Last week, the State sold $1.2 billion in general obligation (GO) bonds for capital projects, including $1 billion in new tax-exempt bonds and $200 million in new taxable bonds. The true interest cost (TIC) for the tax-exempt bonds is 3.28%, and the TIC for the taxable bonds is 4.52%.

According to the Department of Legislative Services (DLS), the TIC for the most recent tax-exempt bond sale in March 2023 was 2.91%, and the TIC for the taxable bonds was 4.07%. The higher TIC is in line with the recent rise in interest rates. The TIC for the taxable bonds was higher than that for tax-exempt bonds with longer maturities, underlining the additional costs paid when taxable bonds are issued.

Fiscal 2025 Capital and Operating Budget Impacts

Debt service costs are less than projected, and the bonds sold at a premium. Fiscal 2025 debt service is fully funded, so the debt service savings and premium revenues will accumulate in the Annuity Bond Fund (ABF), increasing the end of fiscal 2025 balance by $149.6 million.

Lower debt service costs are attributable to lower coupon rates for taxable bonds of between 4.44% and 4.61%, compared to estimated coupon rates of 5.00%. The State did not estimate any bond sale premiums, so $147.6 million in net premiums will go to the ABF balance. These net premiums are bond sale proceeds requiring 15 years of debt service payments to retire.

The sale’s net premiums totaled $152.6 million. Federal regulations limit the proceeds generated by bond premiums that can support debt service to $147.6 million. The remaining $5.1 million in premiums goes toward additional project funding to support tax-exempt capital projects authorized in 2025.

The large end-of-year ABF balance will reduce projected general fund debt service costs in fiscal 2026 by almost $150 million, offering some much-needed budget savings.

Maryland Bonds Rated AAA, but Moody’s Revises Outlook to Negative

As discussed on a recent episode of the Conduit Street Podcast, the three rating agencies rated Maryland GO bonds AAA. However, while Standard and Poor’s (S&P) and Fitch continue to rate Maryland’s outlook as stable, Moody’s revised its outlook for Maryland to negative.

A state’s bond rating, also known as its credit rating, is crucial because it affects the interest rate the state pays on bonds it sells to investors. The rating also indicates a state’s ability to fulfill its future financial obligations and the likelihood of default.

While all three rating agencies noted Maryland’s credit strengths, including high wealth and income levels, a broad and diverse economy, robust and well-embedded financial practices, strong debt affordability management and rapid debt amortization, and adequate reserves and liquidity, Moody’s cited “expected structural imbalances and planned depletion of General Fund surplus through fiscal 2025, which threatens to undermine performance relative to peers.”

DLS anticipates that the State’s structural deficit will grow from $483 million in fiscal 2025 to $3.7 billion by fiscal 2029, meaning ongoing spending will far exceed projected revenues.

As previously reported on Conduit Street, the cash and structural budget outlook deteriorates substantially through 2029 primarily because the costs of ongoing K-12 education enhancements outpace the availability of special funds in the Blueprint for Maryland’s Future Fund, the fund dedicated to implementing the Kirwan Commission on Innovation and Excellence in Education’s recommendations.

With actions taken in the fiscal 2025 budget and Budget Reconciliation and Financing Act (BRFA), Blueprint resources provide adequate funding for Blueprint programs through fiscal 2027. However, by the end of fiscal 2027, the Blueprint Fund will be exhausted, resulting in substantial K-12 costs shifting to the general fund beginning in fiscal 2028.

DLS notes that this is not the first time Moody’s has applied a negative outlook in its Maryland rating. In July 2011, while federal officials struggled to increase the federal debt ceiling, Moody’s applied a negative outlook to Maryland and four other states due to high reliance on federal spending.

There was evidence of higher interest rates at the initial bond sale conducted several weeks after the negative outlook was issued, but no statistical evidence of any effects beyond that sale. Moody’s withdrew the negative outlook once the debt crisis ended. DLS will continue to monitor any adverse impacts tied to the negative outlook.

Challenges Identified by Rating Agencies That Could Lead to Ratings Downgrade

S&P and Fitch did identify challenges and factors that could lead to a rating downgrade or negative outlook:

• Fitch notes that a “failure to adhere to policies to address large, unfunded pension liabilities” or an “economic or financial deterioration leading to continued structural operating deficits that cause reserve draws beyond fiscal 2025, without a plan for near-term replenishment” could individually or collectively lead to a downgrade.
• S&P notes that the “ability to manage these costs while keeping its liabilities within the State’s affordability guidelines, particularly during downturns and periods of increased spending demands, is crucial to rating stability.
• Maryland is a high-debt state, and Fitch ranks the State’s long-term liabilities as AA, which implies that managing debt is critical to maintaining a AAA rating.
• S&P advises that it scores Maryland at AA+ due to high liabilities like debt and unfunded pension / Other Post Employment Benefit liabilities. S&P has “notched up to AAA, as allowed per our state rating methodology, due to Maryland’s strong financial management and ability and willingness to adjust spending, if revenues decline, which we believe supports credit characteristics in line with those of comparable ‘AAA’ rated peers.”

Maryland remains one of only 15 states to retain the highest possible rating from Fitch, Moody’s, and S&P.

Stay tuned to Conduit Street for more information.