S&P Downgrades City Credit Rating

One of the nation’s big three credit rating agencies downgraded its long-term rating of the city’s new and existing debt Wednesday in a report that the chair of a local independent financial review board called ​“sobering.”

The agency, Standard & Poor’s (S&P), also warned that New Haven’s credit ratings may continue to drop in the near future if the city fails to address its structural budget imbalances and if it continues to rely on refinancing existing debt to pay the bills.

On Wednesday afternoon S&P gave New Haven a BBB+/Negative long-term rating for the $160 million that the city hopes to achieve through refunding its existing debt on or around Aug. 2. The report notes that the city could produce upfront debt service cost savings of $33.1 million for Fiscal Year 2018 – 2019 (FY19) with the refunded debt.

The agency gave the same BBB+/Negative rating and outlook to the city’s $58.03 million in new debt for upcoming capital improvement projects.

The new ratings represent a third-step downgrade from the A-/Negative score that the city last got from S&P in Dec. 2017.

Even though the BBB+/Negative rating is still several notches above S&P’s threshold for ​“investment grade” debt, which the agency sets at BBB‑, a lower rating could still result in the city paying higher interest rates the next time it needs to borrow money.

The report also added new fuel to the growing concern in town over the city’s precarious financial position and estimated $30 million long-term structural deficit, which led the state’s budget director to summon officials to a recent meeting about whether a state bailout may loom.

Click here to read S&P’s full July 25, 2018 report.

The New Haven report comes one week after S&P gave the city’s neighboring shoreline suburb Branford a AAA/Stable long-term rating for its new and existing general obligation bonds. While Branford is a wealthier town with few of New Haven’s urban challenges, the two reports nevertheless point to some ways New Haven can possibly learn from its shoreline neighbor, including in how it forecasts state aid and funds pensions. (More about that later in this article.)

S&P: Tough Years Ahead

Written by New York-based analyst Thomas Zemetis and Boston-based analyst Victor Medeiros, the New Haven S&P report paints a bleak picture of the city’s fiscal present and future, despite the fact that the rating downgrade is only a third of a step.

“The downgrade reflects our view of New Haven’s sustained structural imbalance,” the report reads, ​“stemming from optimistic revenue and expenditure assumptions, contributing to misaligned revenue and expenditures over the past three fiscal years, including a projected $13 million to $15 million deficit in fiscal 2018.”

The report singles out weak management assessment, weak budgetary performance and flexibility, and weak debt and contingent liability positions as contributing to S&P’s negative assessment.

It does note that New Haven has adequate cash liquidity and a strong economy, but even there expresses caution over the difficulties the city faces in raising local sources of revenue because of the high percentage (54 percent) of tax-exempt properties within its tax base.

“Given material changes in these credit factors over several years,” the report warns, ​“we believe New Haven’s weakened budgetary performance and flexibility will unlikely return to levels that support a higher rating in the near-term.”

In fact, it goes on to say, there is a one-in-three chance that S&P will lower the city’s rating yet again over the next two years.

Two weeks ago, Mayor Toni Harp said the city was considering refunding its existing debt to help close a projected $15 million budget deficit for the fiscal year that ended in June. Based on the S&P report, the city seems to be prepared to follow through on that proposal in its commitment to achieve $160 million through refunding existing debt on or around Aug. 2.

The report notes that the city could produce upfront debt service cost savings of $33.1 million for Fiscal Year 2018 – 2019 (FY19) with the $160 million in refunded 2018B bonds.

The restructuring of the city’s existing debt now leaves New Haven with a $709.9 million debt load, according to the report. S&P notes that the restructuring has allowed the city to extend the aggregate average life of its general obligation bonds through Aug. 1, 2048, which is approximately 3.1 years later than the bonds’ due date before the restructuring.

City Hall: Future’s Still Bright

“New Haven’s consignment to a slightly lower bond rating reflects the city’s admittedly challenging fiscal circumstance,” city spokesman Laurence Grotheer stated in a press release. “[N]evertheless, development projects in New Haven continue to attract robust private-sector investment, suggesting a persistently bright economic outlook.”

“It’s noteworthy that an agent at New Haven’s bond insurance provider, Build America Mutual, cites ​‘reduced state aid (PILOTS, educational grants)’ first among causes for the city’s financial difficulties,” he continued.

Mohit Agrawal, the chair of the city’s independent Financial Review and Audit Commission, had a more bracing take on the report.

“S&P’s downgrade on New Haven is sobering,” he wrote in a statement responding to the downgrade. “[R]esidents must make their voices heard when it comes to the hard decisions we have to make, such as raising taxes or cutting city services or cutting public employee benefits.” Click here for a story inviting the public to join that process.)

