Kansas is taking advantage of continued low interest rates with a $502.6 million taxable deal to pump money into its underfunded state retirement system.
The pension obligation bonds on Tuesday's calendar are coming through the Kansas Development Finance Authority with Citigroup as book runner.
The bonds are rated Aa3 by Moody’s Investors Service and A-plus by S&P Global Ratings. Outlooks are stable.
“The stable outlook reflects an expectation that Kansas has the capacity to generate the resources necessary to sustain structural balance in a period of economic stability or to withstand a moderate shock to revenue in a period of economic weakness,” said Moody’s analyst Matthew Butler.
Because debt service is subject to appropriations by the Kansas Legislature, the POBs are rated a notch lower than the state’s issuer ratings.
“Though the credit ratings for Kansas remained the same, this is still positive news for the state’s budget and economic outlook — especially during a global pandemic,” Gov. Laura Kelly said in a statement. “We remain cautiously optimistic that our efforts to strengthen our budget and our economy through pro-growth policies are paying off.”
The 30-year bonds will reduce the unfunded actuarial liability and employer contribution rates. Since 2012, the Kansas Public Employees Retirement System improved its funded ratio from 56% to 75% at the end of 2020.
The KDFA is also issuing $43 million refunding revenue bonds for interest-rate savings.
The deal comes as the Sunflower State continues its recovery from the pandemic and last year’s recession.
“Kansas came through the pandemic-sparked recession in relatively good financial shape, largely due to conservative revenue estimates for fiscal 2021, which has left the state with a strong combined general fund and budget stabilization fund balance at fiscal year-end 2021 equal to 26.5% of estimated budgetary expenditures,” said S&P analyst David Hitchcock.
“The state estimates a substantial structural surplus occurred in fiscal 2021, after years when ongoing tax revenues did not cover expenditures, and the state routinely underfunded annual pension contributions,” he added.
Revenues came in better than expected at the end of fiscal 2021 on June 30. That left the general fund with a balance much stronger than projected, which will carry over into fiscal 2022, and is now estimated to leave the state with a strong general fund balance of 16.1% of expenditures at fiscal end 2022, Hitchcock said.
“Although the state expects to fully fund its annual pension contributions on an actuarial going forward, and the ending fiscal 2022 fund balance would still be strong, we believe it will still need to show a commitment to structural balance in future budget years to display credit improvement,” he said.
KPERS has been facing a long-term funding shortfall, significantly affected by two recessions and the state making less than the required employer contributions for 25 years, officials said.
“Projections continue to show the legacy unfunded actuarial liability will extinguish in 2033 as scheduled,” KPERS said. “Continued funding improvement hinges on meeting our investment target over time and consistent funding with increasing employer contributions to match actuarial funding requirements.”
After years of troublesome finances in the wake of Republican tax cuts, Kansas lawmakers in 2015 approved the initial $1 billion of pension obligation bonds to reduce the unfunded liability.
Gov. Sam Brownback, the Republican who preceded current Democratic Gov. Laura Kelly, had originally proposed $1.5 billion of POBs, but Senate Bill 168 trimmed that to $1 billion.
S&P downgraded its Kansas rating and outlook four times between 2014 and 2017, citing structural budget pressures caused by the Brownback tax cuts.
Moody’s rating outlook was lowered from stable to negative in 2016, citing ongoing difficulties to restore structural balance to its budget and get on a path to sounder funding of its pension liabilities.
The state was also downgraded by Moody’s to Aa2 from Aa1 to in 2014 because of falling tax revenue, unfunded pension costs, and the possibility of high court-ordered spending on education.
With proceeds from the 2015 bonds deposited in the Kansas Public Employees Retirement System, the state's funded pension ratio improved to 66% from 60.7%.
The state’s economic recovery was reflected in July tax receipts that rose 11% above the estimates for the month.
State officials said year-over-year comparisons would be misleading because last month’s figures included receipts from tax returns from an extended filing period. States followed the IRS's lead in 2020 in delaying the income tax filing deadline to July from April because of the pandemic.
“Our July tax collection numbers are encouraging, but we must maintain fiscally-responsible policies to ensure our continued growth,” Kelly said in announcing the results.
Individual income tax receipts were $20.8 million, or 8.9%, more than the estimate with $255.8 million collected. Corporate income tax collections were $34.2 million, which was $19.2 million, or 8.9%, more than the estimate.
Retail sales tax collections were up $11.6 million, or 5.2%, for the month with $233.6 million collected. That was $15 million, or 6.9%, more than the previous July.
“Consumer spending on goods and services has not slowed down,” Secretary of Revenue Mark Burghart said. “Our economists are watching closely to determine if the spread of the COVID-19 Delta variant will impact what has been a strong economic recovery in Kansas.”
When Kansas issued its initial $1 billion of POBs in 2015, pension bonds were considered riskier because of the risk of lower investment returns.
Over the past year, markets have shown impressive strength as fixed interest rates remained low.
“We view the sale of pension bonds as moderately increasing the state's risk, as essentially a bet that the state can earn a higher return on the invested bond assets than it will pay in taxable bond interest costs,” S&P’s Hitchcock said about the upcoming deal.
“The state believes that the $500 million pension obligation bond will improve the KPERS pension funding ratio,” he said. “The state has not budgeted any expenditure savings in its fiscal 2022 budget, and future reduced pension contribution payments will depend on the next actuarial valuation.”
On this week’s deal Columbia Capital Management is financial advisor, with Gilmore Bell as bond counsel.
