Morgan Stanley Investment Management releases annual State of the States Report

Morgan Stanley Investment Management (MSIM) today released the 12th annual State of the States Report, which highlights slowing revenue growth after two years of expedited growth related to pandemic-era government stimulus. Furthermore, the State of the States Analysis indicates a stable credit outlook for most states with many planning for budget cuts of approximately 6% in the next fiscal year.

Commenting on the report’s finding, Craig Brandon, co-head of Municipal Investing for MSIM, said: “While we believe most states are on solid footing, there are several critical factors looming that will have long-term implications for states’ creditworthiness and ability to respond to shifting market dynamics. Unfunded pension liabilities and increasing Medicaid costs continue to challenge state budgets, while natural disasters continue to have an outsized impact not only on budgets but also future planning. Additionally, out-migration and demographic shifts are two issues that warrant close examination.”

The States of the States Report reveals that state debt generally remains low as many states curtailed borrowing after the Great Recession and experienced increasing state gross domestic product (GDP). Rainy day fund balances, a strong indicator of how prepared each state is for recessions and economic downturns, are at all-time highs with the median state at 13% of expenditures in 2024 while projections indicate a potential increase to 15% in 2025. However, five states have less in reserves now than they did in 2007.

“Understanding how states rank from a credit standpoint influences portfolio decisions,” said Brandon. “With a new Presidential Administration and uncertainty related to the potential extension of the Tax Cuts and Jobs Act, this analysis pinpoints areas of strength and deficiencies, and helps us identify which states are positioned to address policy changes, demographic shifts and unforeseen events that tap into state agencies and budgets and leverage infrastructure resources.”

Key findings:

  • Debt and unfunded pension burdens largely declined due to GDP growth, investment returns and pension reforms. However, overall pension liabilities remain large despite many states over-contributing to their plans in recent years.
  • Most state budgets are well-positioned to address debt, pension and Other Post-Employment Benefits (OPEB) expenses, however these expenses could crowd out other spending initiatives if paid in full.
  • Puerto Rico remains a significant outlier; its 59% liabilities-to-GDP ratio is nearly double that of any other state.
  • Medicaid costs play a significant role in state budgets and dwarf other fixed-cost spending; this is particularly acute for Colorado, Missouri, Arizona, Pennsylvania, Connecticut and Kentucky.
  • Only one quarter of states have better funded pensions now than they did in 2018, which means less well-funded pensions states have less flexibility for other necessary spending.

Developed by the municipal research team, this comprehensive report details what the team sees as the biggest issues facing the 50 states and Puerto Rico and ranks the states based on their creditworthiness, ability to pay back obligations, and overall financial health. The State of the States report leverages a proprietary ratings methodology that is based on both quantitative factors like overall state wealth, financial performance and outstanding debt as well as qualitative analysis, including projected budget shortfalls or surpluses, track records of meeting budget projections, and pension reform initiatives.

Read the full State of the States Report.

About Morgan Stanley Investment Management Morgan Stanley Investment Management, together with its investment advisory affiliates, has more than 1,400 investment professionals around the world and $1.7 trillion in assets under management or supervision as of December 31, 2024. Morgan Stanley Investment Management strives to provide outstanding long-term investment performance, service, and a comprehensive suite of investment management solutions to a diverse client base, which includes governments, institutions, corporations and individuals worldwide. For further information about Morgan Stanley Investment Management, please visit www.morganstanley.com/im.

About Morgan Stanley Morgan Stanley (NYSE: MS) is a leading global financial services firm providing a wide range of investment banking, securities, wealth management and investment management services. With offices in 42 countries, the Firm's employees serve clients worldwide including corporations, governments, institutions and individuals. For more information about Morgan Stanley, please visit www.morganstanley.com.

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This material is a general communication, which is not impartial, is for informational and educational purposes only, not a recommendation to purchase or sell specific securities, or to adopt any particular investment strategy. Information does not address financial objectives, situation or specific needs of individual investors.

This material is only intended for and will be only distributed to persons resident in jurisdictions where such distribution or availability would not be contrary to local laws or regulations. MSIM, the asset management division of Morgan Stanley (NYSE: MS), and its affiliates have arrangements in place to market each other’s products and services. Each MSIM affiliate is regulated as appropriate in the jurisdiction it operates. MSIM’s affiliates are: Eaton Vance Management (International) Limited, Eaton Vance Advisers International Ltd, Calvert Research and Management, Eaton Vance Management, Parametric Portfolio Associates LLC, and Atlanta Capital Management LLC.

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Colleen McElhinney 617.672.8995 Colleen.McElhinney@morganstanley.com

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