Hamden Bond Rating Downgraded

As Hamden prepares to issue two $16.5 million bond packages, rating agencies handed down their verdicts this week on the town’s financial situation with rating downgrades that place the town closer to the junk-bond cliff, but that could have been worse.

On Friday, S & P Global, one of three rating agencies that rates Hamden’s bonds, announced that it had downgraded the town’s bond rating two notches, from A to BBB+. It also changed the town’s rating outlook to negative.

On Monday, Fitch Ratings downgraded the town one notch, from BBB+ to BBB. It affirmed the negative outlook it handed the town in December.

Hamden finance officials met with those two rating agencies two weeks ago so they could rate the upcoming bond issues. About $16.5 million of the proceeds from those two bond packages will pay back a short-term bond anticipation note to Webster Bank and will secure long-term funding for various capital projects. Another $16.5 million will restructure the town’s debt, providing $8.7 million in savings this year to help mitigate the last fiscal year’s deficit. The town’s Legislative Council passed that restructure in June. Read more about it here.

When Hamden issues bonds, it asks the agencies to rate them. That gives investors information on how secure the bonds are based on the town’s financial situation. Ratings give investors an idea of how likely the issuer is to repay them. Low ratings indicate financial distress, a higher risk that a bond issuer — in this case Hamden — will not be able to pay back its bonds.

The higher risk means fewer buyers are willing to buy bonds, and they can charge higher interest rates. That means low bond ratings often make borrowing money more expensive.

In December, Moody’s downgraded Hamden to Baa3 with a negative outlook. That is one step above “junk bond” status. Any further downgrades from Moody’s, and the town would have a junk rating, which indicates a high level of financial distress and can make it difficult to find bond buyers.

This time around, because of the danger of another downgrade, Hamden did not ask Moody’s to rate its bonds. Instead, it sought ratings only from the other two agencies.

The new rating actions cement Hamden’s status as one of the lowest-rated municipalities in the state.

Only Hartford and West Haven, both of which are under state budget oversight, have lower ratings from S&P than Hamden. The S&P downgrade brings Hamden on par with New Haven.

Hamden is now tied for the lowest rating of any municipality in Connecticut from Fitch, though Fitch rates bonds from only a handful of towns and cities in the state. Its partner at the bottom of the state’s rating ladder is, again, New Haven.

While the rating downgrades are no boon in the town’s struggle to dig itself out of a deepening hole of financial distress, they could have been much worse. Neither rating agency downgraded the town to junk bond status. The town has a two-notch buffer from S&P before it gets there and a one-notch buffer from Fitch. A junk bond rating would have made it very tough for the town to find buyers for its two upcoming bond packages.

“Although S & P and Fitch have downgraded the town, we still feel that the rating outcome was better than what the administration initially feared,” said Finance Director Curtis Eatman, because the new ratings leave the town a few notches above junk status.

During discussions about the debt restructure, Barry Bernabe of Phoenix Advisors, who advises the town on financial matters, repeatedly said he was afraid rating agencies would saddle the town with a junk bond rating. A junk rating would have made it tough to find buyers for the bonds the town is now getting ready to issue.

“Based on my preliminary feedback,” he said, “underwriters feel confident, not completely certain, but confident that there will be a market for Hamden this time around.”

A junk bond rating would have also made the town meet the criteria for the state to step in and take over its finances.

Liabilities, Deficit, Uncertain Revenues

Both rating agencies cited the financial hit the town has taken from the pandemic and its projected $6 million deficit in the last fiscal year for the rating downgrades.

“The downgrade reflects our view of the town’s weak financial position and projected deficit for fiscal 2020 that will lower the general fund balance to a negative position, as well as high pension and other postemployment benefit liabilities, largely due to years of underfunding pension liabilities, including in fiscal 2019,” Analyst Victor Madeiros is quoted as saying in the S & P report.

Hamden has about $300 million in unfunded pension liabilities for its town pension plan that was one of the reasons Moody’s downgraded Hamden in December. The town also has large other postemployment benefits (OPEB) liabilities, and large annual debt payments.

For the 2020 fiscal year, which ended June 30, the town is projecting about a $6 million deficit. That projection is down from about $13 million in May, partly due to savings in salary expenses, medical insurance costs, and from the board of education. Eatman said that revenue shortfalls in three major revenue areas are driving that deficit. He said taxes, including current taxes on the grand list, motor vehicle taxes, back taxes, and other tax department revenues, have come in about $3 million short.

The miscellaneous revenues section of the budget, he said, is short by about $2 million. That section of the budget included a $2.1 million line for a voluntary gift from Quinnipiac University. The town’s May financial report shows that as of May, the university had not given the town any of that anticipated $2.1 million. The university is facing its own financial challenges due to the pandemic.

In addition to those two large shortfall drivers, Eatman said, revenues from fees for services are down by about $1 million. None of those numbers are final, though, until the fiscal year’s audit comes out.

Rating agencies also cited uncertainty regarding town revenues as another reason for the downgrade.

