This piece first published May 30, 2017, Debtwire Municipals
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While some distressed municipalities seeking market access can break through and obtain financing at reasonable rates, several factors play into a municipality’s ability to issue debt, market sources say.
The level of state oversight, the presence of a statutory lien and state intercept all play a role in the market’s reception to a distressed issuer. Last week, Atlantic City issued about USD 75m in debt, and with the presence of all three — plus the added protection of bond insurance — investors oversubscribed to the deal by 20x and spreads narrowed on the longest-dated paper by about +30bps when pricing concluded.
“It’s extraordinarily likely you’ll find a market for any bond if you find enough security protections to it, someone will buy it,” said Lisa Washburn, managing director for Municipal Market Analytics. “When you look at the Atlantic City transaction, it’s not too dissimilar to what was done to give Detroit market access. The state gave a statutory lien on Detroit’s personal income tax – it wasn’t the general credit of Detroit. Both cities had something to offer better than their own credit.”
Using New Jersey’s Qualified Bond Act, Atlantic City and several other distressed municipalities within the state can use a pledge of state aid, which carries a statutory lien, to fund debt service. The funds go directly toward debt service. In Michigan, shortly after Detroit emerged from bankruptcy, it issued debt using a statutory lien on Detroit’s personal income tax in 2015; in 2016, it issued debt securitized by state aid and a statutory lien on those revenues.
The Detroit deals carried additional security for bondholders, with the state treasurer disbursing funds for debt service directly to the trustee for the 2016 transaction, as reported.
Atlantic City is operating under state control and Detroit, following the oversight of an emergency manager and the emergence from bankruptcy, reports to a state-run Financial Review Commission.
Sweetening the pot
There are very few issuers with underlying credit ratings below investment grade in Build America Mutual (BAM)’s portfolio, said Suzanne Finnegan, BAM’s chief credit officer. Atlantic City’s underlying credit rating is Caa3/positive from Moody’s Investors Service and CCC/developing from S&P Global Ratings. However, using the Qualified Bond Act, it obtained the state’s appropriation debt rating: Baa1/stable from Moody’s and BBB+/negative from S&P, which paved the way to the boost from BAM’s involvement, with BAM’s AA/stable rating from S&P.
“We don’t insure transactions we believe to be noninvestment grade,” Finnegan said. “We’re not always in lockstep with (the ratings agencies), just as they’re not always in agreement with each other.”
State intercept programs show the state is being proactive to resolve problems, making them more attractive to insurers, Finnegan said. Even states with intervention programs, but no intercept for municipalities, like Pennsylvania, show “a good use of the state’s fiscal discipline,” she said. Pennsylvania does offer an intercept for school districts.
“Traditionally states have offered these kinds of intercept programs for school districts,” Finnegan said. “School districts have been traditionally funded by state aid, (and intercepts offered) because if they have a lower cost of borrowing, then at the end of the day, it saves states money because it provides much of a school’s revenue.”
And a state intercept does not guarantee an insurer’s interest in the issuance, Finnegan said.
“You have different economic factors and financial flexibility- you have to drill down on each scenario,” Finnegan said. “Having some state oversight is helpful but it really depends on the scenario.”
Bond insurance is also concentrated to specific states and sectors, with the top five states – California,
Pennsylvania, Texas, New York and Illinois making up about 61% of all credits insured since 2014, Washburn said. California and Pennsylvania’s school districts, bolstered by their well-known state intercept programs, make up a large portion of the insured issuance.
The statutory lien establishes credibility to an issuance, creating market access and acceptance, said Jim Spiotto, managing director of Chapman Strategic Advisors LLC.
“It takes away the risk if you’re a challenged (municipality),” Spiotto said. “The purpose is to make sure they have access to the market at a low cost.”
About 22 states have state credit enhancement programs providing additional security to bondholders for general obligation and lease bonds, according to a 2016 report from S&P Global Ratings.
New York, Massachusetts and Rhode Island are also examples of states that have intervened to help struggling municipalities – New York on an ad hoc basis, while Massachusetts and Rhode Island have strong oversight legislation, Washburn said.
“The state can be very helpful when it wants to be,” Washburn said. “The states, because of powers they hold and local governments being wards of the state, there’s a lot the state can do that’s helpful for distressed municipalities.”
A distressed issuer playbook?
The distinct characteristics of the Atlantic City and Detroit issuances, combined with the fact not all states offer the structure New Jersey and Michigan did, respectively, suggests that other states and municipalities can build off the concepts used, but the transactions will not be the same.
The Atlantic City and Detroit issuances were unique as they were refinancings “taking out” other obligations, Washburn said. Although they obtained access to the market with the additional security, taking on additional debt is not usually the best strategy for a distressed municipality, she said.
“You don’t see a lot of distressed municipalities coming to market, at that point, they’re trying to work out problems, market access becomes difficult without additional security features because their credit is so bad,” Washburn said. “The state is not going to encourage issuance for a distressed municipality unless there’s some reason to be in the debt market.”
Illinois does not offer a state intercept, and the underlying credit quality makes would make it difficult for a city like Chicago to obtain bond insurance, Washburn said.
“They are in the business of underwriting to a zero loss, and once you think there’s more incremental risk than that, it’s questionable (that bond insurance is possible),” Washburn said. “If they are investment grade, and the state’s intercept program is sound, there’s plenty of insurance placed on that.”
Connecticut does not offer an intercept to local governments but is redeveloping its municipal oversight program to stabilize municipal distress, said Ben Barnes, the state’s secretary of the Office of Policy and Management.
“More commitment from the state may be helpful…we’re talking about ways to enhance distressed municipalities, and we could get there with Hartford, Bridgeport, Waterbury quickly,” Barnes said.
by Maria Amante