Hamden ​“Scoops & Tosses” $25M

Hamden’s Legislative Council approved a $25 million debt restructure to save $16.5 million over two years, to avoid an immediate cash-flow crisis.

If fiscal discipline doesn’t follow, said experts, it could be another band-aid that keeps the town’s fiscal wound infected without healing it.

The vote of approval was taken a little past 1 a.m. Friday, after hours of debate.

The restructure marks the second time in two years that the town has issued refunding bonds to save money in the short term and then smooth out interest payments further into the future. In 2018, the council passed a restructure that saved $12 million in the 2018 – 2019 fiscal year.

As in 2018, the town will do what’s sometimes known disparagingly as a ​“scoop and toss.” The town will issue about $16.5 million worth of ​“refunding” bonds that will pay down the town’s existing principal payments in the next two years — $8.7 million in August, and $7.7 million next August. Essentially, the town is taking out a loan to pay for past loans. This time, it will help close a deficit, and then if all goes according to plan, will help build the town’s fund balance next year.

That does not mean Hamden is adding $16.5 million to its debt service. Rather, it’s replacing one $16.5 million of debt with another $16.5 million of debt that has a lower interest rate but that will take longer to pay off. Since interest rates are currently low, the rate the town will get on the restructuring bonds will likely be lower than the interest rates it got on the bonds it is using them to pay for.

This type of restructuring allows municipalities to get savings in the short term and push out debt payments further into the future. While the interest rates on the restructuring bonds may be lower than those of the bonds they will replace, that doesn’t mean the restructure brings a net savings to the town. Financial advisors estimate that in the long run, the restructure will cost an additional $4.6 million because of the extended amount of time the town will be paying interest. That additional $4.6 million cost will come due about a decade in the future; calculated in today’s dollars, it is estimated to be worth around $600,000.

This type of restructuring may help municipalities weather short-term crises, but it can have consequences if the practice, or the problems it seeks to address, are chronic. In 2018, New Haven did a similar restructure of $160 million of debt, which passed only because alders secured a commitment from Toni Harp’s administration to enact strict fiscal controls. At the time, experts warned that ​“scoop and toss” restructuring had sent Hartford into fiscal disaster.

Municipal bond experts acknowledged that sometimes debt restructures are necessary. ​“Scoop and toss… doesn’t have a great connotation to it, but there are certain sets of circumstances where things like that are kind of what you have to do,” said Joseph Krist, publisher of Muni Credit News.

While the restructure carries risks, Barry Bernabe of Phoenix Advisors, who advises the town on financial matters, said the alternative would not be pretty. Hamden is running a deficit in the fiscal year that ends on Tuesday of somewhere around $10 million. In May, Mayor Curt Leng told the council that it was somewhere between $8 and $12 million. Finance Director Curtis Eatman later said the upper limit was $13 million, not $12 million. On Friday, Leng said that through savings among various departments and in medical insurance, the deficit now appears to be somewhere between $6 and $8 million.

As Bernabe told the council Thursday evening, there isn’t really any other plan to mitigate that deficit. Without the restructure, the town will in all likelihood come out the other end of an audit with a negative fund balance.

“As is, there is no other plan in place to get the town back to a positive fund balance,” he told the council.

And that’s not all. Hamden has a meeting with rating agencies on Tuesday, as agencies determine how to rate its bonds. One rating agency, Moody’s, already has Hamden rated one step above junk bond status, though S & P and Fitch both give it a higher rating, with a little more room for downgrades.

On Tuesday, if Hamden does not show a plan to mitigate its deficit and then grow its fund balance, the ratings will not be pretty, said Bernabe. And that will have immediate consequences.

In August, Hamden has $16.5 million (a different $16.5 million from the restructure) due back to Webster Bank. Last year, the bank lent the town bond anticipation notes (BANs) to provide immediate cash for capital projects before the town actually goes out to issue long-term bonds for those projects in August. The town will issue bonds, and then use the bond proceeds to pay back the BAN.

But if Hamden’s bond ratings dip below investment grade and reach junk status, the town might struggle to find buyers for those long-term bonds. As Bernabe and Deputy Finance Director Rick Galarza have told the council multiple times, last year when the town sought buyers for its BANs, it sent inquiries to 12 banks. Only Webster Bank responded. The rest had no interest in investing in Hamden’s notes.

Finding buyers is already getting tough, said Bernabe, and if the town has a junk bond rating, it might not even have market access at all. In the worst-case scenario, no one would buy its bonds, and it would default on the $16.5 million BAN to Webster Bank.

