U.S. public finance started 2024 with a mixed credit view that was largely realized. As the page turns on 2024, S&P Global Ratings recaps five major themes that underpinned the U.S. public finance credit landscape this year while we wait for how the incoming Presidential administration's policy implementation details could affect credit quality in 2025.

Our Five Takeaways

1. Better-than-expected growth stabilized ratings across most sectors.   Our economic forecast indicates that the U.S. economy may expand 2.0% in each of the next two years following 2.7% growth this year (see table below). Real GDP growth in 2024 is nearly 2x our economists' forecast at the beginning of the year. A relatively resilient labor market and the gradual decline in inflation led to robust revenue and demand activity that supported operations and debt service obligations across most U.S. public finance asset classes. Meanwhile, the final year of federal pandemic stimulus contributed to revenue strength across sectors. For example, most states saw surplus operating results and record reserves. (See "States' Median Reports: Our New Methodology Highlights Rating Consistency," published Nov. 20, 2024, on RatingsDirect.)

In addition, U.S. not-for-profit transportation infrastructure enterprise financial medians improved in fiscal 2023 across asset classes given continued revenue and activity growth (passengers, tolled transactions, and tonnage) and a combination of management actions such as increasing rates, fees, and charges and reserves, resulting in rating actions that were overwhelmingly positive (32 positive to just one negative rating action) from Sept. 1, 2023, through Sept. 1, 2024. (See "U.S. Not-For-Profit Transportation Infrastructure 2023 Medians: Demand And Revenue Growth Improved Financial Medians To Post-Pandemic Highs," published Nov. 12, 2024).

Finally, our not-for-profit acute health care sector showed signs of stabilizing in 2024. Although difficulties persist, significant management actions, easing of labor cost growth, and reimbursement improvements are benefiting margins and cash flow, albeit at lower levels than historically. (See "U.S. Not-For-Profit Acute Health Care 2023 Medians: Remarkably Level With Prior Year, But Performance Remains Notably Below Historical Norms," published Aug. 30, 2024, and "U.S. Not-For-Profit Acute Health Care 2025 Outlook: Stable But Shaky For Many Amid Uneven Recovery And Regulatory Challenges," published Dec. 4, 2024.)

2. Some sectors saw persistent bifurcated credit quality and others showed signs of weakening.  Some sectors saw credit pressures, and in the case of water and sewer utilities these led us to revise the sector outlook to negative from stable at midyear. For this sector, flat-to-declining median financial metrics reflect tightening margins, as most utilities were operating with higher cost-of-service requirements. Against this backdrop, the credit quality of smaller utility providers could remain volatile, in our view, given staff limitations, infrastructure deficiencies, and smaller rate bases across which to spread fixed costs. (See "U.S. Municipal Water And Sewer Utilities Navigate A New Environment As Performance Drops," published Nov. 5, 2024.)

Not-for-profit U.S. electric and cooperative utilities are also under pressure from a confluence of inflation, reduced consumer wherewithal to pay utility bills, sensitivity of rate-setting bodies to economic conditions, and a developing trend of weakening financial margins. These credit challenges led to negative rating actions' outnumbering positive by seven to four in the first half of the year, outpacing the 2023 result. (See "2024 Biannual Rating Actions For U.S. Municipal Retail Electric, Gas, And Wholesale Electric Utilities," published July 29, 2024.)

In 2024, the U.S. higher education sector continued demonstrating an uneven credit picture, with median operating income turning negative for private universities for the first time in more than 10 years, but public university margins were steadier given greater state support in the past five years. Competition for students and operating expenses remained elevated, but these issues were more pronounced at the lower end of the ratings scale. Some institutions responded to these pressures by dipping further into their endowments, and others delayed capital projects, leading to an ever-increasing median age of plant (particularly for private universities). (See "The New 'New Normal': Trends In U.S. Higher Education Post-Pandemic Versus Post-Recession," published Sept. 25, 2024, and "U.S. Not-For-Profit Higher Education Outlook 2025: The Credit Quality Divide Widens," published Dec. 5, 2024.)

Finally, we have begun observing charter schools' and public school districts' having difficulty closing budget gaps as they struggle to maintain funding for pandemic-era learning loss programs while managing higher personnel costs to recruit and retain teachers. We believe this trend could continue, particularly for public school districts, as recently negotiated multiyear labor contracts across the country are in various phases of implementation.

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3. Evolving risks--climate, cyber, and crypto--continued to test management teams.  In 2024, Hurricane Helene set a new bar for inland destruction, including extensive damage to transportation and utility infrastructure. The uncertainty of the storm's impact on long-term credit quality for local governments in the hardest-hit areas led us to place the ratings on 12 local governments and three utilities on CreditWatch with negative implications. The CreditWatch action did not reflect our view of these issuers' ability to pay debt service on time and in full but our view of potentially prolonged economic recovery especially when combined with regional geographic challenges that could hinder rebuilding and restoration of utility services.

We believe storm events, including those that lead to $1 billion or more in losses that are tracked by the National Oceanic and Atmospheric Administration, will become more frequent and severe (see chart 3). The year 2030 could see 40% more disasters than 2015, with 250 events globally a year, if mitigation of greenhouse gas emissions is not accelerated, according to a 2022 report by the U.N. Office for Disaster Risk Reduction.

