HARRISBURG, Pa. — With Pennsylvania's bond ratings at stake, lawmakers and officials this week resume debate over state and local unfunded pension liabilities.
Finding pension and budget solutions palatable to various political factions and to the capital markets won't be easy.
Pennsylvania has an estimated $53 billion unfunded pension liability that was the main driver of downgrades in 2014 from all three major bond rating agencies. Additionally, state Auditor General Eugene DePasquale has identified 562 municipal pension plans statewide as fiscally distressed, with a combined liability of nearly $8 billion.
And from DePasquale came another bombshell on Tuesday: the existence of meeting tapes related to an investigation into double pension benefit payments Scranton awarded to non-uniformed employees in 2002 and 2007. The development will delay his department's report on the deal, he said.
"It's encouraging that DePasquale is digging deeper," Gary Lewis, a private-sector financial consultant and former Scranton mayoral candidate, said in an interview. "All kinds of things have come out of Scranton - lack of oversight, double pensions, finger-pointing, lack of controls over the years."
At the state level, lawmakers Tuesday began public hearings on bills to overhaul the benefit system for state employees.
Moody's Investors Service rates the commonwealth's general obligation bonds Aa3, while Fitch Ratings and Standard & Poor's rate them AA-minus.
"We knew back then the extent of their budgetary problems and we knew the problems they had with pensions, so none of this is a surprise," Fitch Ratings director Eric Kim said of its downgrade last September.
Fitch rates only Illinois, California and New Jersey lower, with Kentucky on a par.
"That puts Pennsylvania in the bottom five, which speaks to the depths of their challenges," said Kim. "Our stable outlook reflects our view that Pennsylvania has the tools to deal with these issues."
DePasquale also said Scranton could go bankrupt within two years - advancing his timetable from the five years he estimated last fall.
Pennsylvania is not alone in pension struggles. Pension funding is a flashpoint in neighboring New Jersey. The struggle with pensions in Illinois, where the state Supreme Court recently struck down a state plan to overhaul its retirement systems, led Moody's to downgrade Chicago to a junk-bond rating. Puerto Rico, where pensions are also a serious headache, is deep into junk status.
Municipal markets are increasingly pricing in pension risk with spreads wider for Illinois, New Jersey and Pennsylvania, according to Janney Capital Markets managing director Alan Schankel. Illinois, the state with the lowest pension funding levels, has experienced spreads ranging from 105 to 182 basis points for 10 year maturities based on Municipal Market Data benchmarks, said Schankel.
"New Jersey and Pennsylvania spreads have also been moving wider, with Pennsylvania particularly tested by a $1.24 billion new issue sale last week," he said.
Lewis, however, thinks California will provide the ultimate barometer for pension funding, despite Illinois providing the noise of the day.
"Illinois is definitely the most recent piece of news, but I think the final solution will be what happens with CalPERS," he said of the $300 billion California Public Employees' Retirement System. "That will have more of an impact on the other states."
CalPERS reports a 77% funding level as of June 2014.
CalPERS, whom former San Jose Mayor Stephen Reed called "the biggest bully in California" in a recent Bond Buyer interview, has been fighting pension cuts in bankruptcy filings by localities within the state. Reed says CalPERS' contribution requirements are squeezing out cities' ability to provide services for their residents.
According to Lewis, Pennsylvania's local liability problem is more critical than the state's.
"The state pensions need better management, but the localities are more on the cusp of a financial disaster. And that eventually will trickle up to the state," he said. "The credit agencies will then worry about the state having to backstop them. Once the credit agencies take their swings at you, you're not off their short list and then you have to take some serious steps to improve things."
David Fiorenza, a professor at Villanova School of Business, sums up the pending DePasquale report in one word: regulation.
"Unfortunately, municipal pensions are in distress with underperforming results, so not many choices are available but for the commonwealth to issue strict guidelines to the municipalities," said Fiorenza, a former chief financial officer of Radnor Township, Pa.
While DePasquale was warning of dire consequences for Scranton, the union-controlled pension boards for city firefighters and police officers were suing for raises for many of its retirees.
On the state employee side, the House state government committee is considering Senate Bill 1, a Senate-approved bill to change pension benefits for future and current state workers and teachers.
It would put new employees into a 401(k)-style defined contribution plan while letting current employees stay in the traditional defined-benefit public pension plan and decide whether to contribute more to maintain current benefit levels or take a benefit reduction instead. The bill would also create a Public Pension Management and Asset Investment Review Commission.
The state's major pension funds are the State Employees' Retirement System and the Public School Employees' Retirement System.
The labor-oriented Keystone Research Center has called SB1 unconstitutional, saying it will meet a similar fate as the Illinois overhaul.
"Our reading of the court decisions is that the reductions in benefits required of current members would be ruled unconstitutional," said Keystone economist and executive director Stephen Herzenberg, who called the bill "not ready for prime time" because it was rushed through the Senate.
While the Republican-controlled House and Senate debate several bills, Wolf's proposed $30 billion budget for fiscal 2016 includes $3 billion in pension obligation bonds.
Janney analyst Tom Kozlik has called the issuance of pension bonds a "noteworthy credit negative" and urged states and localities to shun them. The Government Finance Officers Association has also advised against such a move.
"It differs state by state, but I think the common theme is that whether it's a state or a local government that's considering this kind of tool, it's a way for issuers to punt difficult decisions down the road, mostly raising revenue or raising taxes," he said in a
