The COVID-19 pandemic and sudden-stop recession contributed to unprecedented rating volatility in 2020. The record economic expansion ended abruptly in March, replaced with a sharp decline in GDP, surging unemployment, and reduced consumer demand. This has created major revenue and spending challenges across our rated universe. After 10 years of upgrades outpacing downgrades, that shifted abruptly in 2020. The majority of rating actions have been negative outlooks to date (80%).
The challenges associated with the pandemic have been actively managed. Most public finance entities steadily improved their financial reserves during the record economic recovery that preceded the pandemic and this provides some financial flexibility to react to budget shortfalls or other unforeseen circumstances in a timely manner. Most have proactively managed their budgets which has lessened the credit pressure.
Federal fiscal and monetary policy provided significant credit support. The actions of the federal government were swift and supportive, which bolstered the economy, mitigated some budget pressure and stabilized the municipal market--all of which helped meet the challenges of 2020. The magnitude and duration of the pandemic are testing whether it was enough to bridge to normalized economic and health conditions.
The pandemic and its aftermath will continue to dominate credit conditions in 2021. Despite a vaccine in sight, the virus curve is spiking and there is likely to be additional economic damage ahead in the U.S. We expect the aftershocks from 2020 will be reverberate for many years in U.S. public finance and will continue to be felt unevenly by sector and state.
This Year Won't Be Over For Years To Come
The extraordinary events of 2020 will likely shape the decade ahead. As the pandemic has continued to spread this year, public finance issuers across the U.S. have had to navigate the social, financial, and economic effects of the disease. We have been and will continue to update our views on credit conditions across sectors and share them via published commentary, webcasts, and our bi-weekly newsletter (www.spratings.com). Throughout the year we have received many inquiries from market participants on our rating approach (see "Credit FAQ: COVID-19, Recession, And U.S. Public Finance Ratings," published on RatingsDirect on May 13). Below, we discuss what we think will be the key issues in municipal finance in 2021.
Economic Update: A Ho-Hum Holiday And A Sluggish New Year?
As we look forward to 2021, the economic forecast has key uncertainties. Our chief U.S. economist has recently updated the forecast ("Staying Home For The Holidays," Dec. 2) with key highlights:
- The U.S. economy, which has recouped two-thirds of the economic losses from the COVID-19 recession, is showing signs of weakness this holiday season in the midst of climbing COVID-19 infection rates.
- S&P Global Economics expects real GDP to contract 3.9% this year and not get back to precrisis levels until the third quarter of 2021 The U.S. unemployment rate won't reach its precrisis low until after 2023.
- We have said, since June, that it's not a far-fetched possibility the U.S. economy could see a scenario of no more fiscal stimulus and a COVID-19 resurgence that cripples growth in the fourth quarter, which we are seeing now. In our downside scenario, GDP would drop by 4.4% in 2020 and would rise by only 0.8% in 2021.
- But there may be reasons to be joyful. In our upside scenario, reopenings take place sooner than we thought amid promising treatment and vaccine news, with the government providing additional support in the tune of $1.5 trillion. The U.S. economy contracts by 3.8% in 2020 and rebounds 4.5% in 2021.
(See Appendix for full economic forecast data.)
The year started with three U.S. public finance (USPF) sectors on negative outlook: higher education, ports, and mass transit. By April 1, all sector outlooks in USPF were negative due to the rapidly declining economic forecast and uncertainty around the pandemic. (see "All U.S. Public Finance Sector Outlooks Are Now Negative"). Sector outlooks are a macro, forward-looking view on where we see credit trends in the year ahead. The sector outlooks have remained negative since then, reflecting ongoing pressure that credits face across the country. To date, we have taken more than 1,600 rating actions (see "COVID-19 Activity In U.S. Public Finance") that have had a decidedly negative bias but the majority of actions have been outlook changes (80%). Downgrades have dramatically outpaced upgrades through three quarters of 2020, with only 0.27 upgrades for every downgrade. This is notable because downgrades have not outpaced upgrades since 2011.
Will U.S. Public Finance Be Back On Track In 2021?
We will provide detailed insights on this question across sectors when our 2020 credit outlooks are published in January. In advance of these more detailed sector views, the following considerations will be important to economic recovery and credit direction for USPF in 2021:
An uneven health recovery will continue. Despite differences in state and local protocols and virus infection rates, the recent surge of COVID-19 cases across the U.S. has affected nearly all states and contributed to increased social-distancing measures and restrictions. We expect this to last until a vaccine has been widely distributed, presumably in mid-2021. This will continue to influence consumer demand, including services such as transportation and higher education.
