NEW YORK - Moody's Investors Service said it has downgraded the state of Connecticut's general obligation bond rating to Aa3 from Aa2, affecting approximately $14.6 billion in outstanding general obligation bonds.

Concurrently, Moody's has downgraded the state's general fund obligations to A1 from Aa3, bonds supported by a special capital reserve fund (SCRF) make-up provision to Aa3 from Aa2, and the University of Connecticut general obligation bonds (state debt service commitment) to Aa3 from Aa2. The outlook is stable, revised from negative.

The rating downgrade is based on Connecticut's high combined fixed costs for debt service and post employment benefits relative to the state's budget; pension funded ratios that are among the lowest in the country and likely to remain well below average; and depleted reserves with slim prospects for near-term replenishment. Connecticut's state employees retirement system (SERS) and teachers retirement system (TRS) had funded ratios of 44% and 61%, respectively, as of June 30, 2010.

The state has committed to paying the full actuarially determined annual required contribution (ARC) for both systems, and some pension and healthcare reforms were achieved in last year's round of union negotiations. A new valuation is expected to be published soon incorporating the reform measures.

However, funded ratios are not likely to improve significantly until closer to the end of the remaining amortization periods -- 21 years for SERS and 25 years for TRS. Connecticut's combined fixed costs for debt service, pension, and other post employment benefits (OPEB) are already high and, absent significant further reforms, will continue to consume an increasingly larger portion of the state's budget.

Following the 2001 recession, Connecticut rebuilt its rainy day fund, the budget reserve fund (BRF), to a healthy $1.4 billion, although the unreserved, undesignated General Fund balance (UUFB) remained deeply negative on a GAAP basis due to decades-old liabilities that have never been repaid. Over the course of the recent recession, Connecticut depleted its BRF and issued deficit bonds to fill budget gaps. The state plans to use surplus funds to retire the deficit bonds two years ahead of schedule. However, this reduces the amount of funds that may be available to rebuild reserves in the near term. The current biennial budget includes funds to begin addressing the negative UUFB, and Connecticut plans to start budgeting on a GAAP basis in fiscal 2014.

The Aa3 rating with a stable outlook incorporates our expectation that Connecticut's revenue trends should improve as it emerges from the recession, and the state will maintain its new commitment to structural budget balance and addressing its negative GAAP basis unreserved undesignated General Fund balance (UUFB).


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