Fitch: Downgrades Loom for U.S. Cities and States

Cash-strapped US states and cities face the prospect of downgrades after Fitch Ratings changed the way it analyses their burgeoning pension bills to slightly more realistic assumptions, reports FT.



So will Charlie Gasparino attack Fitch the way he did Meredith Whitney? Not a chance.

In a report just published Fitch warns the new approach could lead to “limited negative rating action”, particularly for local governments with big wage bills. Just where Whitney warned the problem is.


“The key questions are whether states and local governments are funding their pensions, how much it is taking up of their general fund and concern about the crowding out of spending for other needs,” said Laura Porter at Fitch.

The rating agency, which used data from 2009, said there was cause for near-term concern about “a number of” pension plans and pointed to the “considerable pressure that these obligations will place on many government budgets”. The greatest risk would come at the local level since labour-related costs were a higher percentage of local government budgets, Fitch said. It should be noted that some critics of Whitney argue that there is no problem with general obligation bonds at municipalities. Fitch's statement would suggest otherwise.
 

In Miami, Florida, a quarter of the city’s operating budget pays for pensions. Among states, Illinois stands out for setting aside 12 per cent of its budget for its chronically underfunded pension.

In valuing pension liabilities in its credit analysis of states and local governments, the rating agency will now assume a return on assets of 7 per cent, lower than the average return of 8 per cent used by most pension plans. That translates to an increase in the average plan liability of 11 per cent.

Using the 7 per cent rate does not shift any plans from being adequately funded, which Fitch considers to be assets equal to 70 per cent of liabilities, to “weak”, or under 60 per cent. However, plans in Montana, Hawaii, Vermont and New Jersey are among those whose funding ratios fall under 60 per cent using Fitch’s assumptions.
The Illinois State Employees Retirement System is the weakest at 37 per cent, compared with 44 per cent using its reported 8.5 per cent assumed rate of return.

A hypothetical 6 per cent assumption, however, would drag plans in Nevada, Massachusetts and Minnesota from adequately funded to weak ratios.

For state-run plans that also cover local workers, Fitch said it is difficult to assess how much of the liability is the obligation of the local government because plans typically do not provide this breakdown. That can overstate states’ obligation and understate what local governments owe.
 
I further note that a return on assets of 7% will only occur in the current stock market continues to climb, since yields on even long-term corporate debt securities are well under 6%, never mind 7%. If the stock market climb stops, the return on assets for will collapse.