“Weak” Performance And Management

The report assesses the city’s current financial management as ​“weak” because of New Haven’s ​“sustained structural imbalance over the past three fiscal years, which we believe is attributable to an uncertain revenue environment and pressure from fixed costs related to retirement and self-insurance, but also the city’s historical use of somewhat optimistic revenue and expenditure assumptions in its budget development framework.”

The analysts note that New Haven does not have a formal long-term financial plan, but that city officials are moving in the right direction in their promise to develop and submit a five-year financial forecast to the Board of Alders later this fiscal year.

Under ​“weak budgetary performance,” the report notes that the city had operating deficits of negative 2.2 percent in the general fund and negative 1.7 percent across all governmental funds in Fiscal Year 2016 – 2017 (FY17).

It also chastises the city’s finance department for using debt restructuring to cover existing deficits.

“In our view, recurring misalignment of New Haven’s revenue and expenditures have demonstrated structural imbalance over the past two audited fiscal years,” the report reads, ​“and the city’s year-end projections show a general fund deficit in fiscal 2018, indicating budgetary performance will likely remain very weak in the near-term. In addition, its reliance on short- and medium-term relief from debt restructurings or cost deferments to achieve budgetary alignment could mask underlying factors that prolong structural imbalance.”

Those underlying factors, it notes, include persistent and yet unexpectedly high medical self-insurance claims that left the city’s self-insurance fund with a net deficit of $7.38 million in FY15, $9.15 million in FY16, and $5.59 million in FY17.

“While New Haven increased its fiscal 2019 appropriation by $5 million to address medical self-insurance costs,” it notes, ​“we believe volatility in claim activity will likely challenge the city’s budget beyond the current budget year.

The report says that New Haven is uniquely vulnerable to cuts in state aid because of its reliance on Payment in Lieu of Taxes (PILOT) and Education Cost Sharing (ECS) grants.

In FY17, state aid generated 48.5 percent of general fund revenues, while local property taxes accounted for only 43.3 percent. And in FY18, the report notes, the city budgeted to receive the exact same amount in state aid as it had in FY17, but instead saw a $9.4 million net reduction.

The analysts say this reduction in state aid will likely require the city to continue to increase its mill rate, even beyond the 11 percent tax increase passed for FY18.

“This could prove difficult,” the report notes, ​“given New Haven’s overall high amount of tax-exempt property and weaker wealth and income factors relative to other Connecticut municipalities, which could burden its existing tax base.”

S&P says that the $33.1 million in deferred debt payments that the city will achieve through its most recent restructuring will allow city officials to restore balanced operations, address the deficits in the medical self-insurance account, and fund capital improvements.

But, it continues, even more state cuts are likely on the way, considering the state’s own projected $4 billion-plus budget deficit over the next two years.

“Therefore, we believe our view of New Haven’s budgetary performance will remain very weak over the next two years,” the report says.

A Strong Economy

One of the few bright spots in the report comes in S&P’s analysis of the city’s economy, which it describe as strong, despite the fact that 54 percent of its property is tax exempt.

The report says that city residents have a projected per capita buying income of 75 percent of the national level, and that its net taxable grand list is $6.6 billion as of FY19. It describes the city’s tax base as diverse, with the top 10 taxpayers comprising only 15.4 percent of the city net taxable grand list.

A stabilizing factor for the city’s economy, it says, is the university at the center of it: Yale.

“Although the university’s large student population and inventory of tax-exempt property could understate local wealth and income levels,” it reads, ​“we believe Yale’s outsized presence in New Haven is a stabilizing factor that anchors the local economic and employment base.”

That stabilizing influence comes in part through the university’s continued capital expansion programs at its university and medical campuses, as well as its ability to attract federal research grants, venture capital investment, and technology, pharmaceutical, and biotechnology start-ups.

Further good news is that city officials estimate that the city will add nearly $300 million in taxable value to the grand list over the next five to seven years as a result of expiring commercial and residential property tax easement programs.

Debt and Pension Liabilities

And yet, the report continues, one of the most concerning factors of New Haven finances is its very weak debt and contingent liability position.

It notes that the city pays 10 percent of each year’s budget in debt service, and its net direct debt is 78.1 percent of total governmental fund revenue.

“We revised our assessment of the city’s debt profile to very weak from weak due to the extension of debt maturities following the current debt restructuring,” it reads. About 50 percent of the city’s direct debt is scheduled to be repaid within the next decade, which S&P notes as no longer ​“rapid.”

The analysts are as concerned with the city’s large pension and Other Post-Employment Benefit (OPEB) obligations, for which, the report notes, the city does not have ​“a plan in place that we think will sufficiently address increasing costs of these obligations.”

The city’s combined pension and OPEB contributions made up 9 percent of the total budget in FY17.

New Haven’s two public employee pensions, the City Employee Retirement Fund (CERF) and the Police & Fire Fund (P&F), are funded at 34 and 40 percent respectively as of June 30, 2017. CERF has a net pension liability of $472.5 million and P&F has a net pension liability of $793.7 million. And the two pension funds use 7.75 percent assumed rates of return.

