Public pension funds are on a path to report a second straight year of weak investment performance, says Tim Blake, Managing Director at Moody’s Investors Service, who adds that in the first half of this fiscal year funds have recorded negative investment performance. He also discusses the credit implications of rising unfunded liabilities and looks at the effect of the new GASB reporting rules on state and local governments.

SPEAKER: With three months to go in fiscal 2016, public pension funds are on a path to report their second consecutive year of weak investment performance. The funds in 2015 undershot their investment targets by four to five percentage points and they'll likely see a similar or even larger gap this year. More specifically for this year, in the first half, funds recorded negative investment performance about negative three percentage. And based on the stock market in the last quarter, they're likely still negative after nine months.

Even if we look at an optimistic scenario where they recover to say positive five percentage points for this year, the two-year trend will mean that unfunded liabilities will increase by our estimates, almost 30%, reversing the funding progress from 2013 and 2014. The credit implications for governments are twofold. First, virtually all state and local governments are exposed through their pension funds to the volatility of the stock market.

Second, government budgetary contributions in for most are still too weak to begin reducing pension liabilities, and so there will be pressure to increase budgetary contributions in the future for this reason. One other important point is that government financial statements that are available today mostly feature pension information from 2014, and that is clearly outdated already in terms of reflecting recent stock market performance. Well, [unintelligible 00:01:47] 67 and 68 have been implemented already and they are helpful in terms of providing additional disclosure, but they don't alter underlying credit risk.

Our basic view that pensions are debt-like obligations is unchanged by the new reporting rules, and our analytical process is really minimally affected. Pensions are one of many factors that we look at when determining government credit rating and there's wide variation amongst governments in the degree of pension burden. Clearly, in more than a few credits, pension pressure is very significant and pensions have also featured very prominently in several of the bankruptcies in defaults of recent years, typically to the detriment of bond holder recovery.