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Outlook For U.S. States: Symptoms Persist, But A Shot In The Arm Could Lead To Growth


Chart 1


Questions That Matter

1. Why is the state sector view for 2021 negative?

COVID-19 has affected the credit of all states, although unevenly. As the economy gets back on track, we expect those with the highest fixed costs to have the most difficulty adjusting their budgets.

How this will shape 2021

More budget stabilizing actions to come.  Sizable budget gaps remain for many states. Achieving balance often requires making difficult decisions--cutting programs, using reserves, raising revenues--not easy in benign economic times and harder still now. States already used reserves and cut programs to balance fiscal years 2020 and 2021, so further actions will cut deeper. New revenues are being tried, primarily gaming and taxation of cannabis, with 15 states already with legalized marijuana.

Hospitality, energy, and transportation backed debt will be slow to return.  Whereas income taxes and sales taxes have held up better than expected, hotel taxes, gas taxes, and revenues from these industries have fallen sharply and remained depressed affecting other state budgetary decisions.

Uneven economic recovery will continue.  States have been affected by the virus in different waves and measures taken to control the spread have also varied. This will continue and so the pace of recovery will also be uneven.

What we think and why

Active management and adequate liquidity are key to creditworthiness.  Consensus revenue forecasting and quick actions to adjust expenditures have long been a hallmark of good government. Managing through the recovery, achieving structural balance, and rebuilding rainy day funds will be key determinants to maintaining or regaining credit ratings.

Uncertain support from the federal government.  Any stimulus that supports the economy supports credit to some extent. But we're also watching if there is any revenue replacement in any further stimulus. There is still a risk of premature austerity in relation to state credit, if Washington cannot come to consensus.

Fixed costs may drive upcoming budget debates.  The combined fixed costs of debt service, pensions, other post-employment benefits (OPEB) and Medicaid are already typically over a quarter of a state budget, and in some states these are over 40% of the budget. This concentration makes budget balancing harder as the cuts elsewhere need to be greater.

What could change the trajectory

Rapid coordinated vaccinations.  We are maintaining a negative view on the sector due to the budgetary and recessionary pressures. However, should vaccinations enable economies to regain revenues our view could return to stable.

Continued federal stimulus, particularly infrastructure.  Infrastructure funding has historically been bipartisan, and a common tool used in economic recovery. We see a multiplier effect in infrastructure investment. Done well, it could help to drive economic stability.

A strong stock market and a rapid jobs recovery.  Pensions and OPEB costs were credit pressures before COVID-19 and will continue to be afterwards. The strong stock market bounce back from the recessionary lows could help to mitigate retirement fund losses, and should the markets continue to advance.

2. What federal fiscal and policy initiatives will matter?

Federal initiatives are likely to change in a Biden administration, although how much may depend on the Senate. Stimulus funds, heath care programs, tax policies, trade agreements, energy matters, and infrastructure incentives could all drive credit.

How this will shape 2021

Medicaid costs may rise as additional aid ends.  Medicaid enrollment trends are countercyclical, and the recession has caused a larger pool of individuals to be eligible for the program. Due to public health emergency restrictions which halted non-urgent services, Medicaid utilization has decreased to date, but the increased enrollment will likely lead to higher costs.

Energy states have been doubly affected.  The Biden energy platform is unlikely to have a meaningful direct credit impact on the oil-producing states, but any policy changes that lead to less mineral extraction could further pressure the credit of energy states.

Federal infrastructure funding has waned.  Federal construction stimulus was vital following the Great Recession to prevent steeper declines in capital spending, but currently there is no consensus on the need for a new spending plan. Action in Washington could help revitalize a once bipartisan practice of predictable infrastructure spending.

Chart 2


Chart 3


What we think and why

Medicaid is a unique driver of expenditures.  Through the Families First Coronavirus Response Act, Congress raised the Federal Medical Assistance Percentage (FMAP) by a flat 6.2% and required coverage to be maintained for all currently qualifying, limiting state actions to control costs. Should this enhanced level sunset as planned, costs could rise as resources decline.

Infrastructure investment is more than roads, but...  The continuing travel restrictions instituted to control the spread of the virus caused a reduction in the billions of dollars in transportation-related revenues. Transit system and airport revenues could remain depressed for years. This may affect decisions on all capital spending.

