CHICAGO — Fitch Ratings stripped Minnesota of its coveted AAA rating Thursday, punishing the once flush state for political gridlock that has driven a reliance on one-time revenue gimmicks to balance recent budgets, and is also behind the current impasse over a $5 billion budget gap that has shut down state government.
Fitch lowered the rating one notch to AA-plus and assigned a stable outlook. The action directly affects $5.7 billion of state GO bonds. The downgrade also drove a one-notch drop in the state's school district credit enhancement program to AA. Minnesota retains its AAA from Standard & Poor's while Moody's Investors Service rates it Aa1.
The state, which enjoyed billion-dollar-plus reserves before the latest recession, faces a $5 billion deficit in its next two-year general fund budget of about $35 billion. Gov. Mark Dayton of the Democratic-Farmer-Labor Party wants a mix of cuts and an income tax hike on top earners to erase the red ink. Republicans, who control the Legislature, won't approve any tax increases. The GOP has also offered several one-time measures such as a tobacco bond issue and school payment delays, but Dayton has refused.
Unable to bridge a divide of about $1.4 billion, most state operations shut down July 1. Fitch cited the state's contentious political environment in its downgrade, along with its use of non-recurring revenues to close budget gaps over the course of the recession and its difficulties in solving the current budget deficit.
Analysts believe the current political environment makes it likely the state will again turn to one-shots.
"While negotiations continue, it is impossible to know at this point when a budget agreement will be reached or the shape that the final agreement will take. However, it appears likely that the outcome will continue the use of non-recurring balancing tools and that deferred payment obligations will continue to be a drag on the state's finances," analysts wrote. "Fitch believes that as a result Minnesota's financial posture is no longer consistent with an AAA rating."
The state last year approved a budget agreement that cut spending, including aid to local governments, and pushed off $1.8 billion owed to schools to address a $3 billion shortfall. The Legislature then was controlled by Democrats while the governor's office was held by a Republican, Tim Pawlenty. Democrats wanted a mix of cuts and tax increases, but Pawlenty — who is now seeking the Republican presidential nomination — opposed any move to raise taxes.
Dayton's office of management and budget commissioner Jim Schowalter sought to use Fitch's comments to support the administration's position.
"This downgrade is the result of several budgets in which the state didn't act to address its structural deficit. For years Minnesota has prided itself on having constructive, responsive public solutions, but in the eyes of the marketplace, we are slipping," Schowalter said.
At the AA-minus level, the state's credit still remains strong and reflects its solid fiscal profile and practices, Fitch said. The stable outlook reflects analysts' view that the state will rebuild its reserves and repay school pay school district payment deferrals. The credit benefits from moderate debt levels, conservative debt policies, strong personal income levels on a per capita basis, and an unemployment rate below the national average.
Although most state operations are shuttered, state debt service continues to be paid under an ongoing appropriation and was further enforced by a court order last month that included debt obligations in the list of state functions that remain in force and operational during the shutdown.
Minnesota posted investor notices of the court order that allows it to "make payments necessary to carry out the critical core functions of the state executive and legislative branches, including payments" on debt obligations.
Also on Thursday a group convened by former Democratic Vice President Walter Mondale and former Republican Gov. Arne Carlson released a framework for resolving the impasse. The group called for eliminating 70% of the deficit through cuts and 30% through tax increases with no use of one-time revenues.