The Week in Public Finance: Detroit, UConn Dominance and Pension Warnings

A roundup of money (and other) news governments can use.

Motown shuffle

Fitch Ratings agency gave the latest settlement in Detroit’s bankruptcy trial between bond insurers and the city its stamp of approval this week (beginning April 7). The settlement will give the insurers of unlimited tax general obligation bonds (ULTGOs) 74 cents on the dollar, a return that Fitch said was more in line with its “expectation for how such securities would fare in bankruptcy.” (When bonds are insured, the insurers – in this case Assured Guaranty, Ltd, Ambac Assurance Corp. and National Public Finance Guarantee Corporation – rather than the bondholders stand to lose their investment.) The ULTGOs were voter-approved bonds to be paid back via a property tax. The previous offer from Detroit Emergency Manager Kevin Orr was 15 cents on the dollar, a decrease from the initial 20 cents proposed in the city’s readjustment plan.

The bond insurers also agreed to allow the city to send the remaining 26 percent of tax revenues levied for ULTGOs to a fund for Detroit's "most vulnerable" retirees, a move that is likely meant to win pensioners’ support for plan. Whether or not this convinces retirees to accept the settlement remains to be seen.

Street cred only for a Big Dance appearance

The University of Connecticut’s double-championship week may help its recruiting prospects but the school is sitll located in a state that has suffered a credit rating downgrade thanks to rising debt and pension costs. A little over two years ago, Moody’s downgraded Connecticut one step from Aa2 to Aa3 and followed up that action by striking UConn with the same downgrade to Aa3. This month, the university’s men’s and women’s basketball teams both won national championships, the second time in school history its teams have enjoyed a double title (the first was in 2004).

According to a Standard & Poor’s report issued this month to subscribers, schools that have a good showing in the tournament generally draw fans to future games and can get a leg up in perusing students and money because of their status as a nationally recognized institution. "This is especially important given that tuitions and fees are already high and rising well above the rate of inflation, meaning that most colleges and universities won't be able to rely solely on higher tuition to close any financial gaps," said S&P credit analyst Bianca Gaytan-Burrell in the report, entitled "A Trip To The Big Dance Can Help The Finances Of Winning Schools, But A Quick Rating Boost Isn't Likely."

Down on pensions

Janney Montgomery Scott Analyst Tom Kozlik notes an interesting dichotomy with regard to state finances and the economy in his April State Fiscal Health update.

If current trends continue in 2014, this year would mark the 6th-longest expansion for the U.S. economy since World War II. As such, state tax revenue would continue to rise. The problem is that states still haven't fixed their financial problems. State spending continues on a dangerous path, particularly when it comes to pension funding, Kozlik says. Many states curtailed pension funding during or before the recession. In some cases states haven’t resumed proper funding. “This is creating an increasingly worrisome level of fiscal damage that could be all but irreversible unless significant reforms are made,” Kozlik writes. “So far, we have become increasingly pessimistic about the prospects for reform.”

He notes that Illinois, Kentucky, Connecticut, New Jersey and Pennsylvania have all suffered credit downgrades, in part as a result of such practices. Kozlik adds: “We believe there is a strong likelihood that the credit circumstances within these states will worsen, especially when there is an economic downturn.”

Beware of quick fixes

Speaking of pensions, Municipal Market Advisors’ Matt Posner predicts that 2014 could mark an increase in governments issuing Pension Obligation Bonds to cover shortfalls in pension funding. These bonds are taxable debt that governments sell in order to dump the proceeds into pension funds to help fill funding gaps. They make the fund appear healthier, but also put more debt on the government’s books that must be paid out to bondholders. As such, “POBs are almost always a drag on credit quality,” Posner, a municipal analyst, writes in his Municipal Issuer Brief.

Posner lists four reasons for why POBs may become more attractive this year:

  • Rising awareness of unfunded pension liabilities thanks to new accounting standard being applied this year that will require states to include pension liabilities in their balance sheets; 
  • Robust pension investment performance of late that may lead managers to believe these results can be continued, which is needed to properly pay back POBs;
  • Moody’s focus on pension obligations could compel issuers to replace those liabilities with POBs and
  • State and local budgets under pressure from rising expenses and a weaker economic recovery may be tempted by the one-time budget savings allowed by POBs.
Posner warns that any government that issues POBs is sending up a red flag to investors. "Governments that have used POBs are likely to be viewed with some suspicion by investors [because this is] reflective of a gimmick," he writes.

Liz Farmer is a former GOVERNING fiscal policy writer.