The report commends New Haven for asking new employees to contribute toward OPEB at 0.5% of pay in 2017, 0.75% in 2018, and 1.25% in 2019 in recently agreed-to city contracts.

“Nevertheless, we view New Haven’s retirement costs as an ongoing credit concern,” the report notes, ​“which could continue to pose negative implications for the city’s credit profile.”

Looking Ahead

Mohit Agrawal, the chair of the city’s independent Financial Review and Audit Commission, described S&P’s new report as ​“sobering.”

“The proposed refunding bonds of $160M are far larger than refundings in recent years and will extend debt maturity by 3.1 years,” he wrote in a statement. “[I]n essence, we are refinancing the city’s credit card and are pushing out the payment schedule.”

He said the $33 million generated in cash savings in FY19 simply push the city’s financial problems out into the future.

Click here to download Agrawal’s full response to the report.

“The city has a structural imbalance between our costs and our revenues,” he continued, ​“and all stakeholders – taxpayers, Yale, the state, and our public employees – must come to the table to discuss solutions.”

Agrawal noted the glimmers of positive news in the report, including its indication that $300 million in new developments and expired tax deferrals will be entering the grand list soon.

“That amounts to roughly $12M in increased tax revenue to the city,” he said, ​“which will appreciably help reduce our structural deficit.”

He called on all city residents to take part in the ongoing discussion over how to mitigate the city’s structural deficit ​“because,” he said, ​“there are no easy solutions left, and residents must make their voices heard when it comes to the hard decisions we have to make, such as raising taxes or cutting city services or cutting public employee benefits.”

A Sunnier Outlook For Branford

As a counterpoint to the New Haven report, S&P’s analysis of Branford’s finances praises the shoreline suburb for its conservative and ​“forward-looking” budget practices, its near-fully-funded public pensions, and its lack of dependence on state and federal aid.

It also notes that Branford pulls over 80 percent of its annual revenue from property taxes paid by a predominantly wealthy, suburban population.

On July 17, Standard & Poor’s (S&P) credit rating agency gave the town of Branford an AAA/Stable long-term rating for its new and existing general obligation bonds.

Click here to read the full report.

That’s the highest rating available. It means that S&P thinks that New Haven’s suburban shoreline neighbor to the east is on sound financial footing even as it plans to receive less and less money from a state government that faces a projected $4.6 billion deficit over the next two years.

“The stable outlook reflects our view that Branford’s management will continue to adapt budgetary assumptions to incorporate changes in state aid,” the S&P report reads. ​“Further rating stability is provided by the town’s participation in the broad and diverse New Haven-Milford MSA [metropolitan statistical area], and our belief that its economy will continue to grow, along with consistently very strong budgetary flexibility and liquidity.”

Even though Branford’s population is over six times smaller than New Haven’s, and even though the two shoreline neighbors are significantly different in terms of economy, demographics, and scope of government services, the Branford report nevertheless sheds some light on the conditions and decisions that result in stable municipal finances.

Despite the differences, the Branford report may still offers some clues on to how to mitigate New Haven’s $30 million structural deficit, ward off another potential credit rating downgrade, and reduce the risk the Elm City faces of paying a greater interest rate when it needs to borrow money.

Reduced State Aid Assumptions

The S&P report, written by Boston-based credit analysts Christian Richards and Victor Medeiros, identifies seven key characteristics that contribute to Branford’s stable fiscal outlook: a strong economy, sound fiscal management, consistent budgetary performance, budgetary flexibility, ample cash liquidity, a strong debt and contingent liability position, and a strong institutional framework score.

Throughout the report, the S&P analysts consistently call out Branford’s town government as taking a responsible and realistic approach to forecasting how much money to expect from Hartford in the midst of the state’s fiscal crisis.

“Intergovernmental aid reductions will continue to play an important credit factor for municipalities across Connecticut,” the report reads. “[H]owever, we believe that Branford’s management has shown it will use conservative budgeting assumptions that result in at least balanced operations at year-end.”

Richards and Medeiros identify Branford’s population of 27,409 as belonging to a very strong local economy that is seeing continued growth in advanced manufacturing, health care, biotech, and tourism. It notes the success and planned expansion of the town’s three breweries, one of which is even building a hotel to meet its ever-growing number of visitors.

The report commends the town for having a relatively low mill rate of 28.47 for Fiscal Year 2017 – 2018 (FY18) and for investing in transit-oriented development around Branford’s Shoreline East train station.

Under ​“strong management” and ​“good financial policies,” the report praises Branford’s finance department for using multi-year budget-to-actual analyses to identify trends in both revenues and expenditures for the purposes of developing sound future budgets.

