Moody’s Sees Non-Improving Credits

Six consecutive quarters of state tax-collection increases failed to improve the credit outlook for state or local governments, according to two studies from Moody’s Investors Service set for publication Monday.

The rating agency said strong budgetary management and rising revenues among states simply won’t be enough to fully replace federal stimulus funds that expired in June.

As states struggle with less federal aid, the trickle-down to municipalities will be diminished. That’s keeping a lid on credit upgrades for local governments already constrained by falling property tax revenue.

The negative outlook reaffirmations — which first took effect in 2009 — express assumptions for the next 12 to 18 months.

Culprits are legion: the economic recovery is fragile, consumer sentiment is at a record low, slow job creation is diluting growth, and a double-dip recession looms.

The Rockefeller Institute of Government recently reported that the April-to-June period was the sixth straight quarter of revenue growth for states, with tax collections growing by 11.4% versus the same period one year before.

Moody’s references that study but suggests it would be wrong to project the trajectory forward. Federal stimulus funds made up 18% and 14% of state budgets in fiscal 2010 and 2011, respectively, and they were a major factor allowing states to close $110 billion in budget gaps in fiscal 2012.

But the end of stimulus funding would lead to a loss of $66 billion in temporary federal funds to states in 2012, says the National Association of State Budget Officers.

“Revenue growth has been healthy and in most cases is exceeding forecasts,” Moody’s said. “However, growth may be slowing and some states may have to make mid-year budget adjustments.”

Collections are nearly 8% less than pre-recession levels, it noted.

Revenue weakness is aggravated by pressures on the U.S. sovereign credit and political determination to slash spending.

Moody’s Analytics is pricing in a 40% chance of a second recession, though its baseline forecast assumes a 2011 growth rate of 2.7%, followed by 3.2% GDP in the next two years, 3.4% in 2014, and 2.9% in 2015.

Nicholas Samuels, co-author of the states report, said the recovery was looking robust several months ago but now it appears some new challenges have arisen. In spite of these pressures, he noted states are in a moderately healthy condition with a median average rating of Aa1.

A major positive is that state debt is “relatively affordable” at 6.1% of total state GDP, including unfunded pension liabilities. By contrast, the largest industrialized nations have an average debt-to-GDP burden of 103.8% — excluding pensions.

“Despite the ongoing stress on state finances, states possess strengths that support their high ratings profile,” Moody’s concluded. It cited balanced budget requirements, sovereign taxing authorities, and the ability to push costs down on to local governments.

The timing of that last dynamic is less than ideal for local governments, which have now seen two straight quarters of property tax revenue declines.

Such taxes are “generally the largest and most stable component of local municipal revenues,” Moody’s said in its local government report. It noted that property taxes fell 1.6% year-over-year in the first quarter, a trend which is “likely to continue into fiscal 2012 … as assessed value declines outpace rate increases.”

Naomi Richman, co-author of the local government study, said the impact of federal cuts ripples through to local economies in other ways beyond state cuts.

Local economies dependent on federal employees, contractors or other entities that receive money “are going through a retrenchment,” she said Friday, and “that can have an indirect effect on the tax revenues derived from that economic base.”

Moody’s expects these numerous challenges to result in downgrades continuing to outpace upgrades among local governments, and says downgrades of two or more notches can be expected wherever there is acute deterioration.

Defaults and Chapter 9 bankruptcy filings are projected to remain rare, however, given the market access, revenue-raising power, and manageable debt structures common to most issuers.

Neither analyst would comment on what role President Obama’s jobs plan, if it is adopted, might play for the credit outlooks.

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