WASHINGTON — One of the biggest investor concerns about unfunded public pension liabilities is whether a government's payment obligations to retirees will compete with debt repayment, according to a Wells Fargo report issued Wednesday.
This concern is playing out in Stockton and San Bernardino, Calif., where each city recently filed for bankruptcy and decided to default on their pension obligation bonds. The POBs are insured so bondholders will continue to be paid.
However, bond insurers argue that obligations to the pension fund — the California Public Employees Retirement System — should not have special status relative to other creditors. CalPERS claims that its obligations comes ahead of bond payments.
POBs are general fund obligations and constitute a weaker security than general obligations with a statutory lien.
In California, local agencies need a two-thirds vote to sell municipal bonds secured by a pledge to levy unlimited ad valorem taxes. By comparison, general fund obligations are paid from legally available funds.
Natalie Cohen, senior analyst and author of the report, said the evolution of the disagreement between the bond insurers and CalPERS largely depends on the courts' interpretation of "obligation."
Investors are also worried that the Golden State's bankruptcies will spill over into other states.
There are 3,418 state and local government pension systems in the United States in 2010, according to the Census Bureau.
"While we envision additional bankruptcies in California, we do not expect widespread infection of bankruptcies across state lines," Cohen wrote. "Most places where distress is heavy are not marrying bond defaults with pension costs."
"That is not to say municipalities in other states do not face fiscal challenges. We see states and local governments working through tough fiscal issues for the most part without bondholder impairment," she noted.
Late last week Moody's Investors Service announced it is considering across-the-board downgrades in California in the aftermath of the three cities that filed for bankruptcy this year: Stockton, Mammoth Lake and San Bernardino.
Moody's said it expects more bankruptcies and defaults in California, the country's largest municipal bond issuer. The credit rating agency also said that the fiscal distress in many of the state's cities was putting bondholders at risk.
Cohen said other states have been using a variety of tools to achieve changes in the cost of retiree benefits.
Some state systems have raised the contribution levels, raised the retirement age and reduced benefits for new employees, or else have shifted toward a 401(k)-type plan.
For example, Kansas and Louisiana have ended defined-benefit programs for new hires and moved them to cash-benefit plans. Virginia and Rhode Island now have hybrid pension plans for new members. Alabama and New York have closed their existing plans and raised the retirement age.
Still, most states have been slow to drastically alter their pension systems due to the potential political fallout for local lawmakers during an election year.
Meanwhile, the Governmental Accounting Standards Board has approved pension accounting changes that will show the full effect of unfunded liabilities on the balance sheet. The changed definitions and measurement of unfunded liabilities will go into effect beginning in June 2013.
Similarly, Moody's has proposed adjustments to the way it analyzes public pension data. If implemented, the changes would go into effect this fall.
