Moody’s Outlook Negative on State’s Long-term Debt

Swift on the heels of state union coalition SEBAC's failure to ratify Gov. Dannel Malloy's union concessions package, Moody's Investors Service lowered its outlook on the State of Connecticut's general obligation bond rating from stable to negative last week. However, it affirmed the Aa2 credit rating on expectations that Connecticut can fix its problems before it gets worse.

“Government is facing more scrutiny from rating agencies,” said Pete Gioia, vice president and economist at the Connecticut Business & Industry Association, Inc., several of whose member companies are located in north central Connecticut. 

Gioia felt Moody’s concerns are typical of any credit rating agency and Malloy is on top of things.

“I believe the governor is fully aware of these issues and the administration is moving in the right direction,” he said. “The revenue changes the government has put in place are substantial.”  

One hopes that is the case. But the revenue changes are hardly adequate and still not a done deal. Malloy's proposal to cut municipal aid to towns met with unanimous disapproval in the legislature and the government doesn’t have many tools on hand besides reducing state government jobs.  

For the longest time, state administrations have put a spin on numbers to make balance sheets look pretty. To Malloy's credit, he is the first governor in years to initiate transparency and bold austerity measures at a difficult time.

Still, his task gets more and more difficult. Several of the state's funding sources were on a one-time basis and any surplus that was built has no means as yet of being replenished. 

State Comptroller Kevin Lembo said in a July 1st press release that the state's general fund surplus of $85.5 million for 2011 masked a severe structural deficit. He said the surplus would have been a more than $1 billion deficit had the state not relied on significant one-time financial fixes.

“This is an example of when a surplus is not a surplus,” Lembo said. “Last year, our state was forced to do the financial equivalent of gluing petals back onto a flower in order to address a budget crisis. This repair carried us through the year, but our state needs significant budgetary reform to permanently repair Connecticut’s finances.”

Connecticut has approximately $14 billion in outstanding general obligation bonds and its resources are highly leveraged.

Moody’s negative outlook also applies to the state’s general fund obligations (rated Aa3), bonds supported by a special capital reserve fund (SCRF) make-up provision (rated Aa2), and the University of Connecticut (UConn) general obligation bonds – the State Debt Service Commitment (rated Aa2).

The agency’s rationale is built on the following concerns:

• Connecticut’s reserves are depleted and prospects for replenishment in the near-term are dim.
• The state’s pension funded ratios are among the lowest in the country and likely to remain well below average. Connecticut’s state employees’ retirement system (SERS) and teachers’ retirement system (TRS) had funded ratios of 44 percent and 61 percent respectively, as of June 30, 2010.
• The combined fixed costs for debt service and post employment benefits relative to the state’s budget are disconcertingly high.

“In the absence of a clearly articulated plan to achieve meaningful improvement in the state’s pension funded ratios and reduce its fixed costs, as well as progress toward adequate reserve levels, Connecticut’s rating could be downgraded,” the agency cautioned in its June 28th report.

While Moody officials haven’t said anything we already don’t know about the precarious state of the state’s long-term finances, the possibility that the rating could be revised downward on the heels of a negative outlook is enough cause for concern. 

“Moody’s was particularly concerned about the absence of a long-term strategy to address liabilities, given the apparent failure of the SEBAC agreement. The danger is that the state’s credit rating can actually change – as of now only the outlook has changed – which will significantly increase the cost of borrowing. As state bonds mature and the state has to refinance those bonds or issue new bonds, the higher cost will drain dollars from other parts of the state budget,” Fred V. Carstensen, a professor of economics at UConn, said.

He pointed out that because so much state government activity is in north central Connecticut, the threat of a downgrade to the credit rating would mean yet more economic troubles for the region – more loss of jobs in both the public and private sectors, loss of spending on goods and services, and yet more stress on the area economy.

Moody officials also expressed concern over Connecticut’s vulnerability to market volatility. Even small changes in the state’s income tax receipts, which are dependent on capital gains and the exercise of stock options, can result in large revenue fluctuations. Moody’s cited income data in 2008, where Connecticut’s millionaire residents (earning at least $2 million or more) made up only 0.2 percent of the state’s income tax filers but accounted for as high as 23 percent of the state’s tax liability. The current economic downturn will exert downward pressure on this source of state revenue.

Thomas F. Scanlon, CPA, Borgida & Company, P.C., in Manchester, said tax receipts tend to track the economy. During economic expansions, higher income earners get higher bonuses, may exercise and sell stock options and have other capital gains. These taxes in turn fill the coffers of the state, at least for a short time. During an economic slowdown bonuses dry up, options become worthless and capital gains turn into capital losses. Less income for taxpayers means less income to the state.

“The problem now is that the tax income to the state is less stable. This hurts the budget and undermines the ability to deal with longer-term structural issues of employee pensions and post retirement benefits,” Scanlon said.

Enfield-based John Turgeon, CPA, said it was time to take another look at Connecticut’s generous benefits package for retirees in the government sector.

“We have one of the most generous benefits packages in the nation,” he said, adding that future generations will suffer if cost reductions are not made now.

Turgeon’s daughter is studying to become a teacher, a field with a high number of recent retirees. Yet, those vacant positions are not being filled in light of budget constraints.

“Towns have fewer teachers because of budget cutbacks and are not hiring new ones,” he said. “So my immediate concern is not so much about the stability of the teachers pension fund in the future. It’s whether my daughter will find a job upon graduation.”