With Pennsylvania state lawmakers in a continuing budget stalemate that led the governor to propose borrowing against liquor revenues, muni observers wonder how far the commonwealth can plummet in the capital markets.

The commonwealth enters the fourth month of its impasse knee-deep in budgetary one-offs.

"Pretty soon, Pennsylvania will be in a horse race with New Jersey to see who wins the award for the most rating downgrades," Villanova School of Business professor David Fiorenza said Wednesday after Gov. Tom Wolf called for securitizing $1.2 billion of future expected payments from the commonwealth's state-run liquor system.

The three-member Pennsylvania Liquor Control Board must sign off on the move.

Alan Schankel, a managing director on Janney Capital Market’s fixed income strategy team focusing on municipal research and strategy.
Pennsylvania could face more downgrades if it doesn't solve its structural budget problem, said Alan Schankel of Janney Capital Markets.

Wolf, a Democrat, said the proceeds would pay off a hangover deficit from fiscal 2017.

"It's not new revenue, it's money being moved around," said Alan Schankel, a managing director at Janney Capital Markets. "It doesn't deal with the problem of structural imbalance."

Pennsylvania is staring at a $2.2 billion gap for its current fiscal year. Democrat Wolf in July let a $32 billion spending plan become law without his signature, but he and the Republican-controlled lawmakers have yet to agree on a tax-and-revenue plan to fully fund it.

The Senate approved a plan over the summer, but the House of Representatives has balked, reflecting friction within the Republican Party, whose members control both houses. Efforts Wednesday to bring a state hotel tax and then a Marcellus Shale tax on natural gas drilling failed to come up for a vote.

The commonwealth, no stranger to tardy budgets, is attracting unwanted attention from rating agencies.

Two weeks ago S&P Global Ratings downgraded Pennsylvania’s general obligation bonds to A-plus from AA-minus. Moody’s Investors Service rates the bonds Aa3 while Fitch Ratings assigns its AA-minus rating.

Pennsylvania was nine months late with its fiscal 2016 budget. The spending plan the following year took effect without Wolf's signature.

Proposed revenue packages this time have emphasized stop-gap measures such as borrowing against revenue from the landmark 1998 settlement with tobacco companies, an expansion of gambling, and transfers from other state accounts. In addition, Pennsylvania has done some short-term borrowing.

"I don't see another downgrade in the near term, but there could be more over time if they don't deal with the structural problem," said Schankel.

One-offs will only accelerate Pennsylvania toward the single-A-rating category, according to Municipal Market Analytics.

"Reliance on borrowing, fund sweeps and expansion of gambling likely means that future budgets will become even more difficult to balance," MMA said. "Pennsylvania was recently awarded a downgrade to A-plus by S&P and the balance of the agencies aren’t likely to find its proposal to achieve budget
balance fiscally responsible.

"Pennsylvania state and local bonds generally are now at greater risk of underperforming the market."

In a statement, the liquor board said it has provided more than $15.8 billion in taxes and cash transfers to Pennsylvania's general fund since the agency’s inception, plus an additional $1 billion to support various liquor law enforcement efforts, treatment services and grants.

Annual cash transfers to the general fund -- "transfers of our own profit and operating capital" -- have not dipped below $80 million for more than a decade, it said.

“Although we have yet to discuss the proposal as a board or begin to delve into details of a potential arrangement, we pledge to work collaboratively with the Governor’s budget office to explore a revenue-backed contract to deliver significant immediate revenue while capitalizing on the PLCB’s long-term profitability," the board said.

Wolf's predecessor, Tom Corbett, tried to privatize the liquor-store system but could not rally his fellow Republicans in the face of union-backed Democratic opposition.

According to MMA, Pennsylvania is better positioned to cope with its problems than its troubled peers,

"Its legacy liabilities [debt, pension and other post-employment benefits] are more manageable," said MMA.

While Moody's pegs Illinois, Connecticut and New Jersey among the top five states for fixed costs, Pennsylvania ranks 10th. A Sept. 15 Moody's report had Connecticut's fixed costs at 31%, Pennsylvania's at 15%.

"The saving grace for Pennsylvania is that it's not in as deep a hole of some of its brethren, such as Connecticut," said Schankel.

Recent data from the Tax Foundation puts Pennsylvania's tax burden 15th among the four states while Connecticut, New Jersey and Illinois ranked second, third and fifth, respectively. That, said MMA, suggests room for Pennsylvania to raise recurring revenues.

Municipalities are accustomed to the dysfunction in Harrisburg, said Fiorenza, a former chief financial officer of Radnor Township, Pa.

"The township and borough CFOs in Pennsylvania are not relying on the state for any type of benchmark and will utilize all the necessary fiscal tools to keep their bond ratings stable for 2017 and 2018," he said.

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