Muni Credit News May 14, 2015

 

Joseph Krist

Municipal Credit Consultant

ILLINOIS FACES THE MUSIC

Illinois provided lots of muni news this week. Within a couple of days, the IL Supreme Court was voting 7-0 to find that the state constitution would not allow the legislature to unilaterally alter worker pension benefits and the Governor released his recommended FY 2016 budget. Effectively, they are both the same story.

The enacted pension changes would have reduced future cost-of-living adjustments for workers, increased the retirement age for some and capped on pensions for those with the highest salaries. The court however, cited the state Constitution which says that benefits promised as part of a pension system for public workers “shall not be diminished or impaired.” “Crisis is not an excuse to abandon the rule of law,” Justice Lloyd A. Karmeier said. “It is a summons to defend it.”

The decision itself was anticipated but some of the direct language included in the opinion was. “The General Assembly may find itself in crisis, but it is a crisis which other public pension systems managed to avoid,” Justice Karmeier wrote. “It is a crisis for which the General Assembly itself is largely responsible.”

The Governor has suggested that voters should consider a constitutional amendment that would mark a distinction between guarantees of benefits already earned and changes to future benefits. Under the state’s Constitution, officials may assign new benefits to future workers, but cannot diminish benefits already promised. Several states have adopted “tiered” pension systems where pension terms are adjusted for prospective employees. One state which has successfully employed such a system in New York.

The court acknowledged that the decision complicates the state’s fiscal outlook. “The financial challenges facing state and local governments in Illinois are well known and significant,” the opinion read. “In ruling as we have today, we do not mean to minimize the gravity of the state’s problems or the magnitude of the difficulty facing our elected representatives. It is our obligation, however, just as it is theirs, to ensure that the law is followed.”

The Governor’s recommended budget relies on $2.2 billion in savings related to a new proposal to reform Illinois’ critically underfunded retirement systems. These savings are assumed to be realized in the fiscal year that begins on July 1, 2015, even though the pension proposal has not been introduced as legislation in the Illinois General Assembly and is likely to face its own legal challenges.  In addition to pension savings, the proposed FY2016 budget assumes a reduction of $655 million, or more than one third, in the cost of State group health insurance through collective bargaining. Both the magnitude of the projected savings and the short timeframe for reaching agreement with the State’s largest union suggest that the budgeted numbers are unlikely to be realized. Other budgeted savings, particularly in the Medicaid program, depend on changes in State law or require federal approval.  The Governor’s recommended budget cuts local governments’ share of State income taxes by half. The budget also proposed cuts to spending on community care for the elderly, disabled and those with mental illness.

The state is also not the only entity potentially impacted by the decision on pensions. The City of Chicago’s pathway out of its pension minefield most likely became more twisted. According to Moody’s, if current laws stand, Chicago’s annual pension contributions are projected to increase by 135% in 2016; by an average annual rate of 8% in 2017-21; and by an average annual rate of 3% in 2022-26. Looming contribution increases to the Municipal and Laborer plans could be reduced if the courts find Public Act 98-0641 unconstitutional. The city’s impending contribution increases to the Police and Fire plans will be reduced if the state amends Public Act 96-1495 per the city’s request.

That law requires that the City fund the Police and Fire pension funds annually in amounts are equal to (1) the normal cost of the pension fund for the year involved, plus (2) an the amount sufficient to bring the total assets of the pension fund up to 90% of the total actuarial liabilities of the pension fund by the end of municipal fiscal year 2040. Without the increased payments that current statutes require of the city, the plans will continue to liquidate assets to pay benefits. As the plans approach insolvency, risks to the city’s solvency will grow. The legislature will likely have concerns about the legality of any changes it must approve which would alter the City’s pension systems. All of this resulted in Moody’s Investors Service downgrading the city’s debt rating on bond issues backed by property, sales and fuel tax revenue to Ba1 from Baa2.

Mayor Rahm Emanuel maintains that pension changes he engineered for the workers and laborers funds can withstand the legal challenges they face. Moody’s said however that, “we believe that the city’s options for curbing growth in its own unfunded pension liabilities have narrowed considerably. “Whether or not the current statutes that govern Chicago’s pension plans stand, we expect the costs of servicing Chicago’s unfunded liabilities will grow, placing significant strain on the city’s financial operations absent commensurate growth in revenue and/or reductions in other expenditures. The magnitude of the budget adjustments that will be required of the city are significant.” Emanuel responded to the double downgrade by saying Moody’s had overreacted and noted that they did not downgrade the state of Illinois.

