Conn. still paying high bond yields despite improvement
We’re in the dog days of summer as candidates for governor and other state offices line up furiously, so a statement about Connecticut’s fiscal health by Treasurer Denise L. Nappier this past week went by without much notice.
It’s worth a close dissection. It was Nappier’s assessment of how the bond markets view Connecticut, based on the results of an Aug. 16 bond sale totaling $889.2 million.
“While we have a ways to go, the municipal finance marketplace has taken notice that Connecticut’s fiscal position has turned a corner,” Nappier said in a written release.
Turned a corner? That’s strong stuff, coming just three months before Nappier wraps up her 20-year tenure as fiduciary of pension funds now worth about $35 billion.
Connecticut, if you’re just in from Las Vegas or the moon, dwells among the bottom five states in most measures of fiscal health, such pension funding and the ability to raise enough money to pay our bills.
Have we turned a corner? Well, the rainy-day fund is bigger, and the governor and General Assembly put in some formal controls that took effect in May. But a turned corner -- probably not yet unless we’re talking about the clubhouse turn with most of the race yet to go.
The results of that Aug. 16 sale, which closes next month, reveal a mixed picture. On the one hand, the effective yields Connecticut must pay — the interest rates on money the state borrows, basically — have indeed come down since a big bond sale in March. And, as Nappier was quick to note, the recent sale attracted far more order than the state’s underwriter could fill.
Despite that, a close analysis shows that even though Connecticut bonds in the recent sales were rated in the high-A’s — lower than AA but well above the B’s — the bond market is demanding yields more typical of BBB-rated bonds.
The difference matters. Seemingly tiny yield differences between grades such as A and BBB can total perhaps $1.5 million or $2 million a year for a bond sale the size of the latest one. Stretched across the state’s entire collection of $18.7 billion in outstanding general obligation bonds, it can easily total $50 million or more a year — although that picture changes very gradually, as the state issues new debt each year.
Yes, the analysis shows we’re better off than we were in March. But the bottom line is we’re still paying a premium over what we should see based on the rating we have, let alone the AA ratings that most states enjoy.
Turned the corner? “That in itself is a gross exaggeration,” said Howard D. Sitzer, senior analyst at CreditSights in New York, who follows the state closely.
Considering the state’s credit ratings and considering some fundamental improvements in state finances, some people thought the extra yield Connecticut must pay over a theoretical ideal borrower - known as the credit spread - might narrow more than it did, Sitzer said.
“It widened beyond what I think people were expecting to get the deal done,” he said.
But what about those long lines at the Connecticut bond cash register? Buyers placed $1.25 billion in orders for the $639 million in tax-exempt bonds this month, and $778 million in orders for the $250 million in taxable bonds, Nappier reported.
“Connecticut was on sale,” Sitzer said. “It was not quite a fire sale but it was a Best Buy Black Friday price.”
Meaning, for the credit risk Connecticut represents, it’s still forced to pay a hefty premium to borrow money.
“The market is still in a bit of a show-me type of mentality with Connecticut,” said Tim Heaney, senior managing director and senior portfolio manager of municipal securities at Newfleet Asset Management in Hartford. “What is plaguing Connecticut to create these wider spreads compared to what you would expect for its rating…is weak funding ratios for its pension funds.”
And that’s not something that turns around very easily.
Still, it’s been a pretty good year for Connecticut’s fiscal climate, by the glacial standards of a state turnaround. The rainy-day fund will soon reach $1.5 billion, up from barely more than $200 million a year ago. And, while much of that was due to a one-time tax windfall stemming from a 2008 federal hedge fund rule, Connecticut passed significant reforms last fall, which took effect in May.
That includes a requirement that revenues over a certain level from capital gains in the personal income tax be moved to the rainy-day fund. And it includes an annual borrowing ceiling of $1.9 billion.
Borrowing has already come down from a peak of a few years ago. New debt for the general fund totaled $1.5 billion in the recently ended fiscal year, down from $2 billion the year before.
Ultimately, there’s almost no way to measure exactly how the state is faring against itself and against competitors in the bond market, because rates change every day for every class of debt.
Nappier cited a drop in the effective yields Connecticut must pay for the longest bonds, around 20 years. In the March sale, the state sale was 96 basis points (just under 1 percentage point) above the index for the best borrowers. In the June sale, the so-called yield spread was 85 points.
And in the Aug. 16 sale, the total slid down to 82 points. That’s good, but some of that decline was due to a narrowing of the spreads in the market as a whole.
My calculations showed that in the March sale, Connecticut paid what I’ll call a theoretical premium of $250,000 over BBB-rated bonds for one year of interest payments. That’s’ taking the yield for each maturity year and multiplying it by the amount Connecticut actually issued, compared with an index called the Municipal Market Data, or MMD scale, which attempts to peg rates for each class of debt every day.
The premium over A-rated bonds was $1.9 million even though Connecticut was rated as A+ across the board.
These are not payments the state actually made, but rather a hypothetical for the purpose of comparing where we might have been. Actual payments depend on many factors in these complicated deals.
In the August sale, with a theoretical interest payment of $18.7 million, we were dead-on the BBB rate, $2.1 million above the A rate and $3.9 million above AA.
Again, these figures are not what the state will pay, they’re only calculations to illustrate proportions.
The takeaway: “Turned the corner” is a phrase with many meanings and we’re not where we want to be. But everyone agrees we’ve shown improvement over the dark days of the summer of 2017, when we had no state budget.
Sitzer rates Connecticut bonds as “market perform” and he disagrees with a Standard & Poor’s downgrade in the spring, from a high-A to a plain-vanilla A. And he pointed out, at least we’re not Illinois.
That state paid a premium of more than 1.7 percentage points in a big bond sale Thursday, even though it’s a BBB - which should fetch better rates.