As of last Thursday afternoon, at least seven states had not adopted operating budgets for the 2018 fiscal year, which started on July 1: Connecticut, Massachusetts, Oregon, Rhode Island, Pennsylvania and Wisconsin. The states of Maine and New Jersey had also failed to adopt budgets in time for their new fiscal year, and each had a partial government shutdown for a short period of time.
While the SNWAM Investment Team maintains a stable outlook on the State GO Sector, and while debt service on GO bonds and other debt has not been threatened for those states that still have not adopted budgets, credit pressures on states have increased. State tax revenues are growing, but at lower rates than in the past and expenditure demands are growing, particularly for retirement benefits, which include rising pension contributions. We have also noted that political discord in some statehouses has been an impediment to achieving consensus on budget priorities, and that states controlled by one political party have not been immune from budget delays.
For some states, the budget delays reflect deeper credit issues. In Connecticut (General Obligation Bonds rated A1 by Moody’s and A+ by Standard & Poor’s), for example, the state’s fiscal cushion has dwindled due to an underperforming economy, growing debt levels and growing budget gaps that have caused revenue declines despite the state’s high wealth levels. Moody’s downgraded the state’s GO rating on May 15. Pennsylvania (GO Bonds rated Aa3/AA-) had its GO ratings placed on Rating Watch for downgrade by S&P last Thursday, as the rating analysts are concerned that the commonwealth will not be able to enact a structurally balanced budget. The legislature has passed a spending plan, but it has not been able to adopt a revenue package to close a $2 billion budget gap.
The budget problems of other states pale in comparison to the budget crises that the state of Illinois (GO bonds rated Baa3/BBB-) has faced. The state failed to adopt budgets for the 2016 and 2017 fiscal years, and last week the budget stalemate in Springfield crossed into its third fiscal year. The state has endured numerous ratings downgrades and was on the precipice of falling to junk bond status without a balanced budget for FY ’18. The legislature finally adopted a budget four days into the new fiscal year, but on the July 4 holiday, the governor vetoed the budget package because it included an income tax hike without other reforms that the governor felt were crucial to the long-term economic health of the state. In a last ditch effort to avoid the downgrade, the Illinois legislature overrode the governor’s veto. Although the state now has a budget, it still has a lot of work to do to improve its credit quality. Prior to the veto override, both Moody’s and S&P had placed their ratings of state GO bonds on a Downgrade Credit Watch, and the state may still be at risk for downgrade because of the volume of unpaid bills, low pension funding levels and potential revenue shortfalls.
Source: Bloomberg News, Moody’s, National Conference of State Legislatures, Standard & Poor’s