The cure for the pension problem is easy – new revenue and negotiated changes in benefits. The dilemma for both entities is the lack of political support for higher taxes. Other than savage cuts to services which may be even more politically unpalatable, increased revenues dedicated to pension funding seem to be the only way to address the chronic underfunding practices which created the current crisis. Unless plans emerge to address the situation, the downward pressure on ratings and valuations will continue for both entities. S&P put the State ratings on negative outlook on Friday.

PUERTO RICO FINANCIAL REPORT

It’s not an audit and while it is a “quarterly” report and it’s been seven months between releases, a current financial update was provided by the Commonwealth. It was unsurprisingly bleak. The commonwealth in fiscal 2016 “may lack sufficient resources to fund all necessary governmental programs” requiring “emergency measures [possibly including] a moratorium on payment of debt service,” the report said. It also referenced the potential for a debt adjustment, or the utilization for the payment of the commonwealth’s debt service of certain taxes and other revenues previously assigned by law to certain public corporations to secure their indebtedness.”

The government estimates a $2.4 billion deficit in the coming fiscal year, assuming no steps are taken to increase revenue or cut expenditures. In comparison, the current fiscal year budget is $9.56 billion. The report projects a current fiscal year will end deficit of $191 million. It says that there are resources to pay off its debts in the current fiscal year. It potential difficulties with the commonwealth’s and the Government Development Bank for Puerto Rico’s ability to make roughly $800 million in payments in July and August.

CALPERS WINS SAN BERNARDINO RULING

Bondholders lost another round in bankruptcy court in the ongoing tug of war between creditors and pensioners. A bankruptcy judge has dismissed a suit challenging the city of San Bernardino’s decision to make its pension payments in full to CalPERS. The ruling from U.S. Bankruptcy Judge Meredith Jury rejected the claim filed by Ambac Assurance Corp. and a Luxembourg bank named EEPK. Last fall the city, which filed for bankruptcy in 2012, said it would pay its $24 million-a-year CalPERS bill in full. Ambac and EEPK said that arrangement was unfair to other creditors.

Although San Bernardino hasn’t filed its complete repayment plan, it’s likely that many creditors would stand to receive only a portion of what they’re owed. Ambac and EEPK are owed a total of more than $59 million in the San Bernardino bankruptcy.

CalPERS welcomed the ruling saying,  “The judge in this case has ruled appropriately”. “Now the city can turn its attention to the more pressing matter of completing its plan of adjustment for exiting bankruptcy.”

Last fall, a bankruptcy judge ruled that Stockton had the legal right to reduce its payments to CalPERS. But the judge also approved Stockton’s repayment plan, in which the city agreed to continue paying CalPERS in full. Anything less than full payment by cities triggers a complicated legal mechanism that would result in a significant slashing of benefits to current and future retirees. In Stockton, for example, pension benefits would have dropped 60 percent, and city officials claimed that police, firefighters and other municipal employees would have quit for other jobs.

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.

One thought on “Muni Credit News May 14, 2015

  1. Michael D'Arcy

    Dear Mr. Krist,

    Hello. We met at a MAGNY luncheon in March of this year. I finally got a chance to check out your blog. It’s very informative. The discussion of the Chicago and Illinois pension travails of the past week was worth reading in detail. I hope you plan to dig down into the weeds of the origins of the Illinois pension crisis in future issues of Municreditnews. There seems to be a story there that not a lot of people outside of the Illinois state government are aware of given how seldom detailed stories concerning public pensions have appeared in the newspapers until fairly recently (i.e. about 2011).

    Janney Montgomery’s Tom Kozlik published a good piece about POBs a couple of weeks back and made reference to the Illinois state pension plan being underfunded as long ago as 1917, and was able to refer to a long history of legislative actions, speeches, op-eds and the like from the 1920s until very recently that highlighted this problem. Just what is it about Illinois that has caused the state to underfund its pensions for the past 100 years? It would be interesting to get the whole story.

    All the best,
    Michael D’Arcy

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