Armageddon prep

Fitch Ratings has issued a report on the financial qualities of municipalities that are best able to withstand a disaster. (It kind of makes you wonder if they know something we don’t.) In its Dec. 2 report, Fitch said its ratings already “speak to overall resiliency to manage unexpected events.” This is largely because when disaster strikes, affected areas need quick access to cash. “Under a disaster scenario, those issuers which possess revenue diversity as well as an ample supply of reserves and liquid assets can quickly restore operating capabilities, as well as finance the clean-up and recovery effort, until private insurance and state and/or federal disaster reimbursement funds are received,” Fitch's report said.

Here, size matters. Fitch said that smaller issuers with limited liquid financial resources or limited assets (e.g., a higher education institution or health care facility) “may be more vulnerable to credit deterioration following an event.” Conversely, cities or states are viewed more favorably as they can call upon more resources during such events.

Actions have consequences

The financially struggling state of New Jersey this week issued $525 million in bonds to help fund science, technology, engineering and math programs in schools. In a Dec. 4 analysis of the sale, Bloomberg News noted that New Jersey's borrowing costs had swelled since the last time it went to market with General Obligation bonds. In a newsletter, Bloomberg said this week’s bonds mature in June 2025 and were priced to yield 2.75 percent, or about a half-percentage point more than the average (a.k.a., the yield spread). That's roughly five times the 0.09 percentage point yield spread for 10-year debt the state sold back in May 2013. The increase means that it’ll cost New Jersey $1.4 million more per year in debt payments, compared with its payments on the May 2013 debt.

Bloomberg, noting that the state’s credit rating has been downgraded  eight times by the three biggest rating companies under Gov. Chris Christie, attributes much of the price hike to the state’s deteriorating pensions. This year, Christie cut $2.5 billion in promised pension payments to balance the state’s budget. In a supplement to the bond offering, New Jersey last week reported its retirement system had enough assets to cover 32.6 percent of projected liabilities as of June 30. The state was the first to use new pension accounting methods required for public plans that have not been fully funded by their governments.

The experience of New Jersey, which has the second-lowest rating of any state, serves as a warning to other states that have also neglected their pensions – namely Illinois (the worst-rated state), Pennsylvania and Kentucky. Heads up, guys.

Singing Kumbayah

As if filing for municipal bankruptcy weren’t historic enough, the Southern California city of San Bernardino was also,  in 2012, the first city to skip out on its pension payments to the big, bad CalPERS (California Public Employees Retirement System). Up until that point, no other California city (not even Vallejo in its 2008 bankruptcy), wanted to pick a fight with one of the world’s largest pension plans.

Well, now it looks like the city is coming hat in hand to CalPERS and has apparently worked out a deal to pay back $14 million of missed payments. According to a Moody’s Investors Service analysis of the development, San Bernardino will make the payments over a two-year period and will likely continue making all future pension payments. While the agreement with CalPERS significantly advances the city’s complex plan of adjustment in bankruptcy, it “indicates that San Bernardino is unlikely to reduce pensions in its plan of adjustment, a credit negative for holders of the city’s certificates of participation (COPs) and pension obligation bonds (POBs),” Moody’s said in the analysis. San Bernardino hopes to issue its plan of adjustment in 2015.

This trend of bondholders being placed behind pensioners is playing out in the more recent city bankruptcies and is one that ratings agencies generally don’t like. (And they’ve said so on several occasions this year.) Moody’s warns that “San Bernardino’s choice to leave its accrued pension liabilities unimpaired means that its contribution requirements to CalPERS will likely increase to the point where they weaken the city’s financial profile, even after the relief provided by the bankruptcy adjustments.” Of course every municipal bankruptcy is different and each case requires a tailored solution. But so far, it seems that cities are more comfortable making faceless bondholders pay more over their own retirees.