The state of Alaska pulled its proposed multi-billion dollar pension obligation bond sale last week shortly before it was to be priced. The state had planned to issue up to $3.3 billion of new pension bonds, with the intent of improving the funding levels of its public pensions. Alaska Governor Bill Walker halted the transaction on Wednesday after meeting with the Alaska Senate Finance Committee. After the meeting, Governor Walker announced that the bond sale would not proceed due to a lack of legislative support. While the state did not need legislative approval to sell the bonds, the governor is trying to build a consensus with the legislature to address Alaska’s budget crisis, which was triggered by the precipitous drop in oil prices last year.
The state’s decision to halt the pension bond sale was, to at least one rating agency, a credit positive. Standard & Poor’s had placed Alaska’s general obligation bond rating on credit watch negative after the state’s original proposal to issue the pension bonds. In its rating report, S&P said that it would downgrade Alaska’s GO from AA+ to AA if the state issued the bonds, as the issuance would cause Alaska’s debt levels to balloon, limit its bond capacity, and increase the budget risk if investment returns were lower than the interest cost of the bonds. Subsequent to the governor’s move to pull the issue from the market, S&P removed its credit watch from its rating of the state’s GO bonds.
While S&P and Fitch maintain AA+ ratings on the GO bonds, Moody’s GO rating is one-notch lower at Aa2. All three agencies had rated the state GO at their highest level, Aaa/AAA/AAA, at the beginning of the year, but each agency downgraded Alaska by one notch during the 2016 fiscal year due to the state’s multi-billion dollar budget deficit, caused by dwindling state oil revenues. Moody’s downgraded the state for a second time to its current level in July. All three agencies maintain negative outlooks on the ratings.
While many muni credits have benefitted from lower oil prices, the impact has had a substantial negative impact on the state of Alaska, as it is more dependent on petroleum derived revenues than any other state. When oil prices were higher, Alaska had been able to generate surplus revenues and large reserves. Despite its concentrated tax base and dependence on volatile petroleum revenues, Alaska had garnered its top ratings due to those substantial reserves. By the end of FY 2014, the state had built up approximately $17.6 billion of reserves, nearly three times its annual operating budget, but 75% of its revenues were generated from petroleum. As oil prices declined, Alaska’s operating revenues fell by over 52% in FY ‘15, much more than had been estimated in its budget, forcing the state to start tapping into the reserves.
Even after the recent downgrades, Alaska still has high-grade ratings due to the financial cushion from its large remaining reserves. However, Governor Walker and legislative leaders acknowledge that the state must revise its financial structure to maintain its high grade credit quality. That consensus has been difficult to achieve. Alaska’s FY ’17 budget has balanced only by drawing $3.2 billion from its reserves, and the state will face more downgrades if it continues down the unsustainable road of tapping into reserves. Judging from S&P’s reaction, the state will need to address its structural budget deficit, as well as address pension funding levels through higher annual contributions, rather than resort to a strategy of using pension bond proceeds.
Source: The Bond Buyer, Fitch Ratings, Moody’s, Standard & Poor’s