Trade policies can impact state economies.  With China, North America, and European trade agreements possibly being reconsidered, major changes could affect tax collections for various affected states. Less impactful change may occur should the two Senate runoff elections in early January maintain the status quo.

What could change the trajectory

Continued federal stimulus, particularly jobs focused.  Despite record job gains since May, the U.S. economy still needs to gain at least 10 million jobs to regain the 22.2 million jobs lost from the COVID-19 recession. Worryingly, this was also likely the easier half of the jobs recovery.

Continued federal stimulus, particularly FMAP.  The enhanced reimbursement level is set to expire in March. If it does and utilization increases, the intent of the enhancement may not be met, and the states may be picking up more of the costs.

A surprise California v. Texas decision.  Should the Supreme Court decide in 2021 that severability of parts of the Affordable Care Act is not allowed and the ACA is deemed unconstitutional, this disruption to the broader health care field would likely roil over into state finances as well.

Chart 4


3. How will demographics and migration affect credit in 2021?

As the population continues to age and move, these changes can influence state credit. Pension and OPEB costs remain a credit focus in many states.

How this will shape 2021

Older states will continue to age.  States with an older population typically deliver different services than younger states. These social services are often more costly, and the retiree recipients typically pay less to the state than do working-age residents.

Infrastructure pressures increase where population is increasing.  Growth states, like Texas and Florida, will continue to see population grow, but that economic positive comes with infrastructure needs (housing, roads, schools, etc.).

Census data always affects federal flows.  The decennial census will be published in 2021. Along with determining seats in Congress, nearly $1 trillion in Federal spending is tied to this information.

What we think and why

Demographic changes could pressure structural balance.  States unable to adapt tax and expenditure policy to address demographic changes are likely to face revenue shortfalls over the medium and long term.

Migration could affect financial forecasts.  The continued migration from the Northeast to the Sunbelt is well known, but states with progressive income taxes could have lower revenue predictability should extremely high-income people decide to leave for states with lower taxes.

Pensions pressures are already high in some states.  Fixed costs in some states are limiting the actions taken to speed recovery. States with aging workforces also face the challenge of seeing the ratio of active workers to retirees moving in the wrong direction. States with greater budgetary flexibility will see the positive economic effects of recovery sooner.

Chart 5

What could change the trajectory

Older states already attracting remote workers.  Many states have been experiencing an exodus of the young for years and have economic development policies focusing on attracting remote workers. Should this continue to succeed, it could help to stabilize these secular changes.

A robust economic recovery.  People are less apt to move for tax reasons when employed and part of a community. More often, the relocation decision is made at time of retirement. So, a return to economic stability could limit migration impacts.

Pension and other post-employment benefit assumptions continue to trend more conservatively.  Changes to retiree benefit costs are akin to turning a large ship--it can only be done slowly. Recently, systems have been lowering target rates of return and controlling benefit levels. Coupled with a strong stock market, this could lessen long-term pressures.

4. How will regional and sectoral economic differences affect credit?

The health impact, social distancing measures, and other economic influences have varied by region and sector. Tourist destinations and energy centered economies have fared less well than financial and tech driven employment centers. As state and local government make up nearly 20% of the nation's economy, continued sector and regional slumps could further slow the broader recovery from the COVID-19 induced recession.

How this will shape 2021

Regional variations will continue.  Regions of the country have responded to COVID-19 differently and will also recover at different speeds. States with extended shutdowns that have led to small business closures will need more time to recover.

States with concentrations in energy or tourism could continue to struggle.  Tourism states, particularly where air travelers have historically been a significant tourist component, will be delayed in recovery as the general population eases back into flying. The concurrent energy price declines have hurt oil state economies through the recession, and uncertainty over the pace of recovery and federal policy could keep these economies muted for a while longer.

The urban-suburban divide could highlight inequalities and affect state policies.  With many local governments in the suburbs primarily funded by property taxes, the single-family housing price increases recently seen will help cushion the broader suburban impact. However, the larger cities, with more state aid and other varied revenue sources, continue to see meaningful budget gaps. How states respond in their upcoming budget will be key to credit on many levels.

What we think and why

The nation needs a healthy government sector.  With state and local governments accounting for a significant portion of national gross domestic product, further cuts needed to balance budgets could have a negative effect on the pace of economic recovery.

