Illinois Settlement Shows Worst Pension’s True Cost: Muni Credit
Illinois taxpayers are learning the price of having the worst-funded U.S. state pension system.
The state settled yesterday with the U.S. Securities and Exchange Commission over charges it misled investors from 2005 to 2009 about shortfalls in retirement funds. Yet buyers in the $3.7 trillion municipal bond market are still penalizing Illinois.
Investors demand 1.3 percentage points of extra yield to own 10-year debt of the state and its localities, almost seven times the average in 2005, when the SEC said the inadequate disclosure began. Illinois had its credit rating cut by Standard & Poor’s in January, leaving it the lowest of any state, after lawmakers failed to bolster its pension or whittle down a backlog of $9 billion of unpaid bills.
“Where other states are making progress, they’re not,” said Daniel Solender, who helps manage $19.5 billion of munis at Lord Abbett & Co. in Jersey City, New Jersey. “It definitely makes you more hesitant to increase positions on the bonds.”
Illinois joins local governments nationwide facing growing retiree burdens after the 18-month recession that ended in 2009, including Chicago, its largest city. States and localities are grappling with more than $2 trillion in unfunded public-employee retirement costs, Moody’s Investors Service said in July.
Illinois failed to disclose how much it was underfunding its plans as it sold $2.2 billion in bonds, the SEC said. The fifth-most-populous state became the second to settle over such charges. New Jersey resolved a similar case in 2010, as did San Diego in 2006.
Illinois neither admitted nor denied the SEC’s findings in the settlement, which didn’t include fines, according to a statement from Governor Pat Quinn’s Office of Management and Budget. Abdon Pallasch, an assistant budget director, said the administration would have no further comment beyond the release.
“It goes back to an era, which wasn’t that long ago, where there just wasn’t as much attention placed on pension obligations,” said Howard Cure, director of muni research in New York at Evercore Wealth Management LLC, which oversees $4.5 billion. “You’re not talking about small, infrequent issuers.”
Illinois didn’t adequately disclose cuts in annual payments to its retirement funds, the agency said. Its pension debts swelled as it borrowed and used accounting techniques that delayed for years steps to shore up the systems, the agency said.
“The state knew that the plan was unmanageable, but failed to disclose the significant risks to those who bought its bonds,” Elaine Greenberg, Philadelphia-based head of the SEC’s municipal and pension enforcement unit, said in an interview. “We hope that our heightened scrutiny of pension disclosure will continue to serve as a warning to other state and municipal issuers.”
Chicago is an example of how difficult it is for municipalities to slow the growth of pension burdens.
The Chicago Police Sergeants’ Association yesterday rejected a deal that Mayor Rahm Emanuel called a “framework” for pension change. The administration has warned that retirement plans will consume 22 percent of the city’s budget -- about $1.2 billion -- within four years, unless the state legislature restructures them.
For Illinois, its most recent bond sale served as a reminder that it was paying up for past practices.
The state sold general obligations in March 2005, with a 10-year portion priced to yield 0.13 percentage point more than AAA munis, data compiled by Bloomberg show. In the state’s debt issue in September, the interest rate on the 10-year segment was 1.19 percentage points above top-grades.
Illinois and its municipalities pay the highest interest rate among the 19 states tracked by Bloomberg.
“We will all be paying for the mishandling of the pension funds for many years to come,” Illinois Comptroller Judy Baar Topinka said in an e-mailed statement. “It is critical that we learn from the state’s mistakes and never again play games with our pension systems.”
S&P downgraded Illinois Jan. 25 to A-, six steps below AAA, after lawmakers were unable to produce a plan to shore up the pensions, which have just 39 percent of assets needed to cover projected obligations. No other U.S. state has a ratio that low.
The state of about 13 million delayed a $500 million general-obligation offering in January five days after the downgrade, citing unfavorable market conditions.
Guy Davidson, who helps manage $32 billion as director of munis at AllianceBernstein LP in New York, allocates about 2 percent of the holdings to debt from Illinois. That’s below the 4.6 percent share that the state and its issuers account for in a Barclays Plc muni index.
“They have some very real and significant challenges that they have to address, and we hope soon,” Davidson said. “We would not take a large weighting in the portfolio, but you are getting paid enough to take a small position.”
In trading yesterday, yields on 30-year benchmark munis rose 0.09 percentage point to 3.06 percent, the highest since August, according to Bloomberg Valuation data.
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