- The record economic expansion translated to credit stability across U.S. public finance in 2019.
- Key credit risks require active management and funding, which continue to strain budgets.
- Low interest rates spurred taxable bond issuance in 2019 but not major infrastructure investments, and rates will remain low.
- The economic outlook has improved but downside risks remain; see a precarious balance ahead for 2020.
This year was notable on many fronts. The decade winds down with the longest and slowest economic recovery in history, the lowest unemployment rate in 50 years, and equity markets reaching new highs. The post-tax reform stimulus continued to support expanding revenues, which has been positive for state budgets and for the other sectors in public finance that rely on state funding. These generally positive trends, along with interest rate reductions from the Federal Reserve, the First Circuit Court decision on the status of special revenue secured debt in bankruptcy (see "Has S&P Global Ratings' View On Special Revenue Debt Changed Following The First Circuit Decision?," published May 1, 2019, on RatingsDirect) and other policy shifts led us to publish a mid-year outlook update for the first time ("U.S. Public Finance Midyear Outlook: Will The Sizzle Fizzle?", July 18) that covered all sectors.
When we released our nine sector outlooks for the year in January, stability was a consistent theme and that has been the credit story this year. In fact, the overall public finance rating distribution improved modestly in 2019 to date ("U.S. Public Finance Upgrades Drop But Still Surpass Downgrades," Dec. 6). Upgrades continue to outpace downgrades, albeit at a slower pace, but there is variation by sector. It is noteworthy that 96% of the outlooks are stable.
As we look toward 2020, the economic forecast has improved. Our economists have raised their forecast for real GDP growth to 1.9%, compared to 1.7% in September. The risk of recession over the next 12 months has also eased and is estimated at 25%-30% compared to 30%-35% earlier in the year ("Fewer Signs of Scroog-ing Up U.S. Growth in the New Year," Dec. 4). The forecasts for robust consumer spending, rising real wages, and healthy housing starts are noteworthy because they are key to revenue generation across public finance. While the economic forecast has improved as we head into 2020, growth will revert to a slower pace. The key question for credit stability in U.S. public finance: Will the pace of economic growth generate sufficient revenue to keep pace with spending pressure?
So what does this mean for U.S. public finance in 2020? We will explore this sector-by-sector in our nine 2020 outlooks which will be released in January (click here for the webcast schedule).
A Look Back At Key Credit Risks In 2019
During the year, we focused our research on several risk topics that we thought would be significant from a credit standpoint. We also published over 100 event-driven articles to give timely credit focus to a range of policy, budget, and natural disaster events that we thought were significant. We continued our ongoing commitment to enhancing the transparency, relevance, and clarity of our criteria. In total we had two criteria releases and four guidance releases including updated guidance on how pension and other post-employment benefits (OPEB) are analyzed for state and local governments.
Environmental, social, and governance (ESG)
S&P Global Ratings has a long record of incorporating environmental, social, and governance (ESG) factors into its analysis of public finance entities including U.S. state and local governments, school districts and charter schools, public housing agencies, public utilities, universities and colleges, health care providers and other municipal enterprises. In 2019 we published an article that highlighted a two-year review of ESG factors in our criteria and how they influenced, positively or negatively, the credit profile of our U.S. public finance entities. From Jan. 1, 2017, to Dec. 31, 2018, we found that ESG factors were primary credit drivers in 34% of the total 3,315 U.S. public finance rating actions. Also covering the ESG topic was a targeted article on coal producing states ("Long-Term Credit Challenges Facing U.S. State And Local Governments In Coal-Producing Regions," Sept. 25). Finally, we continued our coverage on green bond trends in public finance ("2019 U.S. Municipal Green Bond And Resiliency Outlook: Will The Self-Labeled Market Rebound?," March 14).
Challenges remain with respect to data and disclosure, although we anticipate that, over time, disclosure from obligors will converge to better highlight ESG issues. We also believe ESG analysis of public finance entities will increasingly require a qualitative view of an entity's capacity to anticipate a variety of long-term plausible disruptions to its credit fundamentals, as well as an assessment of management's awareness and adaptive capacity to respond.
The U.S. municipal market has always faced credit exposure to hurricanes, floods, drought, fires, tornados, earthquakes, and other catastrophes. This was true in 2019 when wildfires and extreme weather events were in the headlines. In addition to episodic event risk from natural disasters, S&P Global Ratings believes it is important to consider the current long-term credit implications of the physical impact of climate change that municipal debt issuers must contend with. In our view, the risks are on two fronts: from the growing cost of extreme weather events; and more gradual changes to the environment affecting land use, employment, and economic activity that support credit quality.
