Financial management credited as Kentucky gains positive rating outlook

Kentucky's improved financial risk management practices were the key to S&P Global Ratings' decision to lift the state's rating outlook to positive.

The rating agency Jan. 28 revised the outlook from stable on the Bluegrass State and affirmed its A issuer credit rating.

At the same time, S&P affirmed the A-minus rating on the appropriation-backed obligations linked to the state rating, issued by the State Property and Buildings Commission and other state agencies.

"Our ongoing effort to attract new investments in the commonwealth while continuing to be fiscally responsible is having a positive impact," said Kentucky Gov. Andy Beshear.

The agency also affirmed the BBB-plus rating on Kentucky's lease debt backed by appropriations from the Administration Office of the Courts, issued for county court projects.

"The positive outlook reflects our view of Kentucky's improved risk management practices that we capture under our environmental, social, and governance (ESG) factors, including less reliance on one-time items to balance the budget and a higher rainy day fund, the budget reserve trust fund, that increased to $1.9 billion, or 16% of general fund expenditures, from $303 million in fiscal 2020," said S&P credit analyst Anne Cosgrove.

S&P noted the improved governance as Kentucky made changes to the state Teachers' Retirement System with a transition this year to a hybrid structure for teachers hired after Jan. 1.

“We believe these changes improve the legal flexibility to meet our view of minimum funding progress, as well as modifying a number of plan assumptions,” S&P said. “This is in addition to Kentucky continuing its commitment to fully funding the actuarially determined contributions (ADCs) of the pension plans since fiscal 2017, which we view positively.”

S&P said its A rating reflects Kentucky’s ability to maintain fiscal balance and reduce reliance on one-time measures to balance the budget.

It noted that the significant federal relief funding in fiscal 2021 helped improve overall financial flexibility during a time of significant uncertainty because of the pandemic.

Under the 2021 American Rescue Plan Act the state will receive more than $3.77 billion, which includes $868 million for counties and $931 million for cities. The state had received about $1.7 billion in federal aid under the 2020 Coronavirus Aid, Relief, and Economic Security Act.

“Our ongoing effort to attract new investments in the commonwealth while continuing to be fiscally responsible is having a positive impact on the experts' view of Kentucky,” Gov. Andy Beshear said. “S&P cited a reduced reliance on one-time items to balance the budget and a higher balance in the state’s Rainy Day Fund as primary factors influencing the change.”

He noted the key drivers of the outlook revision.

“Their outlook on where our economy is is not stable — but positive,” he said. “Our continued economic recovery — including significant investments like Ford Motor Company and SK Innovations decision to build what we believe will be the largest battery production facility in the United States — were also cited by S&P as key to the decision to revise Kentucky’s outlook to positive.”

S&P said some large investments from the auto industry are expected to generate many new jobs. It also cited as positive the improved governance over the past few years, including recent teachers pension reform and a demonstrated willingness to reduce expenditures to balance the budget.

Still, S&P said the state’s strengths are offset by high fixed costs such as pension liabilities, which it expects will weigh on future budgets. Additionally, S&P noted that future budgets could be pressured by having to deal with a large percentage of Medicaid costs along with weaker demographics and a low labor force participation rate.

“We could raise the rating if Kentucky continues to show a commitment to structurally balanced operations and improved pension funding, even after incorporating potential increased pension costs in the proposed budget,” S&P said

However, the agency noted it could revise the outlook back to stable if the state misses its revenue collection forecasts, leading to poorer-than-expected budgetary performance; if pension and other post-employment benefits costs increase faster than expected; or if there is a lack of structural balance or reduction of the budget reserve trust fund balance.

Over the past few years, Kentucky’s leaders say business-friendly business friendly business-friendly policies have helped it achieve record growth and investment. And it continues to look ahead to increased economic activity.

The governor announced that in the last week in January more than 1,200 new jobs will be created with almost $292 million in investments by businesses across the state.

“Companies across the country and around the world have recognized what we’ve known all along — that Kentucky is the place to be,” Beshear said. “We’ve already broken every record in the books for economic development.”

Last year, the Beshear administration said, Kentucky saw a record $11.2 billion in private-sector investments for new-location and expansion projects and commitments to create over 18,000 full-time jobs over the next few years.

Kentucky is rated Aa3 by Moody’s Investors Service and AA-minus by Fitch Ratings and Kroll Bond Rating Agency. All three have stable outlooks on the credit.

In 2021, issuers in the state sold more than $3 billion of debt, with the top issuer being the Northern Kentucky University Foundation with $210.5 million.

“With all the negative we’ve had to deal with, positive feels pretty good,” Beshear said.

Kentucky has been grappling with both the fallout from the COVID-19 pandemic and the recent aftermath of death and destruction left in the wake of last December’s tornadoes.

Since the pandemic began in 2020, the state has seen 1.2 million coronavirus cases with more than 13,000 deaths.

In early December, 70 tornadoes tore through the state and hit Arkansas, Illinois, Mississippi, Missouri and Tennessee as well. This resulted in at least 77 deaths in Kentucky, making it the state’s deadliest weather disaster on record. It also left widespread destruction of property and damaged infrastructure in towns throughout the southwestern part of the state.

Kroll said that favorable liquidity will help Kentucky manage its tornado recovery efforts.

“In KBRA’s view, the Commonwealth of Kentucky’s improved reserve position together with federal assistance provide important support to address the added costs that could result from the recovery efforts,” Kroll said in a December ratings note.

President Joe Biden visited Kentucky on Dec. 15 to tour some of the most devastated areas.

“There’s no red tornadoes or blue tornadoes,” Biden said at a briefing with the state’s leaders. Beshear is a Democrat while both houses of the state legislature have Republican majorities.

Biden issued a major disaster declaration, which activated the Federal Emergency Management Agency to respond and send 700 personnel to the affected areas.

“As a result of federal assistance and state resources, Kentucky is well placed to manage the financial implications of the substantial damage caused by the recent tornadoes,” Kroll said.

A resident sits outside a damaged home after a tornado in Dawson Springs, Kentucky, on Dec. 13.

In early January, Beshear sent his fiscal 2022-2024 executive budget to the state Legislature, noting that fiscal 2021 saw an all-time revenue surplus and that the years ahead looked promising.

“The revenue estimates for the 2022-2024 biennium are bright, with $1.9 billion more in General Fund revenues than budgeted in the current year, and a growth rate of 7.5% that follows the 10.9% growth rate last year,” he said in his budget message sent to the state House and Senate.

General Fund receipts have grown over 15% in the first half of the current fiscal year, he said, adding that the Consensus Revenue Forecasting Group predicts growth rates for fiscal 2023 and 2024 at 2.1% and 4.2%, respectively.

The governor’s budget would add almost $2 billion to state education spending, with $915 million more in fiscal 2023 and $983 million more in fiscal 2024. The budget also stayed under the state’s debt service to revenue policy cap of 6%, with a ratio of 3.68%.

However, later last month, the House passed its $65 billion fiscal 2022-2024 version of the budget, which has now gone to the Senate where it will be amended and undergo some changes before both bodies get together to negotiate a final version that will be sent to the governor for his signature.

It was the earliest vote on a House budget bill in many years and lawmakers said preparations during last year’s interim session allowed them to accelerate the pace on budgeting this year.

The House version was more conservative than the governor’s proposal in that it held back about $1 billion in unallocated funds whose purpose will be decided upon later.

Some have speculated the GOP legislature may want to revise the state’s tax code during the current session and provide across-the-board tax cuts. Democrats have urged spending on education programs and infrastructure should take priority.

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