Moody's Officials: State Sector Stable, But Some States Still Struggling

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WASHINGTON — While Moody's Investors Service gives the state sector a stable outlook, some states are in better shape than others, analysts with the rating agency said in a conference call Tuesday.

Moody's gives 30 states' general-obligation bond ratings of Aaa and Aa1, the two highest categories. In the last few months, the rating agency has upgraded New York and California, but has downgraded Kansas, New Jersey and Pennsylvania.

California's rating upgrade to Aa3 from A1 and New York's rating upgrade to Aa1 from Aa2 are "partially due to some governance improvements," said Emily Raimes, a Moody's vice president-senior credit officer.

California voters in 2010 passed a constitutional amendment that lowered the threshold needed for budget approval in the state legislature to a simple majority from a two-thirds vote. And the state legislature recently passed a measure that would put in a rainy day fund any capital gains revenues that are greater than 8% of general fund tax revenues. This measure will go before voters in the fall, and if it passes, California will be able to build a reserve to "cushion" against some of the volatility it has seen in the past, Raimes said.

In New York, mandated caps on spending growth for school aid and Medicaid have helped to limit the growth in the state operating budget. Also the state legislature has passed four consecutive budgets on time and the state is increasing reserves and pre-paying future year expenses.

Meanwhile, Moody's downgraded Kansas, New Jersey and Pennsylvania because of factors including revenue under-performance, weak economic growth, and increasing pension liabilities.

Kansas' GO rating was lowered to Aa2 from Aa1, in part because tax reform led to lower revenues, Raimes said. Also, the state has budget stress from increased pension contribution requirements and additional school funding needs.

New Jersey's downgrade to A1 from Aa3 was due in part to revenues that were not as strong as forecasted and increasing pension contributions, Raimes said. And Pennsylvania's downgrade to Aa3 from Aa2 related to the fact that the commonwealth's enacted fiscal 2015 budget is "structurally imbalanced," and dependent on some one-time revenue sources, she said.

Moody's Macroeconomic Board expects employment and income levels to rise over the next five years said. In the first six months of 2014, the United States added over 200,000 jobs, Moody's analysts said.

Consumer confidence is rising, though it has not yet returned to pre-recession levels. Retail sales are also growing, which is important because sales tax revenues make up a significant percentage of states' general fund revenues, said Nick Samuels, a Moody's vice president-senior credit officer.

States are replenishing their reserves and state debt growth and municipal debt issuance are down.

Still, states face challenges, including pension costs exceeding revenue growth in some states, pent-up demand for more spending following years of austerity budgets, and Medicaid expenditure growth, Moody's analysts said.

"We expect to see a change in some of the borrowing needs," Raimes said. Infrastructure funding has been constrained in recent years while infrastructure needs have been increasing, and federal and state gasoline tax revenues have been stagnant.

Additionally, there can be negative effects from federal fiscal policy.

Many taxpayers shifted income from the 2013 tax year to the 2012 tax year, in advance of federal tax rates starting to rise on Jan. 1, 2013. This one-time shift caused states to have an increase in tax collections in fiscal 2013, which for many states began July 1, 2012.

As a result, many states adjusted their revenue estimates downward for fiscal 2014, Samuels said. But in some states, the revenue estimates were not low enough and states experienced large shortfalls in April compared to their forecasts.

Raimes also noted that Congress will have to address to address the federal debt ceiling again. The debt ceiling is currently suspended until the middle of March 2015.

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