Of course, the town’s finance department and financial advisers would do everything possible to avert that disaster. The town could raise taxes immediately by 4.73 mills, or about 9 percent on top of the 6.4 percent the town already raised taxes for the next fiscal year. Perhaps it could negotiate with Webster to push back the payment.

With that worst-case scenario looming in the back of members’ minds, the council eked out the ten votes necessary to pass the restructure Thursday night/Friday morning. Bond issues need a two-thirds majority to pass, and ten of 14 members voted in favor.

That means there may not be a sudden 9 percent tax increase looming in the next month, or an all-but-certain negative fund balance looming shortly thereafter.

Hamden is beyond the point where painless solutions to its financial problems exist. Short of a miracle, the restructure will work only if it is accompanied by steep tax increases and debilitating cuts down the road. Whether Hamden’s elected officials are the ones who ultimately have the courage to make those painful decisions, or whether the state has to step in and do it for them, remains to be seen.

Three-Year Plan

The plan Bernabe presented to the council would give the town three years of savings, and would require two bond issues. Thursday evening, the council passed the first bond issue, which will create savings in the first two years. Savings in the third year would come from a bond issue next year.

While the ordinance the council passed Thursday authorized up to $25 million of bonds, the town will likely only issue $16.5 million. The extra is for flexibility.

Once the town issues the restructuring bonds, it will put the bond proceeds in an escrow account, invested in treasury securities, with US Bank. The escrow will then use it to pay down the town’s debt in two increments, the first this year and the second next year.

Since restructuring bonds can only pay for bond principal, the restructure can only bring in $8.7 million in savings this year, because that’s the amount of principal the town has to pay in 2020. (That doesn’t include principal from its pension obligation bond, which cannot be refinanced through these refunding bonds.)

Next year, the town will receive another $7.8 million from the second half of the restructure.

If the town follows phase two of the plan, it will issue another bond next year that would give small additional savings next year, and much more in 2023. A debt schedule shows savings that year of about $10 million. About $8 million of that would replenish the fund balance, after a $6.7 million replenishment the year before. The town’s fund balance is currently about $2 million, though it may get wiped out by this year’s deficit.

Bernabe said he had proposed two separate bond issues because some bonds can be refinanced on a tax-exempt basis, but others cannot. Bonds refinanced within 90 days of their call date are tax exempt. Next year, more bonds have their call dates, meaning the town can do more restructuring on a tax-exempt basis, which leads to lower interest rates on the refunding bonds.

While the first phase of the restructure would come at a net loss to the town, the second phase, if projections hold, could give the town a net present-value savings.

“With the debt restructure approved, the savings created in year one will be enough to fully cover the FY20 deficit and ensure a positive fund balance position all in the first year,” Leng wrote to the Independent. ​“The savings created in the second and third years give us an amazing opportunity to replenish Hamden’s fund balance to a very strong position, all completed with the present value cost savings to the town, which makes it even more of a win-win.”

Bernabe said he will present that plan, with one year of deficit mitigation and then two years of fund balance replenishment from the restructure, to rating agencies.

Having that plan in place, he said, could help avert a downgrade to junk bond status, though even with that plan, Hamden’s ratings may still slip.

Saturday afternoon, the town sent out a press release about the restructure. Four hours later, it sent out another release retracting it. The second release said the first had been sent without legal review. ​“The proposed debt restructuring transaction referred to in the Media Release has not occurred may not occur in the future, or the financial results thereof may be different from those set forth in the Media Release, and such differences could be material,” it said.

“Masking A Deep Problem”

Debt restructures are a tool at local governments’ disposal, and they’re not uncommon, said Victor Medeiros, an analyst at Standard and Poor’s, one of the rating agencies Hamden will be presenting to on Tuesday. But when they’re done repeatedly, that can be a problem.

“If it’s done routinely, what it tends to look like is it tends to be a budgetary measure that is masking a deep problem,” he said in a phone call with the Independent in April. ​“If conducted without a comprehensive plan of how you are going to ameliorate that problem, it could have credit consequences.”

Adam Stern, senior vice president and co-head of research at Breckinridge Capital Advisors, said he understands why the restructure might make sense for Hamden. One way of seeing it, he said, is that ​“they need the cash, this is a way to do it. Is this an unreasonable thing to do given the current conditions? No, it’s not.”

But over the course of an hour-long phone call, as he looked deeper and deeper into Hamden’s last audit, Stern began to point out many of the hallmarks of a town whose problems a ​“scoop and toss” restructure can exacerbate.

“The way local governments get in trouble is a multi-year pattern of financing deficits with something other than recurring revenue,” he said. And on that front, Hamden does not have a good track record.

