New Jersey's Municipal Qualified Bond Act is helping distressed Atlantic City, N.J. access the bond markets this month with deals that highlight the role state credit enhancement programs can play for municipalities with pressing liquidity needs.
In bond deals under the New Jersey MQBA program, the state treasurer's office intercepts qualifying state aid before it goes to the participating municipality and instead directs the money toward debt service.
Atlantic City, which is under an emergency manager's control as it faces a $101 million budget gap, will use the program to issue debt that will pay off a $40 million state loan, for which it received a 60-day extension in late March, and $12 million of maturing bond anticipation notes.
Standard & Poor's analyst John Sugden said state enhancement programs like the New Jersey MQBA enable struggling cities like Atlantic City to access the credit markets in periods of financial turmoil.
"It provides greater confidence to the bondholders that cash flow will not be interrupted," said Sugden. "The idea is to assure the bondholders that the state is providing oversight."
Moody's Investors Service analyst Josellyn Yousef said roughly half of the 50 U.S. states have a form of a credit enhancement program, with the majority only geared toward school districts.
New Jersey's MQBA is available for all municipalities, with Jersey City, Harrison and Patterson taking part in the program over the last few years.
"A lot of cities would have a hard time accessing the capital markets without this program," said Yousef. "The program structure enhances credits by intercepting state aid."
Atlantic City revenue director Michael Stinson said the city is on track to issue separate transactions through the New Jersey MQBA program before Memorial Day.
A taxable bond deal will be used to pay off the $40 million state loan Atlantic City owes by the end of May.
A tax-exempt bond deal not exceeding $12 million will allow the city to retire its maturing BANs.
Stinson said without New Jersey's credit enhancement program, accessing the municipal bond market would be very difficult at a time when vital payments are due.
"It's certainly a major help," said Stinson of the MQBA. "It does not appear we would be able to go to market without this program."
James Spiotto, managing director at Chapman Strategic Advisors LLC in Chicago, said he expects more states to add credit enhancement programs to backstop municipalities facing severe financial struggles.
He said many states have already seen the need for these programs to prevent school district defaults, and the same concerns are now being demonstrated for towns and cities.
"It is being recognized as something that is necessary given our economic times and the tough times facing municipalities," said Spiotto of his forecast for more state credit enhancement programs. "When you provide liquidity it provides a calming effect on creditors."
Spiotto said a recent example of state proactively addressing risks of municipal distress was a 2010 law the Rhode Island legislature passed that placed a statutory lien on the struggling city of Central Falls' property taxes and earmarking this revenue toward bondholders in the event of a bankruptcy filing.
When Central Falls went bankrupt, its GO bondholders were kept whole pensions were cut up to 55% -- in contrast to later bankruptcies in Stockton, Calif. and Detroit.
The Rhode Island measure produced positive results for bondholders and Spiotto said similar laws will be needed in other states to help cities and school districts avoid the fate of Chapter 9.
"It's a question of how to lower borrowing costs for those that are financially challenged," said Spiotto. "When a municipality needs financing the most, it is at its most risk."
Wells Fargo Securities issued a research report in March 2014 saying that state enhancement programs provide "an additional layer of protection for bondholders" of local governments and school districts in the event of a default or potential default.
Roy Eappen, a Wells Fargo municipal analyst who authored the report, said bonds that are part of a state enhancement program generally gain added value from a higher credit rating tied to the state, which can be especially advantageous for a distressed government.
"It's beneficial to the bondholders and it helps the locality access the market through a better rating," said Eappen. "They provide the security that investors like."
Eappen added that while state enhancement programs do provide benefits for issuers, not all receive the benefit of an improved credit rating. He said an example of this is the South Carolina's constitution providing an intercept provision of state aid for any locality that issues general obligation debt, which does not translate to enhanced ratings.
"There is a state intercept [in South Carolina] even though the rating agencies do not necessarily treat it as an enhancement and provide such debt with a higher rating,' said Eappen. "Regardless of a lack of a higher rating, any provision that helps bondholders I don't view as a negative."
Moody's modified its methodology for post-default intercepts that include state enhancement programs in July 2013, with enhanced ratings capped at two notches below the state's GO rating. This resulted in Moody's withdrawing programmatic ratings for post-default intercept programs in Arkansas, Indiana, New York, Pennsylvania and Virginia.
"We felt that we needed a bottom-up approach," Moody's analyst Orlie Prince said about the methodology switch. "It reflects the risks to cuts in aid."
Sugden said that since the economic collapse of 2008 more issuers have explored these state credit enhancement programs to combat existing or potential financial struggles.
"There has been an increasing shift to partnering in these programs to assure that local governments access to the credit markets is persevered," said Sugden. "It is valuable to have that option."