Standard & Poor's Ratings Services said it has revised its outlook to negative from stable and affirmed its AA-minus issuer credit rating and A-plus appropriation-backed debt rating on the commonwealth of Kentucky.
Standard & Poor's also assigned its A-plus long-term rating, with a negative outlook, to Kentucky Asset Liability Commission (ALCo)'s funding notes, 2013 general fund first series (taxable), supported by the commonwealth of Kentucky.
"The outlook revision reflects our concern over pension funded levels, which have declined and are likely to continue declining due to lower-than-actuarially required funding of pension liabilities, and budgetary pressures associated with funding post-retirement benefits," said Standard & Poor's credit analyst John Sugden.
The issuer credit rating reflects the commonwealth's: economic base that is experiencing a healthy recovery; conservative revenue forecasting coupled with an improving revenue environment; and moderate debt burden and debt service carrying charges.
Partially offsetting these strengths are Kentucky's structural imbalance and sizable pension and retiree insurance unfunded liabilities, which further pressure the budgetary imbalance that Kentucky is working to correct.
The A-plus rating on the 2013 general fund first series (taxable) reflects: the risks associated with appropriation-backed debt; and Kentucky's general credit characteristics.
The commission adopted a resolution dated Jan. 14, which authorized the issuance of the notes and an additional resolution approving a trust indenture, financing agreement, and other documents pertaining to the notes' issuance. The commission entered into a financing agreement that is effective Feb. 1, with the Kentucky Finance and Administration Cabinet and the Kentucky Teachers' Retirement System (KTRS). Also effective Feb. 1, the commission will enter into a trust indenture with U.S. Bank N.A. as trustee.
Note proceeds of about $153.5 million will used to fund $152.4 million of the state-supported portion of the healthcare benefit contributions to the KTRS medical insurance trust fund for fiscal 2013 and 2014 as required by Kentucky Revised Statutes Section 161.550(2). The financing represents bonding to fund operating costs related to providing post-retirement healthcare benefits during the current biennium and therefore constitute deficit financings on behalf of Kentucky.
The negative outlook reflects Kentucky's weakened pension funded levels, failure to adequately fund post-retirement benefits in this biennium, and pension reform efforts that still require legislative consensus and action.
Pension funded ratios, which have declined to 49.9% from 53.4% as of their June 30, 2012 valuation, are likely to continue declining due to lower-than-actuarially required contributions. The underfunding of the state's post-retirement liabilities, including other postemployment benefits, is indicative of budgetary pressures that could contribute to credit deterioration.
The state's pension reform efforts, which began in 2008, are ongoing and more recently include recommendations from the Kentucky Pension Task Force on how to improve the state's funding status. However, there is no clear timeline on when the state legislature will consider these recommendations. And even if the legislature adopts some of the recommendations, it's unclear when the changes would take effect, especially if these reform efforts face legal challenges.
Standard & Poor's will continue to monitor the federal consolidation efforts and will evaluate their effect on the state's finances and officials' response to these potential revenue reductions. Should Kentucky take credible action to enact comprehensive pension reform plan that improves funded levels and take measures to address budgetary pressures related to post-retirement liabilities, it could revise the outlook back to stable.
