Kansas ditches debt as it strives for rating upgrades

With a stabilized budget and amid stronger-than-expected revenue growth, Kansas paid off a chunk of debt and will fund some projects with cash, saving $754 million in interest costs as it builds a case for rating upgrades.

The state tapped its surplus to pay down $1.6 billion of debt mostly owed to its pension system, redeemed callable bonds, and will cash fund $203 million of capital projects instead of issuing bonds, Gov. Laura Kelly announced Monday.  

"By prioritizing fiscal responsibility, we have put Kansas back on track and ready for the road ahead," she said in a statement.

State of Kansas

State Budget Director Adam Proffitt said budget maneuvers such as delayed payments and interfund borrowing used by previous administrations have stopped, while budget reserves have grown — steps that should "warrant a pretty strong consideration of a (rating) upgrade or an outlook upgrade. "

"I stress with the rating agencies this is not just happenstance in Kansas," he said. "We've been on a path forward and we've been good stewards and fiscally responsible for a number of years now."  

Issuer ratings for Kansas have not changed since the state was downgraded during the prior decade when tax cuts under then-Republican Gov. Sam Brownback were not offset with spending reductions resulting in budgetary imbalance.

Concerns over underfunded employee pensions were a contributing factor.

Moody's Investors Service downgraded Kansas to its current Aa2 rating from Aa1 in 2014.

S&P Global Ratings cut the state's rating to AA from AA-plus in 2014 and then to AA-minus in 2016. A negative outlook assigned to the lowered rating in 2017 was revised to stable in 2018 when revenue exceeded estimates following the repeal of income tax cuts.

David Hitchcock, a S&P analyst, said paying down debt was a "favorable" move, but the rating agency needs to see Kansas' fiscal 2022 audit to review those actions in the context of total liabilities. He added the state has a history of cyclical fund balances and funding pensions below actuarially required levels. 

"It's easy to pay down liabilities and fully pay your pension system when revenues are running above budget," he said. "The question is what happens if there is a recession." 

Ted Hampton, a Moody's analyst, said while Kansas still faces pension challenges, the recent developments were "credit positive," noting the state is making decisions that will benefit "its long-term fiscal health and sustainability of its finances and ability to manage its liabilities.

"This is good news from a credit perspective, but it's certainly not uncommon these days given the very strong revenue trends we've seen in states in the last couple of years," Hampton said.

When it recently revised the outlook on New Jersey's A2 rating to positive from stable, Moody's noted the state leveraged strong tax collections to pay down debt while meeting an annual obligation to its pension system for the first time in nearly 25 years.

Kansas' total general fund tax receipts of $2.2 billion in the first quarter of fiscal 2023 were 12% over the budget estimate and 4.4% more than the same period in fiscal 2022. In announcing September revenue results, Kelly said Kansas has had 26 months of revenue surpluses.

The state ended fiscal 2022 on June 30 with a record-high rainy day fund balance of $969 million after lawmakers approved $750 million in deposits and higher-than-estimated revenue led to an additional $219 million deposit. The general fund balance was roughly $1.4 billion, according to Proffitt.

The state's total tax revenue of nearly $9.8 billion exceeded estimates by $438 million and was 9.5% higher than in fiscal 2021.

Fiscal 2022 marked the first time in 23 years that the Kansas State Finance Council did not have to vote to take out a short-term loan to cover the state's day-to-day expenses.

Kansas, which has no general obligation debt, issues revenue and appropriation-backed bonds. At the end of 2021, the state, which has about 2.9 million residents, had about $4 billion of tax-supported revenue debt outstanding mostly from pension bonds sold in 2004, 2015, and 2021, and highway bonds, according to a Kansas Development Finance Authority report.

As part of its debt payoff, the state saved $22.2 million in interest when it called for redemption and payment on Sept. 1 nearly $100 million of series 2012C Kansas Department of Transportation revenue bonds due in 2023 through 2032.

Most of the payoff benefited the Kansas Public Employees Retirement System with lawmakers passing a bill this year to pour $1.125 billion into pensions in four payments, including $254 million for skipped contributions from fiscal years 2017 and 2019. 

Meanwhile, KPERS in May lowered its assumed investment return rate to 7% from 7.75% for the 2021 valuation. The pension fund ended last year with an unfunded actuarial liability of $9.8 billion, up from nearly $8.5 billion at the end of 2020, and a funded ratio of 72%, down from 73%.

The state sold $500 million of 30-year taxable bonds last year to boost pension funding, which followed the issuance of $1 billion of pension debt in 2015.

On the economic front, the state in July announced Panasonic Energy Company plans to invest up to $4 billion in an electric vehicle battery facility in De Soto that is expected to create as many as 4,000 jobs.

State tax credits and other incentives available to the company after completing the project and hiring workers are estimated at $829.2 million under the state's Attracting Powerful Economic Expansion Act enacted earlier this year.

Moody's Hampton said the project could be a significant economic positive for Kansas as it would be positioned to benefit from the transition to electric vehicles. 

Meanwhile, the Nov. 8 election is looming. Kelly, a Democrat who is seeking a second term as governor, faces Republican Derek Schmidt, the state attorney general since 2011, with polls showing a close race.

If reelected, Kelly promises continued balanced budgets and additional ahead-of-schedule debt payments as a precursor to "responsibly" cutting more taxes, according to her campaign website. She also pledged to push legislation to eliminate the state sales tax on food immediately.

The Republican-controlled legislature last session opted to phase out the tax.

Schmidt's platform also calls for paying off more state debt, including pensions, and slowing the growth of state spending. He wants to exempt retirement income from state taxation.