Minnesota ready to sell with high-grade ratings intact

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CHICAGO – Minnesota takes competitive bids Wednesday on $847 million of bonds with it high-grade credit intact thanks to flush coffers and reserve policies that ease some analysts’ concerns over rising pension pressures and a budget feud.

Fitch Ratings affirmed the state’s AAA while Moody’s Investors Service affirmed its Aa1 and S&P Global Ratings affirmed its AA-plus rating.

"The stable outlook on Minnesota reflects our view of the budget impasse, which has partially stemmed from a political disruption generally uncharacteristic of the state,” said S&P Global Ratings credit analyst Eden Perry.

“We believe the issues governing the fiscal 2018 budget outcome illustrate a departure from what we consider as very strong management commensurate with higher-rated issuers,” S&P added.

Gov. Mark Dayton’s administration and the legislature's Republican majority late last week began mediation talks – ordered by the Minnesota Supreme Court – over the size of tax relief and several policy issues. Dayton is a member of the state’s Democrat-Farmer-Labor Party, and the GOP holds the legislative majorities. Talks broke down Friday and the next step, in the hands of the state's high court, is unclear.

The governor vetoed the legislature’s $82 million appropriation in the state’s $46 billion two-year budget in an attempt to force lawmakers back because he believes $143 million of $650 million in tax relief is unaffordable over the long-term.

The feud has entangled repayment of $80 million of state-backed bonds issued to fund a new Senate office building that are repaid using lease payments from the Senate’s budget. S&P initially put the state on watch over the issue but took it off after lawmakers and the administration reached a temporary funding agreement.

Funds are on hand from Senate lease payments to cover a December payment and the rating agencies said the state has time to deal with the June payment.

“The ongoing non-appropriation has not, to date, affected the state's issuer default rating or the ratings on the state's other appropriation-backed debt due to Fitch's assessment that the state will work to ensure the payment of debt service in full and on time,” the rating agency wrote.

Still, the dispute could signal longer term trouble.

“Should Minnesota's underfunding of its pensions due to the state's use of a statutory funding formula, …translate into weaker funded levels, or if budgetary pressures…challenge the state's commitment to structural balance and reserve replenishment, or if the stalemate between the governor and the legislature intensifies again, there could be downward pressure on the rating,” S&Psaid.

Alternatively, if the state remains on course to structurally balance its budget, it manages spending pressures, and makes meaningful improvement to match the statutory funding formula to an actuarial determined contribution while returning to its strong budgetary management practices, S&P said it may raise the rating.

The state has about $6.5 billion of GOs outstanding. The upcoming five-series issue will raise $455 million in new money for capital building, environmental, local government, and transportation projects and the remainder will refund debt for savings.

The state’s strong economy and budget surpluses provide a buffer for any credit concerns. A previous income tax hike and growing economy have allowed the state to boost cash flow and budget reserves to about $2 billion and improve the structural balance of its budget.

Pensions pose a growing pressure point for the state after the system which includes three funds saw its funded ratio drop to a combined 70% funded ratio in fiscal 2016 due to a change in the discount rate and weak return rates.

The largest of the state funds – the Minnesota State Retirement System – had a net pension liability of $14.6 billion and a funded ratio of 47%. The state's contributions to the MSRS based on a statutory formula are just 76 % of the actuarially determined contribution, or ADC.

The Dayton administration backed a series of reforms that would have raised both state and employee contributions and cut benefits but late changes by the GOP prompted Dayton to veto it. Dayton’s top fiscal officer Myron Frans said in a recent interview the administration will try again in the next session with the same package. It’s uncertain at this point whether the plan will include a shift to an ADC payment.

Moody’s considers the state’s pension pressure manageable.

“A manageable debt and pension burden, along with growing revenues, affords the state financial flexibility,” Moody’s wrote. “Reserves continue to grow, though that pace may slow as the state looks to fund some one-time expenditures and tax cuts over the next two years. The state continues to adhere to sound financial practices, but idiosyncratic governance issues continue to arise from time to time.”

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