As Connecticut prepares for its $500 million general obligation bond sale, a hands-tying bondholder covenant has triggered debate over its effect on the state’s credit.
Monday’s retail order period will precede Tuesday's institutional pricing on $400 million in new-money bonds and a $100 million refunding. Bank of America Merrill Lynch is leading the underwriting syndicate.
The far-reaching covenant commits the state – over five years -- to four financial-restraint measures the General Assembly passed last year with its fiscal 2018 biennial budget.
The move comes as Connecticut struggles with budget imbalance and high debt and pension liabilities that have generated a rash of rating-agency downgrades over the past two years.
“Although the new requirements on bond issuances may seem daunting to some in the executive and legislative branches of Connecticut, the unprecedented level of fiscal discipline is long overdue and is a step in the right direction in restoring some stability in the state’s fiscal house," said state Sen. Scott Frantz, R-Greenwich, who co-chairs the legislature’s finance, revenue and bonding committee.
It's no cure-all, said Alan Schankel, a managing director at Janney Capital Markets.
“I’m happy to see it, but it’s no panacea," he said. "I don’t see any significant shift in Connecticut’s credit."
The covenant prohibits the state from altering the four caps for five years from issuance of the bonds and prevents changes to the formula that establishes the state’s debt limit. GO bond authorizations may not exceed 1.6 times general fund tax receipts, except in cases when the governor has declared an emergency and three-fifths of each chamber of the General Assembly votes in support of a change to any cap for that year.
“This is generally a positive for the state credit, offsetting some of what is still a net negative bias in medium- and long-term credit quality [and ratings] via slow economic growth, widening income disparities and the steep and rising cost of servicing state employee pensions,” said Municipal Market Analytics.
S&P Global Ratings said Connecticut’s covenant could set a precedent among states.
S&P rates Connecticut general obligation bonds A. It downgraded the state one notch in April, citing the additional debt Connecticut must carry as guarantor of capital city Hartford's $540 million of GO debt over 20 to 30 years. The bailout is aimed at keeping the capital city out of bankruptcy.
Moody's Investors Service rates Connecticut GOs A1, while Fitch Ratings and Kroll Bond Rating Agency assign A-plus and AA-minus ratings, respectively.
Kroll assigns a negative outlook, the others stable. Kroll said its outlook “reflects the state’s ongoing difficulty in accurately projecting state revenues, the continuing structural imbalance in the FY 2018-FY 2019 biennium budget after the midterm budget revisions, and the continued weakness in the state’s economy.”
Connecticut lawmakers on May 9 passed a $20.8 billion second-year adjustment to the biennial budget, which Gov. Dannel Malloy signed six days later. Malloy and the General Assembly were four months late with last year’s plan.
Kroll still considers the spending plan structurally imbalanced, “based on a substantial level of non-recurring revenue sources, including transfers from state operating funds and … the charge back to FY 2018 of certain costs of supplemental hospital payments included in the FY 2019 budget.”
The Hartford intervention, the on-time budget and the bond covenant are immediate plusses for the state, Schankel said.
“On the other hand, there have been no big-picture changes that could adjust the trajectory of Connecticut’s credit issues.”
According to Municipal Market Analytics, “strict and overlapping limits” on spending growth could hamper the state’s ability to return to more normal spending following an economic downturn, and could intensify the political dynamic.
MMA also said tighter state budget and debt controls will reduce the state’s capabilities to craft another Hartford-style bailout. “The implications here are a material negative for Connecticut’s local governments, in particular middle- and working-class communities most vulnerable to hypothetical state aid reductions in the future.”
Hartford’s City Council on May 29 signed off on a $570 million fiscal 2019 spending plan – down $43 million from last year. The new state Municipal Accountability Review Board must approve it.
Disclosure counsel for the bond sale are Day Pitney LLP and Soeder & Associates. Tax counsel are Robinson & Cole and Soeder & Associates. Financial advisors are Acacia Financial Group Inc. and PFM Financial Advisors LLC.