In the latest rating hit to Connecticut, S&P Global Ratings revised its outlook on the state to negative from stable.
"The outlook revision reflects our view that projected growth in fixed costs could rise to a level we believe could comprise a substantial proportion of the state budget and thereby hamper Connecticut's budget flexibility as the state addresses large out-year budget gaps," S&P credit analyst David Hitchcock said Wednesday night.
S&P affirmed its AA-minus rating.
Earlier Wednesday, state budget director Benjamin Barnes and the General Assembly's independent Office of Fiscal Analysis told a joint legislative panel that fixed costs have risen from 37% of general fund revenue in fiscal 2006 to a projected 53% in fiscal 2018, which will start on July 1.
S&P said debt service, pension, and other postemployment benefit costs alone will account for nearly 33% of state revenue.
Bond rating agencies have cited dwindling reserves and budget imbalances in three general obligation downgrades this year.
S&P, Fitch Ratings and Kroll Bond Rating Agency assign AA-minus ratings while Moody's Investors Service assigns an equivalent Aa3 rating. Moody's has a negative outlook while Fitch and Kroll have stable outlooks.
"Should fixed costs rise substantially further as a percent of the budget, pension funded ratios decrease below 40%, or the state resort to structurally unbalanced budget balancing measures over our two-year outlook horizon, even while the nation is experiencing economic growth, we could lower the rating [further]," said Hitchcock.
S&P also affirmed its AA-plus rating on the state's appropriation-secured debt, and its A-minus rating on its moral obligation debt.
"S&P's shift in its outlook for Connecticut reflects what we've known for some time: that our state's long-term obligations and fixed costs are growing, and that if left unaddressed, can lead to serious challenges for future budgets," state Treasurer Denise Nappier said in a statement. "Sobering, to be sure, but unfortunately, it comes as no surprise.
"This is an outlook change, not a ratings change," said Nappier. "Connecticut continues to earn a 'strong' rating from S&P for financial management of its budget, debt management and investing, and S&P maintains its view that the State's overall management practices are 'robust.'"
Connecticut intends to refund $320 million of GOs next week.
"With the sale next week, it is worth noting that spreads have already pushed out," said Eric Kazatsky, a director at Janney Capital Markets. He cited TM3 data that showed a widening from 59 basis points vs. AAA Municipal Market Data in the 10 year, to 70 basis points. "The latest outlook revision could potentially have the effect of costing them additional money in borrowing costs for the upcoming $320 million [sale]."
Barnes, speaking to a joint session of the appropriations committee and the finance, revenue and bonding committee at the state capitol in Hartford, said slow revenue growth and the need to ramp up pension liability payments largely account for Connecticut's projected $1.3 billion deficit for fiscal 2018.
"If we can make the adjustments for fiscal 2018, then '19 and '20 will be less difficult as long as the revenue and cost growth are better aligned," Barnes told lawmakers.
"We're aggressively ramping up payments against long-term liabilities," said Barnes, related to chronic underfunding of the state employees' and teachers' pension funds. "There were decades in which we decided not to do this."
Connecticut will make a $120 million payment to other post-employment benefits, or OPEB, said Barnes. The state, he added, is also in the final year of an economic recovery notes commitment.
According to Barnes, recovery from the recession has been uneven both in Connecticut and nationally. "There are also a number of international factors," he said.
Gov. Dannel Malloy, a Democrat, is scheduled to present his biennial budget in February.
Office of Fiscal Analysis director Neil Ayers called personal income tax growth "increasingly volatile." Income the state's top 50 taxpayers reported was down a combined $2.9 billion in 2015, which converts to an annual revenue loss of $217 million.
"Fifty people have accounted for a quarter of the entire problem," he said.
The recession hurt finance, insurance and manufacturing sectors the most, according to Ayers.
S&P said outyear gaps might be difficult to close given tax increases already imposed in the past two millennial budgets and cuts that already have occurred. "Budget cuts have had the unintended impact of raising the proportion of the budget composed of fixed costs and constraining future budget-cutting flexibility," Hitchcock wrote.
The move by Fortune 500 behemoth General Electric from Fairfield, Conn., to Boston generated national headlines. Additionally, insurance giants Aetna Inc. and Travelers Cos. have complained over the past two years about the tax and business culture in Connecticut.
On a positive business note, Sikorsky Aircraft announced a major manufacturing plant expansion, following state tax incentives and union wage concessions. Separately, Pratt & Whitney announced its own plant expansion. Both companies are U.S. defense contractors.
When the new legislature convenes in January, the Senate will have an 18-18 split following Republican gains in the November election. Democrats will have a 79-72 edge in the House of Representatives, down from 86-64.
The state has targeted 2032 for fully funding its pensions. "If we can do something over the next few years to avoid the cliff, we would make things realistically easier for our children," said Barnes.
According to Kazatsky, another problem for Connecticut is its dwindling budget reserve, down from $1.4 billion in 2009 to $236 million in 2017.
"However, they are not alone and better than peers such as Pennsylvania, which have long depleted their rainy-day money," he said.