“The one-notch downgrade and negative outlook reflect Fitch’s concerns regarding the town’s dependence on various one-time measures and optimistic budget assumptions that may not be fully realized, creating large future budget imbalances in a time of uncertainty and economic contraction,” the Fitch report said. Specifically, it referred to two revenue lines the council voted to include in its 2021 budget. One was a $6 million state grant intended to make up for a revenue shortfall from the pandemic, which state legislators said the town is unlikely to get. The other is a $500,000 voluntary gift from Quinnipiac. Both of those, the report said, “Fitch believes are optimistic.”

Both agencies did acknowledge a few steps that should help the town. Fitch noted that in 2021, the town will make the full payment into its pension that will allow it to be on track to full funding. This was a positive step, the report said. Both agencies also noted that the town had raised taxes by 3 mills (or about 6 percent), saying this will bring in more revenue, though it will also increase the tax burden on residents who already pay very high taxes and may have trouble affording an increase.

The Fitch report outlined the conditions necessary for either an upgrade or a downgrade for the town. “An upgrade in the rating over the next two years is not likely,” it said. “The rating outlook could be revised to stable if the town is able to demonstrate balanced operations and improve levels of reserves to achieve a higher level of financial resilience.”

The list of factors that could lead to a downgrade was much longer. A downgrade could result from continuing “reliance on the use of non-recurring revenues and optimistic revenue assumptions to balance the budget,” it said, or from an inability to increase budget reserves or a decline in revenue growth.

In the short-term, if the town is unable to carry out its impending debt restructure, that too could result in a rating downgrade, the report said.

Restructure

The council passed the restructure a few days before the town was set to have a phone call with rating agencies. Bernabe told the council that the restructure was the town’s only option to mitigate the deficit. Without it, the town have a negative fund balance, and rating agencies would likely give much harsher ratings.

Both rating agencies acknowledged that the restructure would help the town stay afloat. Though neither report said the ratings would have been lower without it, Fitch’s note that the restructure’s failure could lead to a downgrade suggests that if the council had not passed it, the ratings would be worse.

But both reports cautioned against restructures as recurring budgetary measures.

“Ultimately, we view the town’s repeated debt restructurings and its plans for another in 2021 as a sign of budgetary distress and limited financial flexibility,” the S & P report said.

The restructuring plan Bernabe presented to the council would have multiple parts. It includes another restructuring bond issue next year. The town also restructured its debt in 2018.

Fitch included a similar line in its report. “Management plans to take advantage of future refunding opportunities to lower debt service costs and help build reserves, but Fitch does not consider the continued practice and use of non-recurring revenue sources to be a reliable budget measure,” it said.

Bernabe said that rating agencies had indicated that the town’s bond ratings would have been lower without the restructure, but that they still have concerns about the town’s ability to follow through with its plans to create structurally balanced budgets going forward.

“The big concern both of them said was that the town does not have a good history of following through with these plans,” he said of the restructuring plan he presented to the council. Bernabe’s plan hinges on the town budgeting its full debt service payment, which will likely require tax increases as debt payments mount in the coming years, and on budgets that do not end in deficits. If the town budgets its full debt service payments and ends future fiscal years without a budget shortfall, that would allow restructure savings to be used to grow the town’s reserves. Without budgeting for the full debt service payment, or with imbalanced budgets, any saving from a restructuring will simply be eaten up by another deficit.

If that happens, Bernabe said, rating agencies will say “‘what good does the restructuring do?’ It’s like you’re on a treadmill, but you’re not going anywhere.”

Insurance

Overall, Bernabe said the rating process turned out better than he had anticipated. The town will likely be able to find buyers for its bonds, he said. And now as the town prepares to issue them, it has gotten some potential good news.

The bond underwriters, Raymond James and Mesirow Financial, are working out the details of the bond packages, and have found an insurer that is likely willing to insure the town’s new bonds.

Bond insurance ensures that if the issuer is unable to pay back the bond, the bond holder (the person who bought the bond) will still be paid back. The main reason Hamden’s low bond ratings will make issuing bonds more difficult is that potential buyers will be scared off by the possibility that Hamden could default on its debt, meaning they would not get their money back.

If Hamden manages to get insurance for its bonds, buyers will not have to worry about the town defaulting, because no matter what happens, they will still be repaid. (Defaulting on insured bonds would still be disastrous for Hamden, but not for bond holders.) The insurance will decrease the risk on Hamden’s bonds, and more buyers will want them.

With more competition to buy its bonds, Hamden can probably get much lower interest rates on those bonds. The town will still need to pay for the insurance out of the bond proceeds, but Bernabe said the savings from lower interest rates would likely outweigh the costs of the insurance.

Despite the lower bond ratings, Hamden is now poised to follow through with its bonding plans, averting the immediate fiscal insolvency their failure could mean. But as the next year progresses, rating agencies will be watching, and more bad news for Hamden could mean more bad news for its bond ratings.