MuniLand: Chronic Connecticut and Pennsylvania Procrastination

Budget issues are chronic in Connecticut and Pennsylvania, as they continue to procrastinate passing a revenue plan. The debate about how to close Connecticut’s $3.5 billion biennial budget gap and Pennsylvania’s $2.2 billion annual structural imbalance is keeping state legislators busy well into the new fiscal year. The numbers are big, but when viewed as a percentage of total government expenditure the issues become more manageable. Connecticut needs to close a 6% budget gap, while Pennsylvania needs to figure out how to close a 3.3% hole. Both states were downgraded by S&P this year to A+ from AA- primarily due to budget stress. 

The states’ share similar stories. For example, both state economies lag GDP growth relative to the national average. Slower economic growth resulted in revenue projections missing budget targets. On the expenditure side, pension and health benefit payments in both states are accelerating at unsustainable rates. Connecticut pensions are poorly funded at around 40%, while Pennsylvania is in a slightly better position, with pension funding ratios around 50% of the assets needed to meet their liability. To Pennsylvania’s credit, the legislature did reach an agreement to slow future liabilities by renegotiating new hires’ pensions. 

Structurally imbalanced budgets are not the end of the world for states, but they do represent stress or deferred decision making. States have enormous leverage to balance their budgets. For example, they can borrow from internal funds, take out short term loans, delay payments to vendors, restructure contracts and reduce assistance to local governments. These sovereign powers are states’ greatest credit strengths. However, there must be a willingness to make changes and compromise on both expenditures and revenues. Over the long term, Pennsylvania is in a better position because of growth in natural gas mining and potential royalty payments from natural gas extraction. A “severance tax” is currently being discussed, which would pay natural gas royalties to the state. This new revenue source is sustainable and, more importantly, growing. Pennsylvania has the third largest natural gas reserves in the world, and is one of the cheapest places for energy companies to drill. Connecticut, on the other hand, has less going for it. The state is very wealthy, but lacks a major city and a supportive business ecosystem to attract and retain businesses. General Electric recently decided to move out of the woods of Connecticut to downtown Boston to be more connected and have access to a larger pool of talent, both of which Fairfield lacked. 

There are fundamental credit weaknesses and strengths to both States. But for the right “yield,” certain state bonds could be attractive. Pennsylvania has a well-defined priority of payments schedule for debt, which is a strong credit positive, and Connecticut issues some dedicated tax revenue backed bonds that don’t need legislative appropriation. When we can find the right bond structures, we get paid to endure chronic delays and procrastination risks.

Source: SNWAM Research, The CT Mirror, WSJ, Governing Magazine, S&P Ratings