Example Bond Issue: April 2011

The basics of a Municipal Bond are straightforward. The City borrows some money, pays interest while using it, and then pays it all back on the due date.

The reality of the bond markets is more complicated. As an example, consider the Bond issue that Hartford did in April of 2011. The City issued $25,000,000 in debt in the first half of 2011.

Page 2 of the Offering Statement showed that the issue was actually a series of 13 bonds. The first 12 were scheduled to come due each April 1st beginning in 2013 and ending in 2024. The face value of those notes was relatively constant each year, and the coupon rate varied between 3.00% and 5.25%.

The final bond was written to be due on April 1, 2031 with a face value of approximately 7 times as high as the others. The final bond also included a mandatory sinking fund provision that forced the principal to be paid off in 7 equal annual installments on April 1 of 2025 through 2031.

Each bond is an individual financial security, with it’s own unique ID called a CUSIP Number. Each bond can be bought and sold independently of the others in the series.

2014-10-31 April 2011 GO Bond Series

Because the coupon rate for most of the individual bonds in the series was above the market interest rate at the time (yield), the proceeds from the overall issue was higher that the $25,000,000 face value of the debt. The proposed Sources and Uses table on page 10 of the Offering Statement (numbered as page 8 in the document) shows that the proceeds totaled $25,609,052.

One way to understand the debt issue is to plot the annual principal and interest due on the series of bonds. Interest is highest in the early years, because interest is due on all of the individual bonds in the series. As time goes on, some of the bonds come due and the City pays off the principal. Paying down the principal causes the annual interest to fall.

2014-10-31 April 2011 Payment Summary

Note that the annual principal payments remain constant throughout because of the mandatory sinking fund provision placed on the bond due in April of 2031.

Principal repayment for the $25,000,000 in debt was to be paid off in roughly equal installments over 19 years.

Intro to Municipal Bonds

Cities and Towns typically do not have enough cash available to pay for large expenses, so they borrow money. Municipal Bonds are the most common way in which the borrowing is structured.

A bond is a type of contract between two parties that specifies legal and financial terms for lending. In this case, the City of Hartford is asking to borrow money and offering to pay it back in the future.

It is traditional in the bond market for the borrower to receive all of the money up front. The borrower then pays interest twice per year at a fixed interest rate for the life of the bond. At some point in the future, when the bond is due, the borrower pays back the entire amount of the bond.

Suppose Hartford borrowed $1,000,000 at 5% for 10 years. The City would receive the $1,000,000 when the deal closed. Every six months, the City would make a “coupon payment” of half of the annual interest:

$1,000,000 * 5% * 1/2 = $25,000

In 10 years, when the bond is due, the City would pay $1,025,000 to cover the final interest payment and the full face value of the note.

Municipal Bonds are a special type of debt contract. Government entities are allowed to issue debt in which the interest income (the coupon payment) is exempt from income taxes.

The effect of this policy is to lower the interest rate for municipal bonds below that of corporate bonds. Municipalities, and therefore their taxpayers, save money by taking advantage of the lower cost of borrowing.

PILOT in Hartford

Data from the CT.gov Open Data Website shows that Hartford was the second largest recipient of Payment in Lieu of Taxes (PILOT) funding in the State for the fiscal year ending in June of 2014.

2014-10-29 Top PILOT Recipients

Within the City of Hartford, the market value of tax exempt property eligible for PILOT funding totaled about $2.6 billion during that fiscal year. As a point of comparison, this was slightly higher than the market value of all the Residential property.

Property tax rates in Hartford vary by property type due to the split assessment ratio. The effective “tax rate” of the PILOT program can be calculated and compared to the other property classes.

The chart below shows that the State paid a lower tax rate than even the heavily protected Residential property owners. Data for the taxable property classes came from a handout given to the 2013-2014 Tax Task Force.

2014-10-29 PILOT Tax Rate

Interactive Hartford

What if all of Hartford became an interactive museum?

