New Jersey tests the market with a general obligation bond deal to open the new year that analysts expect will garner strong demand from investors seeking higher yields.
The Garden State is bringing a $325 million competitive offering slated for Tuesday featuring $150 million of tax-exempt GO bonds and $175 million of federally taxable GOs from the
The GO bonds carry ratings of A3 from Moody’s Investors Service, A-minus from S&P Global Ratings, A from Fitch Ratings and A from Kroll Bond Rating Agency. Only Illinois has lower ratings among U.S. states. All the rating agencies assign New Jersey stable outlooks.
Lisa Washburn, managing director at Municipal Market Analytics, said the rarity of a New Jersey GO deal should bode well for how the market receives the bonds. She said demand for New Jersey paper also stems from the $10,000 cap on deductions for state and local taxes imposed under federal tax changes that took effect in 2018.
“The New Jersey GO transaction should be well received when it comes to market,” Washburn said. “It has a number of things in its favor including general investor demand plus in a SALT-affected state, some potential for incremental yield, and the relative scarcity of NJ GOs in comparison to its appropriation debt.”
New Jersey's ratings are dragged down by a long record of pension underfunding. The record $3.8 billion allocated toward pensions in New Jersey’s 2020 fiscal year budget only represents 70% of the actuarially determined contribution level and the state isn’t scheduled to reach full ADC funding until 2023.
“In the absence of additional pension reforms, incremental pension contribution increases will consume the bulk of natural revenue growth for the next several years and remain a significant part of the state's budget, crowding out other state priorities,” Fitch analyst Marcy Block wrote in a Dec. 19 report. “The state's revenue system is highly influenced by economic trends and has only recently benefited from more robust growth following the end of the Great Recession.”
Block noted that New Jersey's combined burden of debt and net pension liabilities is fourth-highest among U.S. states, at 23.1% of personal income as of Fitch's 2019 state pension update report, which is well above the 5.7% U.S. state median. New Jersey’s long-term debt totals $40 billion including $3.2 billion of grant anticipation revenue vehicles and $3 billion in tobacco settlement asset-backed bonds. The state’s 2018 net pension liability declined a “sizable” 13.4%, or $15.5 billion from 2017 to $99.6 billion.
Howard Cure, director of municipal bond research at Evercore Wealth Management, said that since the bulk of New Jersey’s debt issuance derives from legislative appropriations, demand for voter-approved GO bonds should be strong. Cure noted that New Jersey spreads for appropriation debt issued have tightened “significantly” to 110 basis points from a wide of 220 bp from the 2015 Municipal Market Data AAA scale. He stressed though additional momentum might be muted by the state’s myriad of fiscal challenges from pension liabilities to limited budget flexibility and the need for new revenues from tax increases.
“This narrowing of spread is somewhat driven by a stabilized credit situation but is primarily caused by strong demand for paper in a high-tax state,” Cure said. “Despite continued demand for New Jersey paper, it is difficult to get the political cooperation necessary to tackle these challenges and you may not see further spread tightening.”
Cure said New Jersey faces tough obstacles to new taxes because of resistance Democratic Gov. Phil Murphy has encountered from his own party that controls the state legislature. In addition to lawmakers fighting Murphy’s proposals for new taxes such as a millionaire’s tax, the state is also grappling with finding needed extra funding for New Jersey Transit, school districts and community colleges.
“There will be a need for additional tax increases and economic growth, which means there will have to be some cooperation between the executive and legislative leaders and this is where the state can have some problems in moving forward and structurally balancing its budget,” Cure said. “There is limited budget flexibility with recent increases in reserves that still remain weak compared to other states, particularly given the late stage economic recovery.”
A Dec. 31 report from Janney Capital Markets noted that New Jersey GO 10-year yields were about 76 bp over the AAA benchmark yield in January 2019 before falling to a low of 28 bp in July and then rising again with a current standing just below 50 bp. The state has about $1.8 billion of GO bonds outstanding, according to Janney.
S&P credit analyst David Hitchcock noted concerns in a Dec. 20 report about New Jersey’s ability to achieve full ADC pension funding levels by 2023 because the state’s major revenue sources are prone to volatility in an economic downturn. While the current 70% pension funding level is New Jersey’s highest in 24 years, it still amounts to a $1.64 billion shortfall, or 4.2% of budgeted fiscal 2020 appropriations, according to Hitchcock.
“New Jersey's high costs and need to increase pension funding limits future financial flexibility, as increased pension contributions effectively soak up much of the state's revenue growth,” Hitchcock wrote. “The state's pension system remains the worst funded in the nation and a primary reason why our GO rating on New Jersey is the second-lowest of all the states.”
The New Jersey GO bond deal is part of a busy week for the Garden State. The New Jersey Economic Development Authority is also slated to sell $500 million in transportation project bonds for New Jersey Transit to purchase 600 buses and 17 trains. The Jan. 9 negotiated offering led by Barclays Capital is rated Baa1 by Moody’s, BBB-plus by S&P and A-minus by Fitch.
The tax-exempt GOs will fund various state capital projects authorized by voters including water supply, library construction, stormwater management and environmental projects, and land conservation. Proceeds from the Securing Our Children's Future Bonds will go toward capital grants for school districts and county colleges.
