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Fitch warns Alaska of potential credit downgrade if fiscal ship not righted

  • Author:
  • Updated: July 7, 2016
  • Published February 29, 2016

One of the nation's three major bond-ratings agencies on Monday downgraded Alaska's credit rating, while a second issued a warning about Alaska's fiscal crisis even as it maintained the state's AAA rating for its next bond issue.

Moody's Investors Service said in a report it would downgrade the state's general obligation rating to AA1, a step below the gold-plated AAA rating the agency had previously given Alaska.

The downgrade reflects Alaska's "unprecedented structural imbalance" as it struggles to rein in a $3.8 billion deficit brought on by crashing oil prices.

"Even with significant spending reductions, recurring revenues cannot keep pace with recurring expenditures, and the state would deplete its main budgetary reserves by fiscal 2019, absent significant changes in its financial framework," Moody's said.

In January, Standard and Poor's also downgraded Alaska's general obligation credit.

Fitch Ratings may soon join them. That ratings agency said on Tuesday it may downgrade the state's top-notch credit rating for general obligation bonds if officials don't properly address the turmoil, but it is leaving its AAA rating for Alaska bonds intact.

The announcements will cost the state a bit more for the March 9 sale of $151 million in general obligation bonds designed to pay for transportation projects around the state, an official said.

Assuming interest rates remain low, as expected, the cost to the state for the bond sale, approved by voters in 2012, may not be huge. The state may have to pay about $500,000 extra in today's dollars, with payments spread out over the 20-year life of the bonds, estimated Deven Mitchell, the state's debt manager.

"It will result in our cost of capital increasing. The costs could be negligible or somewhat significant depending on market we're selling into," he said.

Fitch Ratings said Monday it will put Alaska on "negative watch" as it waits to see how elected officials deal with the state's massive budget shortfall. The watch applies not just to the March bond sale, but to another $1.9 billion in bonds that have already been issued by the state or by municipalities with the state's backing.

But the state will not face additional interest costs for those bonds. Any additional costs for those bonds will be borne by investors who already own them, Mitchell said.

Fitch Ratings said the warning stems from "uncertainty" over budget initiatives that would reduce draws on savings and diversify the state's sources of revenue, and specifically mentions Gov. Bill Walker's proposals to overhaul state finances. Walker is calling for an income tax, reduced spending, smaller Permanent Fund dividend checks and using Permanent Fund earnings to pay for most state services.

The state's top-notch AAA bond rating for general obligation bonds will likely be given a "negative outlook or downgraded" if new budget measures aren't adopted to improve the state's long-term outlook, the New York agency said in the report.

The Fitch report comes as members of the Republican-led Legislature say they will implement cuts, and, later this session consider measures to generate new revenue.

With oil prices at their lowest levels since 2008, the state faces a $3.8 billion budget deficit that would come atop a similar shortfall last year, the ratings agency said.

Standard and Poor's decided in January to lower Alaska's general obligation credit to AA+ from its top ranking of AAA, and noted that one factor in the decision was lawmakers tepid response to the governor's plan.

Mitchell, who communicates with the ratings agencies before bond sales, said their analysts realize Alaska is spending its readily accessible savings at unsustainable levels. They're looking for the state to adopt a viable fiscal plan, he said.

"To retain a high-level credit rating, you can't say, 'We'll figure that out in the future,' " Mitchell said. "To be credit-worthy you have to say, 'We are on a path to make change. We'll have a balanced budget and here's how we'll make that change.' "

Fitch Ratings highlighted positive aspects of the state's financial condition, saying it has acted "prudently" by stashing away substantial savings, kept debt burdens "moderate," took steps to address pension obligations for retired employees, and altered its oil production tax so it brings in more income than its predecessor in the current low-oil-price environment.

Including about $6.5 billion in the Permanent Fund earnings reserve, the state expects to have $13.4 billion in savings at the close of the current fiscal year in June, not counting the billions in the Permanent Fund principal that can only be accessed with a constitutional amendment, the report said.

"Conservative planning, particularly in the context of currently weak crude oil prices, supports the state's high-quality rating given a limited economy and a budget historically tied to natural resource revenue. Fitch expects Alaska to manage its reserve funds prudently and adjust its expenditures promptly as needed, consistent with the state's historical practice."

The report notes that the governor's proposal to alter the Permanent Fund so investment earnings help pay for state services would reduce volatility for a budget that has long been tied to fluctuating oil prices. It contains several "fiscally prudent" measures, including reducing the dividend by more than 50 percent, to $1,000 in the first year and less in future years.

But Fitch also said such a heavy reliance on investment earnings -- the earnings would pay for almost three-quarters of the operating budget -- comes with risk, too.

Moody's also commented on the governor's plan, calling it a "positive step for Alaska's finances" that could provide a "greater degree of budgetary stability," though it noted that the plan's "assumptions also would be strained" if Alaska tries to increase expenses one day.

But Moody's said the plan faces "political hurdles" because it would reduce the popular dividend payout and add the first personal income tax since 1980. And it's not perfect.

"Even if the proposal is enacted, the state still faces budgetary risks related to its narrow oil-dominated economy," the Moody's report said.

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