April 9 (Bloomberg News) -- Investors such as BlackRock Inc. andWasmer Schroeder & Co. are growing wary of New Jersey debt,saying the state’s credit rating is poised to fall further withoutsteps to address revenue and pension gaps.

While declining bond issuance has reduced the extra yield on NewJersey debt to a three-month low, the level doesn’t compensateinvestors for a possible rating cut, according to Peter Hayes, headof municipal debt at BlackRock. Yield spreads may balloon iffinancial challenges garner headlines, as happened during fiscalcrises in California and Illinois, said Justin Land, who helpsmanage $3.5 billion of munis at Wasmer Schroeder in Naples,Florida.

New Jersey is rated three steps below benchmark debt, with anegative outlook. A one-step downgrade would place it withCalifornia and Illinois in the single-A category, below the 47other states. Economic growth trails its neighbors, and revenue hasmissed Governor Chris Christie’s goals for three straight years.His fiscal 2015 budget plan includes a record $2.25 billion pensionpayment that crowds out other spending.

“They’ve had some pretty optimistic assumptions on the revenueside, which haven’t come to fruition,” said Hayes, whose NewYork-based firm oversees about $108 billion in state and localdebt. “Barring any pretty big pension reform, I would not besurprised at all to see a downgrade before the end of theyear.”

Record Spending

Christie, a 51-year-old Republican who began a second term inJanuary, has proposed raising spending 3.5 percent to a record$34.4 billion for the year beginning July 1. Excluding costs forhealth benefits, pensions and debt, his budget would have been $2.2billion smaller than in fiscal 2008, he has said.

The increase in spending “isn’t going to schools and roads andinfrastructure and all these things you need to entice businessesand get people to want to stay,” Land said.

The state’s retirement costs are increasing even after Christiesigned into law June 2011 legislation that raised public workers’pension payments over several years, boosted the minimum retirementage to 65 from 62 and froze annual cost-of- living adjustments

‘Same Page’

Kevin Roberts, a spokesman for Christie, said the state’sunfunded pension liability and mounting health-care costs need tobe addressed. A downgrade isn’t a forgone conclusion, he said.

“We diagnosed that problem and have been aware of it,” he saidby telephone. “In that respect, we are in the same vein or on thesame page as the credit companies are.”

The three largest rating firms each cut New Jersey one levelsince Christie took office in January 2010, and give it a negativeoutlook. The state has a Moody’s grade of Aa3, and a AA- fromStandard & Poor’s and Fitch Ratings.

Fitch on March 21 lowered its outlook on the state, citingfiscal strains and an economic performance that hasn’t been robustenough to keep pace with rising liabilities. The budget is“structurally imbalanced,” as New Jersey phases in full pensionpayments and Christie relies on one-time fixes, Marcy Block, aFitch analyst, wrote in a report.

The move by Fitch put “an even greater emphasis” on Christie’scall to lower pension and long-term costs, Chris Santarelli, aTreasury Department spokesman, said at the time.

Union Role

Christie said in February that the pension was underfunded by$52 billion after a decade of expanded benefits and missedpayments. Public-employee unions must agree to changes in theirretirement and health plans because his 2011 overhaul didn’t go farenough to contain costs, the governor said. His budget relies onrevenue growth of 5.8 percent.

“They’ve got to be a little bit more realistic in their revenueassumptions in the 2015 budget,” Hayes said.

New Jersey’s gross state product rose 1.3 percent from 2011 to2012, ranking thirty-sixth among U.S. states, and lagged behind thenational gain of 2.5 percent, according to the U.S. CommerceDepartment’s Bureau of Economic Analysis.

The state’s 7.1 percent jobless rate in January and February,while the lowest since 2008, is still higher than that of New Yorkand Pennsylvania.

Economic Laggard

“New Jersey is clearly a laggard and there’s really not much inthe way of strong growth prospects for the economy going forward,”said Larry Bellinger, municipal credit analyst in New York atAllianceBernstein Holding LP, which oversees $30 billion ofmunis.

Yields on New Jersey’s debt may increase by as much as 0.2percentage points above top-grade munis in the event of adowngrade, Hayes said. Relative declines may create buyingopportunities in BlackRock’s national muni funds, he said.

“It becomes more interesting for non-New Jersey funds,” Hayessaid. “And that’s where we’d probably look to add potentially.”

Land foresees even wider spreads, which he said may make thebonds attractive.

“We’ve seen what happens when the media and the populace gets ahold of an idea that a state is in trouble,” Land said. “Once theindividual investor gets in on that and once everybody startsfocusing on that, you could see their bonds widen” by a fullpercentage point.

California Example

California is an example of that stress. In 2009, when the thestate resorted to IOUs to pay bills, spreads on 10-year Californiabonds almost quadrupled to about 1.7 percentage points in the spanof a year. The gap has since returned to about 0.4 percentagepoint.

Even with the negative credit outlooks, investors demand about0.07 percentage point of extra yield to buy 30-year New Jerseybonds rather than benchmark debt, close to the smallest gap sinceDecember, data compiled by Bloomberg show.

A drop in New Jersey borrowings has helped spur the gains, Hayessaid. The state and its municipalities sold about $1.3 billion offixed-rate bonds in 2014 through April 4, or 72 percent less than ayear earlier.

That drop exceeds the 25 percent decline in issuance across theentire $3.7 trillion municipal market.

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