Credit cycle peak
The duration of the economic expansion highlighted above has brought a focus across S&P Global Ratings on evaluating what will happen in various sectors when the credit cycle turns. We continued our publishing on this in 2019 to provide forward looking views on how well public finance obligors are positioned to weather a turn in the economic cycle. Of particular note this year was a focus on states and how their government framework can be key to navigating changing economic conditions ("When The Cycle Turns: Government Framework Is A Significant Factor In States’ Ability To Navigate Downturns," May 23). We also looked broadly at U.S. airports given the surge in infrastructure financing ("When The Cycle Turns: U.S. Airport Balance Sheets--And Exposures--Increase With Traffic," July 9).
We believe that management of cyber-related risk is increasingly important in public finance. Our analysis focuses on how local governments prepare for, respond to, and recover from cyberattacks. While all our sector-specific criteria allow for analysis of the credit risk presented by cyberattacks, we continued our coverage of some of the unique cyber issues facing government and not-for-profit issuers ("For U.S. Municipal Issuers, Proper Governance Can Mitigate The Credit Risks From Cyberattacks," June 3). It is also noteworthy that we had our first rating action directly tied to a cybersecurity breach in 2019 (see Princeton Community Hospital, W.Va., April and November reports).
|Cyber Governance Credit Considerations|
|Infrastructure and staff investments||Liquidity||Contingent liabilities|
|Employee training||Accountability||Constituent trust|
Pension and other post-employment benefits
We continue to see underfunding of pension and OPEB as a key credit issue. Our cross-sector team has worked extensively to analyze this risk and provide robust analysis to the market. As government and not-for-profit entities struggle with growing unfunded liabilities and related budget pressures, our analysis continues to focus on providing greater transparency about the associated short- and long-term costs of funding these obligations. See "S&P Global Ratings' U.S. Public Finance 2019 Pension And OPEB Research Recap," Dec. 11), for updates to our annual 50-state pension and OPEB survey, a comparative look at pension and OPEB trends for the 15 largest cities, key takeaways for new OPEB accounting standards, our credit view on pension funding practices that drive growing costs, as well as regional insights and event-driven reviews on specific reform measures and our analytical approach.
Technological change continues at a rapid pace across public finance. It will require ongoing analysis to assess benefits and risks and the potential impacts on credit quality. Our reports this year that highlighted this topic include: "Consolidation Or Closure: The Future Of U.S. Higher Education?," March 14; "The Drawbacks And Benefits Of U.S. Local Government Consolidations," March 21; and "Effective Management Continues To Enable Not-For-Profit Health Care To Adapt," May 13.
Fiscal sustainability has been a key focus for us as slower economic growth has become the new normal and demographic changes ("U.S. States May See Negative Revenue Effects From Aging Demographic Trends," Feb. 14) continue to weigh on revenue generation and service delivery. The economy was buoyed this year due to the lingering federal stimulus following tax reform, but we expect that this will moderate ("Credit Conditions: In The Mist Of Mixed Economic Signals, U.S. State And Local Credit Quality Remains Strong," Oct. 29).
Infrastructure and deferred maintenance
Infrastructure deficiencies in the U.S. are widely known but measuring the size of this deficit and how it will be funded will be a continued credit focus for us as issuers in the municipal market fund the majority of infrastructure in the U.S. Our review of debt profiles across the 50 states ("As U.S. State Debt Levels Moderate, Transportation Funding Takes Center Stage," June 11) highlights a trend of restrained debt financing despite the prolonged recovery and record low interest rates. We expect this conversation to continue.
Federal fiscal and policy changes
We close 2019 with the lasting effects of one of the most significant shifts in the federal, state, and local government fiscal relationship in decades--the Tax Cut and Jobs Act. Fiscal interdependencies as well as regulatory and policy linkages with the federal government and how that may influence credit quality will continue to be a credit focus. We highlighted the range of implications relating to tax reform for public finance issuers' credit quality, both short and long term, and we believe that the impact skews negative over the long term despite the surge in revenue collections in 2018 and 2019 ("Thanks To A Delayed SALT Effect, U.S. State April Income Tax Collections Bounce Back," May 14; "U.S. States Take Advantage Of A Prolonged Economic Expansion," May 16). We are watching closely how trade tensions will influence the economic forecast and play out across regions ("Fewer Signs Of Scrooge-ing Up U.S. Economic Growth in the New Year," Dec. 4). With the presidential election looming in 2020 we expect this to be a hot topic.
