Moody's Investors Service gave stable outlooks to the state and local government sectors for 2016.
In a report issued Friday, Moody's Analyst David Strungis and three other Moody's professionals said positive and negative factors affecting the local government sector were in balance.
Property tax revenues are likely to grow at least 2% and as much as 3%, they wrote.
However, the increase in local government tax revenues has been uneven across the country. The one-year full value percent changes were greatest in west coast states, Plains states, Texas and a few surrounding states, some Great Lakes states, North Carolina, and Florida. The weakest performers were in Maine, New York, Rhode Island, New Jersey, Maryland, Illinois, Colorado, and Arizona. This unevenness is expected to continue.
Most localities benefit from strong institutional framework supporting their credit ratings. The institutional framework consists of the local governments' abilities to adjust tax revenues, user fees, and spending to address potential financial problems.
Strungis and his colleagues said that the governments' growing net pension liabilities will be a long-term drag on the sector. Servicing these liabilities will "be increasingly onerous on local government budgets."
Certain local government sectors remain pressured, the analysts wrote. These include cities, counties and school districts in Illinois and cities and counties in West Virginia.
Of cities, counties, and school districts, the third will have the hardest time in 2016, as they are facing growing competition from charter schools.
The analysts wrote that the number of general obligation credits in the local government sector with speculative grades has increased in the past year to 66 from 41.
On the state sector, Moody's senior vice president Kenneth Kurtz and five others said the continuing economic recovery is helping the states but that increasing Medicaid costs pose a challenge.
The analysts expect there will be from a 2% to 3% inflation-adjusted increase in U.S. gross domestic product in 2016. This should increase tax revenue by from 4% to 5%. This would be less than the 6% increase expected in this year.
States' spending on Medicaid continues to rise moderately. However, states generally manage this increase, the Moody's team wrote.
Two thirds of states are making contributions for pensions at or close to actuarially determined levels. "We expect pension cost growth will pause for most states in 2016, as the effect of favorable asset performance in 2013 and 2014 is recognized."
States with major pension liabilities like Illinois, New Jersey, and Pennsylvania will continue to have financially stressed positions.
The analysts said that states that draw substantial revenues from the oil and coal sectors will also face challenges. Oil prices probably will remain comparatively low. This would hurt Alaska, Louisiana and Oklahoma.
Environmentally-driven regulations and competition from cheap natural gas will continue to hurt West Virginia, they wrote.
Finally, states with economies that have substantial exports to China may also feel a squeeze as China's economy cools down. The State of Washington, where exports to China account for 4.8% of gross domestic product, may particularly feel a sting.
In the local government outlook report, Kurtz and his associates included a sidebar about lessons from recent defaults and bankruptcies. There is a waning taboo associated with municipal bankruptcy, they said.
The experience of the recent bankruptcies and debt restructurings in Vallejo and Stockton, Calif., Detroit, Central Falls, R.I., Jefferson County, Ill., and Harrisburg, Pa. have shown that recoveries for bond debt has generally trailed that for pensions, they wrote. Central Falls is the exception in this group. Other post-employment benefits have also frequently taken substantial cuts, though in Jefferson County and Harrisburg they emerged unscathed.
From this experience, the analysts project that recovery rates for bond debt in bankruptcies is likely to remain below the averages found since World War II.
