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By Annie Linskey and Brian Chappatta
March 18 (Bloomberg) -- Providence was so close to running out of cash a year ago that it couldn’t pay for tires on police cars. This month, Wall Street lined up to lend to Rhode Island’s capital, shrinking its yield penalty 30 percent.
Providence’s path toward fiscal health went through the bank accounts of about 1,600 pensioners. They voted to freeze cost-of-living raises for a decade, a move that may be unprecedented, said Alicia H. Munnell, director of the Center for Retirement Research at Boston College in Chestnut Hill, Massachusetts. The deal helped Providence avoid the fate of neighboring Central Falls, which in 2011 became the first city in Rhode Island’s 222-year history to go bankrupt.
City leaders have “done what they are supposed to do,” said Dennis Derby, a senior analyst who manages $31 billion in municipal assets at Wells Capital Management in Menomonee Falls, Wisconsin, and owns Providence bonds. “They’ve been very astute.”
Cities and states nationwide are grappling with public pension benefits more generous than their budgets can accommodate. To make up for the shortfalls, elected leaders have raised taxes, sold assets, borrowed from Wall Street and rewritten pension laws. There’s a $217 billion gap between what localities have promised retirees and what they’ve saved toward those obligations, according to a survey of 61 cities released in January by the Pew Charitable Trusts in Philadelphia.
When Mayor Angel Taveras, a 42-year-old Democrat, took office in January 2011, he faced a $110 million projected shortfall in the city’s $613 million budget for the fiscal year through June 2012.
He closed schools, raised taxes, boosted parking rates and obtained payments from nonprofit institutions, including Brown University and the Rhode Island School of Design. The city of 178,000 put millions of dollars of payments to vendors on hold.
About 20 percent of city spending cuts came from changes to a retirement plan that had allowed some workers to earn twice as much annually as they did when they were employed. Twenty-five retirees made more than $109,000, Providence data show. Average fire and police retirees receive about $40,000 a year, according to city figures. While the checks will keep coming, the annual boosts of 3 percent to 6 percent won’t.
“I don’t think anyone thinks this is a fair settlement compared to what they were getting,” Bob Jarvis, president of the Providence Retired Police and Firefighters Association, said at a public hearing this month. “It was the best deal we could get.”
The city’s annual required pension contribution was about $20 million in 1996, or about 13 percent of the municipal budget, according to city data. By 2012, it had risen to $58 million, or 19 percent of the budget. Had Providence failed to make changes, the payment would have reached $94 million by 2022, according to city estimates.
Providence’s pension funds have been only about 35 percent funded the last five fiscal years on average, data compiled by Bloomberg show.
In 2011, Rhode Island Treasurer Gina Raimondo, a Democrat, spearheaded an overhaul of the state’s pensions. The revamp included measures such as delaying retirement and offering workers 401(k)-type plans that don’t guarantee returns. A handful of states instituted similar changes. Unions are challenging Raimondo’s steps in court.
Wrangling retirees into a settlement outside of contentious litigation, which Providence did, is practically unheard of, said Keith Brainard, Georgetown, Texas-based research director at the National Association of State Retirement Administrators.
Taveras said his strategy involved patience.
“You need to listen; you need to be flexible,” he said in a telephone interview. “You can’t take a ‘my-way-or-the-highway’ attitude with this. Did we get everything we wanted in the settlement? No. But neither did they.”
Just as importantly, Taveras used the city’s financial distress as a strength: He threatened bankruptcy, a tool only available to cities in the 28 states that have some provision for municipalities to file.
That was the route taken by Central Falls, about seven miles (11 kilometers) north, which entered Chapter 9 bankruptcy in August 2011 and exited last year. A judge approved a plan to cut pension payments for retirees in the city of 19,000 as much as 55 percent and ordered them to pay 20 percent of health-care costs until they turn 65.
“In the back of people’s minds was the thought that this could be another Central Falls, where the pensions were reduced,” said Jarvis, the Providence retirees’ representative. “A lot of people didn’t want that to happen.”
His members voted 716 to 177 to freeze cost-of-living increases in May. On March 11, a Rhode Island judge declared the deal “fair.”
Investors in the $3.7 trillion municipal market rewarded Providence’s efforts in a debt sale this month. In some maturities, the city received more bids than there were bonds available.
The city sold $39 million of tax-free general-obligation bonds for road repairs March 7. A portion maturing in 10 years and insured by Assured Guaranty Municipal Corp. priced to yield 3.08 percent, data compiled by Bloomberg show. That was about 1.24 percentage points more than benchmark munis.
That was down from the 1.76 percentage-point premium demanded when the city issued comparable debt in December 2010. Those securities were also backed by Assured, which had its rating cut two levels by Moody’s Investors Service in January.
The spreads on the March deal were “pretty attractive,” said Matt Fabian, managing director at Concord, Massachusetts-based Municipal Market Advisors, an independent research firm.
“Their ability to at least begin to resolve their pension systems has helped,” he said.
Providence retirees have until April 1 to opt out of the plan. If they do, they’ll have to either fight the city as individuals or accept harsher measures approved last year by the city council. The final court hearing is set for April 12.
While the city still lacks cash reserves, vendors are being paid again, said David Ortiz, a mayoral spokesman. They include a $16,500 delinquent payment for tires.
The municipal market is set to begin the week with benchmark yields close to the highest since April as local governments led by the New Jersey Turnpike Authority have scheduled $12.5 billion of issuance in the next 30 days, Bloomberg data show. That calendar is about 40 percent busier than the six-month average.
Ten-year benchmark munis start the week yielding 2.06 percent, according to Bloomberg Valuation data, compared with about 2 percent for Treasuries with a similar maturity. The ratio of the two yields is the highest since October, signaling munis have become relatively cheaper than federal debt after the biggest weekly slump this year for local securities.
Local debt has lost 0.9 percent this month, a steeper loss than both Treasuries and corporate bonds, data from Bank of America Merrill Lynch show.
Munis tend to decline in March as bondholders sell to pay tax bills before the April 15 filing deadline, Bloomberg data show. Local debt had negative returns in March the past four years.
Investors pulled about $113 million from muni mutual funds last week, the largest outflow this year, Lipper US Fund Flows data show. The $3.6 billion iShares S&P National AMT-Free Municipal Bond Fund, the largest exchange-traded fund tracking U.S. munis, is trading at a discount to its underlying assets for the longest stretch since 2011, Bloomberg data show.
Such a phenomenon “has been a precursor to longer-lasting municipal bond fund outflows,” Citigroup Inc. said in a report last week.