Alan Schankel of Janney Capital Markets expects "robust" retail demand to compliment strong institutional demand on Illinois GOs
“I think if the budget thing does not reach a compromise, rating action by one or both of the other rating agencies would be just a matter of time,” said Janney Capital Markets’ Alan Schankel.

Moody's Investors Service on Friday lowered its outlook on Pennsylvania's general obligation debt to negative from stable, citing the commonwealth's four-month budget impasse.

Moody’s, which affirmed its Aa3 rating, said its outlook “reflects the difficulty the commonwealth is likely to have closing its structural budget gap in light of the contentious political environment.”

Analysts who cover the Keystone State don’t see Moody’s move as the end of the story.

“I think if the budget thing does not reach a compromise, rating action by one or both of the other rating agencies would be just a matter of time,” said Alan Schankel, a managing director at Janney Capital Markets.

The outlook shift affects $10.9 billion of bonds, said Moody's. It also affirmed the A1 and A2 ratings on the commonwealth's appropriation bonds, affecting $2.4 billion of debt.

All three major bond rating agencies downgraded Pennsylvania last year, citing chronic budget imbalance and a state unfunded pension liability estimated at $53 billion. Fitch Ratings and Standard & Poor’s rate the bonds AA-minus.

First-year Democratic governor Tom Wolf and the Republican-controlled legislature remain far apart on how to fund a roughly $30 billion spending plan for fiscal 2016. Only Pennsylvania and Illinois have unsigned budgets.

Both parties have invoked Pennsylvania’s increasingly shaky credit during budget debate.

The House of Representatives last week rejected Wolf’s latest proposal, a tax package that would have included a half-point increase in the personal income tax and a tax on natural gas drilling to cover a shortfall that he projected could reach $3.5 billion next year.

David Fiorenza, a Villanova School of Business professor, said rating agencies commonly review a municipality or state's outlook.

“Moody's is doing their due diligence, something Gov. Wolf and the legislature have not,” said Fiorenza, who doesn’t think the outlook would have fallen if Pennsylvania had passed its budget on time.

“All other signs pointed to a stable, healthy economy, but now agencies and school districts are looking for their annual funding,” he said.

School districts and social service agencies are already feeling the pinch.

The Keystone Alliance for Public Charter Schools said lack of state funding is forcing many school districts to reduce or suspend tuition payments to brick-and-mortar charter schools statewide.

“I think the school situation is like the canary in a coal mine. This budget impasse has already impacted school districts,” said Schankel. “Lottery winners are still getting their winnings. No pain is being felt across the board. But if school districts start to close or teachers are being laid off, then reality starts to set in.”

According to Moody’s, ongoing expenditures exceed ongoing revenues by about $2 billion and the structural gap is higher accounting for the commonwealth's pension contribution shortfalls relative to its actuarial required contributions.

“Amid its extreme political gridlock, the commonwealth will be challenged to find solutions to its fiscal imbalance,” said Moody’s.

Moody’s said successful implementation of revenue increases or expenditure cuts to close the state's large structural budget gap could trigger removal of the negative outlook or even drive the rating up. Moody’s would also like to see “substantial progress toward achieving stronger pension funding levels.”

Further declines in its financial position and an even more prolonged budget impasse could drive Pennsylvania’s rating further down, said Moody’s, which is also watching whether the state improves its pension funding.

“This action by Moody's is fully consistent with their previously expressed concerns regarding Pennsylvania’s persistent and chronic pension underfunding,” said Richard Dreyfuss, a Hummelstown, Pa., actuary and adjunct fellow with the Manhattan Institute for Policy Research.

“Unfortunately there also appears to be no scenario in the continuing budget impasse that would properly address the ever-increasing unfunded liabilities with compliant funding policies anytime soon.”

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