Pension Liabilities, Housing, and Bond Costs
Phoenix Curbing Pensions Produces Lowest Bond Cost
By Amanda J. Crawford – Bloomberg – Oct 10, 2013 9:01 PM MT
Investors are driving Phoenix’s financing costs to an eight-month low as officials move to curb a pension burden that one councilman said has Arizona’s largest city on the path to insolvency.
Voters this year raised the retirement age for public workers and their pension contributions in changes projected to save $600 million over 25 years for the sixth-largest U.S. city. A council committee this week recommended limiting a practice, known as pension spiking, that allows employees to increase retirement benefits through perks such as pay for unused vacation and sick time.
Investors in the $3.7 trillion municipal market are taking notice of the steps by Phoenix, which has the third-biggest pension burden among the nation’s 25 most-populous cities, according to Morningstar Inc. Buyers have pushed the extra yield on some debt to the lowest since at least February, data compiled by Bloomberg show.
“Phoenix’s pension carrying costs are an outlier in this sector,” said Neene Jenkins, a muni credit-research analyst in New York at AllianceBernstein, which oversees about $32 billion of local-government debt. “It is a significant credit issue.”
The debate in Phoenix, where the population rose about 9 percent from 2000 to 2010, to 1.4 million, echoes the increasing attention nationwide to pension liabilities. The benefits have driven up costs in localities that lost revenue during the 18-month recession that ended in 2009.
Last year, California and New York took aim at pension spiking as part of overhauls that lifted retirement ages and workers’ contributions. At least 15 states, including Arizona, have passed laws blocking the practice, according to Rachel Barkley, a Morningstar analyst in Chicago. Arizona’s law applies to state-administered retirement systems, including the one for the city’s public-safety workers.
In Phoenix, officials cut more than 2,600 jobs, or 15 percent of the workforce since 2008, trimmed overtime costs and instituted a food tax as part of budget-balancing steps during the recession as pension costs rose and tax revenue fell. The ratio of employees to residents is at a 40-year low, according to data from the city, even as its economy has rebounded.
Home prices in Phoenix reached a five-year high in July, although they’re still down almost 40 percent from a 2006 peak, according to the S&P/Case-Shiller property-value index.
Retirement contributions rose to $253 million this year, or about 7.2 percent of the total budget, from $56 million in fiscal 2003-2004, or 2.6 percent, according to data from the city. It has a total unfunded liability of about $2.4 billion, according to Chief Financial Officer Jeff DeWitt.
At 61 percent, the city’s funded ratio is below the 70 percent threshold considered fiscally sound, according to Barkley. Its pension costs account for 19 percent of general-fund spending, less than only San Diego and San Jose, California, among the 25 largest U.S. cities, according to Morningstar.
DeWitt said that analysis overstates the burden on the general fund since some employees are covered under enterprise and special-revenue funds.
Changes approved by voters in March to the pension system for new, non-public-safety employees raise the retirement age by three to five years and require workers to pick up half their pension costs. The city also capped the amount of accrued sick time that could be cashed out and counted in pension calculations. That move led to another lawsuit by an employee union last year.
“A new employee starting today doesn’t have to worry about getting their pension payment when they are 82 years old,” DeWitt said.
So far the efforts are being applauded by investors.
Phoenix general-obligation bonds maturing in July 2015 traded Sept. 25 at an average yield of 0.36 percent, or 0.16 percentage point less than benchmark munis, data compiled by Bloomberg show. It’s the lowest relative borrowing cost since at least February.
The city may refund about $150 million in wastewater bonds this year and about $150 million in general-obligation debt early next year, DeWitt said.
Matthew Jones, a senior vice president in public finance for Moody’s Investors Service in New York, said the city was able to maintain its Aa1 rating, the second-highest rank, through the recession because of sound management.
“Their pension liability is higher than average,” he said. “But it is not unmanageable given their resources.”
Among the 50 largest U.S. local governments by debt, Phoenix ranked 10th in terms of the size of pension liabilities relative to annual operating revenue, at about 240 percent, Moody’s reported last month. The ranking used fiscal 2011 data. Chicago was first, with 678 percent.
Councilman Sal DiCiccio, a Republican who is critical of the pension system and employee benefits, said changes haven’t gone far enough.
In addition to ending pension spiking, he wants the city to move to a defined-contribution plan.
“This path is unsustainable if it doesn’t get fixed,” DiCiccio said. “The path that led to Stockton and Detroit is the same path everyone else is on. We’re all going to end up there.”
Detroit filed a record U.S. municipal bankruptcy in July. Emergency Manager Kevyn Orr has said its biggest unsecured debt is an unfunded pension liability of $3.5 billion. The city also owes about $1.4 billion on bonds issued to bolster pension systems. Stockton, California, sought court protection last year, citing accounting errors, rising retiree health-care costs and a drop in tax revenue from the recession.
DeWitt, who has been nominated by Washington’s mayor to become chief financial officer there, rejects the comparison to those cities.
He said the changes to Phoenix’s pension system will keep costs rising at about the pace of inflation. The city has $3.8 billion of pension assets, is paying down unfunded liabilities and is required to pay the full actuarially required contribution to its plans.
The Goldwater Institute, a Phoenix-based research group that promotes limited government, sued the city in August. Its complaint challenges provisions in a contract with a police union allowing long-time officers to be paid additional salary instead of accruing vacation or sick leave.
The practice violates state law that blocks leave from being used in pension calculations in Arizona’s Public Safety and Personnel Retirement System, according to the complaint filed in state court in Phoenix.
“It is costing Phoenix an extraordinarily high amount of money,” said Jonathan Riches, an attorney at the Scharf-Norton Center for Constitutional Litigation at the nonprofit institute named for late Republican Senator Barry Goldwater.
The pay is for taking a lessened benefit, which makes it salary legally included in retirement calculations, according to a statement from the city’s legal department. The city filed a motion to dismiss the case.
David Leibowitz, a spokesman for the Phoenix Police Sergeants and Lieutenants Association, the union named in Goldwater’s lawsuit, declined to comment, citing the pending litigation.
A council subcommittee voted Oct. 8 to recommend ending certain spiking practices among workers other than police and firefighters. If the council adopts the changes, accrued vacation that can be used to increase pensions will be capped and other allowances, such as for vehicles or phones, will no longer count in pension calculations, said City Councilman Bill Gates, the Republican vice mayor.
Gates said he wished the committee had gone further by recommending the city block the use of accrued vacation in pension calculations altogether. The council is set to consider the changes Oct. 22.
Ron Ramirez, president of the Administrative Supervisory Professional & Technical Employees Association, said his union opposes the pension changes. The organization, which represents about 3,200 city workers, is suing the city along with other unions over last year’s change to cap sick time that could be used to determine pensions.
“It’s in lieu of compensation,” Ramirez said. “The taxpayer is getting a bargain. If you want to give it to me in wages, then go ahead.”
The case involving the Goldwater Institute is Wright v. Stanton, CV2013-010915, Maricopa County, Arizona, Superior Court (Phoenix).
In the municipal market this week, issuance remains limited as the partial federal shutdown continues. Borrowers have about $8.3 billion of sales scheduled for the next 30 days, about 11 percent below the 2013 average.
Governments such as Wisconsin are issuing with top-rated 10-year munis yielding 2.75 percent, the highest since Sept. 23. The interest rate compares with about 2.69 percent for similar-maturity Treasuries.
The ratio of the yields, a gauge of relative value, is about 102 percent, compared with an average of 93 percent since 2001. The higher the figure, the cheaper munis are compared with federal securities.