Physical risks can pose a particular threat to the creditworthiness of many issuers that have fixed locations and that cannot divest or diversify risk away. Management teams can offset physical risk exposures by addressing the needs and costs associated with adapting to them. Disclosure of these risks and related management actions are an important aspect of our assessments of management planning. When policies and practices are material and relevant, we incorporate them into our overall assessment of creditworthiness. (See "Navigating Uncertainty: U.S. Governments And Physical Climate Risks," published April 23, 2024.)

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The establishment and embedding of practices that minimize the risk of security crises--practices collectively known as cyber hygiene--is essential to effective management of organizational risk. Poor cyber hygiene can lead to operational disruptions and weigh on our view of creditworthiness.

The fast-changing nature of cyber threats ensures that state and local governments and not-for-profit enterprises, many of which maintain critical infrastructure, will need to stay vigilant in their efforts to prevent attacks.

While issuers monitor bad actors and information technology systems for cyber vulnerabilities, the adoption of AI and the explosion of online information may come with risks related to traceability, identity management, cyber security, and energy consumption. Blockchain and cryptographic technologies (collectively referred to as crypto) offer tools to identify, track, and protect data and thus possibly mitigate those risks.

For example, AI deep-learning models can analyze large data sets for unidentified vulnerabilities, and large language models can be trained on libraries of malware to detect patterns of attack and pinpoint vulnerabilities in code. However, AI models could be targeted and manipulated to compromise their effectiveness. To mitigate these risks and maintain AI-driven security, continuous updates and validation are essential as with all information technology software systems.

While AI adoption and application, particularly by U.S. public finance issuers, remains nascent, we believe acceleration could bring new opportunities and cost savings, but management teams may need to monitor risks from regulations and legal initiatives. (See "AI And Crypto Will Shape The Future Of the Internet," published Oct. 1, 2024.)

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4. Heightened affordability issues could begin affecting domestic migration trends.   In 2022, more than 23.6 million households (33% of the national total) in highly populated U.S. counties spent more than 30% of their income on housing. Among households in highly populated counties earning less than median income, the proportion that was housing burdened rose to 63% (see chart 5). Costs from increasingly frequent and damaging storms and flooding amplify affordability challenges, and economic growth and property values could decrease in the long term without tax base growth as an offset. This confluence of events could lead to a downward credit trend for some U.S. local governments. (See "No Quick Fix For The U.S. Affordable Housing Shortage," published Aug. 21, 2024, and "Rising Insurance Costs And Mounting Affordability Challenges Could Weigh On Some U.S. Governments' Creditworthiness," published Oct. 31, 2024.)

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Housing affordability weighs on other sectors, including utilities. Some management teams may forego rate increases, which, in part, are necessary to cover the rising costs of labor, regulatory requirements, and hardening of assets. For example, in California, utilities may become more pressured as the cost of future supply and storage projects--and the extensive water conveyance infrastructure that goes with them--exceeds historical spending, especially as nondiscretionary capital spending also continues to rise. (See "California Utilities Enter Period Of Significant Capital Spending That May Strain Water And Sewer Rate Affordability," published Oct. 3, 2024.)

Retail electricity rate inflation has consistently outpaced the broader Consumer Price Index in the past two years. Therefore, the financial burdens of adding generation, transmission, and distribution resources to serve additional load attributable to data centers and customers' compliance with beneficial electrification mandates will likely magnify the cost pressures that utilities and their customers face. The outsize inflation that retail electricity prices exhibit magnifies the affordability difficulties associated with recovering added capital and operating costs from consumers, and may weaken credit metrics in the long term. (See "Data Centers: U.S. Not-For-Profit Electric Utilities Explore Ways To Mitigate Risks From Load Growth," published Nov. 21, 2024.)

Affordability issues could lead to management teams' foregoing property tax and rate increases by drawing on reserves and balance sheet resources to maintain budgetary balance. Issuers that utilize long-term financial forecasts to inform these decisions could maintain credit rating stability in the face of competing operating priorities.

5. Demographics will be a megatrend that could have more credit impact in 2025.  We believe demographics are a pervasive issue that will continue influencing U.S. public finance credit quality over time and in various ways. In 2025, we will monitor the effect of an aging population and the potential for climate hazards to influence migration patterns.

The Congressional Budget Office reports that by 2050 U.S. population growth could average 0.2% annually (see chart 6). Health care inflation has historically outpaced the broader Consumer Price Index, and this may intensify with the financial pressures that an aging population places on health care providers, including states and large counties as well as not-for-profit acute care hospitals.

Moreover, health care services usually become more expensive with age, which puts pressure on Medicare funding. The incoming administration could bring regulatory and legislative initiatives to help control federal Medicare spending and certain Medicaid costs. In addition, an aging population affects labor supply, a substantial operating cost across all sectors in U.S. public finance that, as explained, is already squeezing operating margins.

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We also believe climate hazards could shape population patterns in the long term, particularly in locations that combine high housing costs with rising insurance premiums, higher deductibles, or an inability to obtain insurance coverage. For example, chart 7 shows that along Louisiana's Gulf Coast--which also faces significant exposure to climate hazards including coastal erosion, flooding, and hurricanes--out-migration is the highest among metropolitan statistical areas. Over the long term, slower population growth, stagnation or decline in certain regions could lead to lower economic growth and weaker associated revenue sources such as property taxes, influencing U.S. public finance issuers' ability to balance budgets with fewer resources against increasing spending requirements.

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Related Research

• Global Credit Outlook 2025: Promise And Peril, Dec. 4, 2024
• Economic Outlook U.S. Q1 2025: Steady Growth, Significant Policy Uncertainty, Nov. 26, 2024
• U.S. Public Finance: In Case You Missed Them, Nov. 20, 2024