Moody’s & Fitch: Kentucky Outlook “Negative”

Steve Beshear

Generally, bond ratings don’t make much of a splash news-wise, mainly because most people — even financially-savvy ones — don’t quite understand them. What does it mean, exactly, that a bond has gone from AAA to AA? And what’s with those weird grades anyway?

Well, don’t expect us to explain bond ratings to you, dear reader (we understand them, but understanding and being able to explain something are two different things). Just take (no) solace in the fact that two of the three major bond-rating agencies, Moody’s and Fitch, downgraded their outlook of Kentucky bonds (but not the bond ratings themselves) last month (from the Courier-Journal) (warning: our sarcasm is at an all-time high with this post):

Two credit-rating services have lowered their outlook on Kentucky bonds, steps that could delay some state-funded construction projects and lead to higher borrowing costs.

Late last month, Fitch Ratings and Moody’s Investor’s Service revised the outlook for Kentucky’s state-supported bonds from “stable” to “negative.”

Gov. Steve Beshear yesterday attributed the moves to the 2008 General Assembly’s failure to raise new revenue or pass legislation to address the $26 billion shortfall in the state pension systems. [our emphasis]

“Moody’s and Fitch expressed concern because of the current economic situation, the structural imbalance in the final budget, the draining of the state’s Rainy Day fund, the failure to pass meaningful pension reform and the continued use of one-time measures …to ‘balance’ the budget for the next two years,” Beshear said.

So as you can read above, the reason for the downgrade is Beshear’s first-term ineptitude. Great. Well, at least he’s contrite about it:

“Continued inaction in addressing pension reform and new revenue sources will bring only more bad financial news for the people of Kentucky,” Beshear said.

Thanks, Steve! So what does this all mean? Well here’s some crap to read that might explain it:

Finance Secretary Jonathan Miller said it’s impossible to say how a cautious approach might affect some of the $1.6 billion in bonds authorized by the legislature this year.

“We’re simply going to have to look at each project carefully,” Miller said. “We’re going to try to work within our means to do as much as we’re capable of doing, but we have to have this long-term outlook in mind to make sure we don’t endanger our finances and get a full downgrade.”

Moody’s and Fitch did not change their ratings of Kentucky bonds. Moody’s continues to rate Kentucky at Aa3, and Fitch rates it AA-.

These ratings are “very good,” according to Tom Howard, executive director of Kentucky’s Office of Financial Management.

But he noted that the third major rating agency, Standard & Poor’s, already rates Kentucky bonds lower, in the single-A category.

And the revisions could be a precursor to downgrades by Moody’s and Fitch if Kentucky’s financial condition does not improve, officials said.

“A one-notch rating downgrade would have significant impact on the state’s cost of borrowing money to fund state projects,” Beshear said.

If Moody’s and Fitch lowered Kentucky’s rating, it could increase the interest the state must pay on its bonds by as much as 33 one-hundredths of a percentage point in the current market, the governor’s statement said. That would result in an increase of about $58 million in debt-service payments for the state over the 20-year life of the bonds authorized during the 2008 session.

In somewhat-related local bond news, some Bermuda outfit called Assured Guaranty (boy, that’s a reassuring name) reached a deal with the Louisville Arena Authority to insure construction bonds for the downtown arena (also from the C-J):

Bermuda-based Assured Guaranty will insure construction bonds for the planned downtown arena under a preliminary deal reached yesterday with the Louisville Arena Authority.

The authority now plans to sell $360 million in bonds, through the Kentucky Economic Development Finance Authority, next month. The sale would include $280 million in variable-rate bonds, with the remainder carrying a fixed interest rate.

Officials said total interest costs on the debt, paid off over more than three decades, would be roughly $602 million — about $60 million less than estimates from earlier this year but more than the $573 million projected by bond underwriter Goldman Sachs when it was hired in January 2007.

“I’m fairly confident that we’re going to end up with a transaction that makes sense,” said Metro Council President Jim King, a banker and nonvoting arena authority member.

The bonds will be backed by a mix of arena revenues, future tax growth in Louisville and a Metro Council pledge. But the bonds aren’t considered state debt and therefore aren’t affected by yesterday’s move by two financial ratings services to lower the outlook for Kentucky bonds from “stable” to “negative.”

Whew! Thank goodness Gov. Beshear’s mistakes didn’t get in the way of Louisville building an arena it doesn’t need! But wait, here’s more details behind the deal:

Goldman Sachs would guarantee an interest-rate swap, which would insulate the authority from dramatic rate swings, according to arena officials. The authority would be at risk mainly if credit raters reduce Assured Guaranty’s rating or Goldman Sachs files for bankruptcy, they say.

“Certainly I would prefer to have fixed-rate debt just like everyone likes to have fixed-rate mortgages … but in this case I believe we’re getting the city the best deal we can get,” King said.

At yesterday’s meeting, King raised concerns about market conditions driving up interest rates before the bonds are sold. In that case, Host said, the deal would be sent back to arena authority members for review.

The arena authority would pay Assured as much as $18 million to insure the bonds. That’s higher than the $11.4 million the authority was prepared to pay Ambac Financial Group, Goldman Sachs’ original choice as insurer.

Host said the Assured Guaranty cost includes insuring the arena’s debt-service reserve fund.

The bonds were supposed to have been sold last fall but were delayed because of difficulties in the credit markets and increased pressure on bond insurers. In January, for example, Fitch Ratings downgraded Ambac’s top-tier ratings.

Tom Rousakis, a Goldman Sachs vice president, said Assured is one of two bond insurers that still has a top-flight AAA credit rating. Others have been downgraded after being hurt by the subprime-mortgage crisis.

Awesome! Way to go, Goldman Sachs! I have every confidence in your confidence in Assured Guaranty now!



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