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January 18, 2021

Smith's Research & Gradings

S&P Outlook 2021

S&P Outlook 2021

S&P Global Public Finance launched the 2021 Credit Calendar with its Outlook for State and Local Governments. Lisa Schroer, senior director and sector lead, was the host for the webinar. She was joined by Geoff Buswick, managing director and sector lead, Jane Ridley, senior director and sector lead, as well as directors and senior analyst, Josh Travis, and Blake Yocum.

Ms. Schroer prefaced, "Before we turn it over to our presenters, we want to address that we have received questions on the events of yesterday in DC. From a credit standpoint, state and local governments have navigated and led through significant challenges over time, and we would expect this to continue. I think you will hear from our speakers what those challenges are, and how states and locals are actively managing them."

State of the States
Mr. Buswick said, "Our overall sector view for states remains negative and there are a number of headwinds facing state credit. It is noteworthy that 11 states begin 2021 with a negative outlook. This is greater than any year in the past decade, and I think it's a good indicator that there are many risks we see.

"More specifically, those risks include uncertainty and timing of vaccination distribution; the possibility of herd immunity being achieved later than forecast; and 35 of 50 states reporting revenue declines in fiscal 2020, according to National Association of State Treasurers. In fiscal 2021, we are still seeing revenue pressures in many states. And our expectation is that the recession will have a long tail in municipal credit. Some states in many instances support these cities and towns — that impact could also affect states, and I think Jane (Ridley) and I will talk about that as we go.

"It's not all dire. The impact of the recession has been felt differently in each state, and some have weathered the  impact well, from a credit perspective. There are credit positives. Many states have reported fiscal 2021 revenues exceeding expectations. Receipts may be down from fiscal 2020, but they're beating their conservative forecasts. Broadly speaking, state reserves, which through the long slow recovery from the great recession had been built up, are not depleted; there's still money left in some reserve funds. And lastly on that positive note, our economists are forecasting that vaccines could help lead to a more uniform and sustainable economic recovery in the second half of the year. There could be light at the end of this tunnel."

Mr. Buswick explained federal policy is a prominent reason the state sector for 2021 is negative. A number of decisions at the federal level affect the economies in the states, the services states deliver, and the cost of states to deliver those services. The new Biden administration will take different paths than the Trump administration. "This happens with each transition of power. But in this instance, healthcare, trade policies, immigration policies, energy policies, could be significantly different. So we're watching to see in what order they may be addressed, how they impact each state, and to what extent they come, within the recovery or within the current recession." Other factors affecting the state sector outlook include the vaccination progress, the structural budget balance, and the uneven economic recovery.

Other credit factors affecting S&P's state sector view include Medicaid, Pensions & OPEB, Event Risk, and Infrastructure. These have been credit pressures throughout the recent recovery from the great recession. S&P believes they will remain as credit pressures after this current recession.

Local Governments
Ms. Ridley said, "I want start out with some of the numbers we think are going to tell the biggest story for what happened in 2020. And that's particularly in the revenue and expenditure mismatch, that is facing local government and that continues on into 2021."

She flashed-up an infographic slide and explained how data from the St. Louis Fed showed between Q1 and Q2 of 2020 State and Local Governments saw a drop in revenues of 17% and a drop in expenditures of 0.1%. Not only is the trend different year-over-year, but Ms. Ridley emphasize the steep decline in revenues and the widening of the gap between revenues and expenditures. "So clearly,  the trend is definitely going to be a credit concern going into 2021," Ms. Ridley said.

What are the federal fiscal policy initiatives that will be meaningful for local government credit?

To answer that question, S&P's Outlook used some statistics from annual surveys done by National League of Cities and National League of Counties. Ms. Ridley noted, "Their surveys are always good, but it was particularly helpful this year because they really gave more real time responses for governments. And, the National League of Cities' survey had over 900 participants. It showed what the gap looked like.

"Cities and Counties had 90% with lower revenues and 76% with higher expenditures," Ms. Ridley said. "With the gap from revenues being down 21% and expenditures up 17% — that gap is wide."

All of those figure added up to make for a tough year 2020. But Ms. Ridley believes it will be an even harder time for local governments to restore balance for 2021 and beyond.

Stimulus for state and local governments did not make it into the December 2020 package. "We expect without any additional federal stimulus, a lot of local governments will have to make cuts to operations in 2021. Some may have been waiting to make them [the cuts] until they knew about the stimulus, but the longer that you wait, often the deeper the cuts have to be. So federal policy changes with the new administration aren't just about stimulus," Ms. Ridley explained.