Cities are not dying.  True, the pandemic and the need to work from home has helped bolster suburban home values, and the economy of the urban core has taken a hit, but once herd immunity is met the cultural and economic diversity of cities will lead an economic rebound.

Economic sectors will continue to respond differently.  Whereas regional economies heavy in technology firms and financial institutions fared well in the recession, as their workforces could generally work from home without meaningful productivity declines (or often even productivity increases), other sectors that depend on person-to-person contact struggled. This will continue even after a broad herd immunity is met.

What could change the trajectory

Federal stimulus.  Although the federal government has approved previously unseen amounts of stimulus to respond to the recession, there has been little in the form of direct revenue replacement. This form of aid would provide a stabilizing shot in the arm for struggling state budgets.

Vaccination problems.  Should there be a slowing in the march toward herd immunity, either by distribution, production, or efficacy of the approved vaccines, those regions and sectors that have weathered the recession will continue to be stable, whereas those who have struggled will struggle greater.

Table 1

Leisure/Hospitality Employment
Industry share of GSP ($ mils.) Y/Y GSP % change
Industry as % of 2019 employment 2019 2020 2021 2019->2020 2020->2021
Nevada 25.1 29,044 22,718 23,895 (21.8) 5.2
Hawaii 19.3 10,871 6,179 6,116 (43.2) (1.0)
Florida 14.0 67,370 51,841 54,187 (23.1) 4.5
Montana 13.8 2,697 2,064 2,132 (23.5) 3.3
Wyoming 12.7 1,708 1,410 1,454 (17.5) 3.2
South Carolina 12.4 12,148 8,547 8,386 (29.6) (1.9)
Colorado 12.4 20,168 15,618 16,361 (22.6) 4.8
Average GSP 20,573 15,482 16,076 (24.7) 3.8
Source: Bureau of Labor Statistics; Bureau of Economic Analysis; IHS Markit

Table 2

Natural Resources/Mining Employment
Industry share of GSP ($ mils.) Y/Y GSP % change
Industry as % of 2019 employment 2019 2020 2021 2019->2020 2020->2021
Wyoming 7.2 7,025 3,223 2,254 (54.1) (30.1)
North Dakota 4.8 6,355 3,295 2,129 (48.1) (35.4)
Alaska 4.0 7,364 3,835 2,822 (47.9) (26.4)
West Virginia 3.1 7,692 4,127 3,517 (46.3) (14.8)
New Mexico 3.0 10,671 6,135 5,214 (42.5) (15.0)
Oklahoma 2.9 21,877 10,003 7,193 (54.3) (28.1)
Texas 1.9 145,058 77,872 60,187 (46.3) (22.7)
Louisiana 1.8 10,963 5,815 4,323 (47.0) (25.7)
Average GSP 27,126 14,288 10,955 (47.3) (23.3)
Source: Bureau of Labor Statistics; Bureau of Economic Analysis; IHS Markit

Table 3

Information/Tech Employment
Industry share of GSP ($ mils.) Y/Y GSP % change
Industry as % of 2019 employment 2019 2020 2021 2019->2020 2020->2021
Washington 4.2 85,623 95,154 105,544 11.1 10.9
California 3.2 300,507 317,470 368,768 5.6 16.2
New York 2.8 147,166 156,284 164,815 6.2 5.5
Colorado 2.7 22,845 25,938 28,327 13.5 9.2
Utah 2.6 9,682 10,005 10,575 3.3 5.7
Georgia 2.5 46,525 46,723 50,453 0.4 8.0
Massachusetts 2.5 32,492 33,351 35,429 2.6 6.2
District of Columbia 2.5 8,317 8,499 8,950 2.2 5.3
Connecticut 1.9 16,143 17,681 19,447 9.5 10.0
Average GSP 74,367 79,012 88,034 6.2 11.4
Source: Bureau of Labor Statistics; Bureau of Econmic Analysis; IHS Markit

Table 4

Financial Activities Employment
Industry share of GSP ($ mils.) Y/Y GSP % change
Industry as % of 2019 employment 2019 2020 2021 2019->2020 2020->2021
Delaware 10.2 34,258 34,618 36,370 1.1 5.1
Arizona 7.8 85,228 89,873 96,297 5.5 7.1
New York 7.4 584,377 603,890 650,540 3.3 7.7
Connecticut 7.3 85,422 87,803 94,467 2.8 7.6
Nebraska 7.3 28,495 30,421 32,377 6.8 6.4
Rhode Island 7.0 14,448 15,061 15,986 4.2 6.1
Iowa 6.9 46,770 48,967 52,128 4.7 6.5
Average GSP 125,571 130,091 139,737 3.6 7.4
Source: Bureau of Labor Statistics; Bureau of Economic Analysis; IHS Markit

