Overview

S&P Global Ratings published its "Methodology For Rating U.S. Governments" criteria on Sept. 9, 2024, and we have applied the criteria to all states we currently rate.

Our ratings on 49 states (Montana has no debt and does not maintain an issuer credit rating), which remain unchanged with the application of new criteria, reflect the sector's strong credit quality with 93% of ratings 'AA-' or higher. All states have reserves at or near historic highs supporting their strong individual credit profiles, with rating differentiation frequently coming down to size of liabilities and management's ability to proactively identify pressures and use flexibility to operate through budget cycles.

We expect U.S. economic growth to slow beginning in 2025 compared to recently strong trends. S&P Global Economics forecasts 2.7% real U.S. GDP growth for 2024 with an outyear figure of 1.8% in 2025. Despite some headwinds for the broader U.S. economy, positive growth is still expected and states have experience managing similar growth rates from the last decade. Businesses continue to face higher costs of capital and policy uncertainty in the near term, which will limit capital expenditure and hiring, and the unemployment rate will likely rise in the next several quarters--to 4.5% by the end of 2025. However, we expect that states would continue to navigate the slower growth with generally strong financial management and significant flexibility to manage budgets to maintain ratings, albeit at varying degrees. This is reflected in over 80% of states having stable rating outlooks. For more information, see "Economic Outlook U.S. Q4 2024: Growth and Rates Start Shifting to Neutral," published Sept. 24, 2024.

The 49 public ratings on U.S. states (for more information on our history of ratings, see "History of U.S. State Ratings," published July 25, 2024) range from 'AAA' to 'A-', with more than 59% of institutions rated in the 'AA' category and over 32% rated 'AAA', along with only four states in the 'A' category. Therefore, changes in median metrics for these rating categories might represent the variability associated with a small sample size, rather than wholesale differences in credit quality. There are currently no non-investment-grade ratings on U.S. states. Only five U.S. states have been rated below the 'A' category in the past, with Illinois being the most recent (June 2016 to February 2023).

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All data and ratings included in this report are as of Nov. 20, 2024. We excluded the data for territories and one state, Montana, that has not yet been rated under the new governments criteria.

Strong Institutional Framework Anchors States' Ratings

The institutional framework (IF) reflects the set of formal rules and laws, practices, customs, and precedents that shape the environment in which governments operate. For U.S. states, IF assessments have been strong compared to other governments, reflecting significant autonomy in raising revenue and managing budgets through changes in economic cycles.

Our IF assessment is mostly qualitative. We consider a state's track record and our forward view of any future changes that are likely to shape the framework. The IF assessment includes the three subfactors: predictability (weighted at 25% of the assessment), revenue/expenditure balance and system support (50%), and transparency and accountability (25%).

For most states we consider the operating environment predictable given states' considerable autonomy regarding their own source revenues. The largest categories of shared revenue for states are income and sales and use taxes. States with active voter initiatives, in our view, limit autonomy and are considered less predictable than peers (Arizona, California, and Colorado).

However, while states vary in their ability to raise revenue, the ability to match revenue to expenses is generally strong given their flexibility to manage expenditures and relatively few states have significant unfunded mandates. We also view states as having demonstrated system support from the federal government in exceptional situations, although we do not consider it guaranteed. The federal response to the pandemic, although significant in both the number of unique stimulus bills and total money appropriated, has aligned with our ongoing view of exceptional but ad hoc support to states. Federal revenue is about 41% of states' total governmental funds and is typically designated for specific funding mandates such as Medicaid and infrastructure financing.

We view states as having the strongest transparency score attainable, generally releasing timely GAAP-based audits, with one exception. California has persistently provided audited results well after the end of its fiscal year. Its most recent available audited financial statements for fiscal 2022 were released in mid-March 2024, which we consider late, and not aligned with peer reporting standards.

Management Assessment Aligns With Rating Level

Our view of U.S. states' management is relatively strong (when compared with other governments) and reflects management practices that are well defined, monitored, and likely sustainable. Compared to other rated governments, states use comprehensive planning tools such as forecasts, long-term planning, and monitoring to manage finances. However, long-term planning and the institutionalized ability to monitor and adjust budgets are key differentiators in management assessments among states. We have observed that stronger management assessments also correlate with higher ratings across the state rating scale.

Slowing Revenue Growth Outpaced By Growing Costs Could Dampen States' Financial Performance

Across rating categories, U.S. states have demonstrated strong financial performance in recent years with 40 of them showing balanced results in 2023. This healthy financial performance reflects robust economic and revenue growth and has led to states building reserves to historically high levels by the end of 2023. For states, our assessment of financial performance includes demonstrated performance in different budgetary environments and our expectations for financial management in the future. While revenue growth for states has been strong at 4.3% in 2023, expenditure has grown at a slightly stronger pace at 4.5%, indicating future pressures as states attempt to reign in inflationary pressures on expenditures. State general operating expenses for 2022 totaled about $13.6 billion, with the two largest budgets alone (California and New York) representing about 26%.

General fund expenditures for K-12 public education typically make up the largest share of state budgets, alongside public health outlays, predominantly for Medicaid. With revenue anticipated to cool, there could be slightly more pressure on public education funding given mandated funding- level requirements for most states, along with strong political efforts to increase funding in light of recent cost pressures. We believe reserves will remain a critical credit factor when analyzing credit strength, especially during times of economic contraction when structural imbalances may develop. At the end of fiscal 2023, most states' reserves were at historic high levels.

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Liabilities Could Indicate Limited Financial Flexibility

States with high fixed costs, including debt, pension, and other postemployment benefit (OPEB) payments, typically have less flexibility to make necessary budget adjustments during periods of financial stress, leading to pressure on credit ratings over time.  As a percentage of general fund revenues, six states had current costs that exceeded 10% of revenues (Massachusetts, Maryland, Illinois, Hawaii, New Jersey, and Connecticut).

We also assess the size of states' long-term liabilities, which indicates a government's ability to manage its long-term obligations over time. Median combined net direct debt and pension liabilities per capita for states rated in the 'A' category was $9,439, which is over 7x the median for 'AAA' rated states at $1,258. For states where we consider OPEB liabilities inflexible, we have made adjustments to reflect the size of the liabilities in our assessments. The states with the highest OPEB liabilities are New Jersey, Delaware, Hawaii, and Connecticut.

Related Research

• Methodology For Rating U.S. Governments, published Sept. 9, 2024.
• Economic Outlook U.S. Q4 2024: Growth and Rates Start Shifting to Neutral, published Sept. 24, 2024
• U.S. States' Fiscal 2023 Liabilities: Stable Debt, With Pension And OPEB Funding Trending Favorably, published Oct 23, 2024.