Oklahoma released its first debt affordability study in January, offering policymakers greater context for decisions about how much the state should borrow and when. Legislation signed by Governor Mary Fallin (R) in May 2017 requires that the analyses be done annually.
Oklahoma joins 28 other states in analyzing debt through affordability studies, according to research by The Pew Charitable Trusts. These studies examine outstanding and future obligations as they relate to state-imposed affordability caps. They compare a state’s borrowing to that of its peers and use metrics such as debt service to revenues and debt per capita to put debt in context. The analyses provide policymakers with better data to inform decisions about borrowing.
Until this year, Oklahoma lawmakers got primary data points on borrowing from the State Bond Advisor Annual Report and the separate Bonded Indebtedness Report. These documents included two key metrics—debt per capita and debt as a percentage of personal income—and projected state debt service and amortization schedules, but they did not include an analytical examination of how much debt Oklahoma could afford. That made it difficult for legislators to assess whether the state was in a fiscal position sound enough to issue bonds to fund infrastructure or other capital projects.
Oklahoma’s new affordability study projects outstanding and future debt, and compares debt levels to those of peer states. It also provides a sensitivity analysis on the impact that fluctuating revenues would have on the amount of affordable debt—and, most importantly, calculates how the state’s current and future debt compares to the affordability ratio set in state statute. This ratio caps debt service at 5 percent of revenues and was in place before the study; however, Oklahoma’s previous debt reports did not assess state borrowing in relation to the cap. The study finds that Oklahoma has room to issue additional debt without going beyond its debt limit.
Historically, Oklahoma paid for infrastructure projects in cash, but in recent years the state has issued bonds to address transportation infrastructure needs. Declining revenues caused by lower oil prices have further hampered the state’s ability to use available cash for these purposes.
As they grappled with reduced energy revenue, state officials debated the impact that new borrowing could have on the state’s long-term fiscal health and credit rating. The recently released study provides them with a sound analysis to evaluate the financial risks of using bonds over the long term. That will allow policymakers to evaluate trade-offs between cash and debt financing. Consistently using this approach is part of developing a debt management policy for the state, a financial management practice recommended by the three major credit rating agencies, Fitch, Moody’s, and Standard & Poor’s.
By clearly stating how much borrowing the state can afford while staying within its debt cap, the new study gives policymakers a reference point for deciding which projects to fund. The study highlights how the state’s 2017 credit rating downgrade will probably, if temporarily, increase the cost of debt. That context can help policymakers think through the best time to issue bonds as well as which projects should be addressed at what point. The study’s sensitivity analysis offers three revenue scenarios and the possible impacts on debt capacity, which provides context for more conservative or aggressive planning.
“If you have other options or tools available for handling the state’s budget, you need to have a good grasp of what are all those choices that are available to you,” said Oklahoma state Representative John Montgomery (R), who sponsored the bill requiring the state to conduct affordability studies. “Do we have too much debt? Do we have some room for targeted investments using debt?”
Oklahoma’s situation demonstrates how affordability studies can benefit even traditionally low-debt states. According to Pew’s analysis of the state’s comprehensive annual financial reports and the financial statements of major component units—which together comprise Pew’s definition of state debt—Oklahoma has the 30th-highest total state debt; only 11 states have less per capita. Still, as policymakers sought to address mounting budget pressures in recent years, they determined that a robust, forward-looking analysis would be a critical tool. In 2017, the state House passed the bill to require regular affordability studies by a vote of 88-3; the Senate passed it unanimously.
“It’s important to know about the relationship between infrastructure investment and what you are able to actually [afford] instead of blindly saying, ‘No, let’s absolutely not [use debt],’” Montgomery said. “We have constitutional limits on how much debt can be taken out anyhow, but you can understand that those boundaries are there for a reason and still strategically use debt when you need to.”
By adding regular affordability studies to the mix, Oklahoma policymakers affirmed the importance of analyzing state debt as a critical step toward financial stability and planning for the future.
Mary Murphy is a director and Adam Levin is a senior associate with The Pew Charitable Trusts’ project on state and local fiscal policy.
Study is first to include both state and municipal pension obligations
Affordability studies can help states decide how much to borrow