NEW YORK - Moody's Investors Service said it has downgraded to Baa1 from A3 the city of Providence, R.I.'s general obligation rating, affecting $55.6 million in outstanding debt, as well as the underlying rating assigned to $247 million in debt issued for school projects by Providence through the Rhode Island Health and Education Building Corporation (RIHEBC).

The ratings assigned to the city's Providence Public Buildings Authority (PPBA) and Providence Redevelopment Authority lease revenue bonds were downgraded to Baa2 from Baa1, affecting $258.3 million of outstanding debt. The city's outlook remains negative.

The downgrade to Baa1 from A3 reflects the city's strained financial position with diminishing liquidity and a sizeable budget gap in the current fiscal year. Despite some success in raising additional revenue and reducing expenditures, the city faces a $20 million deficit in fiscal 2012, which ends on June 30.

Although it is possible that additional revenue from newly negotiated payments in lieu of taxes (PILOTs) will be secured prior to year-end, the primary strategy for closing the gap is the elimination of cost of living adjustments (COLAs) for retirees, which reduces the city's appropriation to the locally-funded pension system by $16 million but is likely to be challenged in court.

The city's cash position is projected to decline to by year-end, and cash flow borrowing is likely to be necessary to finance operations early in fiscal 2013

The Baa1 rating and negative outlook reflect the city's deteriorated financial position, a $30 million projected budget gap for fiscal 2013, the uncertain outcome of litigation challenging the city's ability to transfer eligible retirees to medicare, and low funding of its local pension plan.

The city is likely to remain challenged to maintain structural balance and adequate liquidity for operations and debt service. The rating also incorporates an above average debt burden, underfunding of the pension system, and the city's tax base which, while benefiting from a significant institutional presence, remains pressured by above average unemployment and low income levels.

Providence's RIHEBC bonds are secured by the city's general obligation pledge and carry a Baa1 underlying rating. The Providence Public Buildings Authority (PPBA) and Providence Redevelopment Authority (PRA) lease revenue bond ratings incorporate the city's below-average long-term credit strength along with satisfactory legal provisions and risks associated with annual appropriation.

The Baa2 PPBA and PRA bonds are secured by the agencies' respective pledges to annually appropriate lease payments equal to debt service on the bonds and by liens on pledged collateral, which is comprised of various city buildings, primarily schools and fire stations.

Under the lease agreements, these lease rental payments by the city are subject to and dependent upon annual appropriation. The PPBA and PRA have no taxing powers of their own.

These bonds are issued under Master Trust Indentures pursuant to separate lease agreements with the city. The city will make payments to the Trustee 15 days in advance of debt service payment dates. All outstanding PPBA debt is fully collateralized by city assets.

In the event of default, the Trustee is granted power to sell such real property as may be allowed for cure.

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