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Hartford Could Default On Its Debt As Soon As Next Month, Moody's Says

Published: October 19, 2017
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Source: Zero Hedge

 

Moody’s latest warning about Hartford Connecticut is its most dire yet.

In a report issued Thursday, the ratings agency’s analysts said Hartford, Connecticut’s once-proud capital city, could default on its debt as soon as next month, forcing the capital of the country’s wealthiest state (on a per capita basis) into bankruptcy.

If the city doesn’t change course (and given its shrinking tax base and the departure last year of Aetna, a major insurance company that was founded in Hartford and had located its headquarters in the city for more than 150 years, reforms appear unlikely), receive a state bailout or strike some kind of deal with its creditors, Moody’s says lenders can expect it to run up annual deficits in excess of $60 million through the next 20 years.

Moody’s (along with its rivals Fitch and Standard & Poor’s) downgraded Hartford’s credit rating on Sept. 26 to Caa3 from Caa1, reflecting a view that creditors would only manage to recoup between 60% and 80% of their principal should Hartford default.

 

 

Of course, there’s no guarantee that the state government will be there to support troubled Hartford. Four months into the fiscal year, Connecticut is the only state in the country that hasn’t passed a budget as lawmakers the state’s lame-duck Democratic Gov. Dannel Malloy joust over how to close a $3.5 billion two-year budget deficit. In a reflection of the state’s broader fiscal crisis (as is the case in many US states), Moody’s says Hartford’s public employee unions represent a “significant constraint” to cutting the city’s deficit, as the Hartford Courant points out.

 
 

Moody’s called Hartford’s unions “a constraint” to trimming the city’s deficit. “Contractual salary increases and employee benefits are significant contributors to the city's long term structural imbalance,” the report read. Unions would have to make “significant concessions” for Hartford to narrow those deficits, it said.

 

High labor costs stem from “decades of contractual salary increases and employee benefits,” Moody’s wrote, and those benefits — which include health insurance, pensions payments and workers compensation, among others — are expected to increase by $21 million in 2018. Moody’s found that benefits and insurance costs have increased 6 percent each year for the last 10 years, compared to an annual increase of just 2 percent in the urban consumer price index during the same period.

 

Moody’s called Hartford’s unions “a constraint” to trimming the city’s deficit. “Contractual salary increases and employee benefits are significant contributors to the city's long term structural imbalance,” the report read. Unions would have to make “significant concessions” for Hartford to narrow those deficits, it said. 

To circumvent this, Moody’s suggests the state craft legislation that would open up the arbitration process and allow municipalities to renegotiate contracts - a process that, given the immense political power wielded by public employee unions in the state, appears unlikely to succeed, even as state and local finances rapidly deteriorate.

Unfortunately for the city, Moody’s says debt restructuring wouldn’t be as effective a concession as the other strategies being pursued by the city’s Democratic Gov. Luke Bronin. This is largely because the city would be forced to pay more in interest further down the road. Bronin his hoping to convince creditors to restructure some $600 million in debt.

 
 

Of the three avenues being pursued by Mayor Luke Bronin — debt restructuring, increasing state aid and renegotiating labor contracts — debt service would be “a smaller source for potential concessions” than escalating state aid or negotiating with unions, Moody’s said.

 

Moody’s said bondholders and city leaders discussed issuing new refunding bonds with a maturity of 30 years, rather than the previous cap of 20 years, which “would provide principal repayment in full but over a longer period."

 

While that maneuver would reduce Hartford’s immediate deficits, the city would be forced to pay more interest, increasing the cost of its debt, Moody’s wrote.

 

Bronin has said he is not interested in saddling Hartford with mounting interest for decades to come, and Moody’s said it does not expect him to take this route.

Bond yields on Hartford's muni debt have shot higher since the first spate of downgrades earlier this year...

 

 

...as for the state government, WSJ reported Wednesday that lawmakers have reached a preliminary deal, a sign that the budget impasse may soon be coming to an end.

Unfortunately, this wouldn’t be the first “preliminary deal” to fall apart at the last minute.

* * *

Read the Moody’s press release in full below:

New York, October 19, 2017 -- The City of Hartford (Caa3 negative) is likely to default on its debt as early as November without additional concessions from the State of Connecticut (A1 stable), bondholders and labor unions, Moody's Investors Service says in a new report. How and when the concessions are realized will factor into bondholder recovery as well as the city's financial recovery.

"Our analysis projects operating deficits of $60 million to $80 million per year through 2036, the final maturity of its general obligation debt," says Nicholas Lehman, a Moody's AVP. "Fixed costs — including pension contributions, benefits and insurance, and debt service — are driving large projected operating deficits of approximately 11% of revenues. "

Hartford will look to bondholders to restructure roughly $604 million in general obligation and lease debt. Options for restructuring include refinancing debt by issuing new refunding bonds with a maximum maturity of 30 years, instead of the previous cap of 20 years. As well, the new bonds would be secured by a statutory lien on property taxes.

In the event of a default, bondholder recovery is extremely sensitive to the amount of concessions received from stakeholders, and how those concessions are allocated. Bondholder recovery analysis supports the Caa3 rating based on Moody's expectation the state and labor unions will provide significant concessions.

Hartford has lobbied Connecticut for additional short- and long-term aid, which would be an additional revenue source to help resolve the fiscal imbalance. However, the availability of this support is highly unknown in the midst of a state budget impasse, as one of the key contentious elements within the budget is additional aid for Hartford.

"Beyond the short-term funding that may or may not come in fiscal 2018, the city has urged the state to participate in a long-term solution," Lehman says. "One option is the state fully funding the existing payments in lieu of taxes formula, which has been underfunded for years; fully funding the payments in lieu of taxes (PILOT) formula would provide the city with $52.3 million of additional revenue each year."

Moody's says the additional grant revenue, or an amount equal to the additional PILOT payments, would provide significant improvement to the city's structural imbalance and would cut our projected annual operating deficits by more than half.

Hartford unions are a constraint to significant labor spending cuts. Though the city has reduced its labor force, contractual salary increases and employee benefits are significant contributors to its long-term structural imbalance.
 

 

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