Suppose you could walk through the City and see historical photos from exactly where you’re standing. Or learn the story behind a prominent landmark as you’re looking at it. Or experience an event from years ago where it happened.

Suppose all this was available for free via your phone or tablet.

Technology has the power to create new and unique experiences. This proposal is a basic version of augmented reality, adding layers of information on top of what is experienced in real life.

The implementation could be relatively simple. Once a mapping platform is selected, a variety of content could be linked to locations on the map.

Start with photos, like those published regularly in the the Old Hartford Facebook group, allowing pedestrians to walk the City and compare now and then in real time. Partner with local institutions, and other content owners, to identify additional historical items.

This isn’t a new idea for Hartford. A couple years ago a small group of volunteers created an audio tour of sites in and around Bushnell Park. It continues to be available as downloads on the iTunes Store or directly on the internet. Link these resources into Interactive Hartford too.

I throw this out as a business idea for others to consider, as I’m not tech savvy enough to make it happen on my own.

Maybe it’s a proprietary app that allows users to be notified when they pass a site, or when new points of interest are added near them. Or maybe it’s a layer on someone else’s mapping platform … I don’t know. I would be more helpful with product usability and business planning than technical design and development.

Give it some thought Hartford creatives. I’m happy to talk it through, and would love to be involved at some level if anyone wants to give it a go.

Interactive Hartford would enhance the experience of visitors to the City. If done well, Hartford could serve as the pilot site, and the technology could evolve into a business serving other cities too.

Payment in Lieu of Taxes by the State

The State of Connecticut has created a program to help address the loss of property tax revenue that municipalities experience due to certain types of tax-exempt property. The program is called Payment in Lieu of Taxes (PILOT).

PILOT reimburses cities and towns a percentage of a qualifying property’s potential tax liability. There are two portions of the program. One portion covers State Owned property. It specifies that prison facilities are reimbursed at 100% of the tax rate, and all other qualified state owned property are reimbursed at 45%. The other portion covers Private Colleges and Hospitals, which are reimbursed at 77% of the tax rate.

Sections 12-19a and 12-20a of the Connecticut General Statutes, which define the PILOT program, appear to have been created in the 1970s. There have been numerous changes to each section over the years, including what is covered and the formula used to calculate the grants.

Information from the Open Connecticut Data website shows that the overall PILOT program has been about a $200 million line item for the State over the past 10 years.

2014-10-10 PILOT Funding History

However, the PILOT program is not fully funded. The municipalities that request reimbursement only receive about half of the amount they request according to the Department of Operations, Policy and Management.

2014-10-10 PILOT Funding Rate History

The reimbursement percentage that each municipality receives varies based on their mix of qualifying property types.

To illustrate the calculation, consider a hypothetical town that has one qualifying State Owned building. The town’s Assessor would value the property and calculate a tax bill for the parcel. Since it’s a general State Owned building, it would qualify for the PILOT program at a 45% reimbursement rate. The State Legislature has funded the PILOT program for State Owned buildings at 53.4% in the current fiscal year. The town would receive a grant for 45% * 53.4% = 24.0% of the tax bill for that property.

The program pages on the State website notes that 169 municipalities and 5 boroughs receive grants for State Owned property, while 59 towns and 14 taxing districts receive grants for Colleges and Hospitals.

Opposed to Downtown North

The Hartford City Council has held numerous public hearings and committee meetings in an effort to better understand the Downtown North proposal. They have dramatically increased the amount of information available to the public.

I’ve followed the discussion, and see many positives to the proposal. Yet, I still find myself opposed to the project. I see building out the site as a luxury, and as a distraction.

Hartford has a more important priority right now; restructuring municipal finances and operations to put the City on a sustainable path. My primary concern is that if Downtown North is approved that it will be much more difficult to make the hard choices that a restructuring will require.

