national conference of state legislatures - 2016 legislative summit, august 8th · 2017-06-12 ·...

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National Conference of State Legislatures - 2016 Legislative Summit, August 8th

AAA: Making the Grade in State Credit Ratings

Robin Prunty, Managing Director – S&P Global Ratings

Copyright © 2016 by S&P Global. All rights reserved.


Agenda

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• How much debt is too much?

• When should a state issue debt and how does it affect credit

ratings?

• Explore the proper role of debt as a financing tool, and its

affordability in state budgets.


Ratings and Outlook Distribution

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U.S. states ratings distribution

AAA AA+ AA AA- A+ A BBB+

26%

12%

26%

30%

2% 2%2%

General Obligation and ICR ratings as of 6/09/16.

CA, CT, KS, MI, PA, WV

KY

NJ

IL


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U.S. states outlook distribution

Stable Positive Negative Watch Negative

78%

16%

4%

2%

General Obligation and ICR ratings as of 6/09/16.

HI, MN

IL, LA, MA, NJ, NM, OK, PA, WY

AK


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2016 YTD* rating activityTO: FROM:

State Action Rating Outlook/Watch Rating Outlook/Watch Date

Alaska On CreditWatch AA+ Watch Negative AA+ Negative 6/9/16

Alaska Rating downgrade AA+ Negative AAA Negative 1/5/16

Connecticut Rating downgrade AA- Stable AA Negative 5/19/16

Hawaii Outlook change AA Positive AA Stable 3/1/16

Illinois Rating downgrade BBB+ Negative A- Negative 6/9/16

Kansas Rating downgrade AA- Stable AA Negative 7/26/16

Kansas On CreditWatch AA Watch Negative AA Negative 4/25/16

Michigan Outlook change AA- Stable AA- Positive 3/17/16

New Jersey Outlook change A Negative A Stable 3/22/16

North Dakota Rating downgrade AA+ (ICR) Stable AAA (ICR) Stable 2/18/16

Pennsylvania Off CreditWatch AA- Negative AA- Watch Negative 7/19/16

Pennsylvania On CreditWatch AA- Watch Negative AA- Negative 7/11/16

Pennsylvania Off CreditWatch AA- Negative AA- Watch Negative 3/24/16

Pennsylvania On CreditWatch AA- Watch Negative AA- Stable 3/3/16

Oklahoma Outlook change AA+ Negative AA+ Stable 4/6/16

Tennessee Rating upgrade AAA Stable AA+ Positive 5/26/16

West Virginia Rating downgrade AA- Stable AA Stable 4/21/16

Wyoming Outlook change AAA Negative AAA (ICR) Stable 2/4/16

*As of July 26th, 2016.


State Sector Outlook for 2016

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• Credit quality across the U.S. states sector is somewhat uneven.

• Credit pressures stem from exposure to the energy sector, weakened

budgetary performance, and political stalemates.

• We believe it's possible that in 2016, the state sector could experience

an uptick in rating volatility, with the balance of risk weighted to the

downside.

2016 state sector outlook

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37

5

8 34

11

523

18

9

State fiscal condition leading up start of 2016

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21

15

14

Energy producing states facing fiscal pressure due to fall of oil

price

Current year budget pressure from political gridlock or

revenue shortfall

Future year budget pressure possible or likely due to existing spending baseline,

actual or possible legally required spending, or potential for revenue

volatility

Large unfunded liabilities or high debt burden

Low Medium High

Exposure to Key Credit Risks in 2016

See appendix for details.


State fiscal conditions at start of 2016

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Category One: Weathered the Great Recession with minimal stress and has good reserves.

Category Two: Narrow fiscal margins with near-term structural budget alignment but typically low-to-adequate reserves.

Category Three: Hit hard by recession but has subsequently achieved considerable fiscal repair.

Category Four: Still experiencing fiscal stress typically stemming from soft revenue trends in general or because of a reliance on oil production-related revenue; some states are undergoing self-imposed fiscal distress as a result of political infighting.


