Downgrades Herald New Mexico's $333M Deal

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DALLAS – New Mexico is competitively selling $333 million of severance tax bonds after two downgrades attributed to declining oil and gas revenues.

Moody's Investors Service dropped its rating on the senior-lien severance tax bonds to Aa2 from Aa1 Thursday and retained a negative outlook, "reflecting continued uncertainty about the trend of oil and gas prices, and their effect on severance tax revenues and coverage levels."

S&P Global Ratings also on Thursday lowered $717.8 million of outstanding senior-lien severance tax bonds to AA-minus from AA. The state's $122.5 million of subordinate bonds dropped to A-plus from AA-minus. The outlook is stable.

As one of the state's most dependent on oil and gas taxes, New Mexico saw an 8% decline in pledged severance tax revenue in fiscal year 2015 and expects a 38% decline for the fiscal year ending June 30.

"We believe that prices could remain depressed for some time," S&P analyst David Hitchcock said.

The New Mexico State Board of Finance is taking bids on the $292.9 million tax-exempt piece of the bonds Tuesday at 10:30 a.m. EDT with Fiscal Strategies Group Inc. as its financial advisor.

The senior-lien bonds will be issued as $87.8 million of tax-exempt serials reaching final maturity in 2026, along with $195 million of advance refunding bonds reaching final maturity in 2024. Bids will be taken at 11:30 a.m. on the $49.9 million of taxable bonds maturing finally in 2021.

The refunding is taking out certain maturities of bonds issued in 2011, 2013 and 2014. Proceeds of the Series 2016A and taxable Series 2016C bonds will fund a wide array of general government capital projects as designated by the Legislature.

The bonds are backed by the severance tax bonding fund, including net tax receipts generated from natural gas, oil, and other natural resources in New Mexico.

Supplemental severance tax bonds are secured by a second lien on pledged revenues, after payment of senior debt service.

S&P considers the 2-to-1 ratio of revenue to maximum annual debt service as strong, although the coverage is down from 3.39 times in 2015.

The coverage requirement for issuing additional bonds is revenue at two times maximum annual debt service, which limits the state's ability to increase debt on par with outstanding issues. Hitchcock called that a positive credit factor.

New Mexico's practice of limiting maturities on severance tax bonds to 10 years is also a positive credit factor, according to Moody's analyst Kenneth Kurtz.

"Payout is quite rapid, and annual debt service requirements decline steadily from fiscal 2017 through final maturity in 2026," Kurtz wrote. "As a result of this structure, severance taxes could fall significantly for multiple years without any shortfall in the amounts required for debt service."

New Mexico is the sixth-largest producer of crude oil in the nation, after Texas, North Dakota, California, Alaska, and Oklahoma. The majority of the state's oil is produced in the Permian Basin in the southeastern part of the state. The volume of oil production increased rapidly after 2009, reaching a record level in 2015.

Oil prices and the taxable value of oil peaked in June 2014 before tumbling dramatically in the last quarter of the year and throughout 2015.

New Mexico is also the seventh largest producer of natural gas in the nation, with the majority of the production in the San Juan Basin in the northwestern corner of the state.

The volume of gas production has been in gradual decline since fiscal year 2005, and gas prices and the taxable value of gas peaked in fiscal 2008.

"Severance tax revenues are highly sensitive to the prices of oil and natural gas, the level of production, changes in production technology, and additions to and depletion of oil and gas reserves," Kurtz said.

 "The historic volatility of severance tax revenues was demonstrated by a dramatic 32.2% decline in fiscal 2010 and an 11.7% decline in fiscal 2013," Kurtz said. "The recent decline in oil and gas prices has resulted in particularly large declines in pledged revenues. These losses are unlikely to be recovered in near term."

For New Mexico lawmakers and Gov. Susana Martinez, the allocation of proceeds from the annual sale of severance tax bonds is a perennial source of conflict.

"It is frustrating and disappointing to watch how the Legislature squanders critical infrastructure funding – choosing to spend money on local pork projects that often do not create jobs or develop the economy instead of pooling resources to make long-lasting, impactful infrastructure improvements throughout the state," Martinez wrote in a March 9 letter to the Legislature.

Martinez said the Legislature chose to spend "an unprecedented share of the state's capital outlay dollars (two-thirds of the available $120 million) on local pork projects – neglecting regional and statewide infrastructure needs."

By contrast, 83% of capital outlay went to statewide infrastructure needs in 2008, Martinez pointed out.

"Ultimately, a sad legacy of our Legislature is a string of unfunded and unmet infrastructure challenges throughout the state that, if addressed, could have led to job creation and a more dynamic, thriving state," she wrote.

Martinez also complained about how the funds were applied to projects.

"Countless projects are woefully underfunded, sometimes at one-tenth or less of the total cost of a meaningful phase of the project," she wrote.

"It is simply a fact that this rampant underfunding leads to a string of incomplete projects and wasted infrastructure money," the governor wrote. "Many of my vetoes in this year's capital reauthorization legislation are, in fact, for projects that were underfunded several years ago, have seen little to no expenditure of the appropriation since, and yet were requesting more time to continue holding onto that money."

With 2.1 million people, New Mexico ranks 36th in population among U.S. states and 37th in gross domestic product of $92.2 billion. It is the nation's second poorest state behind Mississippi, with per capita personal income equal to 82% of the U.S. average.

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