Two of the four Wall Street rating agencies lowered Connecticut’s credit rating one notch prior to an upcoming bond sale.

Standard & Poor’s and Fitch Ratings lowered Connecticut’s general obligation bonds from AA to AA-. Moody’s Investors Service and Kroll Bond Ratings affirmed their Aa3 and AA ratings, respectively, but gave the bonds a negative outlook, which means they will be under review for one or two years.

The downgrade, according to S&P Global Ratings credit analyst David Hitchcock, reflects the lack of flexibility in Connecticut’s budget. The rising debt service, pension and other fixed costs are becoming a significant portion of the overall budget and could hamper the state’s ability to make further budget cuts if revenue falls short.

“In our opinion, Connecticut has less flexibility to meet unanticipated revenue shortfalls, such as those that occurred in fiscal 2016, and may be poorly positioned should there be a national economic downturn in the next several years,” Hitchcock said.

Even though the state cut more than $820 million from the fiscal 2017 budget, it did nothing to boost reserves or reduce future budget deficits. However, Hitchcock gave Connecticut’s bonds a stable rating due largely to the legislature’s attempt to make structural budget adjustments.

“Should Connecticut restore material budgetary flexibility either through the build-up of material ongoing reserve levels, or if fixed costs fall as a percent of budget, we could potentially raise our rating on the state,” Hitchcock said. “However, should unfunded pension or OPEB liabilities rise significantly, or large revenue shortfalls reoccur without additional offsetting budget adjustments, we could lower our rating.”

Fitch’s credit rating report was similar.

“The state has experienced chronic economic and fiscal challenges during the current expansion and consequently its scope of flexibility to address future cyclicality, in Fitch’s view, has been reduced,” the report states. “Despite repeated, and generally structural, responses to bring the current biennial budget into balance, it remains unclear whether the state has succeeded in fully aligning its budget to potential future economic and revenue performance.”

Office of Policy and Management Secretary Ben Barnes said they are glad the two agencies maintained Connecticut’s strong bond rating. He didn’t address the decision by two of the agencies to downgrade their ratings.

“The budget adopted by the General Assembly last week helps move us in that direction — one agency praises ‘administrative changes to budgeting supported by the governor’ and the new budget’s emphasis on ‘recurring actions’,” Barnes said in a statement. “The agencies recognize we have begun to make necessary structural changes. But we all know, and are reminded today, that there is much more difficult work to be done.”

State Treasurer Denise Nappier pointed out that with the 2017 budget adjustments, spending levels will be below 2016 levels even with increased fixed costs. And on the revenue side, there are no tax increases or use of significant one-shot revenue sources.

The rating agencies took note of these structurally sound budget actions, as well as other credit positives including the state’s high per capita income and strong governance, Nappier said.

House Minority Leader Themis Klarides, R-Derby, and Senate Minority Leader Len Fasano, R-North Haven, had a different take on the ratings.

Klarides said the downgrade by two of the agencies, “is just more evidence that our finances have been mismanaged for too long and now taxpayers will again pay the price for higher borrowing costs in the future.”

Fasano said Connecticut continues to budget based on “elections and not generations.”

He said the “Democrat majority has failed to mitigate higher debt in future budgets – budgets that will fall onto the backs of our children and our grandchildren. By approving a ‘business-as-usual’ budget, the Democrat legislature has not done its job to tackle the state’s pension issues, debt ratio, and poor spending habits.”

The rating news comes in advance of a $500 million tax-exempt general obligation refunding bond sale being offered next week.

“With interest rates close to historic lows, this debt refinancing transaction will bring down the State’s debt cost and deliver much needed current and long term budget savings for our citizens,” Nappier said.

There will be an exclusive order period for retail investors on Monday, May 23, and pricing for institutional investors on Tuesday, May 24.