Connecticut’s proposed bond covenants could set precedent, S&P says

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Connecticut's proposed bond covenants could set a precedent for other states to adopt, according to S&P Global Ratings.

“We believe these bond covenants regarding financial practices could improve state credit quality if they help a state maintain structural budget balance or lead to increased reserves during economic expansions,” said S&P analyst David Hitchcock.

“Furthermore, restricting financial perspectives through bond covenants might have the effect of amending a state’s constitution, but without the delay and messy process of going to the voters.”

Unless the legislature changes or delays the changes, the state’s biennial budget will require general obligation bonds issued between May 15, 2018 and July 1, 2020 to include a bond covenant that requires newly adopted budget practices to stay in place for the life of the bond or July 1, 2028, whichever is earlier.

Budget changes include budgeting for only 99.5% of consensus forecast revenues in 2020, with a gradual phasing down of revenues allowed to be budgeted to 98% of consensus forecast revenue by 2026; and transferring certain annual income tax revenue above $3.15 billion to the budget reserve.

They also include limiting the ability to budget a reserve drawdown to instances when revenues are projected to decline 1% or more, the reserve equals 5% or more of current-year appropriations or for the purpose of paying the unfunded past service liability of the employees’ or teachers’ pension systems that exceed regular contributions.

Various bond caps would specify that GO authorizations not exceed 1.6 times general fund receipts; cap maximum bond allocation at $2 billion annually with an adjustment based on the U.S. consumer price index and $1.9 billion annually adjusted for CPI, but excluding issuance for the University of Connecticut and the Connecticut State Colleges and Universities system, which consists of 17 other institutions.

“If they're effective, they could still take time to improve credit quality,” said Hitchcock. “Nevertheless, we believe they could lead the way for other states to adopt similar covenants.”

Fitch Ratings and S&P each rate Connecticut GOs A-plus. Moody's Investors Service and Kroll Bond Rating Agency rate them A1 and AA-minus, respectively.

Proponents call the move the right medicine for ailing Connecticut. Opponents say the measures are overly restrictive.

An existing bond covenant already triggered a dispute between Gov. Dannel Malloy and state Treasurer Denise Nappier.

Nappier said Malloy’s proposal to smooth out contributions to the Teachers’ Retirement Fund pension system would violate a covenant from a 2008 bond issuance and create an unprecedented technical default. State budget director Benjamin Barnes said the administration is considering alternative proposals.

Connecticut is on track for a $198.5 million deficit for fiscal 2018, said state Comptroller Kevin Lembo.

The state on Wednesday sold $620 million in GO bonds.

Connecticut days ago agreed to assume capital Hartford's debt payments – up to $40 million annually stretched out over about two decades – in a move that could keep the capital city out of bankruptcy.

State Treasurer Denise Nappier and Office of Policy and Management Secretary signed the agreement Wednesday over objections from angry Republican legislative leaders who said they never had a chance to vet the agreement.

They also said they would try to reduce grants to Hartford in the pending biennial budget adjustments to offset the cost of the debt deal.

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Ratings Budgets Sell side David Hitchcock Dannel Malloy Denise Nappier State of Connecticut S&P Connecticut