A New York minute has never been shorter.

The state will test turbulent market waters this week with a $659.9 million personal income tax bond deal, a sale that comes near the end of a year that's seen a governor resign in disgrace and tax revenue fall off a cliff as Wall Street reeled from the credit crunch.

The leadership of the state Senate is poised to change for a second time in less than a year after the Senate Republicans in last week's elections lost their majority for the first time since the 1960s.

The Legislature will meet next week in special session to try to close a $1.5 billion hole in the current year's budget. Gov. David Paterson has asked for $2 billion of cuts in case the situation gets worse before the fiscal year is over. Looming over the negotiations is the question of whether a lame-duck Senate majority will go along with Paterson's calls for severe budget cuts.

"The longer-term picture may be more positive than the shorter-term picture," said Robert Ward, deputy director of the Rockefeller Institute, a government policy think tank connected to the State University of New York. "In the short run the governor's goal of taking serious action on the budget becomes more difficult."

Ward said with the majority in the Senate in flux there may be less incentive for either party to make the difficult decisions the governor is asking for.

Senate Minority Leader Malcolm Smith, D-Queens, is expected to become the new majority leader in January, but that isn't assured. Democrats in the Assembly and Senate are working with the governor's office and the Budget Division to find cuts, but the current Senate majority has said it is waiting for Paterson to propose cuts before they respond.

It's not yet clear how the transition of power will play out, according to Kent Gardner, president and chief economist at the Center for Governmental Research Inc., a nonprofit think tank based in Rochester.

"Clearly the Senate that convenes in November is not the Senate that's going to pass the [fiscal 2010] budget, and change in party control has an enormous impact on how negotiations occur," he said. "How those power relationships interact simply takes time to gel - you can see it after [former Gov. Eliot] Spitzer took over."

Spitzer, a Democrat, clashed bitterly with long-time Republican Senate Majority Leader Joseph Bruno, but Paterson has long had a more friendly relationship with the GOP chief. Spitzer resigned in March amid a prostitution scandal. But then Bruno stepped down in June and Sen. Dean Skelos, R-Rockville Centre, ascended.

Sparks flew at a meeting of government leaders about the state's financial problems in New York City last month when a rankled Skelos told Paterson not to lecture him on fiscal restraint. That relationship, too, is now about to end with the Democrats taking over the Senate.

With one party in power, "you've got a whole different configuration of rivalries," Gardner said. "It's not that the rivalries disappear, it's assumed within one party. It's possible the geographic divisions within the Legislature perhaps become more apparent."

Republicans have been stronger in upstate New York than downstate, with former Gov. George Pataki and Bruno hailing from upstate. Should Smith become majority leader, then the so-called "three men in a room" who negotiate state legislation will all be from New York City. Assembly Speaker Sheldon Silver and Paterson are from Manhattan.

One mitigating factor is that both parties will already be looking forward to the 2010 elections, according to Ward.

"No one wants to be painted as fiscally irresponsible," he said. "Hopefully there will be some reward for acting in fiscally responsible ways."

The state's financial situation is grim. New York faces an estimated $47 billion total shortfall over the next four fiscal years, including a $12.5 billion gap for fiscal 2010. Paterson will present his executive budget on Dec. 16, more than a month earlier than required by statute in an attempt to lock in cuts earlier before the beginning of the fiscal year on April 1.

"The numbers are bad, and they're going to get worse," state Comptroller Thomas DiNapoli said last week in a press release. "The fallout from deteriorating economic conditions - particularly on Wall Street - hasn't stopped. New York is facing deep budget holes and the state's structural imbalance is worsening."

Personal income tax receipts are forecast to grow by a mere 0.7% in the current fiscal year, compared to 5.7% in the previous fiscal year, according to a report released last week by DiNapoli. Lost jobs, lower wages, and declines in capital gains will cause personal income tax receipts to fall by 3.4% in fiscal 2010, the comptroller's office projects.

On the bright side, the report forecasts wages will begin to grow again, rising 6.2% in fiscal 2011. The state relies on personal and business taxes from the securities industry for 20% of its tax revenue collections.

The comptroller's office projects that all-funds spending will grow to $146 billion by fiscal 2012 from $122.8 billion in the current fiscal year. That projected growth is largely attributed to increased Medicaid spending and aid to local school districts. Debt service is also growing, and will increase by about $500 million annually beginning in the next fiscal year.

