Municipal Bond Watch: Illinois & Pennsylvania Being Dragged Down By Pension Problems

Learn Bonds has just updated our State General Obligation ratings table. In the process, we took the opportunity to review the recent rating changes by two largest municipal raters, Moody’s and Standard & Poor’s. For the most part, the two agencies seem to make their rating changes at different times.  This is a positive in my opinion, as it indicates that they are not looking at each other’s research, but doing independent analysis. Overall, the trend in state ratings appears to be be negative.
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The major rating agencies revised their views of the General Obligation debt of Pennsylvania and Illinois this year. It should be noted that both states still enjoy high investment grade credit ratings, and based on their ratings, should have a very low probability of default. However, there is a major problem which both states are wrestling that will only become larger with time:
Pension Liabilities.

What were the rating changes:

  • Pennsylvania had its rating downgraded by Moody’s from Aa1 to Aa2 (July 16th, 2012) and outlook changed by Standard & Poor’s to negative from stable (July 19th, 2012)
  • Illinois had its rating downgraded by Moody’s to A2 from A1 (January 20th, 2012) and A+ to A by Standard and Poor’s (August 30th, 2012)

Pennsylvania is falling behind in the funding of its pension liabilities. As late as 2007, the state was putting enough money into its pension fund to keep up with liabilities. Unfortunately, that is no longer the case. As the Standard & Poor’s Ratingsdirect report on Pennsylvania; states:

We believe Pennsylvania’s pension and other post employment benefit (OPEB) liabilities will be a very significant source of pressure for the state in the foreseeable future. Although its combined pension funded ratios had historically been above-average compared with those of other states, funded ratios dropped to 67.8% in 2011 from 75% in 2010, and from a high of 97% in 2007, and we expect them to continue falling.

The report also mentions that Pennsylvania’s economy has been slowed by the low prices for Liquid Natural Gas (LNG). Pennsylvania used to be known as a major producer of coal. These days, however, the state’s future as an energy producer is tied to LNG. Unfortunately, the demand for natural gas has not caught up with supply. Across the United States, many electricity producers are switching to LNG plants. Furthermore, facilities which will enable the shipping of LNG abroad are now being built. However, this process of building the infrastructure for LNG consumption and export will take years, or decades. Over the next 5-10 years, this is a huge positive for the state’s economy.

Illinois’ pension problems are far greater than Pennsylvania or anyone else. Moody’s in a special comment that accompanied its rating downgrade of the state said:

Illinois has the largest unfunded pension liability, both in absolute dollars and relative to total state revenues, of the 50 states. Combined, the state’s five major plans had an actuarial accrued liability (AAL) of $146.5 billion as of June 30, 2011. Assets of the plans on that date amounted to only $63.4 billion, leaving an unfunded actuarial accrued liability (UAAL) of $83 billion (as reported in the retirement plan valuations).

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