Economic and credit conditions remain uneven. State revenue collections for March through September ranged from a 10% decline to 3% growth year over year, according to the Brookings Institute. Credit conditions have mirrored this variability. We have taken over 1,600 rating actions since the onset of the recession, affecting about 8% of our rated universe, 80% being outlook changes. The sectors most affected through 2020 are transportation (over 90% experienced a negative outlook or downgrade), higher education (about 40% currently carry a negative outlook), and states (20% have a negative outlook) (see "COVID-19 Activity in U.S. Public Finance").
Federal stimulus hasn't addressed revenue decline. Swift federal stimulus to stabilize the financial markets helped offset the spending requirements of the pandemic. For many public finance entities in the U.S., revenue deterioration has been a more significant challenge--unaddressed by stimulus--contributing to budget pressure. Given balanced budget requirements, spending cuts will be part of the solution. State and local government represent 11% of total U.S. GDP, so this will continue to weigh on the economy.
What we think and why
Fiscal flexibility will diminish despite proactive management. Most public finance entities started 2020 with strong financial reserves, providing flexibility to react to COVID-induced budget shortfalls. Many implemented timely spending reductions, as state and local government employment reductions of 1.3 million (6.4%) since the onset of the recession indicate. Yet, with no additional stimulus, reserve reductions will limit flexibility, and spending cuts will become trickier when they affect core services such as education, public safety, and social service programs.
Federal fiscal and policy direction will be a key focus post-election. U.S. fiscal federalism allows significant autonomy for the state and local government and enterprise obligors that comprise the municipal market. Yet fiscal interdependencies, as well as regulatory and policy linkages with the federal government, influence their credit quality. For example, Medicaid, the co-funded health care entitlement program, represents nearly 30% of total state spending.
A healthy and functioning municipal bond market is important to recovery. Short-term and long-term debt issuances have provided liquidity and restructuring options at cost-effective rates. The Municipal Liquidity Fund and other actions by the Federal Reserve which helped stabilize the bond market will end on Dec. 31, so credit and ongoing market stability will be something to watch in 2021.
What could go wrong
Duration of the virus. Spiking infection rates for a long duration and any delay in the widespread availability of effective immunization will deepen economic contraction and delay recovery. In this scenario, uneven credit conditions would continue in 2021.
ESG Was The Big Story In 2020
S&P Global Ratings has a long record of incorporating ESG factors into its analysis of USPF entities based on factors embedded in our sector-based criteria. In an effort to increase transparency regarding how the most relevant ESG factors affect an entity's creditworthiness we published an update to key ESG credit factors related to criteria frameworks with sector-by-sector analysis ("Through the ESG Lens 2.0: A Deeper Dive Into U.S. Public Finance," Feb. 27). We also launched ESG paragraphs in all credit reports covering new bond sales and reviews to add transparency on an issuer basis.
As health and safety issues played out throughout 2020 along with wildfires, hurricanes, and social unrest, the credit effects were elevated (see "Scenario Analysis Shines A Light On Climate Exposure: Focus On Major Airports, Nov. 5; "Extreme Weather Events: How We Evaluate The Credit Impacts In U.S. Public Finance," Nov. 2; and "Better Data Can Highlight Climate Exposure: Focus On U.S. Public Finance," Aug. 24).
We launched our first ESG Report Card ("ESG U.S. Public Finance Report Card: Tri-State Region Governments And Not-For-Profit Enterprises," Oct. 28) and also participated in the launch of the ESG Pulse in July, which is a-cross practice publication that includes rating activity and case studies across S&P Global Ratings (see the most recent, "The ESG Pulse: COVID-19 Vaccine Hope As Second Wave Sets In," Nov. 19).
