As the world's fifth-largest economy, California enjoys a strong 'AA-' credit rating on its general obligation (GO) debt. Just seven years ago, California's 'A-' GO rating was S&P Global Ratings' lowest for any state. Better budget management that began in 2011 combined with an increase in personal income taxes--which drive much of the state's revenues--have led to a gradual recovery in California's credit quality. By all accounts this represents a job well done in the annals of municipal finance. But this spring when the state issued $2.1 billion in new debt that was snapped up by investors, we cited as a credit weakness the state's infrastructure profile--it has a backlog of deferred maintenance that even the governor's budget summary is calling "staggering."
- State and local governments are deferring maintenance on critical infrastructure assets they own and operate. Due to a lack of standardized reporting, it's difficult to quantify the extent of the maintenance backlog, but it could be significant.
- At high enough levels, deferred maintenance is a credit concern, and we think this will be an area of increasing focus in our analysis. Significant underspending in maintenance can reduce asset life and increase capital costs, pressuring a government's future financial flexibility. Failure to maintain and invest in infrastructure could also lead to slower economic growth or public safety lapses.
- Better disclosure would allow credit rating agencies and municipal bond investors to have better visibility into the relative ranking of state and local governments' deferred maintenance levels, but will take time to achieve.
- A standard system to measure and disclose deferred maintenance is likely to underline problems that may need to be resolved through a number of policy solutions, including potentially asset privatization and/or public private partnerships, especially if debt funding requirements grow to unsupportable levels for some states or local governments.