Finance Officials Reminded Of Key Role

Of Town’s Bond Rating

By John Voket

(An audio file and accompanying PowerPoint slide show from the September 10 Board of Finance presentation are linked to this story at newtownbee.com)

In the lobby of the first selectman’s office at the Newtown Municipal Center, on a shelf lined with coffee table books, Newtown maps, pamphlets, flyers, and a copy of the Newtownopoly game, is a sheaf of nondescript papers labeled “rating criteria.” Compiled from a 2007 report from the Fitch rating service, the document concisely details how the agency weighs various finance and financial practice criteria in awarding municipal bond ratings.

Under an explanation about “Fund Balance Reserve Policy / Working Capital Reserves,” the report states that “Maintaining an operating reserve is perhaps the most effective practice an issuer [of bonds] can use to enhance its credit rating.”

That guideline was published when the global economic downturn was still a wispy cloud on the horizon. But five challenging years later, that advice still rings true, according to Newtown’s bond consultant Barry Bernabe.

The Webster Bank vice president of government banking was on hand September 10 to initiate an hour-long analysis and discussion on the state of Newtown’s credit worthiness, financial practices, and how those practices relate to the money taxpayers are asked to spend to finance debt for capital projects.

In terms of Newtown’s current AA1 (Moody’s) or AA+ (S&P) bond ratings, Mr Bernabe stated, “Your rating now means more than it ever has.” He added that the better Newtown’s bond rating, the lower its borrowing costs will be.

He said that while 18 communities in Connecticut currently enjoy a coveted AAA municipal bond rating — essentially a perfect credit score — Newtown at one rank lower enjoys a Financial Management Assessment (FMA) that is rated “strong.” Mr Bernabe told the finance board that Newtown is among just ten percent of communities in the state to attain this comparative status.

When examining why Newtown’s FMA surpasses a number of AAA-rated towns, the government finance expert said that Newtown aggressively pays down its accrued debt.

“Three-quarters of the debt is gone in ten years,” Mr Bernabe noted, even on bonds with a 20-year maturity. But he pointed out that Newtown is still lagging behind its AAA-rated neighbors, and even some of its AA1 / AA+ peers because of its fund balance to total budget ratio.

Mr Bernabe believes that for Newtown to break into AAA bond rating contention, the community needs to show several years of increasing investment in its fund balance. He said Newtown might adjust the amount it budgets for tax collections to generate fund balance revenue.

Tax Collection Revenue

Finance Director Robert Tait later told The Bee that he is advising next year’s budget account for slightly less revenue from tax collection, in order to create a greater likelihood of increasing surplus dollars that could revert to the fund balance without having to tax residents to build that account.

“Other towns are a little more aggressive on revenues,” Mr Bernabe said during his presentation. “They [budget] 98 percent in tax collection and apply the surplus to fund balance.”

Turning his attention to the value tied to a bond rating upgrade, and the detriment of a downgrade, Mr Bernabe identified the difference in savings or increased borrowing expense Newtown could face in either scenario. In the event Newtown is bumped up to a AAA rating, based on today’s borrowing landscape and related criteria, an upgrade would be worth savings of 15 basis points, while a downgrade by one level would cost Newtown about 25 basis points.

Mr Tait explained later that one basis point is equal to one one-hundredth of a percent. Taking Newtown’s current debt load of just over $75 million, Mr Tait illustrated that even at today’s historically low interest rates, it would still cost Newtown $2 million, or $100,000 per year, more to carry that debt if its bond rating was downgraded one step.

Conversely, Mr Tait said that same borrowing cost would be $1.2 million, or $60,000 per year, less in today’s market if the town was rated at AAA — based on Mr Bernabe’s formula.

“It may not seem like a lot, but that is one payroll position,” Mr Tait said of the equivalent value.

Mr Tait added, however, that the historically low interest rates Newtown is getting will eventually increase, correlating to Mr Bernabe’s earlier statement making the future potential savings significantly greater in an upgraded bond rating environment versus a greater cost to bond at the current rating or an exponentially greater cost if Newtown’s rating is downgraded.

“You have to tie everything to interest rates,” Mr Tait said. “It’s quite possible that long-term [borrowing] rates could go from 2.35 percent rate Newtown earned in February of 2012 to six percent or more in the next few years.”

During the September 10 presentation, Board of Finance Chairman John Kortze referenced the town’s plan to meet an eight percent ratio of savings in the fund balance compared to the overall budget. He asked Mr Bernabe how important it is for Newtown to meet or beat that goal, and the Webster Bank official responded, “The fund balance is [Newtown’s] most important credit rating metric. It is very important.”

First Selectman Pat Llodra then referenced a report Newtown received from Moody’s after its latest bond rating affirmation, noting the eight percent goal is stipulated as a condition directly related to its current and future bond ratings. Mrs Llodra said after transfers, she expects to see slightly less than $1 million reverting to the fund balance from the current budget.

Deferring Bonding

Mr Tait subsequently detailed how revenue generated from the current depleted fund balance can play a role in deferring bonding. He said in the current year, the budget reflects approximately $200,000 in interest earned on the town’s fund balance, while in previous years when the fund balance or funds in a capital nonrecurring account were closer to or above ten percent, that revenue was markedly higher.

In the Year 2000 it was 11 percent.

He said in the years 2002 to 2004, the savings accrued in those accounts represented ten percent of the budget, and were earning between $800,000 and $880,000 in interest revenue. With that increased fund balance cushion, Mr Tait said the town has much greater flexibility in the event of an emergency.

He said before the economic downturn, Newtown would budget to use some of its more robust fund balance, but in most cases, never used that money. But as the economy began slipping, and Grand List growth slowed to a trickle of increased revenue, officials began tapping more of the fund balance to offset taxation.

“For three years we used the fund balance while the Grand List was retracting. It was tough times, but this was a very common practice. Every municipality was doing it.”