Muni Pension-Bond Sales May Increase Default Risk, Moody’s Says

State and local governments issuing bonds to bolster their pension funds may increase the chance of defaulting on their debt while probably failing to improve their credit quality, Moody’s Investors Service said.

The securities will have either a neutral or negative effect on a government’s creditworthiness, depending on the size of the sale and the use of proceeds, Moody’s said in a report today. Turning unfunded pension promises into bonds keeps liabilities unchanged, though it raises the risk of a default as the amount of debt increases.

“Pension bonds are often a red flag associated with greater rigidity of long-term obligations, failure to find sustainable solutions to pension funding and a pattern of pushing costs off into the future.” Moody’s analysts Marcia Van Wagner and Timothy Blake wrote in the report. In some cases, “the issuance of the bonds is sufficiently credit negative to put downward pressure on the issuer’s rating.”

Illinois has borrowed $17.2 billion since 2003 for pension benefits, according to Moody’s. The state’s worst-funded retirement system has only 43.4 percent of assets needed to cover its obligations, according to data compiled by Bloomberg. Moody’s downgraded Illinois in January, citing its “severe pension under-funding.”

Illinois Governor Pat Quinn said yesterday that the battle to control employee pension costs “is our fiscal cliff and we need to deal with it” or ratings companies would lower the state’s grade again.

Municipal defaults this year are still at the lowest since at least 2009, with 80 issuers failing to pay this year, according to data from Concord, Massachusetts-based Municipal Market Advisors.

To contact the reporter on this story: Brian Chappatta in New York at bchappatta1@bloomberg.net

To contact the editor responsible for this story: Stephen Merelman at smerelman@bloomberg.net