CHICAGO — As federal stimulus funds that many states have relied on to balance their budgets run out, states will face tough decisions over how to adapt to a lower revenue environment, a Moody’s Investors Service analyst said at a conference here this week.

The good news is that most states were better prepared to cope with the current downturn compared to the last recession, in 2000, according to analyst Nicholas Samuels. The bad news is that it will likely take states longer to recover from this downturn. During the last recession, Moody’s downgraded 14 states. It has downgraded six states during the current turmoil.

“That tells us there’s more to come,” Samuels said while speaking on a panel at The Bond Buyer’s Municipal Finance in the Stimulus Era conference. “We’re likely to be much slower coming out of this downturn, particularly in terms of revenue … There is no housing bubble to replace the tech bubble this time.”

Moody’s revised its outlook to negative from stable on the state sector in early 2008. Nine states altogether carry negative outlooks from Moody’s. “About the only positive comment is that West Virginia has a positive outlook,” Samuels said.

Most states saw declines in income tax collections this spring and last month, a key month for income tax receipts. The declines mean that states will have less to spend as stimulus funds disappear in 2011.

“These data lag and we know that it’s going to get worse,” he said. “When it recovers, it’s not going to recover as fast as during the first downturn. States are going to have to adjust to much lower revenue going forward.”

As states plan for a future without stimulus funds, some fiscal officials have told Moody’s that they are counting on a second round of stimulus funding to help them carry through the next couple of budget years, while others are cutting spending in anticipation of lower revenue.

“We’re really going to be looking for structurally balanced solutions going forward as stimulus funds go away,” Samuels said.

But fiscal stress might not mean less access to the debt markets, said Chris Holmes
VP Municipal Strategy, JPMorgan.

“Look at California,” Holmes said. “That’s a triple-B credit and they issued in huge size and had great success in both the tax-exempt and taxable markets. The market is conducive to issuers that are facing pretty significant financial stress.”

But some financially strapped issuers — like California, Illinois, and Pennsylvania — will face “headline risk” due to budget gaps in 2011 when it comes to borrowing, Holmes said.

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