Cash-strapped US states and cities face the prospect of downgrades after Fitch Ratings changed the way it analyses their burgeoning pension bills.
In a report published on Thursday, Fitch warns the new approach could lead to “limited negative rating action”, particularly for local governments with big wage bills. The changes to the way it assesses pension liabilities come amid growing concern over the scale of municipal debt problems and the effect on state and city finances of generous, unfunded public sector pension schemes that will run for many years. Sharp falls in equities and other risky assets during the financial crisis reduced the funding levels of nearly all these pension plans, increasing the pressure on states and local governments when they have even less cash because of dwindling tax revenues to make up the shortfall. Revenues have tumbled while spending has been rising…
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.
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….
Hawaii’s credit ratings may take a hit given changes being made by a major ratings agency in the way it looks at public worker pension obligations.
Fitch Ratings, one of three major U.S. ratings agencies, said it’s new evaluation of pension funding may hurt the ratings of some cash-strapped states.
“Fitch expects that limited negative rating action is possible as a result of this enhanced framework, but does not expect the action to be widespread,” the New York-based agency said in announcing the changes.
Fitch didn’t single out any state or local government for a possible ratings downgrade in the report but did provide information showing Hawaii’s funding ratio, like many other states, would fare worse under the new system. Ratings downgrades are potentially costly for states when they sell bonds to finance roads, airports and buildings because investors will demand higher interest rates.
“Fitch generally considers a funded ratio of 70% or above to be adequate and less than 60 percent to be weak, while nothing that the funded ratio is one of many factors considered in Fitch’s analysis of pension obligations,” the report said.
The report lists Hawaii’s funded ratio at 64.6 percent on June 30, 2009.
But when applying one of the new formulas that will be used by Fitch, Hawaii’s funded ratio drops to 58.2 percent.
When another of the changes is applied the ratio drops to 55.7 percent.