New Jersey Rating Cut Shows Pension Gaps May Boost State Risks
2011-02-10 05:01:00.22 GMT

By Darrell Preston and Terrence Dopp
    Feb. 10 (Bloomberg) -- New Jersey’s rating cut by Standard
& Poor’s yesterday shows how rising pension costs for states and
local governments that borrow in the $2.86 trillion municipal-
bond market are increasing risks to investors.
    Municipal-debt issuers from New Jersey to California are
grappling with possible rating reductions because of pensions,
which would devalue their bonds and raise borrowing costs. U.S.
cities, counties and states face a $3.6 trillion gap between
their assets and what they’ve promised pensioners, according to
an academic study published last year.
    As pension liabilities rise, investors such as Allstate
Corp., the largest publicly traded U.S. home and auto insurer,
are reducing municipal-bond holdings. Allstate began cutting
back those investments about 18 months ago because of issuers’
financial statements and the way they were being managed, said
Thomas Wilson, chief executive officer of Allstate Corp.
    “If you’re not comfortable with the governance practices
and the way in which they’re going to manage their financial
situation, you should think about whether you lend them money,”
Wilson said yesterday in an interview. The company said in a
report yesterday that it reduced municipal-debt holdings by $5.5
billion last year, from $21.3 billion at the end of 2009.
    Congress yesterday began looking at whether federal law
should let states enter bankruptcy-court protection, as local
governments can under Chapter 9. In a hearing by the bailout
panel of the Oversight and Government Reform Committee of the
U.S. House of Representatives, members considered how to avert a
possible rescue of cash-strapped governments.

                         Deficits Loom

    New Jersey is among 44 states facing a combined $125
billion of budget deficits in the next fiscal year, according to
a study by the Washington-based Center on Budget and Policy
Priorities, a nonprofit focused on issues that affect lower-
income Americans. Credit-rating companies have begun to weigh
pension liabilities along with other elements when gauging state
and local finances for investors.
    “We’ve always looked at net pension liabilities, but
separately from issuer’s debt,” said Robert Kurtter, managing
director for public finance at Moody’s Investors Service. “If
you don’t pay a bond, you’re in default. If you don’t make a
(pension) contribution, it increases your unfunded liability.”
    “You can add these together to create a new metric that
gives more clarity and transparency to the total liabilities of
each state,” New York-based Kurtter said in an interview.
Moody’s published a report last month that shows combined net
tax-supported debt and pension liabilities.

                         13-Month Gap

    S&P’s New Jersey downgrade to AA- is its first for a state
since it cut California’s rating in January 2010. Only
California and Illinois have lower credit ratings. The downgrade
ties New Jersey’s S&P rating with that of Arizona, Kentucky,
Louisiana and Michigan.
    In cutting New Jersey one step to its fourth-highest level
from AA, S&P cited “concerns regarding the stresses from the
state’s poorly funded pension system.” The cut affects $2.6
billion of general-obligation debt, S&P said in a statement.
    New Jersey, the second-wealthiest U.S. state by income per
person, can manage its fiscal situation without Congress opening
the door to bankruptcy court, Governor Chris Christie, 48, said
last month. He said U.S. lawmakers shouldn’t “paper over”
states’ fiscal holes.
    A seven-year New Jersey general-obligation bond traded
yesterday at an average yield of 3.24 percent, about 6 basis
points higher than a Bloomberg Fair Market Value index of AA-
debt maturing in 2018. A basis point is 0.01 percentage point.

                        Christie Focus

    Christie, a Republican in his first term, has focused on
slashing spending after pledging not to raise taxes on residents
who pay the highest average real-estate levies in the nation. He
faces a budget gap of as much as $10.5 billion next year, more
than a third of his current $29.4 billion spending plan.
    The S&P downgrade shows the drag pension and health-care
costs have become on state finances, Christie said yesterday at
a town-hall meeting in Union City. He said lawmakers need to
stop delaying and pass pension proposals he made in September.
   “For five months, the Legislature has dallied,” Christie
said. “The sky started to fall in today. Now, when we need to
borrow money to keep the government going and to do long-term
capital projects, it’s going to cost us more.”
    The governor has urged the Legislature, run by Democrats,
to pass proposals aimed at reducing the cost of state pensions
and benefits. He wants to reverse a 9 percent benefit increase
in 2001 and raise the retirement age, among other things.

                      2010 Pension Study

    Among the 50 cities whose finances were examined, the
collective unfunded pension liabilities were estimated at about
three years of revenue, Robert Novy-Marx of the University of
Rochester and Joshua Rauh at Northwestern University said in
their October 2010 study. They said that ratio almost exactly
matches that of states’ underfunded retirement costs.
    Seattle’s AAA credit rating may be cut after S&P changed
its outlook for the city’s general-obligation debt to negative
from stable yesterday. S&P cited the city pension fund’s
“recent investment losses” and budget pressures for the move.
    The S&P downgrade of New Jersey wasn’t a surprise, said Ed
Reinoso, who manages $300 million as chief executive officer of
Castleton Partners LLC. “You should expect to see downgrades on
almost everything this year” in the muni market, he said.