Moody’s Investors Service late Monday revised Pennsylvania’s outlook to negative from stable, citing the state’s fiscal 2010 budget impasse and its need to issue short-term debt for the first time in more than 10 years.
The outlook change affects approximately $9 billion of outstanding debt. Moody’s rates Pennsylvania Aa2.
The commonwealth plans to advance refund $689.6 million of general obligation bonds Tuesday to generate roughly $30 million of net present-value savings. To help achieve those savings, the state is considering buying U.S. Treasuries on the open market for the refunding escrow to help offset negative arbitrage.
Matt Fabian, managing director at Municipal Market Advisors, said the refunding will probably be a little more expensive for the state due to the outlook change and Monday’s Treasury rally. He also said the transaction should attract buyers hopeful that Pennsylvania’s GOs will mimic the performance of California bonds, which bounced back after lawmakers there resolved major budget issues.
“It really just confirms that there is difficulty at the state and I don’t think that that’s a surprise,” Fabian said. “As far as pricing, I think the pricing will go just fine especially seeing the example of California. [Its] bonds have had a tremendous rally after California got its budget intact ... so that’s setting the example. I expect there will be buyers that will be looking for a similar kind of performance in Pennsylvania.”
Since July 1, the state has been operating without a budget. Gov. Edward Rendell signed an $11 billion “bridge budget” to cover immediate needs, including debt service, but lawmakers are still in disagreement over whether to cut further to reflect declining revenue or implement tax increases to generate more revenue.
“Moody’s noted, as I have for months, that we need to address our budget’s structural imbalance,” Rendell said in a press release regarding the outlook change. “We need sustainable recurring revenue to ensure a balanced budget this year and next year so we can invest in education and activities to recover from the national recession.”
If Pennsylvania passes a budget that includes additional or new revenue, officials plan to issue $300 million to $400 million of tax and revenue anticipation notes in February. A budget without the new revenue would necessitate borrowing $1 billion or more through a Trans sale around November.
The state typically does not rely on short-term debt for liquidity and last issued Trans in 1998, but declining revenue requires a liquidity boost.
“While the commonwealth has not borrowed for cash flow since fiscal 1998, it is anticipated to execute such a borrowing this year, with the size, timing, and nature of the borrowing dependent on the result of the budget negotiations,” according to a Moody’s report. “While it is not unusual for states to make use of cash-flow borrowing, Moody’s does consider an increase in cash-flow borrowing size from year to year to be a sign of stress.”
In addition, Moody’s pointed to the state’s history of budget stalemates. This is the eighth year that Pennsylvania failed to pass a budget by the start of its fiscal year on July 1.
“Delays in state budget adoption, while not new or unique to Pennsylvania, have become chronic in this decade, which Moody’s views with concern because it has reduced the commonwealth’s ability to respond quickly to shortfalls,” the report said. “It has also added instability and made financial planning more difficult for both the commonwealth as well as its local governments.”
Standard & Poor’s and Fitch Ratings last week affirmed their AA ratings for Pennsylvania, both with a stable outlook.
