Moody’s downgrades Kentucky’s debt, citing pension shortfall

Moody’s has downgraded the debt issued by Kentucky’s state government by one level, to a Aa3 rating, warning bond investors that the state does not collect enough revenue to resolve its $37 billion public pension shortfall.

“The commonwealth has one of the heaviest unfunded pension burden of all states,” Moody’s wrote in a report that it published for bond investors last week. “The commonwealth’s ability to stop the decline in pension funding levels will be crucial to its credit profile.”

Gov. Matt Bevin is expected to call a special session of the General Assembly later this year to address the state’s pension debt and its tax code. The new Moody’s report is only the latest alarm to draw attention to both of those subjects.

The state expects to face tens of billions in unfunded liabilities in coming years at Kentucky Retirement Systems, which provides pension benefits for state and local government retirees, and Kentucky Teachers’ Retirement System, which covers educators. Officials blame several factors for the shortfall, including inadequate contributions by the state and poor investment returns.

Among Kentucky’s other economic problems, according to the ratings agency:

▪  Some of the highest “fixed costs” of any state, which includes benefits owed to public retirees as well as debt service required to pay down past borrowing by the state. Kentucky’s debt service in 2016 was 7.4 percent of its revenue, ranking it seventh-highest among the states and well above the national average of 4.1 percent.

▪  Weakening revenue collection by the state. Revenue growth fell from 5.3 percent in Fiscal Year 2015 to 3.7 percent in Fiscal Year 2016 to 1.3 percent in Fiscal Year 2017, which ended June 30. Growth in individual income taxes was offset by losses in coal severance taxes and corporate income taxes, while sales tax revenue has been flat.

The current two-year state budget relies on $415 million in one-time revenues and “large cuts” of 4.5 percent to 9 percent to most state agencies, including state universities, in order to balance, Moody’s reported.

▪  Weaker job growth over the last 12 months than the rest of the country. Non-farm employment in Kentucky in the last year increased by 28,900, or 1.4 percent, which fell short of the 50-state average growth rate of 1.6 percent. Also, most of that growth (23,200 jobs) was in the service sector, which traditionally does not pay well and offers few to no benefits.

“Kentucky’s low wealth levels will challenge the commonwealth to raise revenues going forward,” Moody’s wrote.

Moody’s uses a sliding scale to publicly evaluate the creditworthiness of entities that issue debt through bonds: Aaa, Aa1, Aa2, Aa3, A1, A2, A3, Baa1, Baa2 and Baa3. Kentucky’s debt previously was rated Aa2. Generally, the higher the rating for debt, the lower the interest rates enjoyed by the entity issuing bonds.

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