Pennsylvania Has Worst Spread Since ’10 on Pensions: Muni Credit
Municipal-bond investors are demanding the biggest yield penalty since 2010 on Pennsylvania issuers as the state’s budget chief warns that a growing pension deficit threatens the commonwealth’s credit rating.
Republican Governor Tom Corbett wants to create a defined-contribution plan for new public employees and trim future benefits for current workers. He is trying to shrink an unfunded pension liability that is set to rise 38 percent by 2018 to $65 billion. Ratings companies may cut Pennsylvania’s credit grade if lawmakers don’t pass the overhaul before the fiscal year begins July 1, said Charles Zogby, state budget secretary.
Investors saw the price of inaction in Illinois, which had its bond rank cut this month after failing to bolster the nation’s weakest state pension system. The extra yield on 10-year obligations of Pennsylvania and its municipalities reached 0.87 percentage point yesterday, the widest since September 2010, data compiled by Bloomberg show.
Legislators “haven’t taken any concrete steps on their pension issues,” said John Mousseau, who helps manage about $2.2 billion in debt at Cumberland Advisors in Vineland, New Jersey. The company sold its Pennsylvania general obligations last year.
“They’re not in the state that Illinois is in, but by not taking action, that’s how you get into the state that Illinois is in,” he said.
Pension funding is a deepening challenge for states and cities nationwide after the recession that ended in 2009. U.S. localities face more than $2 trillion in unfinanced retirement obligations, according to Moody’s Investors Service. Since last year, 15 states and Puerto Rico have enacted changes in areas such as pension benefits and employer contributions, said Luke Martel, senior policy specialist at the National Conference of State Legislatures in Denver.
Pennsylvania is ranked AA by Standard & Poor’s, the third-highest level, with a negative outlook. Moody’s, which also gives it the third-highest grade, cut the state in July, citing rising retiree obligations.
The companies “see the stress that pensions are putting on the general fund,” Zogby said from Harrisburg, the state capital. “They signaled a downgrade is likely absent any reform.”
Analysts at Fitch Ratings and S&P said they would review the state’s budget and any pension changes after the spending plan passes. A Moody’s spokesman, David Jacobson, declined to say if the company would do the same.
“Our concern is the affordability of the pensions and the ability to honor their commitments,” said John Sugden, a senior director at S&P in New York.
Corbett has proposed a $28.4 billion general-fund budget, an increase of about 2.4 percent from this fiscal year.
The senate may vote on a bill this week that creates a defined-contribution plan for new employees, similar to a 401(k), Majority Leader Dominic Pileggi, a Republican from Chester, said in a statement. Republicans control both chambers.
Burt Mulford, a portfolio manager at Eagle Asset Management Inc. in St. Petersburg, Florida, said he prefers debt from states such as Alaska that have moved away from defined-benefit plans. He helps manage around $2 billion in munis, including Pennsylvania and Alaska general obligations.
“States have got to go toward some type of hybrid or mandatory defined-contribution plan as a way to manage their liability,” Mulford said. “You don’t have enough new people entering the workforce to offset the people who are retiring.”
In a letter to residents on June 14, Corbett called the current plan, which guarantees workers a specific benefit regardless of investment performance, “archaic” and the “root cause” of the crisis.
“The weight of this large debt will soon be felt by every taxpayer in Pennsylvania,” said the 64-year-old governor, who faces re-election next year. Voters disapproved of the job he’s doing by 48 percent to 35 percent in a poll released June 7 by Quinnipiac University in Hamden, Connecticut.
The governor’s overhaul would save $11.6 billion over 30 years, Zogby said.
Pennsylvania administers two plans, covering about 830,000 people. As of last year, the combined funded ratio was 63 percent, down from 97 percent in 2007, and the unfunded liability was $47 billion, according to actuarial reports.
Nationwide, state pensions had a median funding ratio of about 72 percent in 2011, according to Bloomberg data.
Pennsylvania’s liability has swelled because of enhanced benefits passed in 2001 and investment losses in 2001 and 2008, according to a report from the state budget office. For at least the past eight years, the state also contributed less to the systems than was actuarially required.
Pension costs will consume 62 percent of new revenue in the fiscal year beginning in July, climbing to 66 percent for the 2015-2016 period. The state will increase its contribution at an annual rate exceeding 30 percent through 2015, according to the budget office.
That rate over so many consecutive years makes Pennsylvania an “outlier” among states, said Baye Larsen, a senior analyst at Moody’s.
Pennsylvania’s Housing Finance Agency joins local-governments selling a combined $9 billion this week with yields at the highest level since 2011. Georgia is among issuers postponing deals because of the increase in borrowing costs.
At 2.76 percent, yields on benchmark 10-year munis compare with about 2.54 percent on similar-maturity Treasuries.
The ratio of the interest rates, a measure of relative value, rose to about 109 percent, the highest in more than a week. The higher the figure, the cheaper munis are in comparison.
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