A Look Across Sectors
- With Oil Price Volatility, Recent Economic Gains In U.S. Oil-Producing States Are At Risk, March 12
- U.S. State Pension Reforms Partly Mitigate The Effects Of The Next Recession, Sept. 26
- U.S. States Are Slow To Reform OPEBs As Decline In Liabilities Masks Increased Risk, Dec. 3
- Fifteen Largest U.S. City Pensions See Modest Gains In 2018, But Recession Risk And Rising OPEB Cost Challenges Persist, Sept. 23
- 2019 Update Of Institutional Framework For U.S. Local Governments, Oct. 22
- U.S. Independent Schools’ Fiscal 2018 Median Ratios Are Steady, With A Stable Sector Outlook For 2019, Feb. 28
- Fiscal 2018 U.S. Charter School Sector Medians: Overall, Enrollment And Financial Performance Improved, June 6
- S&P Global Ratings Introduces 2019 Charter School Briefs, Dec. 9
- U.S. Charter Schools 2019 Year In Review, Dec. 11
- U.S. Not-For-Profit Health Care Pensions: 2018 Funded Ratios Remain Solid And Benefit From The Increase To Bond Rate, July 11
- U.S. Not-for-Profit Acute Health Care Ratios: 2018 Medians Show Operating Margin Improvement But Are Otherwise Stable, Sept. 4
- U.S. Not-For-Profit Senior-Living Sector's Stability Is Built On Favorable Demographics, Strong Demand, Oct. 31
- U.S. Public College And University Fiscal 2018 Median Ratios: The Disparity Between Higher- And Lower-Rated Entities Persists, June 25
- U.S. Not-For-Profit Private Universities Fiscal 2018 Median Ratios: Overall Stability Continues Despite Lingering Issues , June 25
- Recession, Recovery, Rivalry: 10 Years Of U.S. Higher Education Medians, July 2
- U.S. Higher Education Is Learning To Manage Its Own Risk, Dec. 2
- U.S. Higher Education 2019 Year In Review, Dec. 11
- An Influx Of Capital Is Set For West Coast Housing Affordability Challenges, July 29
- Home Is Where The Funding Is: West Coast Housing Issuers And The Recent Capital Flow, Oct. 10
- U.S. Public Finance Report Card: State Housing Finance Agency Programs Show Stability Throughout Economic Expansion While Meeting Affordability Needs, Oct. 17
- U.S. Public Finance Report Card: Housing Finance Agencies Are On Solid Foundations Amid Shaky Federal Landscape, Oct. 18
- An Update On How The Revised U.S. Municipal Retail Electric And Gas Criteria's Implementation And Market Trends Have Affected Ratings, June 5
- Despite ERCOT’s Price Spikes, Texas Public Power Utilities Remain Resilient, Sept. 4
- Sector Review: Despite The Risk Of Shutdowns, GARVEE Bonds Continue Benefiting From Government Support, Feb. 28
- Credit FAQ: Final Update To S&P Global Ratings' U.S. And Canadian Not-For-Profit Transportation Infrastructure Enterprises Criteria Implementation, July 24
- U.S. Municipal Water And Sewer Utility Sector Is Stable As Median Ratios Show Improved Finances, Aug. 23
- A Recent Court Ruling Has Little-To-No Impact On U.S. Municipally Owned Sewer System Credit Quality, May 30
In addition to several criteria articles and requests for comment on proposed criteria changes, we released an important guidance document that provides enhanced transparency on our approach to evaluating pension and OPEB liabilities for state and local governments ("Guidance: Assessing U.S. Public Finance Pension And Other Postemployment Obligations For GO Debt, Local Government GO Ratings, And State Ratings," Oct. 7) and housing cash flow analysis ("Guidance: U.S. Public Finance: Cash Flow Scenarios And Assumptions For U.S. Public Finance Housing Bonds," Sept. 4)
- Issue Credit Ratings Linked To U.S. Public Finance Obligors' Creditworthiness, March 26
- Guidance: Issue Credit Ratings Linked To U.S. Public Finance Obligors' Creditworthiness, Nov. 20
- U.S. Federally Enhanced Housing Bonds Rating Methodology, Nov. 12
- Guidance: U.S. Federally Enhanced Housing Bonds Rating Methodology, Nov. 12
Criteria requests for comment
- Not-For-Profit Transportation Infrastructure Enterprises: Methodologies And Assumptions, July 30
- Methodology For Rating U.S. Public Finance Rental Housing Bonds, Nov. 4
This report does not constitute a rating action.
|Primary Credit Analyst:||Robin L Prunty, New York (1) 212-438-2081;|
|Sector Leaders:||Martin D Arrick, San Francisco (1) 415-371-5078;|
|David N Bodek, New York (1) 212-438-7969;|
|Geoffrey E Buswick, Boston (1) 617-530-8311;|
|Theodore A Chapman, Farmers Branch (1) 214-871-1401;|
|Kurt E Forsgren, Boston (1) 617-530-8308;|
|Jane H Ridley, Centennial (1) 303-721-4487;|
|Lisa R Schroeer, Charlottesville (434) 529-2862;|
|Jessica L Wood, Chicago (1) 312-233-7004;|
|Marian Zucker, New York (1) 212-438-2150;|
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