Credit Effects Research

In the wake of increased unfunded pension liabilities and higher penson costs, attention to public pensions in recent years has grown. The resources below provide context and detail regarding the role and effects of public pensions regarding the credit standing of states and local governments that sponsor pension plans.

US States Rating Methodology, Moody's Investor Services, April 2013

Adjustments to US State and Local Government Reported Pension Data, Moody's Investor Service, April 2013

Local Government Pension Analysis Fitch Ratings, April 2013

Books, Budgets and Bonds; What Do All Those Pension Numbers Mean?, Keith Brainard, Government Finance Review, April 2013

US State and Local Governments Face Risks with Pension Funding Bonds, Moody's Investor's Service, December 2012

State and Local Pensions 101, Rachel Barkley, Morningstar, Inc., November 1, 2012

Pension Tensions: A Primer Wells Fargo, August 2012

Public Pension Plans: What We Worry About Wells Fargo, December 2011

• While most of the attention on public pension plans focuses on the states, Wells Fargo Securities makes the case that municipal pension plans deserve an increased focus.

"State Pensions: A Manageable Longer-Term Challenge," Barclay's Capital, May 2011

• Given that unfunded pension liabilities of the states have been estimated at $0.7trn to more than $3trn, or up to six times the amount of bonds outstanding, the health of public pension plans has become a focus area for municipal bond investors (both tax-exempt and taxable). In this primer on public pension plans, we aggregate some of the key data for all of the states and take a closer look at the four with the largest aggregate unfunded pension liabilities (California, Illinois, Massachusetts, and New Jersey), providing estimates as to when they would deplete their assets under various scenarios, assuming they take no further action to reduce liabilities and/or increase contributions.

State and Local Government Debt: An Analysis Congressional Research Service, March 2011

• This report first provides a broad overview of state and local government finances and how these governments incorporate borrowing into their budget. The second section reports data on state and local government debt and how that debt has changed over time. This section includes a comparative analysis of these debt parameters for each state. The third section discusses different economic perspectives on the use of debt by governments and if governments are intrinsically biased toward borrowing more than is considered economically optimal. The discussion provides background for Congress as it deliberates potential changes in the oversight of the primary and secondary markets for state and local government debt.

GFOA Advisory: Evaluating the Use of Pension Obligation Bonds (1997 and 2005) (DEBT & CORBA) GFOA, March 2005

• A GFOA advisory identifies specific policies and procedures to minimize a government’s exposure to potential loss in connection with its financial management activities. This advisory recommends that state and local governments use caution when issuing pension obligation bonds.

Combining Debt and Pension Liabilities of U.S. States Enhances Comparability Moody's Investors Service, January 2011

• This report is part of a series on pension obligations

State & City Pension Funding: A Contrarian View Richard P. Larkin, June 2010

• This article argues against the presence of unfunded pension liabilities as evidence for pension fund insolvency

Pension Obligation Bonds: Financial Crisis Exposes Risks Center for State and Local Government Excellence, January 2010

• The brief’s key findings are:
  • Some state and local governments issue Pension Obligation Bonds (POBs) to raise cash to cover their required pension contributions.
  • POBs allow governments to avoid increasing taxes in bad times and could reduce pension costs, but they pose considerable risks.
  • Those who issue POBs are often fiscally stressed and not well-positioned to handle the investment risk.

House Committee on Pensions & Investments Texas House of Representatives: Interim Report 2004 Texas House of Representatives, 2004

• This report discusses the use of pension obligation bonds and makes recommendations for guidelines for adoption.

GRS Insight: Questions to Consider Before Issuing Pension Obligation Bonds Gabriel Roeder Smith, February 2004

• This GRS Insight poses questions for consideration for state and local governments interested in issuing pension obligation bonds to cover funding shortfalls.

Risky Business: Evaluating the Use of Pension Obligation Bonds James B. Burhnam, June 2003

• Using two pension bond issues by a previous adopter of this strategy, this article evaluates the conditions under which pension bond issuance may or may not be appropriate.

Reports by Rating Agencies

Fitch Ratings

Local Government Pension Analysis Fitch Ratings, April 2013

• Fitch Ratings continues to review and refine its approach to analyzing the impact of pension liabilities on local government ratings. As one element in our analysis of a government‟s overall credit profile, our goal is to identify cases where pension-related risks are outsized.

Tax-Supported Rating Criteria, Fitch Ratings, August 2012

• Fitch Ratings evaluates four major factors (debt, economy, finances, and management) in determining the credit quality of a tax-supported governmental issuer. The rating process analyzes trends in these areas and seeks to identify actual and potential future obligations and exposures.

Improving Comparability of State Liabilities

• Fitch will calculate an additional long-term liability metric for use in the credit analysis of states. The new metric measures each state’s net tax-supported debt combined with the unfunded actuarial accrued liabilities (UAAL) in its major pension systems against the state’s wealth base, expressed as personal income. Fitch will calculate the debt plus pension metric using an adjusted UAAL to reflect a 7% investment return assumption. Fitch believes that debt and pensions are fundamentally different types of obligations, and the combined metric is inherently more variable.

Enhancing the Analysis of U.S. State and Local Government Pension Obligations

• This report details Fitch Ratings’ approach to evaluating a state or local government’s defined benefit pension obligations. Although this does not represent a change in criteria, Fitch is implementing several additional steps to enhance its analysis.

