LOS ANGELES — Two rating agencies have downgraded Hawaii this year, but they didn’t go far enough, Bank of America Merrill Lynch analysts wrote in an Aug. 5 municipal market commentary, saying the state’s general obligation bond rating should be a notch lower than the agencies’ double-A level ratings.

The rocky recovery that has never quite taken hold has left most state governments battered — and based on economic talk of a double dip, it will be a long time before states can steer their economies on to smooth pavement again.

Even with one of the lowest unemployment rates at 6%, Hawaii has not been immune to the economic battering most states have experienced. Analysts said unique features like the state’s economic dependence on tourism make it vulnerable to a potential economic double dip.

“We are not very concerned about their ability to pay debt service,” said John Hallacy, municipal research strategist at Bank of America Merrill Lynch. “We know they care about their ratings and will shore up their finances, we would just like to see them do it in a more timely fashion.”

The report cited Hawaii’s high 8.6% debt-to-personal-income ratio, successive years of declining general fund balances, the weak funding status of the state’s retirement systems, and reliance on both domestic and Japanese tourism, which makes it vulnerable to economic cycles and unforeseen calamities.

This spring, Moody’s Investors Service downgraded Hawaii $4.9 billion of outstanding GO debt to Aa2 from Aa1, and Fitch Ratings dropped it to AA from AA-plus. Standard & Poor’s affirmed its AA in June.

The state plans to issue $500 million of GOs in the next six months or so. The last time it issued bonds was in January 2010, so the list of $1 million to $2 million of school construction projects has grown over the past year and a half, said Kalbert Young, Hawaii’s director of finance.

Young said 23 underwriters submitted qualifications when the state issued a request for applications recently.

“We did get an impressive list of firms,” Young said. “About 23 firms wanted to be qualified for all the bond issuances for the upcoming fiscal year. The list will be reviewed.”

Though analysts credit Hawaii for some solid fiscal practices, like not bonding for operation costs, the Aloha State is not immune to the current level of economic distress. Features that set it apart from other states have raised concerns among the rating agencies and researchers.

“The reasons the rating agencies listed for issuing the downgrades, we don’t necessarily disagree with,” Young said. “Gov. [Neil] Abercrombie has been trying to deal with those issues, most notably the unfunded [retirement] liability, and the revenue stream for the state, which has been significantly depressed.”

The state’s dependence on tourism with the potential of a double dip to the economy and the resultant slowdown raise some red flags with researchers.

“If we are headed for a slowdown and a double dip, it is realistic to think that there will be a curtailment in travel,” Hallacy said. “Hawaii gets a lot of travelers from California, so to the extent that California is doing okay, Hawaii will do okay.”

Hawaii also receives a significant chunk of its tourism revenues from Japan. The twin earthquake and nuclear disasters Japan experienced earlier this year haven’t had as extensive an impact on visits to Hawaii as originally projected, however.

Young said that Japanese tourism makes up just 10% to 20% of the overall market, which is not a major piece, though it is significant.

“Our numbers show that while there has been some slippage in the Japanese tourism sector, that revenue has been replaced by an increase in other sectors, such as increased visits by New Zealand and Australian tourists,” he said. “Tourism in Hawaii as an industry has been faring pretty well on a year-over-year basis for the last 18 months.”

Hawaii officials are monitoring predictions of a second economic slowdown, because Young agreed with researchers’ assessments that one could put a damper on tourism.

During his six months in office, Abercrombie also has looked at different methods of enhancing revenues, Young said.

In Hawaii, funding for education rests solely at the state level, unlike other states that split the cost of education between the state and local municipalities, counties, or districts.

Young said the governor is looking at public-private partnerships to tackle improvements needed for government buildings and also to ramp up improvements to school buildings.

The heavy debt burden is partially attributable to the state’s direct administration of its education system, as well as the courts and the welfare program, said Bank of America Merrill Lynch municipal research strategist Claire Voorhees.

“Hawaii always has high capital needs, because a lot of government buildings are housed in historic buildings,” Young said. “The upkeep is expensive.”

The governor’s strategy is to put people back to work in construction jobs, an industry that is a strong second to tourism in employing the state’s residents, Young said.

“The cost of capital is relatively cheap right now,” Young said. “The governor thought it would be an ideal time to take advantage of the cheap capital markets and put people back to work.”

In one respect Hawaii is not unique, in that it has been working to tackle pension fund issues. A report showed as of June 2010, the pension system was only 60% funded.

The state has implemented measures to change pension benefits for employees hired after July 2012 to increase employer contributions, which will curtail the growth in unfunded liability in the long run and help to increase the program’s overall funding levels, further reducing its unfunded liability.

On the other hand, Hawaii is delaying the increased contributions to the pension fund until 2013, Hallacy said.

“Quite a few states have delayed contributions in times of economic strain,” Hallacy said. “It’s legally something they can do, but it costs more in the long run.”

Another concern is that the state has depleted its emergency funds.

“A lot of the states have depleted their emergency funds and Hawaii is one of them,” Voorhees said. “They will have completely depleted the emergency budget reserve by the end of 2011 and they have really drawn down on their hurricane relief fund.”

The top revenues keep coming in lower than forecast and the general fund revenues have been coming in lower than projected, Voorhees said.

“With the depleted reserve funds on top of that, if the situation worsens in Hawaii, that is a big issue,” she said.

If the U.S. economy hits the skids again, Hawaii will not be alone in facing issues of economic distress.

Policy analysts at the Center on Budget and Policy Priorities, which issued a report in June looking at how well the states were doing in returning to stronger economic ground, are concerned about how continued problems at the federal level will impact the states.

“The states were facing major fiscal challenges even with the significant federal aid that was available. That money mitigated the need for cuts,” said analyst Phil Oliff.

The expiration of recovery funds means the states will no longer have that resource to help fill funding gaps, Oliff said.

For 2012, states are reporting shortfalls that total $103 billion, with only $6 billion in available federal recovery act money remaining.

“Due to declining federal assistance, fiscal year 2012 has proven to be nearly as difficult a budget year as 2010, when state budget shortfalls reached their peak,” Oliff said. “The federal government is focused on cutting spending. Those cuts will have a deep impact on the state’s fiscal budgets.”

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