Muni Credit News June 11, 2015

Joseph Krist

Municipal Credit Consultant


New Jersey’s highest court ruled on Tuesday that Gov. Chris Christie could skip the pension payments he promised to make in 2011 in the signature law of his tenure. In the short term, it mitigates a huge fiscal crisis just weeks before the state closes its books for the year. In the long term, the 5-to-2 decision by the Supreme Court of New Jersey maintains the negative pressure on the state’s credit which has bedeviled the state’s bondholders throughout Mr. Christie’s tenure.

Christie has aggressively claimed to have fixed the state’s well known pension underfunding problem. He boasted in his keynote speech to the Republican National Convention in 2012 that he had “fixed” the problem of underfunded pensions. Unfortunately, the “Jersey Comeback” the governor regularly cites has seen the state economy lag behind his forecasts, and the nation. As a result Mr. Christie said the state could not afford to make the payments he had promised in the law.

Nine credit downgrades later, “The loss of public trust due to the broken promises” in the law, the court wrote in its decision Tuesday, “is staggering.” The court said that the governor and the Legislature violated the debt limitation clause in the State Constitution when they signed the law requiring the state to make large payments over a series of years. The court supported the view of most fiscal observers when it said  “That the state must get its financial house in order is plain,”. The decision added however, “the responsibility for the budget process remains squarely where the framers placed it: on the Legislature and executive, accountable to the voters through the electoral process. Ultimately, it is the people’s responsibility to hold the elective branches of government responsible for their judgment and for their exercise of constitutional powers. This is not an occasion for us to act on the other branches’ behalf.”

The dispute between the state’s employees and the governor stems from the implementation of the 2011 law and a companion law signed in 2010 requiring public employees to pay more toward their benefits, and in exchange, the state agreed to make the annual pension payments that several governors had ignored. Payments were made for two years, but beginning with the budget for 2014, the governor said he could not balance the budget if he made them. The payment in 2014 was $696 million instead of the $1.58 billion the law required; the 2015 payment was $681 million instead of the $2.25 billion owed.

The unions sued, and a trial court ruled in February that the law had given public employees a constitutionally protected right to those payments. That decision was reversed by the Supreme Court. Predictably, unions called the ruling “devastating” and “indefensible,” saying it was unfair that they had held up their end of the deal, while the Supreme Court allowed the governor to abandon his. In a dissent, it was pointed out that “The decision unfairly requires public workers to uphold their end of the law’s bargain — increased weekly deductions from their paychecks to fund their future pensions — while allowing the state to slip from its binding commitment to make commensurate contributions.”

The legislature is expected to send Mr. Christie a budget that makes the required pension payment in the next fiscal year, which begins in July. The governor however, is almost certain to strike the payment with his line-item veto. He has called on unions to give up more benefits. Unions and Democrats who lent him crucial support in 2011 said Mr. Christie had to guarantee that the state would finally make its payments.


Harbor’s Edge is an upscale continuing care retirement community in Norfolk, Va. It includes amenities, including River Terrace, a dining room with waterfront views originally open to all residents. That changed when management announced, in May 2011, that the River Terrace and certain activities like Fourth of July celebrations would be restricted to independent living residents and off-limits to everyone else. This sparked protests from residents who had lost access to that amenity.

Last month, the Department of Justice issued a complaint which charged that the facility had violated the federal Fair Housing Act by establishing policies that discriminated against people with disabilities and retaliating against those who complained. To settle the case, Harbor’s Edge admitted no wrongdoing, but will pay $350,000 to compensate those harmed, and a $40,000 civil penalty. The consent order also requires the facility to appoint a Fair Housing Act compliance officer, provide training for its staff and adopt a “reasonable accommodation” policy.

