By Adam Pagnucco.

For the first time in its history, the Montgomery County Government will be applying for a line of credit. That’s a sign of how seriously county officials are taking the deep economic downturn caused by the COVID-19 crisis.

MoCo’s general obligation bonds have enjoyed a AAA rating since the 1970s. The county almost lost its credit rating in 2010 but avoided that fate through doubling the energy tax, implementing massive spending cuts and passing a plan to increase reserves to 10% of revenues in ten years. (The county has since met that target.) As bad as that year and others surrounding it were, the county never had to take out a credit line.

Now it will.

County budget director Rich Madaleno confirmed that the county planned to apply for a credit line in a conversation with the county council yesterday. The county’s Office of Legislative Oversight (OLO) has posted documentation on how a credit line would function in the context of county government. County governments, especially well-managed ones, hardly ever use debt to fund operating expenses. Indeed, section 312 of the county’s charter states, “No indebtedness for a term of more than one year shall be incurred by the County to meet current operating expenses.” So if MoCo borrows against the line, it would have to pay back the money pretty quickly.

When questioned about the purpose of the credit line by Council Member Andrew Friedson, Madaleno replied:

It’s to make sure in the extremely rare case that if there were a cash flow issue because of what you well know is the schedule of disbursements – we do not collect the income tax, the state does – we get them on set schedules. If we have to pay bills while two weeks before the February distribution or the November distribution you have in essence a credit card. And as any consumer knows, in these sorts of situations, you would want that credit card in hand and not be applying for it at the register because you don’t know if you’re going to get it and what the rates are going to be. This is a best practice. This is not at all, not at all and you can ask Mr. Coveyou [the county’s finance director] – this is not at all an action being taken because we are concerned about liquidity. This is a backup insurance plan as you would want a smart organization to have in its back pocket.

Let’s remember that the county has had to deal with state distribution schedules of income taxes for decades and never needed a line of credit until now. The difference between now and those other decades is the sheer havoc the COVID-19 crisis could wreak on county finances. Consider that the current worst case scenario estimates up to a $600 million revenue loss in FY20 and FY21 combined and that the current projection for ending reserves in FY21 is $554 million. No one should take comfort from those numbers, particularly given the possibility of their getting worse.

A sneak preview of a county budget briefing six months from now.

The amount of the county’s credit line has not been established but multiple sources suggest that it could be in the hundreds of millions of dollars. No information is available yet on which financial institution(s) would issue it.

Montgomery County is not alone. State and local governments around the country either have or are seeking lines of credit, including the State of New York ($3 billion), the State of Illinois ($1.2 billion), the City of Louisville in Kentucky ($240 million), the State of Rhode Island ($150 million), Cook County in Illinois ($100 million), the City of Portland in Oregon ($100 million), the City of New Orleans in Louisiana ($100 million), Fauquier County in Virginia ($50 million) and the City of Montgomery in Alabama ($35 million). By far the most cited reason for these credit lines is to hedge against the revenue impacts of COVID-19.

Madaleno could be right that this is a smart backup insurance plan. Even Friedson, who has been hammering the Elrich administration’s budgetary practices of late, called it a “prudent action.” But let’s not delude ourselves. Montgomery County Government is preparing for a serious recession.

This year’s budget is only the beginning.

By Adam Pagnucco.

Last fall, County Executive Ike Leggett proposed cutting the volume of new general obligation bonds issued by the county in future years and the County Council concurred unanimously.  Advocates for school construction fretted over the move as the county’s needs in that area, as well as in transportation investment, are enormous.  But Leggett and the council had a point.  The county’s debt has skyrocketed in the past twenty years and especially in the last decade.  It now presents a substantial challenge to the county’s fiscal well-being that the next generation of county leaders will have to deal with.

The county government does not use debt to finance its operating budget, but it does use debt to finance its capital budget, known as the Capital Improvements Program (CIP).  The CIP is a six-year budget that is fully renewed every two years and is adjusted in off years.  The Executive’s latest recommended CIP currently totals $4.5 billion, of which $1.8 billion is recommended for school construction.  The CIP has many funding streams for its projects, but the single largest one is debt.  As of June 30, 2017, the county had $4.1 billion of outstanding primary government debt, of which the largest category is general obligation (GO) bonds, which accounts for $2.7 billion.  GO bonds are backed by the full faith and credit of county government.  The fact that the county’s GO bonds have had a AAA rating assigned to them by the nation’s three largest credit agencies for many years is a substantial source of interest savings to the county.  Other major categories of debt are short-term bond anticipation notes ($500 million outstanding), taxable Build America Bonds created during the recession ($308 million) and revenue bonds which are backed by dedicated revenue streams ($222 million).  All of this is separate from the substantial liabilities the county has for pension funding and retiree health benefits.

There are two salient facts about the county’s debt.  First, it has been growing rapidly.  And second, it is paid off through debt service that is part of the county’s operating budget.  These debt service payments MUST be paid and they compete with other spending priorities.  Along with total debt, debt service has also been growing rapidly.

The chart below shows growth in total outstanding primary government debt and in GO bonds over the last twenty years.  While growth has occurred throughout the entire period, it has accelerated since the onset of the Great Recession.  From 1998 through 2008, GO bond debt grew by an average of 2.9% per year, about equal to growth in the Washington-Baltimore CPI (3.0% per year).  Total debt grew by an average of 5.2% annually over that period.  From 2009 through 2017, GO bond debt grew by an annual average of 8.1%.  Total debt grew by 8.4% annually.  The average rate of inflation in the Washington-Baltimore CPI was 1.5%.  Over the last eight years, the county’s debt has been growing by more than 5 times the rate of inflation.

Relative to the size of the population, the debt has been rising too.  When we compared the county’s total debt levels to population estimates from the U.S. Bureau of Economic Analysis, we found that total debt per capita has grown from $1,370 in 1997 to $3,768 in 2017.

As for debt service, it has risen from $140 million in FY97 to $408 million in FY18.  If debt service was a county agency, it would be the largest agency in county government other than MCPS.  Debt service payments are mandatory and cannot be cut like most other categories of spending during recessions.  The pit of the Great Recession came in FY11, when debt service was $258 million and the county slashed services, doubled the energy tax and furloughed its workforce.  Now that debt service exceeds $400 million a year, it will present a much greater impediment to the maintenance of county services when the next recession comes.

Let’s remember that debt is not an inherently bad thing.  It is the primary vehicle by which the county pays for core government functions like school construction and transportation projects.  The county’s needs in those areas are absolutely undeniable.  Also, construction costs were moderated during the recession, so the county was able to take advantage of that to build relatively cheaply in those years.  But over the long term, if you are going to have rapidly growing debt, you need to have a rapidly growing economy to pay for it.  And MoCo does not have that – instead, it has had weak growth in employment and incomes in recent years.  It saw 57 new business filings in 2015 and 19 new filings a year later.  It passed a 9% property tax hike and a year and a half later suffered a $120 million budget shortfall.

This is evidence yet again that an economic revival has to be a huge priority for the next generation of county elected officials.  Without it, debt service will consume larger and larger chunks of the budget and eventually lead to service cuts and/or tax hikes.  As for those who oppose economic growth or have worked to undermine it, the debt situation makes this clear: you cannot oppose growth and favor expanding school construction and transportation investment.  The economy and the credit markets won’t allow elected leaders to have it both ways.

Bear that in mind as we head to Election Day.