Last Tuesday, the Mayor of Hartford, Conn., Luke Bronin, announced that he has had initial conversations with attorneys who specialize in Chapter 9, municipal bankruptcy. The move was a surprise to the municipal bond market as well as other members of the Hartford city board who were unaware of the mayor's intentions, and many called the move premature.
For quite some time, it has been publicly known that Hartford is facing financial troubles. In October 2016, Moody's downgraded Hartford's general obligation debt to Ba2 in citing the city's inability to run a balanced budget, tax increase constraints as well as limited likelihood that the state of Connecticut will step in to assist them, given the state's in fiscal straits. In fiscal year 2017, they are facing a $14 million deficit and expect to face an even greater $65 million deficit in fiscal year 2018. With all this news, and in an effort to be transparent, as recently as April of this year the mayor has said that bankruptcy was not off the table.
Transparency was not the mayor's misstep. The wrong move he made was jumping to a last resort while skipping other meaningful steps along the way. In these seemingly bankruptcy-happy times that we are living in, Hartford appears to have jumped the gun. Bankruptcy should be the final play for a struggling municipality after all other options have been exhausted. This was something that the Mayor of Hartford understood back in June 2016 when he said bankruptcy was on the bottom of a list of solutions the city is pursuing. As other Hartford council members have expressed, Hartford has not exhausted all of the options - they have not even attempted to implement all of their available options. So by doing what the Mayor believes is prudent, the city has essentially poisoned their own well.
Bankruptcy is a very drastic measure that cannot and should not be entered into easily. In the state of Connecticut, if a city wishes to file for Chapter 9, they must first prove to the state that they are truly insolvent. This is something that Bridgeport, Conn., was unable to do when they sought protection in 1991. Since there are many steps between now and a potential use of bankruptcy protection, the mayor has created many problems for the city by having initial conversations with council at such an early stage in their predicament. The effects will ripple across the Hartford economy in ways many people wouldn't realize.
The cloud of bankruptcy casts such negative publicity that people will immediately associate the city with notable distressed municipalities such as Detroit and Atlantic City. Readers should note that Detroit filed for Chapter 9 bankruptcy in 2013, while Atlantic City was taken over by the State of New Jersey. This, in turn, discourages development and further investment in a city until it can be proven that meaningful corrections have been made.
Another, less publicized effect is the increase in borrowing cost. Borrowing costs are defined by Business Dictionary as "the total charge for taking on a debt obligation." When a city borrows public funds for an infrastructure project or to build a school, there is a borrowing cost associated with those funds in terms of an interest rate paid to borrow the money. Simply mentioning bankruptcy seriously affects a city's borrowing costs, and we can use Hartford as a real-time example of how this works.
On Monday, May 8, Hartford general obligation bonds with an approximate maturity of 15 years out were changing hands at well below a 5% yield. What that translates to is that the city could borrow pubic money at below 5%. The very next day, after the mayor said he had initial conversations with bankruptcy specialists, Hartford G.O. bonds were trading at a yield around 7%. Checking the market trades on EMMA shows the dramatic move.
So, what does that mean? The yield level that Hartford's outstanding debt trades at in the secondary market reflects where they would/should be able to borrow more money at that time.
You see, by mentioning Chapter 9 in such a serious way, Hartford's cost of capital went up 40%. By jumping to bankruptcy prematurely, the mayor could cost the people of Hartford a lot of money, should they need to borrow money in the near term. Bondholders have already suffered a price decrease in their bond holdings, and if a bankruptcy is announced, it would be quite likely that the bonds' value could suffer further.
Maybe Hartford and Connecticut will work out of this problem. Maybe they will not and seeking bankruptcy will be their only option - only time will tell. One thing is for certain: By bringing up bankruptcy before it is absolutely necessary, Hartford has dramatically increased their borrowing costs, and it will take a long time to build back the public trust necessary to lower those costs again.
Disclaimer: NatAlliance Securities LLC may hold a position in Hartford Connecticut GO bonds, and in the future may be a buyer or a seller of the securities. This is not a recommendation to buy, sell, or hold the securities. Las Olas Wealth Management is a wealth management group within NatAlliance Securities LLC.
Disclosure: I am/we are long HARTFORD, CT, BONDS.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.