlook also apply to:

-- $1.38 billion of Philadelphia Authority for Industrial Development pension funding bonds;

-- $238 million Pennsylvania Convention Center Authority refunding revenue bonds, series 1994;

-- $259.6 million Philadelphia Municipal Authority lease revenue bonds;

-- $135.7 million Philadelphia Redevelopment Authority (Neighborhood Transformation Initiative) revenue bonds, series 2002A and 2002B;

-- $44.7 million Philadelphia Parking Authority Parking System Revenue Bonds, series of 1999A.