U.S State Budget Outlook and Themes

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Key themes for 2016

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Slower Revenue Growth

Tax Incentives Spending Restraint

Aid to Higher Education

Pension Pressure Persists

Findings are consistent with recent Rockefeller Institute of Government reportthat: • Personal income

tax growth will decline to 4.4% in FY 2017 from 7.8% in FY 2015

• Sales tax revenue growth will slow to 3.9% in FY 2017 from 4.5% in 2015

Several state budget proposals include targeted spending initiatives or tax incentives aimed at economic development and job creation. Examples include:• New York• Delaware• Florida• Pennsylvania• Rhode Island

According to a survey by theNational Association of State Budget Officers, median general fund spending by states is budgeted to increase by 2.9% in FY 2016

As of FY 2016, most states have restored aid to higher education to pre-recession levels• In some states,

additional state support has been contingent on flat or reduced tuition rates; and

• Fund payouts have been delayed by dysfunctional budget politics

Numerous states continue to struggle with fully providing actuarially based contributions to their systems• We anticipate

contribution pressures will ratchet upward in the coming one to two years as a result of weaker equity market performance in FY 2015


• Most state budget proposals assume economic and revenue growth

will slow throughout 2016 and into 2017

• According to research from the Pew Charitable Trusts, as of mid 2015 there were still 21

states that had yet to see a full inflation adjusted revenue recovery from when revenue

associated with the great recession bottomed out in 2009

• Labor productivity growth is at 1.2%, which is tied with the 1973-1979 period for the slowest

growth rate through a business cycle since 1943

• States burdened by not only slow economic growth, but also complex budget politics (such

as Illinois, Louisiana, New Jersey, and Pennsylvania) face a more challenging outlook from a

credit perspective

• Changing demographics and an aging population are economic challenges that states have

and will continue to encounter during budget formulation

Economic outlook calls for slow growth to

persist

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Most of the states poised for faster economic growth are also those with more rapid

population increases. Conversely, many of the states ranked in the bottom 10 in

population growth are also expected to have slower economic progress

Economic growth trends by state

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Significant changes in state government

spending priorities

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• States that have been unable or unwilling to make the difficult choices necessary to accommodate funding for significant liabilities, such as retiree benefits, were more likely to see their credit quality erode

• For states that have made these trade offs, the impact on credit quality is favorable in the near term (3-5 years). However, looking ahead, the reduced investment in productivity enhancing areas (infrastructure and higher education), paints a dimmer picture of their long term economic growth prospects


States to keep an eye on in 2016

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• Large structural fiscal gap caused by fall in oil prices; major fiscal reform proposed by governor is currently under negotiation. Alaska

• Increasing revenue shortfall stemming from outsized financial sector linkages.Connecticut

• Budget compromise has become a casualty in a protracted standoff between the legislature and governor. The state is in an unprecedented tenth month of a fiscal year without an enacted budget.

Illinois

• Revenue declines that exceeded earlier projections following enactment of sweeping tax reduction in 2012-2013 has led state to rely on extensive one-time measures to close the budget gap.

Kansas

• Existing structural imbalance exacerbated by plummeting oil prices.Louisiana

• Lack of fiscal capacity both to fund actuarially sound pension contributions and maintain operating balance.New Jersey

• Contracting energy sector production and employment rippling through economy.Oklahoma

• Negotiation stalemate that led to extreme late-budget enactment due to disagreement rooted in ideological clash between branches of government controlled by opposing political parties over how to close budget gap.

Pennsylvania


Debt

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How S&P calculates debt

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• Debt analysis remains a primary area

of focus in S&P Global Ratings

overall credit evaluation of states.

• Of particular importance is the

annual cost of servicing debt

compared with current and future tax

and revenue streams.

• Our debt ratio calculations for states

aggregate all tax-supported

obligations, including GO bonds,

appropriation obligations, and

special-tax bonds, such as sales,

personal income, and gas tax bonds.

Debt Calculation

Special Tax

GO

Appropriation


Aggregate state debt levels

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• The state and local government sector has long exhibited sustainable

debt trends.

• According to the Securities Industry and Financial Markets Assn.

(SIFMA), the total amount of new debt (excluding refinancing debt

issuance) issued from 1996 through 2015 increased at an annual rate

of 1.2%, well below the average annual GDP growth rate of 4.3%

• In addition, there has been a pronounced pullback since the onset of

the Great Recession.

