DALLAS — Dallas faces a potential risk to its Aa1 credit rating from continuing troubles in its Police and Fire Pension fund, Moody's Investors Service analysts warned.
After a year of controversy over investment decisions, the fund announced July 9 that it was lowering its expected return on those investments to 7.25% from a previous 8.5%.
"This is not the first time that the public safety plan has revised asset values," analysts Tom Aaron and Adebola Kushimo noted. "For example, a review commissioned by a board trustee estimated in January 2015 that $585 million of select plan real estate assets examined were overstated by $26 million-$78 million."
Despite the warning of the negative credit impact of the pension troubles, Dallas retains a stable outlook from Moody's.
The pension fund's $3 billion of assets are about 6% lower than originally reported in May.
"By lowering its investment expectations, the board has reduced the risk of unexpected increases in future contribution requirements," analysts said. "However, the resulting cost increases already challenge the city, particularly because its current contributions are near a state-defined maximum cap."
Actuaries projected that the city's contribution in 2015, at 27.5% of payroll, will fall nearly $4 million short of the amount the actuaries identified will be needed to pay for newly accrued benefits and to amortize unfunded liabilities within 30 years.
The city's pension costs have grown to 13% of the city's operating revenues in the fiscal year ended September 31, 2014 from 10% in fiscal 2010.
"However, this moderately rising expenditure pressure is concurrent with economic and tax base growth and otherwise strong financial performance," Moody's said. "For example, the city's largest revenue sources, property and sales taxes, have grown at average annual rates of 1.3% and 5.5%, respectively, over the past five years."
The projections of the city's actuarial costs were made before the asset valuation revision and the board's subsequent change in investment return rate assumption. The plan's actuaries have not yet recalculated the required payment, analysts said, but the requirement will increase substantially, meaning the city's currently scheduled payment will fall even shorter in 2015 than the city originally expected.
Unlike private-sector pension accounting, U.S. public pension plans have historically tied the discount rates they use to value liabilities to assumed future investment performance. However, under new accounting standards, public plans may only continue this practice if they do not project that plan assets will be exhausted at some point in the future, analysts noted.
If asset depletion is projected, public plans must use a discount rate reflecting a blend of the assumed rate of investment return and a high-grade municipal bond index.
The Dallas public safety plan's actuaries project that without further changes, the plan will deplete its assets as soon as 2038, with 7% annual returns.
"Thus, under the new accounting standards, it must use a blended discount rate," analysts explained. "Under its downwardly revised investment return and discount rate assumptions, the reported net pension liability for the city's public safety plan will more than triple as of January 1, 2015 to $4.7 billion, from $1.3 billion a year earlier."
The Dallas Police and Fire Pension System became embroiled in controversy over its investments and accounting practices in 2014. City officials wanted to conduct an audit of the $3.3 billion fund.
Dallas Mayor Pro Tem Tennell Atkins, who serves on the pension board, brokered a deal to provide an audited report from the firm of Deloitte.
A summary of Deloitte's report released Jan. 20 focused on $1.287 billion in alternative assets held by the fund at the end of 2013. Of those, Deloitte found that $772 million in assets were at risk of being overvalued "because the valuation approaches or methods appear to have been improperly applied and/or inconsistent with commonly accepted valuation practice."
The Dallas fund also suffered about $96 million in losses on risky real estate investments in 2013 due to write-downs that followed new appraisals.
One of those investments was the Dallas Museum Tower is a luxury condo tower whose sales have fallen far short of expectations two years after it opened. Glare from the tower has also led to battles with the nearby Nasher Sculpture Center in the city's Arts District.
The Dallas Police and Fire Pension System is also a major investor in two public-private toll projects in the Dallas-Fort Worth area, the LBJ Managed Lanes Project in north Dallas and its suburbs and the North Tarrant Express in Tarrant County.
In 2010, the pension fund became one of the first in the country to invest directly in the building and maintenance of a major road infrastructure project.