Moody's Investor Services

US States Rating Methodology, Moody's Investor Services, April 2013

• This methodology provides an updated and detailed explanation of how Moody’s assigns ratings to US state general obligations or their equivalents.

Adjustments to US State and Local Government Reported Pension Data, Moody's Investor Service, April 2013

• This report describes our approach to adjusting pension assets and liabilities reported by US states and local governments for the purpose of our independent credit analysis.

Adjustments to US State and Local Government Reported Pension Data: Frequently Asked Questions, Moody's Investor Services, August 2012

• "On July 2, we published a Request for Comment regarding proposed adjustments to US public sector pension data. This document provides responses to questions that have been raised by investors, issuers and other interested parties. Because of the complexity of this topic, and our desire to provide sufficient time for market participants to provide their thoughts, we have extended the comment period on the proposed adjustments to September 30 and encourage the submission of written comments to: cpc@moodys.com."

Adjustments to US State and Local Government Reported Pension Data, Moody's Investor Services, July 2012

• "This Request for Comment requests feedback on our proposal to implement several adjustments to the pension liability and cost information reported by state and local governments and their pension plans."

Fiscal 2011 Pension Asset Gains Provide Limited State Budget Relief Moody's Investor Services, November 2011

• "Recent improvements in public pension fund asset holdings due to strong investment returns will have modest impacts on the enormous pension funding challenges facing states. Pension funding requirements are expected to continue to place pressure on state budgets for the foreseeable future as states (1) continue to phase in the effects of pension asset losses during the downturn and (2) feel the impacts of pension benefit enrichments together with the increasing numbers of retirees. These factors will prevent gains in asset values, subject as they are to smoothing rules, from providing significant budget relief in the near term."

Standard & Poor's

U.S. State and Local Governments Credit Conditions Forecast: The Difference This Time

• Recovery from this recession has been slower than from others, partly because households are focusing on balance sheet repair.
• We have revised downward one of our forecast measures relevant to state and local governments but raised three.
• Our base case forecast now assumes slightly higher growth in 2012 but lower growth in 2013 than our previous forecast assumed.
• Regional forecasts vary, but we see the strongest growth in 2013 potentially occurring in the West South Central region and the weakest in the East North Central region.

The Decline in US States' Pension Funding Decelerates, but Reform and Reporting Issues Loom Large

• "While funded ratios may be stabilizing, there's still a spotlight on government pension liabilities from a broad array of stakeholders. We believe this has contributed to a more significant focus on pension reform, with an emphasis on sustainability, than we have observed in more than 20 years. Nevertheless, current market volatility and a lag in reporting coupled with the incremental nature of recent reform will likely result in reported funded levels to continue to decline before we see a broad-based improvement in overall funded levels. While there is some evidence of stabilization and in some cases improvement, it could be short lived given the current macroeconomic environment."

For U.S. State Budgets, Austerity Is Here To Stay

• "Although the Great Recession is long over, as we look at U.S. states in advance of fiscal 2013 budget deliberations it appears that austerity is here to stay. Our credit outlook for the sector at the start of 2011 focused on the difficult transition to a post-stimulus budget environment. By all accounts, states have made the often-difficult decisions necessary to transition their budgets. For most, the solutions were structural, with less reliance on non-recurring resources and debt issuance and more focus on spending reductions and, to a lesser extent, revenue enhancement."

U.S. States' Pension Funding Ratios Drift Downward Standard & Poor's, March 2011

• Despite improved performance in the global equity markets that began around March 2009, the funded ratios of U.S. states' pension funds continue to drift downward, our annual survey of state pension funds shows. Without exception, reduced pension asset values relative to estimated liabilities is placing upward pressure on the annual required contributions (ARCs) of state governments, compounding what is already a difficult budget cycle for most states. In many states, large projected budget gaps are causing lawmakers to review services, programs, and benefits—including pensions.

U.S. State Ratings Methodology Standard & Poor's, January 2011

• This article was published by S&P to help market participants better understand their approach to assigning ratings to states.

Pension Funding and Policy Challenges Loom for U.S. States Standard & Poor's, July 2010

• The decline in public pension fund assets that started in fiscal 2008 is now contributing to significant budget challenges for U.S. states as many of them are faced with having to increase their pension contributions even as federal stimulus funding dries up and before meaningful revenue recovery has taken hold. Our observations show that many states are re-thinking core services, programs, and benefit levels--including pensions.

Pension bonds

According to Gabriel, Roeder, Smith & Co., pension obligation bonds

are financing instruments intended to relieve the issuer of some of the annual pension contribution. POB proceeds are typically used to pay some or all of the pension plan’s unfunded accrued liability (UAL) and may also include funds to pay the plan’s normal costs for two or three years into the future. In order to achieve the expected budgetary relief, the issuer hopes to invest the bond proceeds at a rate higher than the total cost of borrowing. The desired result is that the transaction reduces the annual pension contribution required to fund the plan by more than the total cost of borrowing.

From 1986 through 2009, states and local governments issued approximately $53 billion in pension obligation bonds. These issuances were used primarily to pay down unfunded pension liabilities, but also to fund current pension contributions. According to Munnell et al., "The use of POBs is controversial, and many state and local governments remain wary of these transactions. Some view POBs as being unfair to future generations, and others see them as overly risky.".

See also

• Bond Ratings for State Government by State: 2010

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