Pennsylvania's Monday downgrade from Moody's Investors Service could precede more bond rating actions as unfunded pension liability continues to hover over the commonwealth, said capital markets and pension experts.
"I wouldn't be surprised if Standard & Poor's and Fitch [Ratings] lowered their ratings also. Both have Pennsylvania on negative watch," said Alan Schankel, a managing director at Janney Capital Markets in Philadelphia, said Tuesday.
Moody's downgraded Pennsylvania's general obligation rating to Aa3 from Aa2, and assigned a stable outlook. The move affected $11.1 billion of GO debt.
Pennsylvania is staring at an estimated $50 billion of pension liability that Gov. Tom Corbett said could spike to $65 billion within three years if unchecked.
"Doing nothing is not an option," he said Monday.
"Large and growing pension liabilities coupled with modest economic growth will limit Pennsylvania's ability to regain structural balance in the near term," according to Moody's. The rating agency also downgraded ratings for $2 billion of appropriation-backed bonds by one notch, as well as the programmatic ratings assigned to the state's intercept programs for distressed school districts.
"It also affects the street-level, local-level issuers when the state gets downgraded," said Natalie Cohen, director of municipal research for Wells Fargo Securities LLC.
Richard Dreyfuss, an adjunct fellow with the Manhattan Institute for Policy Research, called on lawmakers to implement pension funding policies that eliminate current unfunded liabilities over 20 years. "Until such positive actions are implemented, the action by Moody's represents another downgrade in what is developing as a continuing sequence," he said.
Corbett and his fellow Republicans, who hold a majority in both houses of the state legislature, could not pass a pension overhaul plan in the session that ended earlier this month. Corbett proposed one that would out new state workers in a so-called hybrid plan that merges traditional defined-benefit and 401(k)-style defined contribution plans, but it failed to gain traction.
"Policymakers are focused on debating the design of pension benefit for those members yet to be hired. This is a separate issue from that being raised by Moody's and other credit rating agencies," said Dreyfuss, who oversaw compensation and benefit packages during his 21 years at Hershey Co. and is also a Commonwealth Foundation senior fellow.
Standard & Poor's on April 28 warned about pension inactivity. "The state's growing expenditure pressures, primarily due to inaction on pension reform, coupled with slow economic growth and limited-to-no reserves, have diminished the state's financial flexibility and could result in a downgrade," S&P said at the time.
Last year, Fitch downgraded Pennsylvania's general obligation bonds after the state made no changes to its pension plans. Fitch and S&P rate Pennsylvania AA.
Pennsylvania is one of several pension battlegrounds.
"[Pennsylvania's] problems are not uncommon, although Pennsylvania falls into the category of among the worst in pension liability," said Cohen. "New Jersey, Illinois and Kentucky fall into that bucket."
Pennsylvania has not fully paid its annual actuarially required contribution since 2004. That and investment losses from the recession have accelerated the liability over the last decade.
"Pennsylvania is not as bad as Illinois, certainly, but Pennsylvania's problem is that while they're funding's not great, it will get worse as they continue in glide position with their payment obligations," said Schankel.
Moody's also cited the just-enacted $29 billion budget that depends on one-time resources and a weak generally accepted accounting principles balance position that could further deteriorate. According to Moody's, stop-gaps accounted for 7% of the new budget.
Under the 2010 state law known commonly as Act 120, Pennsylvania will slowly increase its contributions from 29% of the ARC in fiscal 2010 to 100% in fiscal 2017. Its major pension funds are the State Employees' Retirement System and the Public School Employees Retirement System.
Corbett said 163 school districts requested exemptions to increase property taxes above state limits, nearly all of them citing pension costs.
The House is scheduled to reconvene on Aug. 4. The Senate plans to meet for its regular fall session on Sept. 15, right as the November elections hover. "I'd be surprised if anything happens," said Schankel.