- From 1996 through 2010, state and local governments issued an average of $234 billion annually

in bonds (excluding refinancing issues). Following the end of the recession, however, they have

issued a much lower average of $151 billion annually in new capital bonds, according to SIFMA

data.

State and local government debt trends are

sustainable

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Growth in new money municipal bond issuance

relative to GDP

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Source: SIFMA

-60.0%

-50.0%

-40.0%

-30.0%

-20.0%

-10.0%

0.0%

10.0%

20.0%

30.0%

199619971998199920002001200220032004200520062007200820092010201120122013

%

GDP growth (YOY)

Linear (Growth in newmoney U.S. Municipal bondissuance (YOY))

Note: Black line represents trend line for U.S. Municipal Bond New Money Issuance


U.S. municipal bond new money issuance is stable

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0.0

50.0

100.0

150.0

200.0

250.0

300.0

(Bil. $)

U.S. MunicipalBond NewMoneyIssuance

Source: Bond Buyer


• In our view, assessing whether a state's debt levels or its debt

trajectory is sustainable depends largely on its economic -- and

relatedly, its revenue -- capacity to repay its debt obligations.

• Consider two hypothetical states:

Debt sustainability, not balance outstanding is the

key factor

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State A State B

Increasing debt load Flat debt trends

Economic and population base that is growing at a faster rate than its debt burden

Economic base is stagnating and suffering below average rates of GDP and population growth

In our view, State A may have a more sustainable debt profile than the latter despite faster growth in the overall amount of debt.


Growth in tax supported debt versus GSP growth

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• On the fiscal side, it's difficult to argue that aggregate state budget

deficits, estimated to have reached $174 billion in fiscal 2010 -- equal

to more than 25% of projected general spending -- didn't constitute a

crisis.

- State budget gaps -- projected and after budget adoption -- totaled $518 billion through the five

fiscal years through fiscal 2013.

• But as for their debt positions, the situation fell short of the threshold

we consider necessary to have considered it a crisis.

During the recession: states had fiscal crises, not

debt crises

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• As we see it, at least one of two ingredients is necessary for there to

be a debt crisis.

• To our knowledge, the U.S. states experienced neither of these on

any sustained basis throughout or in the aftermath of the Great

Recession.

• Overall, we believe U.S. states' current appetite for issuing new debt

reflects their fiscal experience in the wake of the Great Recession

more than anything to do with their debt levels.

- States have managed their debt levels prudently, in our view.

States had fiscal crises, not debt crises

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1 An obligor's ability to fund its principal and interest payments as they come due must be uncertain.

2 A loss of market access -- the ability to reliably sell debt on the capital markets at a reasonable price.


• Bonded debt is just one portion of a state's overall debt and liability

profile.

- There are also pension and other postemployment benefits (OPEB) liabilities.

• Funding debt and retiree benefit liabilities consumes a material share

of the states' annual budgets, often in the range of 15%.

- This share would likely be even higher if states funded all the retiree benefits at their actuarially

recommended levels.

• Focusing just on bonded debt paints a relatively sustainable picture.

- As of fiscal 2014, total tax-secured state debt was moderate, in our view, equaling 2.9% of total

U.S. economic output as measured by GDP.

State debt levels are only part of the liability

picture

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Collapsing Oil Prices Seep Into State Credit Profiles, 1/21/16

History of U.S. State Ratings, 7/28/16

U.S. Public Finance 2016 Credit Conditions Outlook: Expect Growth But Hold The Cheer, 1/11/16

U.S. State Debt Levels May Be More Sustainable Than The Condition Of The Nation's Infrastructure,

10/19/15

U.S. States Have Strong Credit Quality Though Low Oil Prices And Budget Management Will Test

Some, 1/11/16

U.S. State And Local Government Credit Conditions Outlook: Economic Growth Outlook Dims Amid

Rising Global Uncertainty, 7/27/16

Supporting information:

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https://www.globalcreditportal.com/ratingsdirect/showArticlePage.do?sid=1565382&sind=A&object_id=9489213&rev_id=1&from=SR



https://www.globalcreditportal.com/ratingsdirect/showArticlePage.do?rand=CDwhUnEw4A&sid=1466642&sind=A&object_id=9348785&rev_id=1&from=SR


https://www.globalcreditportal.com/ratingsdirect/showArticlePage.do?rand=lfrBEeoWBd&articleId=1684300&from=SO


Infrastructure

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• Certain infrastructure projects can result in operating efficiencies and

thus, fiscal savings. But, they also implicitly commit to new and

ongoing O&M expenditures.

