Annual underfunding of Birmingham, Alabama’s pension plan led a second rating agency to downgrade the city’s bonds.
Moody's Investors Service lowered the city’s issuer and general obligation limited tax bond ratings to Aa3 from Aa2 on Monday. Also downgraded to Aa3 from Aa3 were the Birmingham-Jefferson Civic Center Authority’s 2018D revenue bonds and the Birmingham Commercial Development Authority’s 2011-A and 2011-B bonds.
The outlook has been revised to negative from stable. The city has about $549 million of outstanding long-term debt.
“The negative outlook reflects the expectation that the city will be challenged over the near term to adequately fund their pension liability,” said analyst Christopher Coviello. “For over a decade, the city's strong financial results have been achieved, in part, by contributing insufficient amounts to the [pension] system, directly leading to higher unfunded liabilities and balance sheet leverage.”
As of fiscal 2018, Moody’s said its adjusted net pension liability for the city was $1.1 billion, or 242% of its operating revenues, and far greater than its debt and unfunded liability for other post-employment benefits.
Unlike most U.S. public pension systems, which are reducing assumed rates of investment return, Moody’s said Birmingham’s Retirement and Relief System increased its assumed rate of return as part of its 2015 actuarial valuation, to 7.5% from 7.0%.
The move lowers reported liabilities and makes the city's annual underfunding appear less severe on a reported basis, but Moody’s said it also adds long-term risk to the city's budget by increasing the probability of investment underperformance and heightening expected return volatility because the system must accept greater investment risk in order to align its asset composition with its return target.
“The longer that Birmingham's pension contribution shortfalls persist, the higher the likelihood that its pension liabilities will eventually result in budgetary stress,” Coviello said. “We expect Birmingham's pension-driven structural operating imbalance to continue absent material increases to contributions and/or reductions to benefits.”
The magnitude of the city's pension challenge could accelerate if the pension system experiences adverse investment performance, he added.
Birmingham's financial position remains healthy with given “solid reserve and liquidity levels,” Moody’s said. The city's debt burden is moderately above-average but it is manageable because of solid tax base growth and the lack of any significant debt plans.
City officials said they notified employees about the new rating downgrade on Tuesday, saying that it wouldn’t impact day-to-day operations or employment.
In a statement to employees forwarded to The Bond Buyer, Mayor Randall L. Woodfin said his administration has publicly identified the pension fund as an issue that has been developing over the last 18 years.
“The administration has made this a priority to resolve and is currently working closely with the pension board to identify a long-term solution,” said the statement, which is similar to one released in March when Fitch Ratings downgraded the city’s bonds. Fitch said it downgraded Birmingham’s GO rating to A-plus from AA-minus because of its decade-long policy of funding the actuarially required contributions below recommended levels. The rating outlook was revised to stable from negative at the lower rating.
The city said it has taken steps to increase its contribution rate.
According to Moody’s, the city will gradually increase its contributions to the system. In fiscal year 2021, officials plan to contribute 9% of payroll compared to 8.5% in 2019 and 2020 and 7.25% in fiscal 2018.
S&P Global Ratings rates the GOs AA.
Birmingham is in north-central Alabama and is the county seat of Jefferson County. It is the largest city in the state even though its population is declining. In 2017, the U.S. Census Bureau estimated the number of city residents at 210,700. In 2010, the population was 212,237.
