DALLAS – New Mexico’s Legislature begins its 2018 session this month with an upbeat economic forecast after two years of austerity.

When the 2019 fiscal year begins July 1, the state should have $199 million of new money available, according to the most recent state estimates in December.

That represents a marked improvement over the August forecast that called for no increase in revenues.

Last summer, New Mexico issued $75.8 million of severance tax bonds to fill a budget gap as the state imposed a hiring freeze and cut spending at some state agencies.

Since then, the state’s reserves have grown to $505 million, or 8.3% of annual spending. The forecast calls for reserves of 9% by mid-2018, just shy of the 10% level recommended by Moody’s Investors Service in the event of a mild recession. A major economic downturn would require reserves of 17% to maintain stability, analysts said.

On June 29, Moody's lifted its negative outlook on New Mexico’s Aa2 general obligation rating to stable based on modest improvement in oil prices and pledged revenues in fiscal 2017 following sharp declines in 2015 and 2016.

S&P Global Ratings maintained a negative outlook on New Mexico’s AA rating in its most recent report.

New Mexico’s severance tax bonds are backed primarily by taxes on the production of natural gas and oil in the state. When prices began falling in mid-2014, the state saw a sharp reduction in debt service coverage.

New Mexico has $734 million of senior-lien severance tax bonds outstanding, all rated Aa2 by Moody’s, and $94 million of subordinate lien severance tax bonds rated Aa3.

New Mexico is the sixth-largest producer of crude oil in the nation and seventh largest producer of natural gas, with most of the resource produced in the Permian Basin that New Mexico shares with Texas.

The volume of oil production increased rapidly after fiscal year 2009, reaching a record level in fiscal 2016. Oil prices and the taxable value of oil peaked in fiscal year 2014. The volume of gas production has been in gradual decline since fiscal 2005. Gas prices and the taxable value of gas produced 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.

Dramatic changes in severance tax revenues included a 32.2% decline in fiscal 2010 and a 10.5% decline in fiscal 2013.

“Past large decreases have generally been followed by large increases,” according to Moody’s. “The recent decline in oil and gas prices has resulted in particularly large declines in pledged revenues -- drops of 8.4% and 38.4% in fiscal years 2015 and 2016.”

As a result of the decline in severance tax revenues, debt-service coverage fell. Fiscal 2015 actual revenues provided 3.64 and 3.30 times coverage of 2015 debt service on the senior and subordinate bonds, respectively, analysts said. Coverage fell to 2.18 and 1.99 times in fiscal 2016. The growth in pledged revenue in fiscal 2017 will result in a modest improvement in coverage.

“Fiscal 2017 estimated revenues provide current coverage of 2.27 and 2.00 times for the senior and subordinate bonds, respectively, and peak debt service coverage of 2.24 and 1.95 times,” analysts said.

State economists adjusted income from oil and natural gas upward by $140 million for the remainder of the 2018 fiscal year and the 2019 fiscal year that begins July 1. Economists predicted an additional 3.3% in general fund spending money over the current $6.1 billion budget.

Revenue from personal income taxes is expected to grow by $167 million over the current and following fiscal years.

At a legislative hearing last month, Sen. John Arthur Smith, D-Deming, said much of the new revenues will be needed to replenish drained state accounts, citing state funding for roads in particular.

Another factor that will affect budget plans is the federal tax reform that went into effect at the beginning of the year.

Lawmakers will know more about the implications of federal tax reforms before they convene Jan. 16 for their 30-day budget session.

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