- Analysis by the Congressional Budget Office (CBO) suggests that more than half (50% to

55% from 2000 through 2007) of total public spending on transportation and water

infrastructure has been for O&M. These estimates may even be understated because they

exclude spending on public power, equipment, or buildings.

• We believe the pullback of state debt issuance in response to fiscal

conditions reflects at least, in part, a rational near-term approach to

fiscal policymaking by lawmakers.

Infrastructure costs go well beyond the initial

investment

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• If state policymakers took it upon themselves to fund the ASCE's estimate

of necessary infrastructure at their historic proportionate share, we can

approximate the impact it would have on their debt ratios.

States can't solve the infrastructure gap with debt

financing alone

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85% state and local government share of infrastructure investment $3.06 billion in needed funding

39% state share of infrastructure investment

$1.9 trillion in debt through 2020

State debt ratios would increase to 7.6% of GDP form 2.9%.

Aggregate tax-supported debt burden as ‘high’ versus ‘moderate’ burden

today.


The Road Ahead

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• Individually, the states could

contribute to reducing the

deficiency of infrastructure

nationally.

• According to our assessment,

however, states won't be able to

solve the problem solely through

the issuance of traditional tax-

supported debt without it having a

negative impact on credit quality.

• A mix of traditional debt, public-

private partnerships, and

additional federal engagement is

likely required.

- We don't currently anticipate a large increase in

federal funding support.

What will it take to meet infrastructure needs?

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Federal Engagement

Traditional Debt

P3


States can't solve the infrastructure gap with debt

financing alone

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• We anticipate that states will

increasingly consider alternative

financing strategies.

• Public-private partnerships (P3s)

are one such avenue.

- P3 is frequently issued as taxable securities, a

disadvantage.

- P3s offer states a way to fold O&M expenses

into the overall cost of financing a project, and

interest in P3s by states is growing

• We expect the number of states

with legislation authorizing the use

of P3 will increase.• However, the P3 model can be complex and in

certain cases, states attempting P3 projects

have encountered political opposition.

Alternatives to consider

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P3


• 60,000 structurally deficient bridges

• $80 billion backlog of repair needs for public transit

• U.S. Corps of Engineers construction backlog totaling $62 billion

• 240,000 water main breaks annually and poor pipe conditions lead to

the discharge of 900 million gallons of untreated sewage each year

• Each driver loses $571 and wastes 26 hours sitting in traffic each year

• Each American household pays $232 more for goods due to delays in

freight movement caused by poor infrastructure

U.S. infrastructure ranked 16th in the world

Sources: Federal Highway Administration, 2014, http://www.fhwa.dot.gov/bridge/nbi/no10/defbr14.cfm.;

Federal Transit Administration, National State of Good Repair Assessment, 2011.; Nicole T. Carter and Charles V. Stern,

“Army Corps Fiscal Challenges: Frequently asked Questions,” Congressional Research Service, August 18, 2011.

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http://www.fhwa.dot.gov/bridge/nbi/no10/defbr14.cfm


An increase in spending of 1% real GDP (roughly $160B over 4 quarters)

would equal:

• $270B over the following 3-year period

• 730,000 new jobs

- 61,000 new jobs per month

Source: S&P Commentary “Global Infrastructure Timing is Everything”, January 2015.

U.S. multiplier effect

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• A risk-sharing partnership—consisting of a government and a private

business—that builds, finances, and operates an infrastructure project

Availability & Volume Risk

Design, Build, Finance, Operate & Maintain

• Roles and responsibilities of both the private-sector and government

participants are typically specified in a contract

• S&P treats the U.S state and local governments’ payment obligations as

debt, as contingent liability, or neither

What is a P3? (public-private partnership)

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national conference of state legislatures - 2016 legislative summit, august 8th · 2017-06-12 ·...

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