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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.
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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.
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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.
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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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5
8 34
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523
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State fiscal condition leading up start of 2016
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21
15
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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.
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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.
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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
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• 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
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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
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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
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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
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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
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• 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.
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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.
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• 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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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.
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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
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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
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• 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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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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