“This is a decision that’s going to put the rest of the industry on notice,” said a senior attorney for the AARP Foundation. While the settlement doesn’t create new law, “it’s a continual battle to get compliance” with the Fair Housing Act, according to Justice in Aging, an advocacy group. Such cases rarely generate the large damages that would encourage lawyers to file suits. Now, Mr. Carlson said, “if I’m running a long-term-care facility and I realize there are significant financial consequences, I think, I’d better change the way I do business.” Though complaints of discrimination or segregation more commonly crop up at communities whose residents have very different functional abilities, the Fair Housing Act applies to any senior housing or care facility — and the Justice Department clearly wants administrators to know it’s paying attention. “It’s not an isolated situation,” said Gregory Friel, deputy assistant attorney general for civil rights. “We’re looking into facilities with analogous practices.”

According to press accounts, the facility initially blamed overcrowding believed that allowing people of different disability levels to use the same facilities violated Virginia regulations. The Justice Department saw a simpler motive. “Harbor’s Edge adopted these policies because it wanted to market its facility as a place for ‘young seniors’ who wanted an active lifestyle,” its complaint said. The DOJ sent lawyers to Norfolk to interview Harbor’s Edge executives, residents and family members, and review thousands of pages of documents. Last summer, it notified the facility that it would bring suit, and executives agreed to begin negotiations.

The three-year DOJ order ensures that Harbor’s Edge can’t revert to discriminatory practices for its duration. Other facilities’ policies are also being reviewed such as the independent living section of Redstone Village in Huntsville, AL. The impact of the Norfolk settlement may be letting residents (and lawyers) around the country know that senior communities must make reasonable accommodations to enable them to use facilities. Segregating them in certain parts of their supposed homes because of their need for assistance is not reasonable. It’s illegal.

The existence of such regulations and the potential for financial penalties at already cash strapped facilities is another item of due diligence for investors in this already risky class of credits found in many high yield municipal funds.


A proposed settlement to resolve years of legal uncertainty over a landmark public pension system overhaul was approved Tuesday by a judge who called it an imperfect but fair solution. The judge, Sarah Taft-Carter of Superior Court, overruled objections, putting an end to nearly all the lawsuits by public-sector unions and retirees against Rhode Island over the 2011 reform, which was designed to save $4 billion over 20 years. The deal would preserve about 90 percent of the savings. Lawmakers must also approve the settlement. Speaker Nicholas Mattiello of the House said the changes from the settlement would be incorporated into the budget, which lawmakers are considering. The settlement provides for cost-of-living increases and one-time stipends for retirees.


Recently, we reported that Pennsylvania Governor Tom Wolf was advancing the idea of issuance of $3 billion of pension debt to temporarily address funding shortfalls in the Commonwealth’s pension systems for teachers and other employees. We opined that this was a bad idea. We have always held to that view for a number of reasons. These mostly reflect our belief that the issuance of this debt is no different than the issuance of debt for any other operating expense. Such practices have always been indicators of fiscal irresponsibility and often strong indicators of fiscal difficulties.

A look at the history of such issuance is instructive. At the state level, major issuers of such debt include New Jersey (the first state to use the technique in 1997) and Illinois. Neither of these two states have managed to properly address their pension funding shortfalls even with the issuance. On the local level, pension funding shortfalls continued to bedevil a number of cities even after such issuance. In some cases, the overall fiscal position was made even worse as poor investment of the bond proceeds resulted in continuing shortfalls, no lessening of the current funding expense requirements, and the additional expense o f debt service associated with the issued debt.

Now, a series of decisions in recent municipal bankruptcy proceedings have increased concerns for investors in these bonds. These securities were generally issued with a security pledge that relied on annual appropriation actions by the legislatures of the issuing entities. They were effectively unsecured obligations of these issuers. As the municipalities involved in recent bankruptcies have sought to restructure their finances and associated obligations, they have sought to use this unsecured status as a basis for effectively repudiating the debt.

The successful effort by Detroit to avoid the repayment of much of the principal on its outstanding $1 billion plus of pension obligations is well documented. The most recent example is in San Bernardino where the city has contested its obligations to make payments to both CALPers and to holders of outstanding pension COPs. Last month, CALPers successfully challenged the city’s effort to avoid required contractual payments due to the pension fund. The City contends that it cannot afford both the payments to CALPers and repayment of debt service on its pension COPs. While not yet final, the city’s recovery plan is expected to include sharply reduced principal recoveries for holders of the COPs.