The new Transportation Secretary nominee, Secretary Buttigieg, has been talking about a $1 trillion infrastructure build based on the Moving America Forward Act. "Obviously, a big infrastructure bill would be good for locals, especially if it can get passed and get implemented. But the bottom line on the federal impact is that we still do think that absence of having some meaningful federal stimulus really will lead to credit deterioration and rating changes," she said.

South and MidWest Region
Mr. Travis is the director and lead analyst in S&P Global's south region, local government group. Mr. Travis has been looking closely at S&P's portfolio on user-backed bonds, such as convention centers and food and beverage. Ms. Ridley noted, "Those kinds of taxes are obviously getting hit hardest from shutdowns and the recession."

Mr. Travis discussed how an uneven health recovery will weigh on credit quality.

He explained, "Throughout the pandemic, we've seen varying health impacts from the virus, from illness spikes, to extended state mandated shutdowns. This variability has also led to uneven fiscal impact, and we expect will further lead to uneven recovery particularly since a starting point is different for everybody.
With more widespread use of the vaccine, some issuers are poised to recover more quickly in a post-virus world. Issuers who are more reliant on economically sensitive revenues, maybe working themselves out of a larger hole. But property tax dependent governments may have seen a much more modest impact.  
"We've seen the biggest revenue impact changes in the hospitality space, including hotel taxes as well as taxes on prepared food and beverage. Revenue shortfalls have led to some downgrades. But most of our portfolio so far has had the resilience to maintain credit quality, even with some drops in coverage. However, with the prolonged pandemic, continued slow recovery in the tourism convention and business travel sectors, we expect that the space will continue to remain stressed throughout 2021.

"But regardless, we expect that most governments will have a hard choice to make with cuts necessary to make up for the lost revenue and virus-driven expense growth. And a stronger proactive management team will be a key determinant to recovery. But there may be a limit to what they can do given the continued uncertainty. And finally, state unemployment rates vary widely, with pockets in the Midwest near pre-pandemic levels, while others are more than double the rate of a year ago. But the spikes are not necessarily showing consistency within regions. And as we move through the virus winter surge, some states and localities will be facing larger hurdles than jump-starting their economies.

Roadblocks to recovery are the prospect of further lockdowns, low economic growth and vaccine-shy constituents, according to Mr. Travis. These health, fiscal and economic challenges weigh upon the responsibility for vaccine distribution, which will likely depend heavily on city and county governments going forward. Mr. Travis concluded, "So limited budgetary flexibility and very resolute readiness for recovery will likely shape our view of local government credit throughout 2021."

Local School Ratings
Blake Yocum, director and lead analyst in S&P Global's Midwest region, began his analysis of how pressures at the state level flow through local governments by noting, "To be clear, our criteria is not linked or capped by local government rating, in relation to state rating. However, we're seeing widespread revenue pressure across the U.S. with some notable outliers.

"States are required to balance their budgets. And often in times of fiscal stress, we see and fully expect a direct impact on locals." Mr. Yocum said. "During our webcast in August, we discussed the states that already made tests to school funding, and at the time it was in the six or seven range. And these tests were to varying degrees and came in different forms. While locals in the states were mostly left out of the federal relief bill adopted in late December, it did include significant dollars directly for schools — over $54 billion. Notably, many districts are likely to see four times the amount they received from the earlier CARES Act funding."

Details are still forthcoming on allocations and distributions and how exactly this will vary from state to state. But early conversations with management teams indicate that this should help with operational results in both fiscal 2021 and 2022.

S&P is starting to see a lot of data as it relates to COVID, particularly on school enrollment. A common theme is the decline in enrollment in the current year, especially at the lower grade levels. "Most states held schools harmless, in the last fiscal year fiscal 2020 and fiscal 2021," Mr. Yocum said. "So those years are less of a concern than going forward. As many states return to legislative session in early 202 and begin to craft their 2022 budget, we're keeping a close eye on how states solve their own budget challenges and the resulting impact to locals. We'll likely see the most pressure on school districts and even more pressure on districts that had not built up reserves over the past several years to weather any potential tests."

Mr. Yocum explained, there has been relative stability of property taxes. He concluded, "Of course, we know this is a lagging indicator, and we're by no means out of the woods yet. We see some positive signs given the low interest rates, the strong housing market, and the like. But in our view, a major drop-off in property taxes has not materialized, yet, and really, nothing like the housing driven Great Recession. Leftover recessionary pressures are sure to impact revenues to varying degrees going forward."

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