Jan 22 - In the course of routine surveillance, Fitch Ratings has downgraded the rating on the state of Maine's approximately $472 million general obligation (GO) bonds to 'AA' from 'AA+'. Fitch has also downgraded the rating on $1.4 billion of the Maine Municipal Bond Bank's General Resolution bonds, supported by the state's moral obligation to replenish the debt service fund, to 'A+' from 'AA-'. The rating on the General Resolution bonds is directly linked to the state's GO rating. The Rating Outlook is revised to Stable from Negative. SECURITY The state's full faith, credit, and taxing power are pledged to the GO bonds. Constitutional provisions provide for the payment of GO principal and interest from first general fund revenues should the debt service appropriation not be sufficient. RATING SENSITIVITY/KEY RATING DRIVERS CONTINUED BUDGET PRESSURES BALANCES: The downgrade reflects the state's persistent budget gaps despite repeated balancing actions. Another sizable imbalance emerged for the current year with revenue underperformance exacerbated by growing Medicaid costs. The administration's proposed mid-year adjustments include several one-time measures. Maine is also preparing a new biennial budget and the 'AA' rating reflects Fitch's expectation that the adopted biennial budget will primarily rely on recurring expense or revenue adjustments to achieve balance in FYs 2014 and 2015. CONSERVATIVE DEBT POSITION: Debt ratios remain low and amortization of GO bonds is rapid. Following pension reforms adopted in FY 2011, funding levels improved significantly and the state contributes its actuarially required contribution each year. RESPONSIVE FINANCIAL MANAGEMENT: Frequent reviews of economic forecasts and financial projections allow the state to adjust to changing conditions. Maine's revenue outlook is weak, but the state historically addresses budgetary challenges in a timely and proactive manner. The state's active citizen initiative and referendum environment creates a level of operating and financial uncertainty, although expenditure restriction initiatives over the past several years have not been successful. SLOWLY GROWING BUT STABLE ECONOMY: The state's economy remained more stable compared to broader national trends during the recession. But the recovery that is underway is sluggish, hampered by weak demographic trends, and continues to limit the upside in the state's revenue forecasts. CREDIT PROFILE The one-notch downgrade on Maine's' GO bond rating reflects its reduced financial flexibility with weak reserve levels and limited options to address a difficult budgetary situation. Economic forecasts reviewed by Fitch indicate the state's economy will remain in a slow-growth mode, which is likely to limit revenue improvements. The 'AA' rating assumes that while the current-year gap solutions may include limited one-time measures, the next biennial budget will follow the state's historical pattern with primarily sustainable and recurring solutions. Fitch notes that the state faces an increasingly contentious decision-making environment. Maine's relatively stable economy has expanded into new sectors, particularly education and health services, but growth prospects remain modest. In 2011, Maine recorded just 0.1% growth, while national employment began its post-recession recovery with 1.1% growth. More recently, December 2012 employment for the state declined modestly (0.2%, preliminarily) from the prior year, versus national employment growth of 1.4%. Maine's median age is the oldest among the states, 43.2 years compared to 37.3 years for the U.S., contributing to uncertainty about future workforce growth Fiscal operations remain challenged as below-budget revenues are not keeping pace with a growing expense base. Fitch notes that regular reviews of economic forecasts and financial projections allow the state to adjust to changing conditions. The December 2012 forecasts led to a downward revision of FY 2013 general fund revenues by $35.5 million, or 1.2% from budget. Adding additional pressure, Medicaid expenses continue a pattern of outpacing expectations, with a sizable projected current-year gap in the Medicaid budget of approximately $87 million. In late December, the governor ordered curtailment of agency expenses equivalent to the $35.5 million revenue shortfall. Two weeks ago, he proposed a supplemental budget for FY 2013 to codify the curtailment and address the remainder of the gap. The proposal relies primarily on expense reductions and one-time solutions such as depletion of the state's already modest reserve levels, and delaying a school aid payment into fiscal 2014. Given the magnitude of the gap with just five months remaining in the fiscal year, Fitch expects the adopted plan will include at least some one-time measures, further limiting the state's future flexibility. Maine is also beginning its budget adoption process for the biennium beginning July 1, 2013 and must address a sizable gap pressured by weaker revenue forecasts as previously adopted tax cuts begin to take hold. The state reported a $756 million structural current services gap in September 2012 (11.1% of projected biennial appropriations), but that gap includes a voter-approved increase to education funding that has been deferred since 2004. Excluding that measure, the structural gap shrinks to $503 million, or 7.4% of projected biennial appropriations. Fitch notes that these structural gap estimates do not include the effects of the December 2012 revenue forecasts that revised general fund revenues further downward over the biennium by $125.2 million. Both the structural gap estimate and the revenue forecast revision include the effects of tax cuts that went into effect on Jan. 1, which the administration projects will lead to $342 million in forgone revenues over the biennium. The governor's biennial budget proposal relies primarily on expenditure cuts, including a $200 million suspension of all municipal revenue sharing. In the November 2012 elections, legislative control flipped to the Democratic Party in both houses, raising the likelihood of increased conflict with the Republican governor over the supplemental budget and the biennial budget. Maine's debt ratios are very manageable and GO bond principal is rapidly amortized, all within 10 years. Debt is strongly secured by constitutional provisions requiring GO principal and interest to be a first charge on the general fund. Net tax-supported debt totals approximately $1 billion, equal to a moderately low 2.1% of 2011 personal income. The governor recently proposed a major bonding initiative that could substantively increase the state's debt load. Revenue bonds, secured by projected revenues from a new contract for liquor sales, would repay the state's $186 million share of a $484 million multi-year Medicaid liability owed to the state's hospitals. Additionally, the state would issue GO bonds totaling $105 million, previously authorized by voters. The proposal also includes a $100 million bond for a new corrections facility, supported by projected savings from operational changes in the Department of Corrections. Funding levels for Maine's pension system, including state employees, teachers (both of which the state is legally responsible for), and participating local districts improved substantially in FY 2011 following recent reforms. The system-wide funded ratio improved to a reported 80.2 % (78.1% with Fitch's liability adjustment of a 7% discount rate) as of June 30, 2011 from 70.4% in the prior year. The ratio remained relatively stable in FY 2012, ending at 79.1 (76.9 % with Fitch's liability adjustment). As of June 30, 2012, the state's pension liabilities for the state employees and teachers plan (which the state is wholly responsible for) were 77% funded as reported by the state. On a combined basis, debt plus system-wide pension liabilities of 7.9% are about average for U.S. states rated by Fitch.