5. Will ESG issues remain a front-and-center challenge for credit quality?

After many years of ESG conversations centering primarily on the 'E', in 2020 'S' and 'G' topics came to the fore, with the 'S' including social justice issues such race and income inequality in government policies. In the 'G' space, in addition to a myriad of pressures related to COVID-19 response, we saw cyberattacks on governments increasing. We expect ESG factors will continue to contribute to credit discussions throughout 2021.

How this will shape 2021

ESG conversations will ramp up.  Issuers, investors, and credit rating firms will spend more time discussing ESG issues.

Social and Governance topics to the fore.  The discussion regarding racial, income, and health care equality will continue, and state policies could change to help address these issues.

Data, data, data.  As extreme weather, cybersecurity, and public safety conversations ramp up, we expect additional information and data to be more readily available. Comparability of environmental data will continue to improve, prompting more meaningful conversations with many issuers on mitigation and long-term stability

What we think and why

ESG is moving ratings and will continue to do so.  Addressing current 'E' and 'S' pressures structurally from both a short-term and long-term perspective is an important part of the 'G' of good governance. Without it, credit quality can deteriorate precipitously.

Environment is back on the table at the White House.  Compared to the outgoing administration, the new one will prioritize environmental topics, prompting more conversation from the Federal level on down.

What could change the trajectory

Delayed economic and pandemic recovery.  A longer timeline to resolution of the pandemic or widespread vaccinations will lessen the focus on ESG—not eliminating itas a credit consideration, but keeping it out of the spotlight.

Additional events drawing national attention.  The December 2020 federal level cyberattack could grow to be more of a national security issue as details are better understood. There could be continued visible events highlighting racial inequality. Weather events disrupting major parts of the economy. As any of these events recur, ESG is brought back to the national discussion.

Rating Actions And Distribution

Table 5

State Rating Actions In 2020
Date State To From Action
April 2 Connecticut A/Stable A/Positive Outlook change
April 2 New Hampshire AA/Stable AA/Positive Outlook change
April 3 Illinois BBB-/Negative BBB-/Stable Outlook change
April 7 Guam BB-/Negative BB-/Stable Outlook change
April 17 Alaska AA-/Negative AA/Stable Downgrade with outlook change
April 20 Hawaii AA+/Negative AA+/Stable Outlook change
April 20 Nevada AA+/Negative AA+/Stable Outlook change
April 29 New Jersey A-/Negative A-/Stable Outlook change
May 11 Oklahoma AA/Negative AA/Stable Outlook change
May 19 New Mexico AA/Negative AA/Stable Outlook change
June 19 Wyoming AA/Stable AA+/Stable Downgrade
July 14 Michigan AA/Negative AA/Stable Outlook change
Aug. 3 Minnesota AAA/Negative AAA/Stable Outlook change
Sept. 1 Pennsylvania A+/Negative A+/Stable Outlook change
Nov. 6 New Jersey BBB+/Stable A-/Negative Downgrade with outlook change
Nov. 10 Vermont AA+/Negative AA+/Stable Outlook change
Dec. 11 New York AA+/Negative AA+/Stable Outlook change

Chart 6


Chart 7


Related Research

This report does not constitute a rating action.

Primary Credit Analyst:Geoffrey E Buswick, Boston + 1 (617) 530 8311;
Secondary Contacts:Sussan S Corson, New York + 1 (212) 438 2014;
David G Hitchcock, New York + 1 (212) 438 2022;
Timothy W Little, New York + 1 (212) 438 7999;
Contributors:Thomas J Zemetis, New York + 1 (212) 4381172;
Todd D Kanaster, ASA, FCA, MAAA, Centennial + 1 (303) 721 4490;
Jillian Legnos, Hartford + 1 (617) 530 8243;
Ladunni M Okolo, Farmers Branch + 1 (212) 438 1208;
Oscar Padilla, Farmers Branch + 1 (214) 871 1405;
Valentina Protasenko, Centennial;

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