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.
The nation's major rating agencies, Moody’s, Fitch and Standard & 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 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||Definition||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.
• 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
|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 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||Definition||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
• 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
|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
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.
|Standards & Poor’s Rating Criteria||Definition||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
• 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
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