Hamden’s revenues have come in under budget every year for at least the last decade. In recent years, the shortfalls have grown. In 2018, the town ended the fiscal year $6.4 million short on revenues, though that was in part because of a last-minute cut to state aid. It closed that shortfall by contributing less to the town’s pension than it had budgeted. In 2019, the shortfall was $5.4 million. Again, the town contributed less to the pension than it had budgeted — $6.7 million less.

Now, of course, the town is looking at another, even larger deficit. It cannot turn to the pension anymore, so the restructure will have to do.

Those practices show in the audit, said Stern, and show a town with a recurring problem in its financial management.

“I can see something is off here within five or ten minutes of looking at their financials,” he said. He pointed out the fact that the debt service is still growing, not flattening out. That means that even with the restructure — especially with the restructure — it will still be an uphill battle to fund it. On top of that there are massive, growing pension liabilities, other post-employment benefit (OPEB) liabilities, and other growing costs. He also pointed out a $12 million deficit in an internal service account in the budget. Some analysts, he said, would apply that deficit to the general fund, and would say the town actually has a negative fund balance of $10 million because of it.

What he saw in the audit, he said, is ​“mismanagement, plain and simple.” If he were giving the bond rating, he would give a junk rating, just based on what he saw in the audit and what he had heard. He added that even with a junk rating, he thinks the town could still get market access and find buyers for its bonds, though it might take some work and some creativity.

Goal: ​“Structurally Balanced”

The restructure may help Hamden weather the next few months, and might help grow the fund balance after. But it does not solve the underlying financial problems the town faces. And without facing and solving those problems, it will be just another band-aide that ends up infecting the wound rather than healing it.

The restructure plan works, said Bernabe, only if the town’s future budgets get ahead of long-term obligations and actually balance.

“Going forward, budgets have to be structurally balanced,” he said. ​“No more phantom revenues. Nothing like that.”

The restructure may work because it differs from the 2018 restructure in one key way.

In 2018, the council approved an operating budget for the 2018 – 2019 fiscal year that counted the debt restructure as savings among the debt service lines. The town’s total debt service that year was supposed to be about $20 million, excluding the pension obligation bond. But the council included a debt restructure line in the budget worth $12.25 million, meaning the town only had to collect enough revenue to pay for a debt service payment of $8.4 million.

This year, Leng originally proposed a similar scheme. The town’s debt service payment is $22.2 million, but Leng included a $7 million debt restructure savings line in his proposed budget. Had the council passed the budget with that restructure in it, the town would have only collected enough revenue to pay for a $15 million debt service payments.

But at Bernabe’s urging, the council removed that restructure from the budget. Bernabe said that the town should not budget restructure savings, but should still carry it out. By removing it from the budget, the council increased total expenses by $7 million, meaning it had to increase revenues by that much as well. That accounted for nearly two mills of this year’s tax hike.

Since the town has the revenue to pay the full debt service payment, it can use the restructure savings to cover the current fiscal year’s deficit, rather than having those savings lost into the black hole of another structurally unbalanced budget.

The fact that the town removed the debt restructure savings from the budget, said Bernabe, is ​“what makes this whole plan work.”

In order for the multi-year restructure savings plan to work, Hamden will have to do the same next year, and the year after that. It will need to budget its full debt service, even though it will be getting savings from the restructure. As long as the town does so, those savings can be used to grow the fund balance, as planned.

But that won’t be easy. If the town issues the $16.5 million of new bonds in August as planned (a separate $16.5 million for the restructuring bonds), next year’s debt service payment will be $25.4 million. After that, it will be $27.7 million. The following year, when the town starts paying back the refunding bonds, it will be $30.4 million.

Each year, the town will need to find corresponding revenue increases to match those debt service increases. And debt is just one of the annual expense increases the town will see. Pension payments will increase, both to the town’s own pension plan, which is one of the main drivers of the town’s fiscal woes, and to the state retirement plan of which the town is now a part. Medical costs will increase. Salaries to unionized employees will increase, unless the town can manage to get some tough concessions and lay off staff. This year, even with heavy cuts, the council still ended up passing a budget about $13 million larger than last year’s.

If the town does not budget fully and accurately for all of those expenses, the restructure savings will be swallowed again to mitigate another deficit. The fund balance will not grow, and the restructure will look like another push-off-the-problem ploy to avoid facing an underlying budgeting problem. It would exacerbate a chronic fiscal illness, rather than acting as an innocuous pain killer.

