Moody's: Public Finance Sector Remains Negative

Despite economic growth, the majority of public finance sectors still face a negative outlook for the remainder of 2013, according to a new Moody's Investors Service report.

Lingering budget stress, weak revenue growth as well as federal budget cuts and growing public pension liabilities are primary contributing factors to the credit challenges state and local governments face, the eight-page report said.

"Many governments, not-for-profits and other municipal market debt issuers made multi-year financial plans assuming a stronger recovery and are now struggling to right-size their long-range budget assumptions," wrote author Eva Bogaty.

Bogaty noted that revenue growth has been weak since the recession due to anemic household incomes, lower home values and taxpayer resistance. In addition, declining federal or state government support has equaled a gradual process of budget adjustment for many municipal market issuers.

The sequester, the $1.2 trillion in automatic, across-the-board budget cuts that went into effect March 1, and any additional federal budget cuts are also negative credit factors for most public finance sectors, the report said.

"While federal budget cuts, taken in isolation, are not likely to cause widespread new credit stress for US public finance sectors, they will compound existing negative effects of the slow economic recovery on public finance revenues," Bogaty said.

The majority of state and local governments are trying to manage rising public pension costs and unfunded liabilities, while at the same time volatile investment returns and historically low interest rates raise the question about pension asset and liability accounting practices, according to the report.

It is estimated that unfunded public pension liabilities could be as high as $4.4 trillion, according to the Harvard Kennedy School Mossavar-Rahmani Center for Business Government.

Even though some state and local governments have adopted pension reforms, legal restrictions and hurdles with union agreements have made it difficult for municipalities to meaningfully reduce service costs, the report said.

The outlook for states is negative for the sixth consecutive year due to high unemployment, tax revenue growth and budgetary pressures. Still, states are supported by broad and diverse economies and low debt burdens, it said.

The outlook for local governments also remains negative as a result of slow growth rates, mixed employment indicators and ongoing constraints in revenues.

The U.S. airport sector was revised to stable following five consecutive years of negative outlooks, Moody's said. While the sector remains vulnerable to economic risks and it remains below pre-recession peaks, airport finances have strengthened since the recession. The long-term Federal Aviation Administration reauthorization bill signed into law last year provides $63.4 billion to fund the agency through 2015 and will provide a stable funding boost.

The toll road sector remains negative for the fifth consecutive year based on continued weak pace of economic recovery and fiscal tightening by the federal government. "Though we expect toll road traffic to grow modestly in 2013, rising toll rates and the slow economy will continue to constrain traffic volumes," Bogaty wrote.

Moody's said it will assign a stable outlook for public finance sectors when there is sustained national economic growth that improves the labor and housing markets, a return to higher consumer confidence, growing household income, higher revenue growth and a resolution of the federal budget that does not involve further cuts to key funding programs affecting the public sectors.

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