Unfunded pension obligations pressuring Kentucky’s budget led S&P Global Ratings to revise the state’s credit outlook to negative from stable.

BRADENTON, Fla. - Kentucky's credit outlook was revised to negative ahead of an upcoming bond deal, a move S&P Global Ratings said was triggered by unfunded pension obligations.

S&P revised its outlook on the state to negative from stable while affirming its A-plus issuer credit rating and A ratings on lease debt issued by various Kentucky public corporations.

S&P also assigned the A rating to the Kentucky State Property and Buildings Commission's upcoming sale of $224 million of revenue bonds expected to price by negotiation around Jan. 25.

"The outlook revision reflects our view that funding levels of the commonwealth's pension plans could significantly weaken and associated fixed costs could continue to rise to a level that might significantly pressure budgetary performance and flexibility," said S&P analyst Timothy Little.

Kentucky's ratings could be downgraded in the next two years if pension funding levels decrease significantly and pension plan liquidity worsens to the point that it will affect the state's ability to return to structural balance, he said.

"While the state has made incremental progress in addressing the underfunding of these obligations, it is our opinion that some plan assumptions may be overly optimistic," Little said.

S&P cut the Bluegrass State's issuer credit rating to A-plus from AA-minus in 2015 citing "the state's demonstrated lack of commitment when it comes to funding its annual contributions."

Last year, Kentucky contributed about $1 billion over the 2017-18 biennium to its pension plans.

However, S&P said that the state's chronic underfunding continues to translate into large unfunded pension liabilities, and funded levels among the lowest in the nation.

The state's largest pension plan, the Kentucky Teachers' Retirement System, had a funded ratio of 31.2% on an actuarial market basis as of fiscal 2016 and the Kentucky Employees Retirement System's Non-Hazardous plan – the second largest - was 14.8% funded, S&P said.

KTRS's unfunded actuarial accrued liability was $14.5 billion as of June 30, 2016, and the system had $17.5 billion of assets, according to the preliminary official statement for the upcoming bond issue.

The KERS non-hazardous plan had an unfunded liability of $11.12 billion, and assets totaled $2.1 billion, the POS said.

Kentucky also faces legal problems that could make it difficult to enact meaningful reform in a timely manner, S&P said.

A number of lawsuits have been filed against some state pension plans, and one organization that the state allowed to participate in its retirement plans filed for Chapter 11 bankruptcy seeking to discharge its liability.

The state has hired PFM Group to review its retirement systems and recommend policy changes.

Kentucky plans to use bond proceeds from the upcoming issuance to fund various capital projects as well as a workforce development program.

Fitch Ratings assigned an A-plus rating to the deal, while Moody's Investors Service assigned an Aa3 rating. Both have stable outlooks.

Citi will be the book-runner. The underwriting team includes First Kentucky Securities Corp., FTN Financial Capital Markets, J.J.B. Hilliard, W.L. Lyons LLC, Morgan Stanley, PNC Capital Markets LLC, Raymond James & Associates Inc., and Ross Sinclaire and Associates.

Dinsmore & Shohl LLP is bond counsel. Stites & Harbison PLLC is underwriters' counsel.

Subscribe Now

Independent and authoritative analysis and perspective for the bond buying industry.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.