Connecticut funds baby bond trust with help of BAM insurance policy

Connecticut officials say a debt service reserve fund insurance policy allowed them to fund the state’s new baby bond trust without resorting to borrowing.

in 2021 but delayed a year later when lawmakers failed to fund it in the fiscal 2023 budget.

The initial structure, passed in 2021, would have required $600 million in state borrowing over 12 years with subsequent debt service costs, according to the Office of the State Treasurer.

Officials sought out another long-term financing model that could gain wide legislative support; in May, Russell and Connecticut Gov. Ned Lamont announced they’d found a solution that would cut costs and avoid debt by using an insurance policy offered by Build America Mutual.

BAM’s debt service reserve fund insurance policy allowed the state to transfer on-hand reserves of $381 million, raised through general obligation bond sale in 2008 and set aside in 2019 during a restructuring of the Teachers’ Retirement Fund, into the newly formed baby bond trust, replacing it with a “relatively inexpensive insurance policy,” said Cheryl D. Rice, press secretary for the treasurer’s office.

The immediate influx of cash shaved over $200 million off the program’s projected overall costs by allowing the state to avoid debt and begin earlier investment of a larger bulk of funds.

“This action was made possible by Connecticut’s progress in recent years to strengthen and stabilize its finances, including in our pension funds,” Rice said. “The reserves being utilized can now be replaced by a relatively inexpensive insurance policy, providing equivalent security for the Teachers’ Retirement Fund and allowing the state to also begin this transformative investment.”

“In this case, the BAM debt service reserve fund insurance policy is similar to, but distinct, from our more-common insurance covering all principal and interest due,” said Kevin Roberts, BAM’s vice president of public finance, who underwrote the Connecticut transaction.

Roberts said BAM’s traditional bond policies help give municipalities access to capital markets “efficiently and at the lowest possible cost” for essential infrastructure projects; DSRF policies, like Connecticut’s, are offered either “in conjunction with a full guaranty of principal and interest” and thereby backed by BAMs double-A rating, or on a standalone basis, in which case the bonds carry the issuer’s underlying rating.

“All of the bonds we insure carry that rating because we guarantee timely payment of all interest and principal on the bonds we insure,” he said. “The added layer of protection for investors helps issuers generate net savings on their debt service costs.”

Connecticut’s policy falls into the latter category, relying on the state’s recently boosted financial footing.

In the last two years, Connecticut has earned several upgrades from major rating agencies; in May, the Kroll Bond Rating Agency upgraded Connecticut’s long-term general obligation rating to AA-plus from AA, while continuing a stable outlook.

Over the last six years Connecticut’s credit profile strengthened as the state showed “significant and continuing progress in improving its financial position,” Kroll said, pointing to the recent extension of fiscal guardrails in February.

Those measures helped beef up reserves by $2.7 billion and add $8.6 billion in supplement funding to address pension debt since being enacted in 2018 by requiring unappropriated general fund balances and personal income tax receipts past a threshold to be directed into reserves or towards other long-term obligations, KBRA said.

They were set to expire at the end of the fiscal year, but state lawmakers unanimously approved their extension in February while also instituting new policies including an increase to the reserve fund cap to 18% of budgeted appropriations.

Bloomberg News

Such considerations are key in BAM’s decisions on coverage, Roberts said.

“BAM’s approach to analyzing the risks is similar to how we approach all of the credits we insure, with a deep review of the legal pledges, and the underlying economic conditions,” he said.

Connecticut’s GO rating was boosted in November to AA-minus from A-plus with a positive outlook by S&P Global Rating and the state’s GOs are currently rated AA-minus with a stable outlook by Fitch Ratings.

In June Connecticut sold $715.8 million of GO bonds through a negotiated sale managed by Morgan Stanley.

Avoiding having to tap future GO issuances for the baby bond program helped addressed concerns surrounding the program’s implementation, Lamont said in a statement, adding that the new plan “will save taxpayers’ dollars, avoid excessive bonding costs, respect our financial guardrails, and ensure that we are not sacrificing programs that help people today.”