New Jersey downgraded ahead of $4.3B sale on structural deficit woes
S&P Global Ratings downgraded New Jersey's general obligation bonds to BBB-plus from A-minus Friday afternoon based on steep revenue losses triggered by the coronavirus.
Citing economic headwinds caused by the ongoing COVID-19 pandemic, the rating agency took the action ahead of the state's planned $4 billion-plus GO sale this month, after two other agencies affirmed the state's rating. S&P also revised the credit outlook to stable from negative.
"The downgrade reflects our view that New Jersey will continue to have a significant structural deficit that will be difficult to close in the coming years because of decreased revenues as a result of the COVID-19 pandemic, combined with high and increasing debt, pension, and other postemployment benefit liabilities," S&P credit analyst David Hitchcock wrote in his report.
New Jersey has now been downgraded 13 times since 2011. The latest downgrade places S&P's New Jersey rating one notch below Moody’s Investors Service and Fitch Ratings, which both affirmed the state, at A3 and A-minus with negative outlooks, respectively, this week, Kroll Bond Rating Agency rates New Jersey bonds A with a stable outlook.
Howard Cure, director of municipal bond research, said a recent uptick in COVID-19 cases and risks of further state shutdown orders coupled with the state's lingering pension struggles may have factored into the S&P downgrade.
"They decided to extrapolate more in terms of the risks involved of what could go wrong and not give them any cushion about revenues improving or receiving additional federal aid," Cure said.
New Jersey is slated to sell $4.3 billion of COVID-19 GO bonds the week of Nov. 16 broken up into $2.15 billion of Series A tax-exempt debt and $2.15 billion of Series B taxable securities.
Hitchcock noted the bonds will be sold at 12-year maturities. The $4.5 billion of net proceeds after bond premium from the transaction, he said, will equal about 11% of fiscal 2021 appropriations on a 12-month basis.
Bank of America is underwriter for the transaction, which is scheduled four months after Gov. Phil Murphy signed the New Jersey COVID-19 Emergency Bond Act authorizing GOs with up to 35-year maturities to combat revenue losses resulting from the virus. State Treasurer Elizabeth Maher Muoio previously forecast revenues would be $5.6 billion less than February's projections, but on Friday announced revenues are $398 million above those latest estimates.
“It’s important to remember that the state’s high fixed costs are largely a result of legacy initiatives inherited after decades of mismanagement," Muoio said in a statement in response to the S&P downgrade. "Prior to the pandemic, we had made significant progress in successfully driving down the long-term structural deficit we inherited. We believe we have taken the steps necessary to position New Jersey on a path to resume this responsible approach and emerge from this recession stronger than before.”
New Jersey previously explored issuing some short-term debt through the Federal Reserve's Municipal Liquidity Facility before BofA advised it to sell long-term bonds instead due to market conditions.
Despite New Jersey's credit challenges, analysts expect the state's upcoming bond sale will be will received.
J.R. Rieger, owner of Rieger Report LLC, said New Jersey would benefit because of high demand and limited supply of Garden State GO debt. He noted that Illinois, which is the only state with lower-rated state bonds, still received favorable rates for its recent GO deal.
“Demand for the bonds should already be strong as there is just not a lot of supply of bonds with incremental yields," Rieger said.
Cure also said the deal will still likely see demand since there is so little New Jersey GO paper available, but that investors will take a cautious approach to the deal because of unknowns about whether rising COVID-19 cases will prompt state shutdown orders. The next stimulus package, he said, will likely provide “diminished” aid for state and local governments since Democrats failed to gain the seats to control the U.S. Senate.
“There will likely be some aid for states, but not a tremendous amount,” Cure said. “The more money the state receives from the federal government the more it would be able to put in reserve.”
The negative outlook reflects expectations that New Jersey will be challenged in restoring budget balance over the next two fiscal years due to a lack of meaningful reserves and growing pension contributions, Moody’s analyst Baye Larsen wrote in her report Thursday. Resolution of the negative outlook, she said, hinges largely on the severity and duration of the pandemic.
Richard Raphael, president of Verify Financial, said investors might be reluctant to invest in New Jersey debt given the state’s longstanding fiscal challenges prior to the pandemic, stemming mainly from a steep pension burden.
New Jersey has the worst pension-funding rate of the 50 U.S. states at an estimated 33% for the 2020 fiscal year, according to Pew Charitable Trusts. The state budgeted $4.7 billion for pension payments in the current 2021 fiscal year, which puts it at just under an 80% actuarially determined contribution level.
“They are going to have a fairly heavy lift to absorb debt service on the bonds as well as the phase-in of the pension requirements,” he said. “If there has to be more shutdowns from COVID that just adds to the risk.”