States are likely to step up bond issuance in fiscal 2009 in response to declining revenue, which will continue to worsen even after the national economic downturn ends, Standard & Poor's said in its 2008 "report card" on the states.
"For the next year, state budgets are likely to be strained because of revenue volatility amid the housing market decline and a general economic slowdown," credit analyst Robin Prunty, an author of the report, said in a release. "This could ultimately lead to significantly higher debt issuance to meet budget requirements, a trend seen in prior downturns."
The report, which was released Monday, said that state revenues will most likely continue to decline "well after the economy begins to rebound," reflecting the last downturn. Following the 2001 recession, nearly $30 billion of debt was issued by states to meet budget requirements and even though the recession was "relatively short-lived," state revenues were weak through fiscal 2004.
Already, California has increased its bond issuance by $3 billion, and many states have increased their short-term borrowing for cash-flow purposes, the report noted.
Weak revenues are not the only factor behind the expectation that states will increase bond issuance. The cost of retirement benefits will also push states to plan significant bond initiatives to deal with unfunded pension liabilities and other post-employment benefits, according to the report.
"A tight budget environment and the impact of financial market volatility on pension funding could accelerate bonding proposals," the rating agency said.
In addition, some states may entertain bond initiatives to stimulate economic activity or will face pressure to fund infrastructure improvements, which remains a high priority having received heightened public attention following the I-35 bridge collapse in Minneapolis.
States also were not immune to disruptions in the credit markets in the past year, particularly the collapse of the auction-rate market. To date, more than $10 billion of states' auction-rate securities have had to be restructured, the report found.
"Many states with auction-rate securities had to reposition or restructure their debt as demand in that market evaporated," Prunty said. "Fortunately, most states were relatively conservative with the structuring of their variable-rate securities and had proactively developed plans to reposition their debt with minimal financial impact up to this point."
The Standard & Poor's report echoes others that have predicted declines in revenues and a long recovery for states. A report released in June by the National Governor's Association and the National Association of State Budget Officers said that states probably would face financial troubles for three or four years following the current downturn.
Revenue estimates were below expectations in 20 states, on target in 14 states, and exceeded expectations in only 15 states, according to the two state groups.
NGA and NASBO said they expected spending pressures to "continue as demand for increased funding of programs, such as Medicaid, persist and states deal with looming long-term issues, such as funding pensions, demographic shifts, and maintenance and repair of infrastructure."
"Unfortunately, when revenue growth declines as a result of a weakened economy, spending pressures for social programs and health care increase," the two groups said
As of June, 13 states had been forced in mid-year to reduce the fiscal 2008 budgets they had enacted by $5.2 billion, the NGA and NASBO report said. That is in stark contrast to fiscal 2007, when only three states made cuts and fiscal 2006 when two cut budgets.
The report found 18 states were projecting negative budget growth for fiscal 2009 and four states were estimating negative growth for fiscal 2008 budgets. By contrast, only one state reported negative growth for fiscal 2007.