AUSTIN -- Now that Dallas and Houston are on a path to solve their pension problems, Fort Worth is seeking solutions to its unfunded obligations.
Like Dallas and Houston, Fort Worth took a ratings downgrade due to its growing pension funding problems, but it has advantages the other cities did not enjoy.
“We’re headed to a place where we don’t necessarily want to be,” said Aaron Bovos, Fort Worth's chief financial officer. “The answer to the question of how to fix that is not so simple.”
One advantage Fort Worth has over Dallas and Houston is the fact that the city council has full authority to change the benefit structure for all city employees, Bovos said. Whereas Dallas has separate funds for its police and firefighters, all three of Fort Worth’s employee groups share one fund.
“We went through a round of pension reform in 2008 to 2009,” Bovos told The Bond Buyer’s Texas Public Finance Conference in Austin Wednesday. “But that didn’t solve the problem.”
“We saw a 22% decline in funded status over the last four years,” Bovos said. “Weak market returns will continue to cause decline in funded ratios.”
A nine-member task force created by Fort Worth city manager David Cooke is seeking methods to reduce the $1.6 billion unfunded liability that has mounted over the past 25 years from benefit decisions, investment losses and unmet assumptions on investment returns.
Taxpayers and employees are expected to contribute to eliminating the unfunded obligation, according to proposals submitted thus far. Proposals include a 2% increase in the amount taxpayers pay to the pension fund from payroll. That would add about $8.8 million annually.
With about 850,000 residents, Fort Worth is the fifth most populous city in Texas. In July, it took a one-notch downgrade from Moody's Investors Service, dropping to Aa3 from Aa2 and retaining a negative outlook.
“The downgrade to Aa3 reflects the city's large and growing unfunded pension liability and growing fixed cost burden, which includes annual pension, OPEB and debt service requirements,” Moody’s analyst Nathan Phelps wrote in the July 13 report.
Houston entered 2018 with restructured pension plans after years of struggle to reach agreement with employee unions on a sustainable path.
The final piece of the plan issuing $1.01 billion in pension obligation bonds in December.
“Houston pulled off what once seemed impossible," the city's controller, Chris Brown, told the conference.
The Houston Pension Solution reforms the city’s three pension systems, addresses $8.2 billion in outstanding pension liability, and does so in a budget-neutral manner, Brown said.
Houston’s pension reform required significant buy-in from multiple sides – receiving support from Houston City Council, the Texas Legislature, and Houston voters, who overwhelmingly supported the issuance of $1.01 billion in pension obligation bonds in November.
"This plan received widespread support at the Texas Legislature, with City of Houston voters, and now with the investor community," Brown said. "The city's all-in true interest cost for this issuance came in at 3.965411% -- significantly lower than we initially anticipated. This represents significant cost savings, and demonstrates investor confidence in this plan's impact on the City of Houston's bottom line."
The pension bonds add $750 million in liquidity to the Houston Police Officers Pension System and $250 million into the Houston Municipal Employees Pension System.
The liquidity shores up the more than $1 billion in deferred payments to the pension systems, and was critical to gain the systems' buy-in to the pension reform plan.
Dallas’ troubled Police and Fire Pension was in worse shape than Houston’s when the Texas Legislature approved changes in 2017 to end a run on the bank for fear the pension funding would be depleted. The state law gave the pension board a new governing structure that provided more control from the city. Before that, plan beneficiaries were running the system with little say from the city.
In November, a new board approved rules for retirees.
Under the Deferred Retirement Option Plan, or what's known as DROP, retirees who paid into DROP accounts previously had full access to the money and could withdraw lump sums. Under new rules, withdrawals were capped at $3,000 a month.
While Texas’ largest cities still face pension pressures after their reforms, most local issuers face manageable situations, S&P Global Ratings analyst Sussan Corson told the conference.
“Although Texas issuers typically have very weak debt and contingent liability profiles, this is often attributable to local governments having high overall net debt as a percent of market value, rather than large pension obligations,” said Corson, who joined other S&P analysts in writing a Feb. 9 report led by S&P analyst Andy Hobbs.
Most Texas governments continue to experience steady gains in market value and economic activity, which equate to growing revenue streams and stable, strong available reserve positions, S&P wrote.
“Healthy reserves and greater financial flexibility will allow issuers to address long-term pension pressures,” analysts said. “Overall, S&P Global Ratings believes Texas local governments have relatively low pension costs and participate in pension plans that are well funded.”
At the state level, S&P sees potential credit pressure on the Employees Retirement System and Teacher’s Retirement System from weak funding discipline and exposure to investment risk.
“Long-term credit risks could result from ongoing challenges to shore up or contain liability growth related to pensions, particularly if costs rise to unsustainable levels absent a credible plan and active management to stabilize or reduce such liabilities,” analysts said.
The state legislature sets ERS employer contributions on a biennial basis as a percentage of payroll, and contributions are constitutionally limited to a fixed 10%. The plan's actuaries calculate a combined actuarially sound contribution rate equal to the percentage of payroll sufficient to fund normal cost plus 31-year amortization of the unfunded liability.
ERS recently reduced its assumed rate of return to 7.5% from 8%. The changes result in a projected decline in the funded ratio to 54.7% from 55.3%.
“The state clearly faces funding challenges,” S&P wrote. “Over the long term, however, we believe certain demographic and employment trends as well as the ability to reform benefits for current state employees and oversight provided by the PRB are advantages relative to some other states.”