economy Fiscal Notes

Texas and the Credit Rating Agencies Determining the Cost of State Borrowing

Most of us find out, sooner or later, that our personal credit rating is important, generally when we start buying big-ticket items. Your credit rating can dictate how much you pay for a house or car, or even whether you can buy it at all.

State governments have credit ratings as well, and in their case the stakes are considerably higher; they spend and borrow billions of dollars each year, and even minor changes in their ratings can have multimillion-dollar impacts on their cost of borrowing.

Texas law authorizes state agencies to issue certain forms of debt to support state projects. This is primarily long-term general obligation debt — bonds backed by the "full faith and credit" of the state government — as well as some short-term debt including Texas Tax and Revenue Anticipation Notes (TRANs). (Texas will not be issuing TRANs this year due to the strength of its cash position.)

Every July, the Comptroller and a team of agency staff members visit the rating agencies to provide information intended to help them determine ratings for the upcoming year. At these meetings, the rating agencies obtain updates regarding the state's economic condition, recent legislative actions and other matters related to its long-term credit rating.

Texas has the highest available credit ratings from the nation's major agencies.

Rating Basics

The nation's major rating agencies, Moody's, Fitch and Standard and Poor's (S&P), issue ratings that characterize the state's ability to repay debt.

The rating agencies provide investors with assessments of the "creditworthiness" of potential investments and the risks involved. And their opinions have dollars-and-cents implications, since they affect the cost of borrowing.

A bond or other debt instrument, after all, is a form of IOU, and more highly rated borrowers usually pay lower interest costs — also called the "risk premium" — based on the assumption that they're more likely to be able to pay principal and interest when the debt becomes due. Many institutions, moreover, invest only in bonds the rating agencies judge to be "investment grade."

Moody's, Fitch and S&P use similar but different methods to determine each state's credit rating, based on factors such as the state's economic and financial policies, its financial management practices and recent legislation affecting the state's finances. The agencies' ratings are accompanied by a commentary outlining the strengths and weaknesses that led to the rating. These debt ratings are reviewed at least annually and updated as the rating agencies deem necessary.

In the following sections, we'll look at the yardsticks the rating agencies use to gauge Texas' financial health, and their current assessments of our state.

Moody's Ratings

As of May 2015, Texas' long-term debt was rated Aaa with a stable outlook, the highest available rating.

Moody's rates long-term debt outlook as (in descending order) Aaa, Aa1, Aa2, Aa3, A, Baa and below. The agency credits Texas with a diversified and fast-growing economy, low bond debt, conservative revenue forecasting and the presence of the state's Economic Stabilization Fund (its "Rainy Day Fund.")

Areas of concern Moody's cited in 2015 include a need for higher transportation and educational spending, as well as high poverty rates creating a need for services that may affect the state's long-term financial security.

Moody's Rating Criteria
Moody's Rating Criteria Factor Weight Factor Elements
Economic Strength
The economic profile of the state, with relative economic strengths and weaknesses
20% Per capita income versus U.S. average
Industrial diversity
Employment volatility
Governance
The quality of financial decision-making and financial policies
30% Financial best practices
Financial flexibility vs. constitutional constraints
Financial Strength
Financial structural balance produced by the decisions and practices of state policymakers
30% Revenues
Balances and reserves
Liquidity
Debt Position
The state's debt and long-term liabilities as part of its overall financial health
20% Bonded debt
Adjusted new pension liabilities

Source: Moody's Investors Service

Fitch Ratings

As of August 2014, Fitch rated Texas' long-term debt at AAA with a stable outlook, its highest rating.

Fitch rates long-term debt outlook as (in descending order) AAA, AA+, AA, AA-, A+, A, A-, BBB and below. It credits Texas for low debt, a diverse and growing economy and its Rainy Day Fund. Areas of concern include the cyclical nature of the Texas energy industry and additional long-term funding needs for transportation, schools and water.

Fitch Rating Criteria
Fitch Rating Criteria Factor Elements
Debt and Other Long-term Liabilities
State debt and other long-term liabilities and their effect on affordability and flexibility
Debt ratios and trends
Debt structure
Future capital and debt needs
Pension and other post-employment benefit funding
Indirect risks and contingent liabilities
Economy
The economy's ability to yield the tax revenue needed to support ongoing operations and repay debts
Major economic drivers
Employment
Income and wealth
Demographic factors
Tax burden
Finances
The state's financial resources and ability to meet short- and long-term goals
Revenue analysis
Expenditure analysis
Operating margin trends
Fund balance and reserve levels
Liquidity
Management and Administration
Management skills of state elected and appointed officials and staff
Institutionalized policies and budgeting practices
Financial reporting and accounting
Political, taxpayer and labor environment
Revenue and spending limitations

Source: Fitch Ratings

Standard and Poor's Ratings

As of November 2014, S&P rated Texas' long-term debt at AAA, its highest rating.

S&P rates long-term debt outlook as (in descending order) AAA, AA+, AA, AA-, A+, A, A- and BBB. Each factor is scored on a scale from 1 (strongest) to 4 (weakest); each metric is averaged and added for a composite score that translates into a rating.

S&P credits Texas with strong employment growth, effective revenue forecasting and cash management and low debt. Areas of concern include long-term budget issues, primarily due to public school funding. FN

Standards and Poor's Rating Criteria
Standards and Poor's Rating Criteria Factor Elements
Government Framework
Government structure and political environment
Fiscal policy framework
System support
Intergovernmental funding
Financial Management
State's ability to make sound and timely financial and operational decisions in response to fiscal and economic demands
Financial management assessment
Budget management framework
Economy
A review to assess the state's overall economic fundamentals
Demographic profile
Economic structure
Wealth and income indicators
Economic development
Budgetary Performance
State's financial condition based on audited financial statements
Budget reserves
Liquidity
Tax/revenue structure
Revenue forecasting
Service levels
Structural budget performance
Debt and Liability Profile
Prioritization of debt service expenditures and other liabilities
Debt burden
Pension liabilities
Risk assessment for other post-employment benefits

Source: Standard & Poor's Financial Services LLC