New Jersey Rating Cut Shows Pension Gaps May Boost State Risks
New Jersey Rating Cut Shows Pension Gaps May Boost Risks
Emile Wamsteker/Bloomberg
The New Jersey Statehouse in Trenton, New Jersey.
The New Jersey Statehouse in Trenton, New Jersey. Photographer: Emile Wamsteker/Bloomberg
New Jersey’s rating cut by Standard & Poor’s yesterday shows how rising pension costs for states and local governments that borrow in the $2.86 trillion municipal- bond market are increasing risks to investors.
Municipal-debt issuers from New Jersey to California are grappling with possible rating reductions because of pensions, which would devalue their bonds and raise borrowing costs. U.S. cities, counties and states face a $3.6 trillion gap between their assets and what they’ve promised pensioners, according to an academic study published last year.
As pension liabilities rise, investors such as Allstate Corp., the largest publicly traded U.S. home and auto insurer, are reducing municipal-bond holdings. Allstate began cutting back those investments about 18 months ago because of issuers’ financial statements and the way they were being managed, said Thomas Wilson, chief executive officer of Allstate Corp.
“If you’re not comfortable with the governance practices and the way in which they’re going to manage their financial situation, you should think about whether you lend them money,” Wilson said yesterday in an interview. The company said in a report yesterday that it reduced municipal-debt holdings by $5.5 billion last year, from $21.3 billion at the end of 2009.
Congress yesterday began looking at whether federal law should let states enter bankruptcy-court protection, as local governments can under Chapter 9. In a hearing by the bailout panel of the Oversight and Government Reform Committee of the U.S. House of Representatives, members considered how to avert a possible rescue of cash-strapped governments.
Deficits Loom
New Jersey is among 44 states facing a combined $125 billion of budget deficits in the next fiscal year, according to a study by the Washington-based Center on Budget and Policy Priorities, a nonprofit focused on issues that affect lower- income Americans. Credit-rating companies have begun to weigh pension liabilities along with other elements when gauging state and local finances for investors.
“We’ve always looked at net pension liabilities, but separately from issuer’s debt,” said Robert Kurtter, managing director for public finance at Moody’s Investors Service. “If you don’t pay a bond, you’re in default. If you don’t make a (pension) contribution, it increases your unfunded liability.”
“You can add these together to create a new metric that gives more clarity and transparency to the total liabilities of each state,” New York-based Kurtter said in an interview. Moody’s published a report last month that shows combined net tax-supported debt and pension liabilities.
13-Month Gap
S&P’s New Jersey downgrade to AA- is its first for a state since it cut California’s rating in January 2010. Only California and Illinois have lower credit ratings. The downgrade ties New Jersey’s S&P rating with that of Arizona, Kentucky, Louisiana and Michigan.
In cutting New Jersey one step to its fourth-highest level from AA, S&P cited “concerns regarding the stresses from the state’s poorly funded pension system.” The cut affects $2.6 billion of general-obligation debt, S&P said in a statement.
New Jersey, the second-wealthiest U.S. state by income per person, can manage its fiscal situation without Congress opening the door to bankruptcy court, Governor Chris Christie, 48, said last month. He said U.S. lawmakers shouldn’t “paper over” states’ fiscal holes.
A seven-year New Jersey general-obligation bond traded yesterday at an average yield of 3.24 percent, about 6 basis points higher than a Bloomberg Fair Market Value index of AA- debt maturing in 2018. A basis point is 0.01 percentage point.
Christie Focus
Christie, a Republican in his first term, has focused on slashing spending after pledging not to raise taxes on residents who pay the highest average real-estate levies in the nation. He faces a budget gap of as much as $10.5 billion next year, more than a third of his current $29.4 billion spending plan.
The S&P downgrade shows the drag pension and health-care costs have become on state finances, Christie said yesterday at a town-hall meeting in Union City. He said lawmakers need to stop delaying and pass pension proposals he made in September.
“For five months, the Legislature has dallied,” Christie said. “The sky started to fall in today. Now, when we need to borrow money to keep the government going and to do long-term capital projects, it’s going to cost us more.”
The governor has urged the Legislature, run by Democrats, to pass proposals aimed at reducing the cost of state pensions and benefits. He wants to reverse a 9 percent benefit increase in 2001 and raise the retirement age, among other things.
2010 Pension Study
Among the 50 cities whose finances were examined, the collective unfunded pension liabilities were estimated at about three years of revenue, Robert Novy-Marx of the University of Rochester and Joshua Rauh at Northwestern University said in their October 2010 study. They said that ratio almost exactly matches that of states’ underfunded retirement costs.
Seattle’s AAA credit rating may be cut after S&P changed its outlook for the city’s general-obligation debt to negative from stable yesterday. S&P cited the city pension fund’s “recent investment losses” and budget pressures for the move.
The S&P downgrade of New Jersey wasn’t a surprise, said Ed Reinoso, who manages $300 million as chief executive officer of Castleton Partners LLC. “You should expect to see downgrades on almost everything this year” in the muni market, he said.
To contact the reporters on this story: Darrell Preston in Dallas at dpreston@bloomberg.net; Terrence Dopp in Trenton, New Jersey, at tdopp@bloomberg.net.
To contact the editor responsible for this story: Mark Tannenbaum at mtannen@bloomberg.net.
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