Jepsen sees a path forward from ‘bond lock’ nightmare

Attorney General George Jepsen raised hopes Wednesday that Connecticut can escape an ugly choice tied to its credit card and a miscommunication between the General Assembly and state Treasurer Denise L.  Nappier.

That choice involves delaying capital projects — such as municipal school construction — or forfeiting the state’s ability to cut debt costs through refinancing.

Though Jepsen declined to speculate on how a court would act, he wrote in an opinion that it would be absurd to assume the legislature intentionally tried to limit its ability to control borrowing costs.

At issue is a new borrowing cap — which calls for no more than $1.9 billion in general obligation bonds to be issued annually — that was adopted last November, and some modifications made to that limit this past May.

General obligation bonds are repaid out of the state’s General Fund, which holds receipts from the income, sales and other major state taxes, as well as casino and lottery proceeds and major federal funding.

To stop future legislatures from repealing this cap, lawmakers also ordered something that’s become known as the “bond lock.”

When the state went to Wall Street to sell bonds in June 2018, it pledged in covenant — the contract language between Connecticut and its investors — not to tamper with the borrowing cap, except under very limited conditions, for five years.

But a problem was discovered shortly after Connecticut bond-locked itself into this new limit.

In May, a few weeks before bonds with the special covenant language were issued, the legislature ordered some key modifications to the bonding cap — namely, that the cap was not to apply to routine debt refinancing. This is done most years to take advantage of lower interest rates and reduce debt costs.

State Treasurer Denise L. Nappier thought the legislature had made those bond cap changes effective immediately. So when she issued bonds in June, the bond covenant language specified that the bond cap and other restrictions would not be tampered with from May 15 until mid-2023.

But here’s the problem: when the legislature voted in May to revise the bonding cap, it made those changes effective July 1 — a common start date for most budgetary changes since it coincides with the state of the new fiscal year.

That means Connecticut pledged in June bond covenants to adhere to bond cap rules effective pre-May 15 — rules that didn’t include the key exceptions since they didn’t take effect until July 1.

State officials began to panic, questioning whether Connecticut would be in default of its bonds if it even refinanced debt to save money.

They also began to point fingers.

Nappier charged lawmakers in a Sept. 18 letter with making last-minute changes on the final day of the 2018 General Assembly session that made no sense. The bond cap revisions should have taken effect immediately, she said, not on July 1.

Office of Policy and Management Secretary Ben Barnes, Gov. Dannel P. Malloy’s budget director, responded one day later.

“Your office and bond counsel failed to correctly read and interpret legislation passed this year, leading to the issuance of bonds by the State that contain a covenant which, at best, is contrary to the will of the legislature, and at worst may harm the ability of future governors and legislatures to finance our capital program in a cost effective manner,” Barnes wrote to Nappier.

“I am pleased that the attorney general has reconciled ambiguous statutory language that would have required conflicting action on my part,” Nappier wrote Wednesday, adding that Jepsen’s conclusion “is clearly consistent with our lawmakers’ intent, and will clear the way for the State to benefit from lower cost refunding.”

“This is welcome news and removes a potential impediment for the incoming administration and General Assembly,” said Chris McClure, spokesman for the governor’s budget office. “Attorney General Jepsen and his staff deserve special credit for addressing this complicated issue quickly and thoroughly.”

So what is the solution? 

Jepsen wrote that the answer rests with the inherent contradiction.

The bond covenant took effect on May 15, as ordered by the legislature. 

But the new exceptions lawmakers mandated didn’t apply until July 1. 

And that’s after the period the cap rules can’t be modified, according to Connecticut’s pledge to bondholders.

“The mechanism with the greatest chance of success is to illustrate for the court both the impossibility of the literal application of the conflicting statutes at the same time and the absurdity of the result,” the attorney general wrote.

Setting a July 1 effective date “essentially eviscerates” the intent of ordering all bond cap rules to be locked into a bond covenant pledge effective almost seven weeks earlier on May 15.

In such circumstances, a court would be obligated to construe the statutes in a manner that would avoid the conflict,” Jepsen continued.

And while he could not say how the court might rule if the state were sued, Jepsen added, the state could simply consider the bond cap exceptions to be in effect now.