Already, the council is trying to find $8.5 million to cut from the 2020 – 2021 budget it just passed. It included a $6 million line for state aid for Covid-19, and a $2.5 million savings line from union concessions. Though he hopes those revenues and savings will actually materialize, said Council President Mick McGarry, the council needs to be ready if they don’t. If the town ends the next fiscal year with an $8.5 million deficit, there go the restructure savings.

Even if the town does get $6 million from the state, and $2.5 million from union concessions, those are not recurring revenue lines. In all likelihood, there will be no Covid-19 aid in the following fiscal year. That means the town will then have to come up with that revenue somewhere else.

State aid will probably increase over the next few years, but increases that match the mounting expenses and also make up for disappearing revenues like the Covid-19-aid line are unlikely. That means the town will have to cut, or raise taxes significantly, or most likely both.

The restructure might right Hamden’s fiscal ship by avoiding a deficit this year. But the ship will only stay righted, and the future increase in the debt service is only worth it, if Hamden can start crafting budgets that do not end in revenue shortfalls. No budget in the last decade has managed that.

“Can you build a multi-year plan so that you right-size the budget? Yes,” said Stern. ​“But you are already paddling upstream.”

Axe 3Rs? MARB?

Council members didn’t start discussing the debt restructure until about 11 p.m. Thursday night. They left the restructure for the end of the meeting, which started at 7 p.m., and spent the first four hours discussing other items.

For the hours on either side of midnight, they grappled with the tough reality of the town’s fiscal situation. Most — 10 members — ended up voting to acknowledge that the restructure really was the only good option.

But some floated a few other choices.

Councilwoman Kristin Dolan, after sitting quietly through other comments, asked whether the town could avoid some future debt costs by canceling its 3R school district restructuring project.

Last year, the Board of Education spent months putting together a plan to move sixth graders to the middle school, create intra-district magnet schools, close two elementary schools, renovate others, and provide universal pre-K. The council approved bonding for the project, called the 3R Initiative, about a year ago.

About $5.9 million of the Webster Bank BAN is for the 3Rs. The town could simply cancel the 3R project, or postpone it, not bond for the project, and simply pay back the BAN. Some 3R funds, though, have already been spent, and an architect has already planned a new wing at the middle school. Axing the 3Rs might allow the town to bond a little less in August. But it would force the board to scramble to find ways of redistricting and renovating schools after the state has already committed to funding many of its renovation plans.

A few council members, especially those who voted against the restructure, also brought up the possibility of state oversight of Hamden’s budget. At one point, Justin Farmer, who voted against the restructure, said it’s clear Hamden is on its way to the Municipal Accountability Review Board (MARB) anyway.

Council members like Farmer, and some residents, have begun to advocate for a state takeover of Hamden’s finances. MARB is the state agency that steps in and takes control of, or reviews, the finances of municipalities under extreme financial distress. Hartford, West Haven, and now Sprague are all under MARB review.

Deputy Finance Director Rick Galarza bristled at the suggestion that the town give up control.

“We are not going to stop coming up with recommendations,” he said. “We are not designed to give up. I think that together, as a town, with respect and trust, we can get through this together.”

“I understand your comments,” he continued, addressing Farmer, “but I need [you] and the council as a whole to understand that we understand it’s a problem, but our job is to go beyond that and come up with solutions. So I am bothered if the legislative council feels… that we are not here to provide solutions.”

Hamden is close to meeting the criteria that make it eligible for a MARB takeover. The state’s system has four tiers of review. The first two tiers are voluntary, and are overseen by the Municipal Finance Advisory Commission (MFAC), instead of MARB. Hamden already meets the criteria for Tier I MFAC oversight.

Tiers III and IV involve MARB. Towns can pursue oversight under those tiers voluntarily, or the state can step in without application from the town.

Depending on how the next few months go, Hamden may soon be eligible for Tier III MARB. That would happen if its fund balance dips below zero, which the council likely just averted. It could also happen if it receives a junk bond rating, which seems more likely.

Hamden’s ratings from S&P and Fitch are both a few notches above junk status. Its rating from Moody’s is the lowest rung of investment grade. The town is meeting with only S&P and Fitch on Tuesday because Moody’s tends to be harder on the town, said Bernabe. But since Moody’s has rated existing bonds, it can still lower the town’s bond rating.

Stern said the town’s path toward stability will likely take it through MARB.

State budget oversight, though tempting to some council members, would be tough. It would likely involve steep tax increases and hard cuts. But that may be what has to happen anyway.

“Any municipality has to weigh what they think the end result of state oversight and or control would be,” said Krist. “Then they have to figure out: Can they get there themselves, or is there not the political ability and or will to get the things done that need to be done?”