Stateline Story

North Carolina Sees Credit Rating Drop

  • August 20, 2002
  • By Jason White

A top investment risk analysis firm downgraded North Carolina's credit rating Monday (8/19), underscoring how a sputtering economy, declining taxes and burgeoning deficits are creating costly fiscal headaches for states.

The downgrade by Moody's Investor Services from Aaa to Aa1 is expected to cost North Carolina taxpayers between $7 million and $15 million per year because the state will likely have to pay a higher return on its bonds. States issue bonds to finance new facilities such as schools, office buildings and other long term capital improvements.

"The rating change reflects the state's continued budget pressure, its reliance on non-recurring revenues, and its weakened balance sheet," said the report from Moody's , a leading global credit rating, research and risk analysis firm.

Moody's is one of three major firms who rate state credit worthiness, which affects the interest rates states must pay on bonds. The other two firms have taken no action on North Carolina.

The downgrade is significant politically since it is North Carolina's first in 40 years. And some of Democratic Gov. Mike Easley's Republican opponents were quick to seize on the issue.

We have out of control spending matched by tax increases and we still have a budget deficit," said Senate Minority Leader Patrick Ballantine (R). "I'm not surprised Moody's downgraded us. It sends a terrible message."

Easley's office saw another side to Moody's action.

"I think this is a wake-up call," said Fred Hartman, Easley's spokesperson. "It is past time for lawmakers to put partisan politics aside."

"We've cut a billion dollars out of the budget over the past 18 months," said Hartman. "And there are probably some more efficiencies to be found. But you have to be careful about cutting vital services. You've got to have a balanced approach."

Despite North Carolina's troubles and the fiscal uncertainty of many other states, most state bonds remain very solid investment options, analysts said.

"States are among the strongest credits we see throughout the public finance world and certainly throughout the corporate world," said Bob Kurtter, a senior vice president of Moody's. "States are sovereign. They have control over their tax base."

Or as Robin Prunty, director of state and local government for Standard and Poor's, puts it: "The security of never going out of business is a strong credit factor."

Moody's Kurtter said the last state to default on bonds or loans was Arkansas, and that happened during the Great Depression.

Bond analysts say that when a state is facing a deficit, the key question they want answered is: "How quickly is the state righting its ship?"

They said they generally don't care whether that happens through tax increases or program cuts.

"We're indifferent as to which side of the equation budgets are balanced," said Moody's Kurtter.

What they don't want to see are budgets balanced by the draining of reserve funds, for this can be a harbinger of even worse things to come.

"Plugging a budget hole one year with non-recurring revenues usually means it emerges the next year with growth," said Moody's Kurtter.

Bond raters like to see reserves of at least five percent, but prefer much larger reserves in states like California and Michigan where tax revenues fluctuate greatly with the economy.

Bond ratings are often regarded as a report card on government performance because the analysts who produce them are among the few players in the state budget game who don't have an obvious political axe to grind.

"My read is that they [the bond raters] call it the way they see it," said Arturo Perez, fiscal analyst for the National Conference of State Legislatures. "It's a fresh perspective."

But what a good budget looks like depends on who is doing the looking.

"The fascination with the bond rating has almost become a political fetish," said John Hood, president of The John Locke Foundation, a conservative think tank in Raleigh, North Carolina. "It doesn't necessarily connect with fiscal reality."