"Revenue growth would need to be significantly higher than currently forecast to accommodate these anticipated higher spending needs," the report said.

These days that doesn't look likely to happen. Falling tax receipts have created another challenge for the state. Its statutory debt cap is partially based on a percentage of personal income tax collections that under current projections will cause the state to cut back on borrowing if nothing is done.

"The state has entered into a period of significantly declining debt capacity," the Budget Division said in an update of its annual information statement included with the preliminary official statement for the PIT bonds. "Based on the most recent personal income and debt outstanding forecasts, the state would exceed the debt outstanding cap in 2012-2013 by over $800 million."

The cap on state supported debt was created by statute in 2000 and will be fully phased in fiscal 2014. Once fully phased in, the caps will limit the amount of new state-supported debt to 4% of personal income receipts and new state-supported debt service costs to 5% of all funds receipts.

Budget Division spokesman Jeffrey Gordon said that proposals to keep New York's debt below its cap will be included in the executive budget. The state has already indicated it will be cutting back on its capital program through a review process designed to allow only new projects deemed essential to go through, though no dollar figure has been set for those cuts.

One possible partial solution to the state's fiscal woes is public-private partnerships to finance capital projects, such as the $16 billion Tappan Zee bridge replacement. The State Asset Maximization Commission began hearings last week on P3s and will release a preliminary report by the end of the year and a final report by the end of March.

Standard & Poor's managing director Colleen Woodell said New York has time to deal with the debt cap issue and that it isn't clear from a forecast that they will actually bump up against that cap in fiscal 2013

"It's not an on-off switch until it actually hits," she said. "You can forecast it, and it sounds like they're going to have a plan in the budget to adjust what's going on so it doesn't hit. Moderating borrowing is about the only thing they can do."

The rating agency is keeping a close eye on how the state deals with its revenue shortfall.

"It's a big gap, but it's also a very fundamentally strong over the long-term economic base," Woodell said. "Obviously what kind of action they take, whether they are able to come close to some structural balance, or whether they just stick their fingers in the dike and hope for the best ... are going to factor into any rating actions we take in the future."

While New York faces pressures, the gap it has to close next year is smaller on a percentage basis than the gap it had to close in fiscal 2004, Woodell said. She added that projected employment losses in New York City are smaller than actual losses in the early 1990s, when the city lost 300,000 jobs.

Standard & Poor's rates the PIT credit, which is backed by a statutory allocation of 25% of state personal income tax receipts, AAA with stable outlook. Fitch Ratings rates it AA-minus with a stable outlook. Moody's Investors Service no longer rates the PITs.

The Dormitory Authority of the State of New York will issue the PIT bonds on behalf of the state. The deal consists of two series: $545.6 million of tax-exempt new money for education and $114.3 million for refunding, of which $51.7 million will be taxable.

Sidley Austin LLP is bond counsel and Morgan Stanley will lead manage the sale. DASNY plans to market the debt to retail investors on Wednesday and to institutional investors on Thursday.

"As of today, we think the markets are operating well enough for us to go out with a sale," the Budget Division's Gordon said in an e-mail. "We ran a successful refunding [last] week for $664 million in service contract bonds, and our hope is to keep our capital program going along normal lines to the extent possible."

Last week the state priced $672.1 million of service contract revenue refunding bonds through the Empire State Development Corp. The credit is rated lower than the PIT credit - AA-minus by Standard & Poor's and A-plus by Fitch. The longest maturity was 20 years and priced with a yield of 5.75% on a 5.625% coupon. The yield was 75 basis points higher than that day's triple-A Municipal Market Data yield curve for 20-year bonds.

Joe Darcy, senior portfolio manager at Dreyfus Corp., said he expects the deal will attract a lot of attention because the PIT credit structure is sound and recognizable, but "how much support it receives is going to be a function of market conditions and pricing, obviously."

"Certainly retail through the 15- to 20-year range is going to be a formidable presence - beyond that it's really going to be a function of market conditions," Darcy added. "I would expect to see some mutual fund participation, but we really travel on a day-by-day type path these days."

Subscribe Now

Independent and authoritative analysis and perspective for the bond buying industry.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.