Conning lowered its outlook on the municipal credit of U.S. states this week to declining from stable as state tax revenue growth turned negative in the first extended decline since the Great Recession.
In its latest "State of the States" report, the investment firm said Wednesday that tax revenues are slowing while state expenditures are rising, resulting in aggregate state reserves falling.
The report, released twice a year, ranks the states by credit quality. The ranking contributes to Conning's internal ratings.
"This report gives a good picture of where we see credit quality for states as a whole," said Paul Mansour, managing director at Conning and author of the report. "State revenues for the first six months of 2016 were lower than the same period last year, the first extended decline in state tax revenues since the Great Recession."
The study found that declines in oil and gas prices, underfunded pensions, and lower capital gains tax revenue have hit more states in recent months.
Lower capital gains taxes were a major reason affecting states such as Connecticut and New York, while declines in oil and gas prices hit the finances of states such as Alaska and Oklahoma, the report stated.
Conning's top-ranked states are Colorado, New Hampshire, Tennessee, and Utah. Most improved states since the Spring report are Michigan and New Hampshire.
In contrast, the report said energy-dependent states have seen their state rankings fall various degrees depending on the diversity of their economies. In fact, the two lowest-ranked states are Kentucky and West Virginia.
Among the larger states, Illinois, Pennsylvania, and New Jersey have seen little improvement in their credit profiles, the report said, because they have large legacy costs with slower-growing economies that have hindered credit improvement.
The firm believes that selected credit and macroeconomic indicators give an accurate assessment of current and future credit quality.
"This report is also forward looking," Mansour said, "focusing on the things that really matter. We want to provide a guide for investors to be able to make informed investment decisions."
He added that accurate information on credit quality was of paramount importance in the uncertain economic times ahead.
"When the tide goes out," he said, "you want to be in the right credits and in the right states."
A key challenge for many lagging states is to attract companies in high-paying and high-growing sectors, the report stated. Among large states, New York has lost jobs over the past 12 months and has fallen to 41st in Conning's state rankings.
Additionally, investment returns of state pension funds for FY 2016 were far below the assumed return levels of between 7% and 8%. Low investment returns will require an increase in pension contributions, especially affecting states with low funded ratios such as Illinois, Connecticut, Pennsylvania, Kentucky, and New Jersey, the report stated.
Over the past few years, weak investment returns together with forecasts of continued low investment returns have increased pressure on states to reduce their discount rate assumptions.
"Lower investment returns have offset savings created by plan benefit changes enacted by many states, leaving the aggregate funded ratio stalled at around 75%," the report stated. "Lower discount rates translate into higher required contributions, amplifying strains on already stressed budgets. While a handful of states have large pension costs relative to their state budgets, the overall state pension contribution is a modest 4.3% of expenditures."
Conning is a global investment management firm with about $120 billion in assets under management as of Sept. 30. The firm supports institutional investors, including pension plans, with investment solutions and asset management offerings, risk modeling software, and industry research. It has offices in Hartford, New York, Boston, London, Cologne, Hong Kong and Tokyo.
