BRADENTON, Fla. – Kentucky’s underperforming revenues and low pension funding levels triggered a slew of credit rating downgrades from Moody's Investors Service.

Moody’s lowered Kentucky's issuer rating to Aa3 from Aa2, its general fund appropriation lease-revenue bonds to A1 from Aa3, and state agency fund appropriation lease-revenue bonds to A2 from A1 late Thursday.

Kentucky Gov. Matt Bevin
Kentucky Gov. Matt Bevin said a deficit in fiscal 2017 underscores the need to reform the state's tax code and public pensions. Bloomberg News

“The downgrade reflects revenue underperformance that will challenge the commonwealth’s ability to increase its very low pension funding levels,” said analyst Julius Vizner. “The commonwealth has one of the heaviest unfunded pension burdens of all states.”

Vizner also said the state’s high fixed costs will also restrict its fiscal flexibility.

Moody's also downgraded the Kentucky Public University Intercept Program and the Kentucky School District Enhancement Program to A1 from Aa3.

The sweeping actions came in conjunction with a review of the Kentucky Turnpike Authority’s upcoming sale of $256.6 million of revenue and refunding bonds.

The Turnpike Authority was downgraded to Aa3 from Aa2. The turnpike bonds are expected to price Aug. 2 with Morgan Stanley as the book-runner.

Moody’s said the outlook on all the debt is stable.

Moody's said its adjusted net pension liability for Kentucky was $37 billion in fiscal 2016, an amount that was 265% of revenues - the fourth-highest among states.

On July 14, Gov. Matt Bevin said he signed a budget reduction order to close a $138.5 million deficit in the general fund at the close of fiscal 2017, as required by the state’s constitution.

The “budget shortfall validates the need for conservative spending plans, and it dramatically underscores the critical need for fixing Kentucky's broken pension systems and modernizing the state's tax code,” Bevin said.

Bevin has said that he plans to call a special session of the Legislature in mid-August to address changes in the state’s tax code and pension reform, although he has not publicly released any information about what changes he will recommend.

The governor said his recent order to balance the budget did not include any reduction to the state's budget reserve trust fund, which he said totals $150.5 million.

Moody’s said the reserve balance stood at $209.4 million as of June 30, 2016.

In fiscal year 2017, the final general fund receipt collections were 1.3% less than the official estimate, according to State Budget Director John Chilton.

The current 2017-2018 biennial budget makes 9% cuts to most state agencies and 4.5% cuts to higher education, and includes a $57 million draw from the rainy day fund.

Chilton said further tightening is expected in the current fiscal year, and if revenues decline as much as in 2017 “significant” additional spending reductions will be needed to balance the budget.

“We are expecting an ongoing challenge with revenues in the next fiscal year and the next biennium,” Chilton said, adding that the budget cuts ordered by the governor “responsibly preserves the rainy day fund as we prepare for the tight fiscal environment in front of us.”

In January, S&P Global Ratings revised its outlook on the state to negative from stable while affirming its A-plus issuer credit rating and A ratings on lease debt issued by various Kentucky public corporations.

S&P said the negative outlook was due to the state’s unfunded pension obligations.

On Thursday, S&P rated the Turnpike Authority’s bonds AA-minus, and revised the outlook to negative from stable.

“The outlook revision reflects our opinion of potentially increasing operating costs, particularly due to increasing retirement expenses because of eroding pension funding levels and actuarial assumption changes,” said S&P analyst Timothy Little.

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