Massachusetts’ downgrade by S&P Global Ratings – the state’s first by a major bond-rating agency since 1990 – was no surprise to state leaders.

S&P, which lowered Massachusetts to AA from AA-plus – affecting roughly $22 billion in outstanding GO bonds -- had warned the commonwealth about red flags for more than two years.

Gov. Charlie Baker and state Treasurer Deborah Goldberg called on the commonwealth to rebuild its stabilization, or rainy-day fund.

“This rating affirms we still have work to do,” said Gov. Charlie Baker, a Republican.

Massachusetts became the sixth state downgraded this year, following West Virginia, Oklahoma, New Jersey, Illinois and neighboring Connecticut. "This year has so far been difficult for credits in the state sector," said Alan Schankel, a managing director at Janney Capital Markets.

S&P cited the failure by state officials to not follow through on rainy-day replenishment despite economic growth above the national average and through prolonged economic expansion that included the relocation of Fortune 500 behemoth General Electric Co. from Fairfield, Conn., to Boston’s bursting Seaport District.

General Electric’s move last year triggered study-in-contrast storylines about Massachusetts and Connecticut. Now the Bay State joins the dubious company of its New England neighbor as a wealthy state downgraded despite a growing economy.

Still, said Schankel, Massachusetts matches favorably against Connecticut. For example, its fixed expenses for debt, pensions and retiree health care reached 12% of annual expenses in fiscal 2016 compared with Connecticut's 30%.

S&P had cited rainy-day concerns since April 2015, its first formal meeting with Baker and Goldberg since each took office three months earlier. The rating agency put the commonwealth on a negative outlook seven months later.

"The downgrade of the state's bond rating is unfortunate, but we are not surprised," said state Treasurer Deborah Goldberg.

“[The] downgrade of the state's bond rating is unfortunate, but we are not surprised,” said Goldberg, a Democrat. “With this news, we must continue to work with the governor and the legislature to rebuild our state's stabilization fund and reaffirm our commitment to fiscal policies that will ensure an upgrade in the future.”

State liabilities are also on the rise, with the funding for pension plans dropping to 57.3% in fiscal 2016 from 60.7% in 2015.

S&P also downgraded several other credits, including those of the Massachusetts Bay Transportation Authority, citing their reliance of funding from the commonwealth. It dropped the MBTA, a state-run agency that operates Greater Boston’s mass transit system, to AA from AA-plus.

State reserves peaked in fiscal 2012, declined the two years thereafter and have stagnated since.

Lawmakers have diverted excess funds from capital gains taxes to operating budgets instead of the rainy-day accounts.

Fitch Ratings and Moody’s Investors Service affirmed their ratings at AA-plus and Aa1, respectively ahead of Massachusetts' $500 million Series C and D competitive GO pricing June 21.

The stabilization fund dropped from fiscal 2012 to 2014 by 24.5%, to $1.65 billion from $1.25 billion, despite state tax revenue growth of 10.7% -- $20.71 billion to $22.9 billion.

"This rating affirms we still have work to do," said Gov. Charlie Baker.

“We therefore view it as a missed opportunity that the state has opted against building its reserve according to its policies and leaves it on a course to experience greater fiscal stress in the event of an economic downturn or if federal funding were capped or trimmed in a material way,” said S&P analyst John Sugden.

S&P said it could raise Massachusetts’ rating should the commonwealth demonstrate “a renewed commitment” to rebuilding its reserves.

In September 2011, S&P elevated the GOs to AA-plus shortly after Deval Patrick and Steven Grossman – the governor and treasurer at the time, respectively – and other political and financial leaders pitched the three major bond-rating agencies for an upgrade during a meeting at the State House in Boston.

Massachusetts’ last downgrade, from Moody’s in March 1990, dropped the commonwealth’s rating to Baa, the nation’s lowest at the time, barely above junk.

Lawmakers are debating the fiscal 2018 budget. The House of Representatives passed a $40.4 billion spending plan, while the Senate’s version is $40.3 billion. By state law, a conference committee must craft a compromise plan.

Tax collections for April were $462 million below the year-to-date benchmark, Kazim Özyurt, chief economist and director of the commonwealth’s Office of Tax Policy and Analysis, said on a May 31 investor call.

Friday’s news was a setback to Baker, a former budget secretary under governors William Weld and Paul Cellucci and later chief executive of Harvard Pilgrim Health Care.

Speaking at the annual Massachusetts investor conference in Boston in December 2014, one month after his election, Baker said the state should strive for a triple-A ratings.

Baker officials, looking for a positive spin, said the S&P report gave his administration a perfect score for budget management.

The administration’s fiscal 2018 budget proposal includes a new method for deposits into the stabilization fund, which will replace what the governor called a well-intended but impractical mechanism. If enacted, it would provide a $98 million pre-budget deposit into the fund.

The new proposal, he said, offers a two-step process for deposits: first, a rainy-day deposit equal to 50% of projected capital-gains revenue above the statutory threshold and second, a mandated deposit of 50% of all tax revenue above projections, regardless of revenue source.

This, said Baker, would increase the chances of a deposit since it includes a pre-budgeted amount.

S&P also lowered its rating on the following bonds, citing reliance on funding from the commonwealth: Series 2003 Boston Housing Authority housing project bonds, West Broadway Homes IV project, to A from A-plus; Massachusetts Qualified Bond Act (Massachusetts General Law, Chapter 44A) and Massachusetts State College Building Authority state aid intercept program bonds, which move in tandem with the state GO rating, to AA-minus from AA.

The MBTA, a unit of the state Department of Transportation, has operated under a fiscal oversight board the past two years.

A report submitted to the board last month said the “T,” as locals call the system, faces an 18-year, $1.5 billion pension shortfall and called for legislative intervention.

The June 21 sale, while mostly new money, will include a refunding component that state Treasury officials will determine, deputy treasurer for debt management Sue Perez told investors.

Next month, she said, Massachusetts will hold a $200 negotiated remarketing of multi-modal tax exempt Series 2014 D-2 bonds. The commonwealth in October intends to sell $350 of new money certified tax fund bonds.

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Paul Burton

Paul Burton

Paul Burton is the Northeast Regional Editor for The Bond Buyer and the author of the book "Tales from the Newsrooms." He is a sought-after public speaker and has appeared on radio and TV shows, including former CBS News White House correspondent Sharyl Attkisson’s public-affairs program, “Full Measure.”