Rainy day rescue called justified

Opinion: The fund is there "for rainy days," one expert says of the decision to tap it to bail out the city's schools.

March 11, 2004|By Bill Atkinson and June Arney | Bill Atkinson and June Arney,SUN STAFF

While Baltimore Mayor Martin O'Malley has faced criticism from Annapolis for his decision to nearly drain the city's rainy day reserve to bail out the school system, financial experts are not alarmed by the decision to use the fund as a temporary salve.

"The rainy day fund is there for rainy days," said Richard O'Brien, senior vice president and director of Folger Nolan Fleming Douglas Inc., a Washington-based investment house. "I believe they will restore the rainy day fund. I am in the vein it is a temporary, not permanent, problem."

The fund is serving its purpose as an emergency cushion, and the city should have the resources to replenish the $42 million being shifted to schools, experts said. They said Baltimore's problems are far less severe than those in some other cities and states, such as Pittsburgh and California.

However, if bond-rating agencies downgrade city bonds, Baltimore will have to pay considerably more in debt service and bond insurance premiums.

O'Malley's decision Monday prompted Fitch Ratings on Tuesday to put Baltimore on "rating watch negative" - a sign that the global bond rating agency based in New York and London is considering downgrading $564 million in city general obligation bonds.

Fitch said it plans to make a decision in the next several weeks. A downgrade would affect future bond issues.

Fitch currently rates Baltimore bonds as A+, its fifth-highest rating and considered a strong grade for a city.

Baltimore and state officials have been struggling for a month to resolve the financial crisis at the city Board of Education, which is $58 million in debt. The $42 million from the rainy day fund, which still requires approval from the city Board of Estimates, would be used to cover school operating expenses through the end of the year.

Under O'Malley's plan, $42 million of the city's $56.2 million rainy day fund is to be lent to the school system. The majority of the money - $34 million - is due back to the city coffers in August. The remaining $8 million would be due in June 2006.

Baltimore's rainy day fund will be at roughly $14 million after the transfer. Cities with a population greater than 300,000 - Baltimore's is 635,000 - typically have a reserve fund in the area of $80 million, based on a survey of the past three fiscal years by the National League of Cities.

Rainy day funds are designed for the unexpected, and this situation appears to be deemed locally as a crisis worthy of such funds, said Chris Hoene, research manager for the National League of Cities in Washington. "I can understand the interest in not wanting to have the state come in, because it always comes with a lack of local control. But I think everybody needs to be cognizant that you do it once and then you build that fund up again."

But the impact on bond ratings could be significant. Analysts expect Fitch and other agencies to cut Baltimore City's rating one notch.

"If you get put on negative watch, it is not a good thing," said Kevin Olson, executive director of MunicipalBonds.com, a public finance watchdog organization in San Francisco. "I don't see too many times when somebody is put on negative watch without getting downgraded."

A downgrading could add hundreds of thousands of dollars in costs to Baltimore's future bond offerings.

A $50 million bond issuance at 3 percent would cost about $1.5 million in annual interest, said O'Brien of Folger Nolan. If the city's rating is reduced, the same issue would cost about $62,500 more a year, or $625,000 more in interest over the life of a 10-year bond, he estimated. In addition, the cost of insurance from private bond insurance companies to cover defaults would likely rise, experts said.

What troubles the rating agencies is the rapid depletion of the rainy day cushion and how the city will cope with an emergency in the next three months.

"The city is taking a bit of a gamble," said Charles Emrich, manager of municipal credit research and strategies at Baltimore-based Legg Mason Wood Walker Inc. "A long-term concern is, is this going to become a structural payment? Is the city going to have to offer continuous payment to the schools?"

A spokesman for Standard & Poor's said Baltimore City's bond rating remained unchanged yesterday, an A plus rating with a stable outlook.

Moody's Investors also reported Baltimore as unchanged with an A1 rating.

"We're waiting now for information," said Lisa Cole, a bond-rating analyst with Moody's Investors in New York. Her firm assigns its ratings by committee and will review Baltimore's situation soon in light of the school plan, Cole said.

"It's a pretty significant move," said Cole. "It's a good portion of the rainy day fund. We definitely see a rainy day fund as something that helps a city's credit rating. The question is how the committee will view even a temporary reduction."

Cole said that in evaluating Baltimore's credit rating, Moody's committee members will consider the likelihood of recurring school funding problems, whether the money will be repaid and the chances that the city will need the money for emergencies.

"The tinier you make the cushion, the harder it's going to be to address these unforeseen things," said Michael A. Pagano, director of the graduate program in public administration at the University of Illinois at Chicago.

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