Debt Refinancing Strategy

Governor Patrick FY2011 House 2 Budget Recommendation:
Issues in Brief
Deval L. Patrick, Governor
Timothy P. Murray, Lt. Governor

The Governor’s Debt Refinancing Proposal

Debt service on outstanding long-term bonds continues to be a significant portion of the Commonwealth’s operating budget. As part of the comprehensive plan to address fiscal year 2011 budgetary shortfalls, the Administration proposes refinancing $200 million of the $1.02 billion in principal due in fiscal year 2011 to smooth an unusual spike in debt service. Second, in the event that the fiscal situation does not improve, we would reserve the ability to refinance an additional $100 million of fiscal 2011 principal to achieve budgetary relief.

This refinancing is a reasonable strategy to assist the Commonwealth in meeting its fiscal challenges:

Refinancing is a small part of the overall solution. We are addressing the financial challenge on all fronts through a balanced set of measures including spending restraint, one-time resources, and select revenues from closing exemptions.
The cost is low. Based on our evaluation of options to achieve budgetary relief from existing liabilities such as debt service and pensions, we have determined that refinancing debt at historically low interest rate levels is by far the lowest-cost and most fiscally responsible solution.
There is an unusual spike in debt service payments in fiscal year 2011 that can be responsibly smoothed over the next several years.
The refinancing will be paid-off in the relative short-term. We propose that the maximum term for the refinancing bonds be seven years.
Other bonds, such as the Plymouth County COPs, can be refinanced concurrently for absolute savings greater than the cost of the proposed refinancing resulting in net present value debt service savings from the combined refinancing transactions.
The refinancings will be subject to the Debt Affordability Policy. Future debt service will be increased somewhat as a result of these refinancings. The proposed refinancing can be accommodated within the constraints of the Debt Affordability policy. The Executive Office for Administration and Finance will continue to this refinancing take this into account as it sets future capital borrowing caps to ensure that total debt service remains within the parameters of the Debt Affordability Policy.

Background. The Commonwealth has $1.02 billion in principal maturing between July 2010 and June 2011 with coupons ranging from 2.00% to 6.00%. The current municipal market yield curve is steep with yields remaining below 2.00% through 2015 and below 3.00% through 2020. Current low interest rates and the structure of bonds due in fiscal 2011 present an opportunity for the Commonwealth to refinance debt at low cost.

As shown in the chart below, the Commonwealth’s outstanding debt service obligations (not including contract assistance obligations) through fiscal year 2040 are generally front-loaded and declining each year - but with an unusual spike in fiscal year 2011 (the second bar on the graph).

The table below shows that compared to fiscal year 2010, total Commonwealth debt service, including the cost of new issuance, would increase $201.7 million for fiscal year 2011. This results from the unusual spike in principal due in fiscal year 2011 shown in the chart above, as well as an unexpected increase in bank liquidity fees, included in the short-term debt service account and the new Accelerated Bridge Program.


Account	Account Name	FY2010 Projection	FY2011 Maintenance	Difference
0699-0015	Consolidated Long-Term Debt Service	1,804,013,573	1,929810,808	125,797,253
0699-9100	Short-Term Debt Service	28,431,384	66,791,391	38,360,007
0699-0016	Accelerated Bridge Program	-	39,979,615	39,979,615
0699-2004	Central Artery/Tunnel Debt Service	91,719,000	90,085,000	(1,634,000)
0699-9101	Grant Anticipation	36,694,000	35,845,000	(849,000)
TOTAL		1,960,857,957	2,162,511,814	201,653,857

First transaction: Smoothing. We propose refinancing $200 million of $1.02 billion in fiscal year 2011 by amortizing principal for the purpose of smoothing the 2011 spike in total debt service. Repayment of this refinancing would occur over the next seven years. Following this transaction, the resulting fiscal year 2011 total debt service will be approximately equivalent to 2010 debt service. At a current interest rate of 2.1%, the estimated cost of this refinancing is $1.2 million, present value. The following chart illustrates the effect of this refinancing on currently outstanding debt service. Note the smoothing effect, as the peak (shown as a checked bar on the chart below) is redistributed to years in which the Commonwealth faces lower debt service.

Second transaction: Budget relief, if necessary. The debt refinancing strategy includes an option to refinance an additional $100 million of principal due in fiscal year 2011 if further budgetary relief is deemed necessary after the October revenue estimate review. At a current interest rate of 2.1%, we estimate the cost of both refinancings to be $2.5 million, present value. The following graph shows the total effect of both transactions on the Commonwealth’s debt profile.

Prepared by Scott Jordan, Executive Office for Administration and Finance ·
www.mass.gov/budget/governor
For more information contact: contactanf@massmail.state.ma.us (617) 727-2040