Connecticut plans $617 million sale amid crisis and controversy
WESTPORT, Conn. — Connecticut, after multiple rating downgrades and facing budget strife, declining revenue and pension funding controversy, intends to sell roughly $617 million in fixed-rate general obligation bonds.
The state will issue $250 million of new-money Series 2018 A bonds and $367 million of Series B refunding bonds through negotiation. The retail order period is Tuesday with the institutional pricing on Wednesday, according to state Treasurer Denise Nappier’s office.
All four bond rating agencies downgraded Connecticut last year, citing a late budget, deficits and high debt and pension liability. A steep drop in capital gains taxes has pushed state revenue downward.
Three weeks ago, the 14-member Commission on Fiscal Stability and Economic Growth, which Gov. Dannel Malloy commissioned, painted a sober picture of Connecticut, where fiscal disarray belies high wealth metrics. Per-capita income is 140% of the national average, according to bond documents.
A Malloy proposal to smooth out contributions to the Teachers’ Retirement Fund pension system has drawn a sharp rebuke from Nappier. The treasurer said such a move would violate a covenant from a 2008 bond issuance and create an unprecedented technical default.
Loop Capital Markets is lead manager for the negotiated sale. Acacia Financial Group is the financial manager. Day Pitney LLP is lead bond counsel.
Final maturities are 2038 for new money and 2028 for refunding. Both series are tax-exempt.
S&P Global Ratings and Fitch Rating both rate Connecticut GOs A-plus. They assign negative and stable outlooks, respectively. Moody's Investors Service and Kroll Bond Rating Agency rate them A1 and AA-minus, respectively. Moody's has a stable outlook, Kroll negative.
“Gap-closing capacity remains strong but its robustness has been reduced by the state's modest economic growth during the current national economic expansion and the resulting repeated need for gap-closing actions,” said Fitch. “Reserve balances are low and the state has continued to increase taxes and cut spending throughout the expansion, reducing its means to tackle future cyclical budgetary challenges, while out-year budget gaps remain an issue to be addressed.”
Malloy finally signed the fiscal 2018-19 biennial budget four months tardy, after a testy back and forth with a divided legislature. The state Senate in Hartford is split 18-18 between Democrats and Republicans while the Democrats hold an 80-71 edge in the House of Representatives.
Connecticut operates on a biennial budget. Malloy’s midterm budget adjustments include $234.6 million in revenue enhancements in fiscal 2019 and $65.4 million in expense increases from the adopted FY19 budget.
The Malloy plan to smooth out TRF payments would constitute a "clear credit negative," Municipal Market Analytics said.
“Once that line is crossed, the rating agencies may take a dim view of our promises, the consequences of which we will face for a generation,” said Nappier.
State budget director Benjamin Barnes said the administration is considering alternative proposals. Barnes also favors diverting lottery proceeds to help fund the teacher pension account. The fiscal panel said a 30-year contribution of the lottery net revenue stream would generate a roughly $7 billion reduction in unfunded liabilities, using a hypothetical evaluation.
Connecticut in 2008 issued $2 billion in pension obligation bonds, depositing the proceeds into the TRF. The covenant requires the state to annually pay the full amount of the actuarially required contribution for as long as the bonds remain outstanding, and prohibited changes to the calculation methods to reduce those annual payments.
Day Pitney advised two years ago that any deferral of related payments would violate guarantees under the covenant.
Connecticut’s two largest pension funds, the State Employees’ Retirement Fund and the TRF, generated returns, net of expenses, of 16.51% and 16.33%, respectively, for calendar 2017, Nappier said this week.
They outperformed benchmarks by a respective 74 and 63 basis points, according to Nappier. In addition, each exceeded respective actuarial investment assumptions of 6.9% and 8%. Together, the funds represent 91% of Connecticut’s pension and trust fund portfolio.
“Investment gains alone will not ensure the solvency of our pension funds,” said Nappier. “Passage of Gov. Malloy’s proposal to restructure payments into the Teachers’ Retirement Fund would undercut a bond covenant that instilled the funding discipline we fought so hard to achieve.”
Glen Anderson, senior vice president at Nuveen Asset Management, expects prolonged fiscal stress for Connecticut.
“The state’s total fixed charges -- debt service, pension and other post-employment [OPEB] benefits -- already among the highest in the nation compared to total expenditures, are set to rise in the coming years,” said Anderson.
The fiscal commission recommended a “revenue-neutral” rebalancing of state taxes that would reduce the income tax across all brackets; selectively increase business taxes; raise the sales tax by less than 1%; raise the gas tax and phase in electronic tolling, which is already up for debate; cut exemptions and exclusions from all taxes by 14%; and eliminate the dwindling estate and gift taxes.
It also called for a $1 billion annual cut from annual operating expenses; reinvestment in transportation and cities; the construction of a major tech campus in one city in partnership with a major university; changes to binding arbitration laws to enable labor compromises; and diversifying revenue streams beyond the regressive property tax.
Sheree Mailhot, assistant treasurer for debt management, said Connecticut’s debt levels are actually about average compared with other states when combining state and local debt and comparing it with personal income and ability to pay.
"This is because all states are different and in Connecticut, debt issuance is concentrated at the state level, particularly due to our method of funding school construction and our lack of local government," she said on an investor call.
A recent $141.7 million University of Connecticut student fee revenue bond sale resulted in oversubscription in many maturities, said Nappier and Scott Jordan, UConn’s chief financial officer.
Individual investors placed $59.5 million in orders for 42% of the available bonds during a March 12-13 retail period. Bonds were repriced to lower yields. The institutional sale was March 14.