N.J. Pension Woes Have BlackRock Watching for DowngradeMichelle Kaske and Terrence Dopp
Investors such as BlackRock Inc. and Wasmer Schroeder & Co. are growing wary of New Jersey debt, saying the state’s credit rating is poised to fall further without steps to address revenue and pension gaps.
While declining bond issuance has reduced the extra yield on New Jersey debt to a three-month low, the level doesn’t compensate investors for a possible rating cut, according to Peter Hayes, head of municipal debt at BlackRock. Yield spreads may balloon if financial challenges garner headlines, as happened during fiscal crises in California and Illinois, said Justin Land, who helps manage $3.5 billion of munis at Wasmer Schroeder in Naples, Florida.
New Jersey is rated three steps below benchmark debt, with a negative outlook. A one-step downgrade would place it with California and Illinois in the single-A category, below the 47 other states. Economic growth trails its neighbors, and revenue has missed Governor Chris Christie’s goals for three straight years. His fiscal 2015 budget plan includes a record $2.25 billion pension payment that crowds out other spending.
“They’ve had some pretty optimistic assumptions on the revenue side, which haven’t come to fruition,” said Hayes, whose New York-based firm oversees about $108 billion in state and local debt. “Barring any pretty big pension reform, I would not be surprised at all to see a downgrade before the end of the year.”
Christie, a 51-year-old Republican who began a second term in January, has proposed raising spending 3.5 percent to a record $34.4 billion for the year beginning July 1. Excluding costs for health benefits, pensions and debt, his budget would have been $2.2 billion smaller than in fiscal 2008, he has said.
The increase in spending “isn’t going to schools and roads and infrastructure and all these things you need to entice businesses and get people to want to stay,” Land said.
The state’s retirement costs are increasing even after Christie signed into law June 2011 legislation that raised public workers’ pension payments over several years, boosted the minimum retirement age to 65 from 62 and froze annual cost-of-living adjustments
Kevin Roberts, a spokesman for Christie, said the state’s unfunded pension liability and mounting health-care costs need to be addressed. A downgrade isn’t a forgone conclusion, he said.
“We diagnosed that problem and have been aware of it,” he said by telephone. “In that respect, we are in the same vein or on the same page as the credit companies are.”
The three largest rating firms each cut New Jersey one level since Christie took office in January 2010, and give it a negative outlook. The state has a Moody’s grade of Aa3, and a AA- from Standard & Poor’s and Fitch Ratings.
Fitch on March 21 lowered its outlook on the state, citing fiscal strains and an economic performance that hasn’t been robust enough to keep pace with rising liabilities. The budget is “structurally imbalanced,” as New Jersey phases in full pension payments and Christie relies on one-time fixes, Marcy Block, a Fitch analyst, wrote in a report.
The move by Fitch put “an even greater emphasis” on Christie’s call to lower pension and long-term costs, Chris Santarelli, a Treasury Department spokesman, said at the time.
Christie said in February that the pension was underfunded by $52 billion after a decade of expanded benefits and missed payments. Public-employee unions must agree to changes in their retirement and health plans because his 2011 overhaul didn’t go far enough to contain costs, the governor said. His budget relies on revenue growth of 5.8 percent.
“They’ve got to be a little bit more realistic in their revenue assumptions in the 2015 budget,” Hayes said.
New Jersey’s gross state product rose 1.3 percent from 2011 to 2012, ranking thirty-sixth among U.S. states, and lagged behind the national gain of 2.5 percent, according to the U.S. Commerce Department’s Bureau of Economic Analysis.
The state’s 7.1 percent jobless rate in January and February, while the lowest since 2008, is still higher than that of New York and Pennsylvania.
“New Jersey is clearly a laggard and there’s really not much in the way of strong growth prospects for the economy going forward,” said Larry Bellinger, municipal credit analyst in New York at AllianceBernstein Holding LP, which oversees $30 billion of munis.
Yields on New Jersey’s debt may increase by as much as 0.2 percentage points above top-grade munis in the event of a downgrade, Hayes said. Relative declines may create buying opportunities in BlackRock’s national muni funds, he said.
“It becomes more interesting for non-New Jersey funds,” Hayes said. “And that’s where we’d probably look to add potentially.”
Land foresees even wider spreads, which he said may make the bonds attractive.
“We’ve seen what happens when the media and the populace gets a hold of an idea that a state is in trouble,” Land said. “Once the individual investor gets in on that and once everybody starts focusing on that, you could see their bonds widen” by a full percentage point.
California is an example of that stress. In 2009, when the the state resorted to IOUs to pay bills, spreads on 10-year California bonds almost quadrupled to about 1.7 percentage points in the span of a year. The gap has since returned to about 0.4 percentage point.
Even with the negative credit outlooks, investors demand about 0.07 percentage point of extra yield to buy 30-year New Jersey bonds rather than benchmark debt, close to the smallest gap since December, data compiled by Bloomberg show.
A drop in New Jersey borrowings has helped spur the gains, Hayes said. The state and its municipalities sold about $1.3 billion of fixed-rate bonds in 2014 through April 4, or 72 percent less than a year earlier.
That drop exceeds the 25 percent decline in issuance across the entire $3.7 trillion municipal market.