There are positives to the proposal, and the first phase of Downtown North seems likely to achieve meaningful goals. There is a good chance that the main benefits would be realized. Baseball would expand and diversify the City’s entertainment options. A grocery store would address the food desert in the northern neighborhoods and provide a new option for the increasing number of Downtown residents. Main Street would be transformed north of the highway. Clay Arsenal would be reconnected with Downtown. There would be more construction jobs. Hopefully phase one would also create momentum that would ensure the entire project is completed.

The Downtown North business case for the City is approximately revenue neutral. The business case has been portrayed as a positive, though I see it as a negative. The Administration is projecting that the City can achieve the benefits listed above without increasing the property tax. The ancillary development can create new revenue that will more-or-less offset the expected costs of the land preparation, stadium construction, and public infrastructure improvements.

Unfortunately, Hartford is in a position where it has to do better than financially treading water. Increasing expenses at the same pace as revenues doesn’t improve the City’s financial position.

Other criticisms of the proposal also resonate.

Stadiums, in general, are regional assets. They provide entertainment to all of the surrounding towns while generally losing money. Asking the City of Hartford, a financially stressed municipality with very low median income residents and a highly taxed business community, to take on the facility alone doesn’t seem appropriate.

The financial model of professional baseball, specifically, has regions paying for the privilege of hosting a team. Again, it does not seem appropriate for the City of Hartford to subsidize this entertainment option on behalf of the entire region.

There has been virtually no discussion about how the XL Center is impacted by the proposed baseball stadium. Hartford needs to ensure that the XL Center, which is the more important of the two sports venues and is already funded at the state/regional level, continues to be successful and remains a top priority.

When looking at the big picture, Downtown North seems like an acceptable project, but not a great one. Choosing to move forward will not expose the City to an unreasonable amount of risk, and would bring some positives.

However, committing time and money to Downtown North will distract from a higher priority effort that the current political leaders have already agreed is necessary.

Approving Downtown North will send conflicting messages to stakeholders that will need to make concessions in the form of higher taxes, fewer services, or fewer benefits as the City works to find a sustainable path.

The best course of action is to put Downtown North on the back burner until the City has an opportunity to reorganize.

It could take years to get Hartford’s proverbial house in order, and at that point the environment may be different. The numerous early-stage Downtown construction projects will be much further along, if not complete. The influx of new residents may even change the priorities for the Downtown North site.

Hartford needs to set sustainable municipal goals. Hartford needs to agree on primary strategies for working towards those goals. Hartford needs to organize and focus its operations around the goals and strategies.

Once those steps are complete, the City will be in a much better position to consider proposals like the one currently on the table for Downtown North.

Implications of the Moody’s Credit Rating Downgrade

Moody’s Investors Service downgraded of the City’s credit rating in the midst of an active debate about a significant construction project on the Downtown North site.

The Mayor interpreted the downgrade as highlighting the importance of economic development. He also implied that the financing structure currently proposed for the Downtown North project is the best available option.

Downtown North supporters using the rating downgrade as evidence the project should move forward need to be absolutely sure that the proposal grows the taxable Grand List without earmarking those new tax receipts to pay for the development. Otherwise the project doesn’t address the City’s financial situation.

Others saw the downgrade as a warning that the City is stretched too thin, and a reason to reject the current Downtown North proposal as an imprudent financial commitment by the City.

Opponents need to realize that the downgrade is independent of the ballpark-centered proposal. Stopping the Downtown North project doesn’t speak to Moody’s concerns either.

There are a limited number of ways that the City’s financial position can be improved – increasing revenue, reducing spending, or improving operations are the most common. Concern about the credit downgrade needs to translate into constructive action to address the problem.

Does this mean that it’s time to get serious about reviewing Hartford’s goals, strategies, and overall business plan?

Fortunately, the Hartford Committee on the Restructuring of City Government was created to start this exact conversation.

