Ratings agencies unfazed as county pension costs rise

Screen Shot 2014-07-02 at 12.59.43 AMPublished in the Pacific Coast Business Times, October 25, 2013 (PDF)

Despite dire warnings that future pension costs could cause a fiscal meltdown for tri-county governments, credit ratings for Santa Barbara, Ventura and San Luis Obispo county bonds remain mostly unaffected by looming gaps in their retirement obligation funding.

Standard & Poor’s, a leading rating agency, ranks all three counties near the top of a scale that spans from its highest AAA to C, the lowest rating a bond can have without defaulting. Santa Barbara County carries the agency’s second highest AA-plus designation. Ventura County is assigned a slightly lower AA-rating this year and SLO County is ranked AA-minus.

The ratings have been bolstered by recent California reforms designed to reduce the impact of upcoming obligations. And despite a high-profile dispute in Ventura County over former Sheriff Bob Brooks’s demand for more pay, the ratings suggest that Wall Street believes the county governments will find a way to pay back their pension obligations without a serious threat to municipal bondholders.

“The argument is that a lot of the bonds would run into the pension problems that would hit further down in the future,” said economist Chris Thornberg, the chief economist at Los Angeles-based Beacon Economics. “There are lots of potential policy choices that can be made between now and then that could head this off.”

Key indicators that could lead to a ratings downgrade would be dramatic growth in unfunded liability, another stock market collapse or the inability for funds to keep up with the flood of government-employed baby boomers who are reaching retirement age. These problems are magnified if the county lacks the necessary reserve budget to cover missing funds, experts said.

Further complications can also arise when pension systems choose to issue their own taxable bonds, known as pension obligation bonds, with the hopes that investment returns will exceed interest rates on the bonds.

Last year, ratings giant Moody’s put the pension obligation bonds of nine California counties under review for a ratings downgrade because of a suspected higher risk of default. These bonds also played a role in high profile municipal defaults in Detroit and Stockton.

“Why the hell would a pension issue its own bonds? That doesn’t make any sense,” Thornberg said.

In the region, only SLO County’s plan currently has outstanding pension bonds, but because of the plan’s relatively small size and conservative accounting practices, those bonds were also rated AA-minus by S&P. The pension bonds also earned an AA rating from Fitch.

SLO County Auditor Controller James Erb said the county has been maintaining a relatively low overall debt burden and healthy reserve budget to cushion any potential pension investment shortfalls. Fitch affirmed an AA rating on the county’s lease revenue refunding bonds last year. Payments for these bonds comes from the county’s general revenue.

“What ratings agencies really want to know is, ‘Do these guys have reserves they can go on if they need to?’” Erb said.

At their most recent S&P assessments, the San Luis Obispo and Ventura county plans were each funded by county and employee contributions at a 78 percent level. In constrast, highly rated Santa Barbara County’s pension plan is funded at just 71 percent.

All three county pension funds outperformed expected return rates for the fiscal year ended in June, but losses incurred by the 2008 economic collapse mean that 10-year averaged returns for each still lag below the actuarial rates needed to make up unfunded liability.

Paul Derse, chief financial officer for Ventura County, said the overall level of unfunded liabilities may not be as important to the rating agencies as management skills. “The bottom line is, clearly, they look at [pension costs], but there are other factors that weigh more heavily,” Derse said. “They really do look significantly at the management and what management does proactively.”

Ventura County offset some of the effects of its steadily rising pension plan costs by growing reserves, which create a buffer against a down year. The county increased reserves by about four percentage points since 2008 to 11 percent of the overall budget.

While Ventura County’s contributions to its pension system have climbed by about 55 percent over the past five years, Derse expects costs to eventually decline thanks to recently instituted reforms to retirement benefits for new employees. Still, the county forecasts that county contributions will grow from its current level of about $175 million to $220 million in the next five years.

The reforms are being implemented in conjunction with a statewide pension reform act signed into law by Gov. Jerry Brown in January known as PEPRA that aims to close many of the loopholes pension employees might exploit to “spike” their retirement pay.

A lawsuit against the county by former Ventura County Sheriff Brooks seeking a $75,000 supplement to his $272,000 annual payout would make him one of the highest paid retirees in California.

Officials from all three counties said they took reforms beyond PEPRA’s regulations by establishing new tiers of pension packages with varying benefits for new employees. The concern at the root of these reforms is an unprecedented level of newly retired employees that are driving up pension costs and rendering current systems unsustainable.

Thornberg said credit ratings tend to not account for this looming crisis because of the limited timeframe of their forecast and the high level of uncertainty over what type of impact the crisis will have and whether it will be potentially mitigated through government reform.

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