S&P brightens Arizona's rating outlook

S&P Global Ratings revised the outlook on Arizona's AA issuer rating to positive from stable, citing the state's "robust" economic growth, as well as its financial management.

The move points to an expectation of a one-in-three chance of a rating upgrade over the next two years, according to the rating agency. 

Arizona Governor's Office

"The positive outlook reflects our view that strengthening reserves and ongoing revenue and expenditure management, supported by strong economic momentum that we expect will continue, could lead to upward rating potential should the state also demonstrate budgetary discipline that helps to mitigate future cyclical pressures on its finances," S&P said in a report on Thursday.

The state's $16.1 billion fiscal 2025 budget tackled a nearly $1.5 billion deficit with fund transfers, rescinded appropriations, and other measures. S&P said the shortfall was mainly due to revenue underperformance, primarily from income tax collections, which were impacted by rate changes enacted in 2021.

"We will continue to closely monitor the state's budgetary performance, specifically in achieving its revenue forecasts, as maintaining this balance could indicate improvement in the state's budget management framework and lead to positive pressure on the rating," the report said.

Moody's Ratings affirmed Arizona's Aa1 issuer rating and stable outlook on Monday, noting the budget gap was addressed without tapping the state's rainy-day fund, which is projected to exceed $1.4 billion or about 10% of general fund revenue when fiscal 2025 ends June 30. 

Arizona Gov. Katie Hobbs said S&P's outlook revision report "reaffirms that Arizona's economic position remains strong and our future remains bright." 

A statement from State Treasurer Kimberly Yee said: "Arizona's economy is strong and growing, and we continue to strive towards even greater financial stability." 

Both rating agencies said Arizona faces environmental challenges. 

"The state has elevated natural capital risk due to pervasive drought conditions and limited supplies of drinking water that are expected to continue in the western U.S., which could potentially affect future population and economic growth," S&P said. "However, we view the state's proactive long-term planning measures in securing rights to water sources to support its fast-growing population as mitigating this risk."

The fiscal 2025 budget fix included a $430 million hit to the state's long-term water augmentation fund, which was created in 2022 with the expectation of $1 billion in appropriations over three years to help finance new water sources.

Arizona ranked seventh among states in population gains between July 1, 2022, and 2023 with a 65,660 increase to 7.43 million, according to the U.S. Census Bureau.

The state, which does not issue general obligation bonds, had $1.82 billion of outstanding debt, including revenue bonds, grant anticipation notes, and certificates of obligation, at the end of fiscal 2022, according to its latest annual comprehensive financial report posted on the Municipal Securities Rulemaking Board's EMMA website.