New Jersey absorbed its 10th downgrade in six years Monday, as S&P Global Ratings dropped the state one notch to A-minus because of expected budget pressures from increased pension burdens and revenue volatility.
"We base the downgrade on our expectation that state budget pressures will intensify in future years," S&P credit analyst David Hitchcock said in a statement. "Recent events have added incremental out-year budget pressure, in our opinion, to what is already a sizable structural budget imbalance driven primarily by pension underfunding."
New Jersey's appropriation-backed debt was also cut one notch by S&P to BBB-plus from A-minus. The state's government departmental appropriation-backed debt was lowered to BBB from BBB-plus and its moral obligation debt was dropped to BBB-minus from BBB.
After 10 downgrades since Gov. Christie took office in January 2010, New Jersey general obligation bonds are rated A2 by Moody's Investors Service, A by Fitch Ratings and A by Kroll Bond Rating Agency. Only Illinois is rated lower of the 50 U.S. states.
S&P retained a negative outlook saying that the state's pension liabilities "will remain a source of downward pressure on the rating."
Hitchcock noted that while the state is planning to incrementally increase pension contributions through the 2023 fiscal year, there is a lack of certainty on whether or not the state will continue to fund pensions based on current funding levels.
"At projected funding levels, pension funding is already a source of pressure on the state's budget, which could rise above projections, whether due to weak investment returns or revised actuarial assumptions," said Hitchcock. "In our view, a continuation of the current trend of declining pension funded levels could lead to diminished credit quality during our two-year outlook horizon."
Willem Rijksen, a spokesman for the New Jersey Department of Treasury, said the credit rating would have been "injured further" if Christie had not enacted pension reforms early in his administration. He said the Republican governor is increasing pension payments in a "responsible manner" with a total of $6.3 billion since he took office.
"Governor Christie has only signed bills reforming pension benefits and has never increased them," said Rijksen. "This stands in stark contrast to previous lawmakers and administrations, which routinely increased benefits for years."
Rijksen added that Christie has limited new bond debt compared to previous governors who increased borrowing by larger amounts.
Hitchcock said other risks to the A-minus rating include the possibility of "significantly below-budgeted revenue growth" for the 2017 fiscal year. The state is also at risk of an increased revenue loss in future years stemming from a legislative package approved as part of a reauthorization of the New Jersey Transportation Trust Fund that includes cuts to offset a fuel tax increase, according to Hitchcock.
Howard Cure, director of municipal bond credit research at Evercore Wealth Management, expressed concern about the TTF bill, which hiked gas taxes 23 cents a gallon for transportation projects, but cut the sales tax to 6.625% from 7% and phases out the estate tax. While the new gas tax revenue will pay for transportation projects, the offsetting tax cuts are estimated to lead to a $1.1 billion loss to the state's general fund by 2021.
"They addressed the transportation funding problem, but created another problem," said Cure. "It's a big enough hole in the budget even before taking away this revenue."
In order for New Jersey's outlook to be revised to stable, Hitchcock said the state needs to implement "credible pension reform" or demonstrate a sustainable funding commitment to pensions that "reverses the trend of growing liabilities and declining funded ratios." He added however that higher pension contributions could translate to less budget flexibility in the near-term and bring other budgetary challenges to the surface.
"Given the state's lack of reserves and high fixed costs, New Jersey would likely need to make other budget reforms to accommodate increases in pension funding," said Hitchcock.
"From an investment point of view, investors may want to wait until a new elected governor is in place," said Cure of how Christie's days running the state are numbered with his term set to expire in a year and talk that he may join the Trump administration before that. "A new governor that could work with the legislature on devising a plan could make some headway in terms of getting rid of their structural deficit."