Harrisburg, Pennsylvania can’t really afford to pay for the Resource Recovery bonds that it guaranteed. Their recently adopted 2010 budget does not include debt service for this guarantee (see prior post with link). It is accepted practice for rating agencies to rate municipally (or state) guaranteed debt off the credit of the guarantor. Unlike bond insurance or any insurance for that matter there are no capital set-asides for guarantees by municipal governments. Market analysts assume that the city or county would raise its taxes to the point of covering the debt. Harrisburg is now testing that assumption.
There has been some disagreement on the underwriting floors (at least in bond insurance, if not at the rating agencies) whether one should take into account the credit quality of the project being financed or simply “look through” to the guarantor’s quality. I suggest a middle ground. Assume that the Resource Recovery project was rated on its own merits as a project finance — what category would that be? Then assume a contingent liability on the balance sheet of the guarantor of that lower credit quality. If it is clear that the guarantor cannot afford the contingency the rating should embed this risk. This thinking extends to “moral obligation” bonds whose ratings are automatically notched down from the state (or infrequently, local) rating. Should a “white elephant” project backed by a moral obligation bear the same rating as one that is performing and essential? (We don’t think so) Affordability of obligations (add pensions, opeb, debt service to the list) is going to become an increasingly important risk factor as government wrestles with raising taxes, reducing expenditures and satisfying multiple constituencies — unions, taxpayers, retirees and service beneficiaries.