These efforts mirror the treatment of certificate of obligation debt by other issuers in bankruptcy or undertaking restructurings outside of bankruptcy. Given the rather thin case history that existed under Chapter 9 prior to the rash of filings over recent years, the resulting decisions upholding efforts to force debt holders to take significant haircuts has begun to establish a pattern of precedent which is highly unfavorable to bondholders.

We believe that these precedents have created a situation where pension obligation securities should not be a part of an individual’s portfolio at any price. The results of the recent restructurings have created a highly insecure obligation that provides a level of risk which is not offset by any available yield.


Over the years, the CA Public Employees Retirement System has been a leader in the management of state pension funds. Whether it be matters of investments, fund management, corporate governance activism, or non-traditional investing, CALPERS has been a leader. For years, the country’s biggest state pension fund, paid billions of dollars in fees to external managers to help finance the retirement plans of teachers, firefighters, police and other state employees.

Now Calpers, which has just more than $300 billion of assets under management, plans to cut back drastically on those fees by severing its ties with half of the external investment managers of its funds. Calpers will inform its investment board this month about its plans to reduce the number of external managers to 100 from 212. As part of the move, Calpers will reduce the number of private equity firms to 30 from 98, giving those remaining managers $30 billion to manage. Calpers invests in some of the biggest and best known private equity firms in the world, including Blackstone, TPG, Carlyle and Kohlberg Kravis Roberts.

The move follows on last year’s decision to liquidate $4 billion in hedge fund investments in an effort to simplify a portfolio that has become complex and expensive. This year, the fund will begin to make more payments to retirees than it receives from its investments. And by 2030, it could be left with a $10 billion shortfall between payments and the total amount of contributions from active workers and income from investments, Calpers said in a presentation in May.

Last year, it paid $1.6 billion in management fees, $400 million of which were a one-time payment for its real estate managers. Many other pensions funds have begun to focus on fees, too. Despite a bull market for the last several years, many state and municipal pension funds have not received large enough returns on their investments and are now faced with having too few assets to cover future costs. They now need to address issues of earning enough to make up for their failure to earn what they said they would earn in the past, and making enough in this environment to pay for new promises.

The change reflects the fact that taxpayers are increasingly being asked to pay for public pension shortfalls. Many feel that the more that is being paid to the asset managers, the less is available for public services. In Pennsylvania, where the state is looking at a $50 billion hole in its pension fund, Gov. Tom Wolf recently asked  “why are we paying Wall Street managers hundreds of millions of dollars?” In New York City, Comptroller Scott M. Stringer has noted that the city’s five pension funds have paid more than $2 billion in fees over the last decade, outpacing the returns during the same period. “Right now money managers are being paid exorbitant fees even when they fail to meet baseline targets,” Mr. Stringer said in April.

The move towards nontraditional investment strategies gained additional traction in response to the financial crisis, when the value of assets was decimated by losses. It led pension funds to shift more aggressively into private equity and hedge fund strategies. But returns after the fees — which typically follow a “2 and 20” model in which investors pay an annual management fee of 2 percent of assets under management and 20 percent of returns — have been disappointing in more recent years.

CALPERS will also use just 15 of the current 51 real estate managers to invest the fund’s $26 billion real estate portfolio. And Calpers will eliminate 24 managers from its general equities portfolio, leaving 20 firms to invest $24 billion.

Disclaimer:  The opinions and statements expressed in this column are solely those of the author, who is solely responsible for the accuracy and completeness of this column.  The opinions and statements expressed on this website are for informational purposes only, and are not intended to provide investment advice or guidance in any way and do not represent a solicitation to buy, sell or hold any of the securities mentioned.  Opinions and statements expressed reflect only the view or judgment of the author(s) at the time of publication, and are subject to change without notice.  Information has been derived from sources deemed to be reliable, but the reliability of which is not guaranteed.  Readers are encouraged to obtain official statements and other disclosure documents on their own and/or to consult with their own investment professional and advisors prior to making any investment decisions.