State Treasurer Denise L. Nappier unveiled a compromise plan Monday to reform state bonding practices while also giving Gov. Dannel P. Malloy and the legislature some flexibility to use borrowed funds to balance the next two-year budget.
But legislators still would have to replace $147 million in savings from bond premiums in the governor’s budget with spending cuts or revenue hikes — a prospect that Nappier said might hurt her plan’s chances for passage this year.
“I’m being realistic,” Nappier, a Hartford Democrat, told The Mirror. If adopted, the plan “will go a long way in ultimately helping the state” reduce long-term debt costs.
Nappier proposed similar reform in 2005. According to her office, had it been enacted 10 years ago, the state’s bonded debt would be $420 million less now.
The treasurer said she wants to give some flexibility to the governor and legislature as they struggle to close a major deficit. “We’re talking about programs and services that are sorely needed,” she said, adding that if lawmakers fear borrowing reform now means cuts to education or health care, “I’m not going to win the argument. I don’t want it to fall on deaf ears.”
The plan is centered on “bond premiums” — special proceeds the state receives as part of a complex process when borrowing funds for capital projects at a higher rate.
Premiums are an effective tool to market state bonds. Investors sometimes want to pay a premium to acquire bonds that earn higher interest rates, particularly when rates generally are low.
The premium’s value matches the added interest costs Connecticut faces by switching from a market rate to the higher rate. If the state immediately used the premium to reduce the principal on its bonding, there is no added cost.
Connecticut, however, does not do that.
Instead the premiums are used to cover future interest charges on the borrowing – an option that forces the state to pay more interest over the long run.
More importantly, the state usually already has budgeted money to cover these interest charges. And when the premiums – borrowed funds – are used instead to cover debt service costs, it creates a surplus in the budget’s debt service account.
Between 2011 and 2014, Malloy and the legislature have created more than $170 million in debt service surpluses through premiums.
Republican legislative leaders have argued the governor and Democratic lawmakers effectively have used borrowing to close mid-year budget deficits and to bolster the state’s emergency budget reserve.
Under Nappier’s bill, the state would have to use the premiums to reduce initial debt, and not to cover future interest charges. But this change would not begin until the 2017-18 fiscal year.
That’s because Malloy’s budget proposal calls for an unprecedented use of bond premiums to cover operating costs. The governor’s budget assumes the state would take $325 million in bond premiums over the next two years combined, and would use those borrowed funds to cover obligated debt payments
Nappier butted heads with Malloy when that plan was unveiled in February, calling it “too aggressive.” And the treasurer said Monday she still believes that is the case, given many economic indications that interest rates likely will rise during the next two-year budget.
“It is not a question of ‘if,’ but ‘when,’” she said.
Still, in an effort to compromise, Nappier recently revised her projections for Connecticut’s debt service needs for the next two fiscal years, taking into account expanded state borrowing plans and – for the first time – anticipating the bond premiums Connecticut is likely to receive.
That revised estimate would cover about $178 million of the $325 million in debt service costs Malloy wants to cover with bond premiums. Nappier’s proposal is pending before the legislature’s Finance, Revenue and Bonding Committee, which is holding a hearing on it Tuesday morning.
Malloy’s budget chief, Benjamin Barnes, wrote in testimony to the panel that the treasurer’s proposal and bond premium estimates would remove the flexibility to use premiums in the general fund, and would require the legislature to find added funds to cover debt costs.
The treasurer said she still considers counting on bond premiums a somewhat risky approach to budgeting, and hopes that this practice would end in two years if her reform bill is enacted.
The market determines the bond structure the state uses, she said. “This is not driven by the Nappier administration,” she added, “It is driven by the market.”
The treasurer added that “my job is to issue bonds at the lowest possible cost to the state.”