We also continued to focus on pension and other post-retirement benefits (see "S&P Global Ratings' U.S. Public Finance 2020 Pension And OPEB Research Recap," Dec. 8) and cybersecurity risks that were elevated at points during the year ("Cyber Risk In A New Era: Disruptions And Distractions Increase Challenges For U.S. Public Finance Issuers," Oct. 19, and "U.S. Public Finance Issuers Must Be Nimble To Fend Off Cyberattacks Or They Could Face Credit Fallout," Feb. 25)
A Look Across Sectors
- Medicaid Diagnosis: U.S. States’ Growing Caseloads Come With Rising Costs, Dec. 8
- Infrastructure After COVID-19: Risk Of Another Lost Decade Of U.S. State Government Capital Investment, Oct. 29
- U.S. States Mid-Year Sector View: States Will Continue To Be Tested In Unprecedented Ways, July 13
- Sudden-Stop Recession Pressures U.S. States' Funding For Pension And Other Retirement Liabilities, Aug. 3
- Moderating Debt Burdens Allow Some U.S. States Room To Borrow During A Recession, June 16
- The Opioid Crisis Is A Credit Risk For U.S. Local Governments, Especially After COVID-19, Dec. 9
- Mounting Pressures Threaten Stability Of 20 Largest U.S. Cities' Pension Funding, Oct. 26
- Credit FAQ: How COVID-19 And The Recession Could Affect Credit Quality For U.S. K-14 Schools, Sept. 3
- U.S. Local Government Mid-Year Sector View: Unprecedented And Unpredictable, July 29
- Changing Landscape Threatens Credit Quality Of U.S. Convention Centers, Arenas, And Stadiums, July 27
- COVID-19: A Closer Look At How It Affects 10 Major U.S. Cities, April 2
- Charter School Brief: California, Sept. 22
- Charter School Brief: Minnesota, March 10
- Charter School Brief: New York, June 8
- U.S. Not-For-Profit Acute Health Care 2019 Medians Show Stability While Recent Rating Actions Signal Weakening Ahead, Aug. 19
- U.S. Not-For-Profit Acute Health Care Mid-Year Sector View: Recovery Continues, Likely Uneven For The Rest Of The Year, Aug. 13
- Overall Not-For-Profit Health Care Pension Funded Ratios Are Stable -- For Now, June 25
- A Bumpy Recovery Is Ahead For Hospitals And Other Health Providers As Non-Emergent Procedures Restart, May 26
- U.S. Public College And University Fiscal 2019 Median Ratios Remain Generally Stable Although Operating Stress Looms, Nov. 24
- U.S. Not-For-Profit Private College And University Fiscal 2019 Median Ratios: Changing Landscape Leads To Weakening Credit Measures, Nov. 24
- Not-For-Profit Higher Education Mid-Year Sector View: Fall 2020 Enrollments Will Drive Credit, Aug. 18
- U.S. Public Finance Report Card: The Not-So-Secret Sauce In State Housing Finance Agency Programs' Stability, Oct. 15
- U.S. Public Finance Report Card: What A Difference A Decade Makes: Housing Finance Agency Rating Stability In Uncertain Times, Oct. 26
- U.S. Public Finance Housing Mid-Year Sector View: Uncertainty Lies Ahead, Aug. 27
- How Job Losses And Rent Moratoriums Might Affect HFA Multifamily Program Performance, May 7
- California's Rolling Blackouts Could Foreshadow Rating Pressures For Public Power And Electric Cooperative, Sept. 10
- California Public Power Utilities Face Disparate Physical And Credit Exposures To Wildfires, Aug. 4
- COVID-19 And The Resulting Recession Are Having A Limited Impact On U.S. Municipal Utility Credit Quality So Far, July 8
- The Recession Could Erode U.S. Not-For-Profit Utilities' Financial Flexibility, April 29
- This Time Is Different: An Anemic And Uncertain Passenger Recovery Will Challenge U.S. Airports' Credit Quality, Aug. 7
- Activity Estimates For U.S Transportation Infrastructure Show Public Transit And Airports Most Vulnerable To Near-Term Rating Pressure, June 4
- Credit FAQ: A Review Of Transportation Criteria: Liquidity And Debt Service Coverage In Light Of COVID-19, April 23
- U.S. Transportation Infrastructure Sector Outlook Update: Now Negative For All Sectors, March 16
|S&P Global U.S. Economic Forecast Overview|
|Real GDP (year % ch.)||2.2||(3.9)||4.2||3.0||2.1|
|Real consumer spending (year % ch.)||2.4||(4.3)||5.0||3.6||2.7|
|Real equipment investment (year % ch.)||2.1||(6.2)||8.5||2.9||1.1|
|Real nonresidential structures investment (year % ch.)||(0.6)||(10.3)||0.2||4.6||2.2|
|Real residential investment (year % ch.)||(1.7)||3.9||5.5||2.9||2.4|
|Core CPI (year % ch.)||2.2||1.7||1.9||1.8||1.9|
|Unemployment rate (%)||3.7||8.3||6.4||5.6||4.6|
|Housing starts (annual total in mil.)||1.3||1.3||1.4||1.4||1.4|
|Light vehicle sales (annual total in mil.)||17.1||14.4||16.4||16.7||16.8|
|Federal Reserve's Fed funds policy target rate range (year-end %)||1.5-1.75||0-0.25||0-0.25||0-0.25||0-0.25|
|Note: All percentages are annual averages, unless otherwise noted. Core CPI is consumer price index excluding energy and food components. f--forecast. Sources: BEA, BLS, The Federal Reserve, Oxford Economics, and S&P Global Economics Forecasts.|
This report does not constitute a rating action.
|Primary Credit Analyst:||Robin L Prunty, New York + 1 (212) 438 2081;|
|Secondary Contact:||Eden P Perry, New York + 1 (212) 438 0613;|
|Sector Leaders:||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;|
|Suzie R Desai, Chicago + 1 (312) 233 7046;|
|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;|
|Contributor:||Zev R Gurwitz, New York + 1 (212) 438 7128;|
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