Distribution of Motor Vehicle Taxes

Motor vehicles are taxed at the municipal level in Connecticut. The City of Hartford’s mill rate is the highest in the state, at 74.29 mills in the current fiscal year. Hartford residents, therefore, pay the highest car tax rate in Connecticut.

The vehicle tax calculation begin with a State-provided schedule that gives a car’s market value based on its year, make, and model. It is an automated step that does not allow municipalities to make adjustments for a vehicle’s condition.

Motor vehicles are assessed at 70% of the market value, and the mill rate is applied to the assessment.

Annual Tax = (Market Value) * 70% * (Mill Rate/1,000)

For the current fiscal year, which is utilizing Grand List 2013, a vehicle with a market value of $10,000 will owe $520 in taxes for the year. The effective tax rate is about 5.2% of market value.

Vehicles are constantly being added to, and removed from, the tax roles. The City Assessor’s office provided a snapshot of the vehicles that were registered in the City on October 1, 2013, which is the valuation date for Grand List 2013.

The chart below shows the annual tax amount along the horizontal axis in bands of $100. The vertical axis shows the number of vehicles that owe annual taxes in each of the bands. For example, there were 8,873 vehicles that owe taxes in an amount between $200 and $299, which is shown as the “$200s” in the chart.

Distribution of Motor Vehicle Tax Amount

There were 46,107 vehicles in the data set. The average annual bill was about $498 and the median annual bill was about $321.

2013-2014 Benefits Task Force: Defined Benefits vs Defined Contribution

The 2013-2014 Task Force on Healthcare, OPEB, and Pension Benefits recommended retaining a defined benefits program for City employees while also adding a defined contribution program. This position was different from what was recommended by the 2009-2010 Budget Task Force.

In support of their recommendations, the 2013-2014 group explained why they felt that retaining the defined benefit plan would be the best approach. The discussion in the report begins at the bottom of page number 29. They highlight three considerations:

Technical Issues: Closing the Defined Benefits plan does not change what the City owes to current and future retirees. However, closing the plan would increase the annual required contributions, prevent contributions and investment gains from future hires from offsetting current expenses, and force the investment strategy to become more conservative as the investment horizon decreased. Closing the plan would actually increase the near-term costs of the existing pension program.

Moral Issues: Defined Benefits plans put most of the investment risks on the City, while Defined Contribution plans put most of the risk on the employee. Moving to only a Defined Contribution plan would expose employees to risks that they are “not prepared to manage.”

Competitive Issues: “The supposed lower costs of DC plans is often just a result of cutting employer contributions to the DC plan, not greater economic efficiency.” This point seems to speak to the Task Force’s concerns about ensuring the City can compete for talented employees and provides viable replacement income.

The Task Force imagined a hybrid retirement benefit structure that could serve as a compromise between the two extremes.

They proposed keeping the existing Defined Benefits plan open to new employees, but thinking of it as providing a baseline of support.

Employees with modest earnings would receive significant protection from the Defined Benefits plan. More highly paid employees would share in the same baseline Defined Benefits plan, but would also have an opportunity to participate in a Defined Contribution plan for their earnings above a predetermined threshold.

In addition to capping the Defined Benefits plan at an earnings threshold, the Task Force also made suggestions about how to reduce the plan’s costs. Their suggestions include increasing the full retirement age to 65, making the adjustment for early retirement actuarially sound, reducing the accrual rate for all employees to no more than 2%, restricting the exchange of accumulated sick days for pension service, calculating the final average earnings using the average of the past five years instead of two or three of the last five, and adopting anti-spiking provisions.

Nearly all of their suggestions would be subject to collective bargaining with the various employee unions, which the Task Force made sure to note.

Following the spring 2014 budget season, the City created a new group called the Hartford Committee on the Restructuring of City Government, which includes representatives of the unions in addition to elected City leaders and experts in government reorganization. The resolution creating the committee specifically referenced the Benefits Task Force and the Tax Task Force as a way to ensure that their recommendations were considered in the restructuring conversation.