Newark debt downgraded to junk bond status, as outlook on 6 N.J. cities turns negative

By Ted Sherman | NJ Advance Media for NJ.com
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on May 20, 2015

The city of Newark—its finances already under state control—has been hit by a major credit downgrade relegating some of its outstanding debt to junk bond status.

The move targeting the state's largest city comes amid growing questions by Wall Street over the financial strength of at least five other struggling municipalities—including Atlantic City, Paterson, Union City, Asbury Park and Kearny—in the wake of New Jersey's own fiscal troubles.

The debt of both Atlantic City and Paterson have also been downgraded below investment grade by Moody's Investors Service. The three other municipalities were rated as an increased risk.

Mark Pfeiffer, former deputy director of the state Division of Local Government Services and now with the Bloustein Local Government Research Center at Rutgers University, said the ratings declines were clear collateral damage from the state's own downgrades sparked by its ongoing pension problems.

"It just speaks to that the state's fiscal condition is now affecting municipalities in a way no one expected it to, and how it needs to get cleaned up," said Pfeiffer.

Any ratings downgrade increases the cost of borrowing for municipalities.

Downgrades not shocking

State officials said municipal bond ratings are always a fluid situation, adding that rating agencies are historically quick to react to developments in the marketplace.

"The recent downgrades seen by certain towns are disappointing, but not shocking given the recent municipal bond climate," said Tammori Petty, a spokeswoman for the state Department of Community Affairs.

She pointed to the recent downgrades in Chicago, where Moody's also dropped the city's debt to junk bond status, which she said was "sure to have reverberations across the nationwide bond market." But Petty said the state's Division of Local Government Services remains confident that all New Jersey municipalities are solid credit risks.

Among the downgrades announced in the past week by Moody's included a drop in Newark's general obligation unlimited tax rating affecting $374 million in debt, to Baa3 from Baa1, indicating substantial credit risk. Another $39 million of general obligation limited tax bonds dropped from Baa2 to Ba1, a rating considered junk bond debt.

Newark officials said they were dismayed by the downgrades, but called the city's weakened financial position a "legacy of prior administrations." The city's new business administrator, Jack Kelly, said Mayor Ras Baraka—who was elected last year—had been in office less than eight months when Moody's requested a credit review.

"The majority of the city's two previous year ending deficits were caused by overestimating revenues to close budget gaps. When these overly optimistic revenues didn't materialize, both the 2013 and 2014 budget years ended with deficits," Kelly said.

At the same time, he acknowledged that city employee contributions to their own health care premiums, mandated under state law, were never properly executed by previous administrations, which will bring in another $6.5 million this year.

"The 2015 budget will also see the earliest introduction to city council in more than a decade. That budget will be presented to council prior to the end of this month. It will be in balance and will only include verifiable revenues and conservative estimates," said Kelly.

The city also plans to audit its special taxes, such as parking tax revenue, and said it is working with the Division of Taxation and the Governor's office to determine how the city can better collect employer payroll taxes.

Cities in distress

Paterson's underlying rating was also dropped by Moody's to Ba1 from Baa2, while its short-term rating went to MIG 3 from MIG 2. The downgrade affects approximately $61.4 million of outstanding general obligation debt and $15 million of bond anticipation notes. The rating agency said the downgrade reflected the city's weak financial position,
which is expected to remain "very narrow" over the near to medium term,
and its reliance on state aid—particularly emergency transitional aid—to maintain operations, in a city characterized by high poverty and unemployment rates.

A spokeswoman for the city did not respond to requests for response.

Kearny, Asbury Park and Union City were similarly hit with downgrades, but not as significant. Again, Moody's cited deteriorating finances and negative cash balances, as well as a high reliance on state aid, with limited flexibility to withstand cuts or delays in that aid. Municipal officials did not return calls for comment.

Kearny was downgraded to Baa1 from A2, affecting $31 million in rated
general obligation debt. Asbury Park went to Baa2 from Baa1, affecting approximately $39.1 million in outstanding general obligation debt. Union City's general obligation rating went to to Baa1 from A3, with a negative outlook, affecting approximately $44.15 million of debt.

Petty said the ratings in each of the downgraded communities would have been worse without the assistance of the state—something she said was viewed as a credit positive by all rating agencies.

"The division uses its oversight role to prevent waste and mismanagement, but also to help communities as they work to bring structural balance back to their budgets," she said.

At the same time, she said credit downgrades were not a one-way spiral.

"It took considerable time, but Camden was recently the recipient of a rating upgrade that allowed the city to access the capital markets for the first time in years," she said.

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