“As evidenced by the incorporation of anticipated state budget cuts into the budget,” the report reads, ​“management is forward-looking and adapts to changes in the financial environment.”

In FY17 Branford property taxes brought in $96.6 million, or 83 percent, of the total $116.3 million in revenue for the fiscal year. That same year state aid made up only $13.98 million, or 12 percent, of Branford’s total revenue.

In comparison, New Haven raised $252.4 million in property taxes in FY17; that accounted for only 48 percent of the city’s total revenue of $521.7 million for the year. State aid added to city coffers another $221.3 million, or 42 percent of all revenue for the year.

The report goes on to praise Branford for further reducing its budgeted expectation of state aid by nearly 10 percentage points between FY17 and FY18.

“Entering fiscal 2018,” the report reads, ​“Branford took a conservative approach to projecting state aid, as the state had not yet adopted a budget and was debating sizable cuts in direct and indirect aid to municipalities.”

In FY18, the report notes, Branford reduced its state expectations from 12 percent to 2.4 percent of the budget, and has further cut its intergovernmental aid expectations for Fiscal Year 2018 – 2019 (FY19) down to 2.1 percent of the total budget.

That represents a drop in state aid expectations from nearly $14 million in FY17 to $2.4 million in FY19.

“Management is proactively working to reduce the town’s reliance on state aid,” the report reads.

In comparison, New Haven reduced its expectations for state aid from 42 percent of the total budget to 41 percent of the total budget between FY17 and FY18. In the FY19 budget that the Board of Alders passed at the end of May, state aid makes up 39 percent of total expected revenue. That’s a decrease in state aid expectations from $221.3 million in FY17 to $215.7 million in FY19.

The report says that Branford hires an outside consultant to assist in forecasting health care costs every year; it maintains a five-year capital improvement plan; and it keeps a debt service schedule for staying on top of future debt payments.

The report also praises Branford for having an informal policy to sustain a ​“rainy day” fund that is at least 9 percent of annual operating expenditures.

In Fiscal Year 2016 – 2017 (FY17), Branford had operating surpluses of 2.4 percent of expenditures in the general fund and 5.8 percent across all governmental funds.

The report further praises Branford for having an available fund balance in FY17 of 24 percent of operating expenditures, and for not needing to dip into that reserve in each of the past three fiscal years due to ​“conservative financial management.”

Branford also has strong liquidity in having on hand its 43.3 percent of governmental fund expenditures available in cash.

“The town maintains an investment policy that limits the town’s investments to U.S. government securities, state short-term investment funds, and other short-term investments such as CDs and money market funds,” the report notes. ​“The policy expressly prohibits investment in derivative securities and other riskier investments.”

Branford’s debt service makes up only 6.7 percent of the town’s annual expenditures, and 75.9 percent of its debt is scheduled to be retired in the next decade.

Well Funded Pensions

The report also singles out Branford’s follow through in funding its two public pensions.

The town’s combined required pension and other postemployment benefit (OPEB) contributions made up only 4.5 percent of total general fund expenditures in FY17.

New Haven’s pension fund payments alone made up 10.2 percent of the city’s general fund expenditures in FY17. Health care benefits made up another 14 percent of that year’s budget for the Elm City.

Branford is a participant in the Municipal Employees’ Retirement System (MERS), which is a cost-sharing, multiple employer public employee retirement system run by the state to provide benefits to public sector employees except for police and volunteer firefighters. (The town’s full-time firefighters are on MERS.)

According to S&P’s report, Branford has a MERS proportionate net liability of $10.7 million. The plan is funded at 92 percent and uses an 8.0 percent discount rate.

Branford also has single-employer public employee retirement systems for its police and fire personnel.

The town’s police plan has a net pension liability of $8.3 million, and is funded at 73 percent. The firefighters plan has a net pension liability of $350,000 and is also funded at 73 percent. In FY17, the police plan used a 7.0 percent discount rate and the fire plan used a 6.75 percent discount rate.

The report notes that the town recently lowered its police plan’s discount rate to 6.5 percent, and that, as of 2012, the police plan was closed to new entrants. All new hires are now in a defined-contribution plan.

In comparison, New Haven’s two public employee pensions, the City Employee Retirement Fund (CERF) and the Police & Fire Fund (P&F), are funded at 34 and 40 percent respectively as of June 30, 2017. CERF has a net pension liability of $472.5 million and P&F has a net pension liability of $793.7 million. And its pension funds use 7.5 to 7.75 percent assumed rates of return.

The town also provides health insurance to eligible retirees through an OPEB trust established in 2009. The OPEB account is funded at 49 percent, with an unfunded liability of $14.6 million, as of June 30, 2017.

Click here to read other stories about the city’s structural deficit and ideas for closing it.

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• Mayor Open To Idea Of Fewer Top Cops
• Hey, Buddy, Can You Spare $30 Million?