Connecticut's budget problems spurred two rating downgrades Thursday.
S&P Global Ratings and Fitch Ratings, in nearly simultaneous afternoon announcements, both downgraded Connecticut's general obligation bonds to AA-minus from AA. Standard & Poor's revised its outlook to stable at the new rating. It had maintained a negative outlook. Fitch maintained a stable outlook after the downgrade.
The rating reviews came ahead of Connecticut's plans to sell $511 million of refunding GOs next week.
"The downgrade reflects our view of reduced state budgetary flexibility," said S&P analyst David Hitchcock. "In our opinion, Connecticut has less flexibility to meet unanticipated revenue shortfalls, such as those that occurred in fiscal 2016, and may be poorly positioned should there be a national economic downturn in the next several years."
Fitch, in its statement, also questioned whether Connecticut has its financial act together.
"Despite repeated, and generally structural, responses to bring the current biennial budget into balance, it remains unclear whether the state has succeeded in fully aligning its budget to potential future economic and revenue performance," Fitch said.
Ahead of the deal, Moody's Investors Service affirmed its Aa3 rating and Kroll Bond Rating Agency affirmed its AA rating, both with continued negative outlooks.
State Treasure Denise Nappier said the new ratings come as policy leaders in Connecticut are recognizing the need to overhaul the state's approach to spending and revenue.
"The message from the credit rating agencies couldn't be any clearer," she said. "It is high time for a sustained commitment to fortify the state's financial footing, in the midst of persistent economic uncertainty.
"The path to recovery is straightforward, and the governor and legislature have positioned the state in the right direction."
The General Assembly last week approved a nearly $20 billion budget that Gov. Dannel Malloy said closed a nearly $1 billion hole in the fiscal 2016-17 year without raising taxes or tipping into its rainy-day fund. Malloy expects to sign it.
"The agencies recognize we have begun to make necessary structural changes," said Benjamin Barnes, the state budget secretary. "But we all know, and are reminded today, that there is much more difficult work to be done."
The budget package included an implementer bill – a budgetary owner's manual of sorts – that calls for budgeting by calculating growth only through fixed cost drivers, which would include debt service, Medicaid, pensions and other entitlements. As a result, all other parts of the budget would assume a budgeting format in which only "fixed costs" would undergo the same "current services" calculation.
"This will result in more realistic estimates of spending in the future," Malloy said in a statement.
The House, however, failed to act on a bonding package that effectively cancels about $1 billion in previously approved borrowing. The House could reconsider the package if the Assembly reconvenes in Hartford in the coming weeks.
"The stable outlook at the AA-minus rating level reflects Fitch's view that, despite its high fixed cost burden and ongoing economic uncertainty, recent state corrective actions have primarily been structural in nature, and state managers continue to pursue fiscal management changes to improve the state's longer term prospects," Fitch said in its statement.
S&P warned that Connecticut is not budgeting to restore reserves in fiscal 2017, and projected out-year budget gaps could "prove troublesome" in view of the state's trend toward cyclical financing.
"Rising debt service, pension, and other postemployment benefit [OPEB] costs have pushed fixed costs to what we see as a significant portion of the overall budget and could potentially hamper the state's ability to make further budget cuts should new revenue shortfalls develop," S&P said.
The bond sale will feature an exclusive order period for retail investors on Monday, with pricing for institutional investors on Tuesday.
Bank of America Merrill Lynch and Williams Capital are co-senior managers. Day Pitney LLP and Finn Dixon & Herling LLP are disclosure counsel, and Robinson & Cole LLP and Soeder & Associates LLC are tax counsel. Acacia Financial Group, Inc. and A.C. Advisory are financial advisors.