S&P warns CT: Surging debt costs could lower bond rating

While legislators learned Wednesday how surging debt costs would hamper the next state budget, a major Wall Street credit rating agency downgraded its outlook for Connecticut for the same reason.

With Connecticut expected to issue bonds later this month, S&P Global Ratings assigned a “negative outlook” to the state’s bond rating.

This is a warning that the state could face a rating downgrade — and possibly higher borrowing costs in the next year or two.

“The outlook revision reflects our view that projected growth in fixed costs could rise to a level we believe could comprise a substantial proportion of the state budget and thereby hamper Connecticut’s budget flexibility as the state addresses large out-year budget gaps,” said David Hitchcock, a credit analyst with S&P.

Retirement benefit costs and payments on bonded debt are expected to equal nearly 33 percent of General Fund revenue in the 2017-18 fiscal year.

By comparison, those costs represented about 12 percent of the General Fund 20 years ago.

Analysts are predicting those costs — and particularly required contributions to the pension funds for state employees and for teachers — will continue to rise steadily through the early-to-mid 2030s.

Most of the problems tied to surging retirement benefit costs stem from inadequate savings habits that go back seven decades.

For example, about 82 percent of next year’s $1.3 billion contribution owed to the state employees’ pension fund is to compensate for insufficient contributions and investment returns in prior years.

State analysts briefed the legislature’s Appropriations and Finance, Revenue and Bonding committees on these issues Wednesday.

S&P also wrote in its latest report on Connecticut that “fixed cost growth has led to large out-year budget gap projections that could be difficult to manage following previous … tax increases.”

Gov. Dannel P. Malloy and the General Assembly ordered a historic tax hike worth more than $1.8 billion in 2011. And in 2015 — seven months after winning re-election on a pledge not to raise taxes — the governor signed another round of tax increases worth more than $650 million per year while also canceling about $220 million in previously approved tax cuts.

Despite those steps, the legislature’s nonpartisan Office of Fiscal Analysis estimates that state finances, unless adjusted, will run $1.5 billion in deficit in the fiscal year that begins next July 1.

S&P also warned that should fixed costs continue to rise, or should Connecticut defer pension contributions as it did prior to 2011, it could lower the state’s bond rating.

“It is discouraging but not surprising that S&P has revised their outlook to negative at this juncture,” Chris McClure, spokesman for the governor’s budget office, said Thursday. “ S&P’s change reflects that our fiscal situation poses very difficult choices for Connecticut, as we all know.  But, for many years, S&P and their rating agency peers disregarded pension under-funding, tacitly blessing the poor decisions that put Connecticut in this position.  Now that they have acknowledged the problem, and now that Connecticut is doing something to solve it, they are voicing concern that we may be spending too much of our budget on our pension. The reality is that if we are to solve our pension problem in a fiscally responsible fashion, we will have to spend more of our budget on it than we used to.”

Malloy’s budget director, Ben Barnes, announced earlier this fall that the administration is in talks with state employee unions to see if Connecticut can restructure payments into the employees’ pension fund. This would reduce surging costs somewhat, but also would mean the state would have to make larger payments in the late 2030s and into the 2040s.

But House Minority Leader Themis Klarides, R-Derby, called S&P’s warning “dispiriting, but not unexpected,” given state government’s fiscal history.

“Years of bad policy decisions have led us to this point where we have little room to maneuver and deal with the huge revenue swings,” she said.

“The continuation of a negative outlook, paired with a growing state deficit, speaks to why so many people have lost confidence in our state,” Senate Republican Leader Len Fasano of North Haven said. “This is why legislative leaders need to work together now to send a strong message to the public that we acknowledge the problems and that we can work together on solutions. We have to agree to and commit to the structural changes our state needs so we can address the concerns raised by multiple credit rating agencies.”

S&P did note that Connecticut enjoys high wealth and income levels, has a diverse economy, and that the current budget that is close to being in balance.

“S&P’s shift in its outlook for Connecticut reflects what we’ve known for some time: that our state’s long-term obligations and fixed costs are growing and that, if left unaddressed, can lead to serious challenges for future budgets,” state Treasurer Denise L. Nappier said.

The treasurer also noted “this is an outlook change, not a ratings change. Connecticut continues to earn a ‘strong’ rating from S&P for financial management of its budget, debt management and investing.”

Nappier said the one of the reasons why state employee pension contributions have grown in recent years — and why the teachers’ pension contribution will jump significantly in 2017-18 — is because Connecticut has reduced investment return assumptions in both programs.

Comptroller Kevin P. Lembo projected Thursday that this fiscal year’s budget is $82.3 million in deficit, a shortfall that represents less than one-half of 1 percent of the General Fund.

But the state’s assets are offset, S&P added, by large, unfunded liabilities in its retirement benefit programs and “weak financial reserves.”

Connecticut has just $235.6 million in its rainy day fund, a level equal to about 1.3 percent of annual operating expenses.

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