As Pennsylvania faces budget deadline, pension reform seen key

Fri Jun 28, 2013 2:21pm EDT

Related Topics

* Fiscal 2014 budget deadline on Sunday

* Pensions consuming growing share of revenues

By Hilary Russ

June 28 (Reuters) - Pennsylvania state lawmakers face a Sunday deadline to approve a fiscal 2014 budget and a pension reform plan that is crucial to avoiding credit rating downgrades that could cause its borrowing costs to rise.

For Republican Governor Tom Corbett, who is up for re-election in 2014, the issues are a test of his leadership.

Without consensus so far in the Republican-led legislature, approval of the roughly $28 billion spending plan could get pushed to the midnight deadline on Sunday, when the new fiscal year starts.

Lawmakers could buy more time for budget negotiations beyond the deadline. In addition to the pension reform plan, there are two other fiscal measures on the table, but there is no mandate that the legislature pass any of them at the same time, despite their future budgetary implications.

The pension reform would shift newly hired state and school employees into defined-contribution retirement plan in 2015, or two other measures. The other measures are for the privatization of state-run liquor stores, and a hike in taxes and fees to fund a $2 billion transportation package.

There is "little appetite" for Corbett's pension proposal in the Senate, which means that the issue could get pushed back until this fall or beyond, according to a report this week by G. Terry Madonna, a public affairs professor at Franklin & Marshall, and Michael Young, managing partner of Michael Young Strategic Research.

"Fairly or unfairly these three agenda items have become litmus tests of Corbett's gubernatorial leadership," they wrote. "Without significant progress on these agenda items many doubt that Corbett can be re-elected in 2014."

Corbett, who proposed pension reforms last February, has trailed potential Democratic challengers in recent polls.

ONE OF THE WORST

Pennsylvania's public pension system has a $47 billion-and-growing shortfall and is among the worst in the United States. Pension costs are consuming a growing share of the state's revenue, something that represents a major worry for investors in the U.S. municipal bond market, with the premium over triple-A-rated bonds paid on Pennsylvania bonds up about a third since January.

Without changes, the growth in pension costs could consume an estimated 62 percent of the nearly $819 million of new revenues the state expects to raise in fiscal 2014, budget secretary Charles Zogby said late last year.

"If they're not careful, the pension costs are just going to continue to consume a significant portion of their budget," said Dan Heckman, senior fixed income strategist at U.S. Bank Wealth Management. His team has not been buying Pennsylvania paper. "We really want to see some progress made on this," he said.

A report by Moody's Investors Service ranked Pennsylvania the eighth worst among all U.S. states as measured by pension liabilities to revenues.

"We are looking to see whether or not there will be reforms. It's a very fluid situation currently," said Kimberly Lyons, Moody's lead analyst on Pennsylvania.

The projected growth in the pension bill "ultimately limits the budget flexibility of the state," she said. Moody's rates Pennsylvania at Aa2 with a stable outlook.

Fitch Ratings said in April that it would decide whether to cut its AA-plus rating on Pennsylvania after reviewing the budget enacted for fiscal 2014.

If Pennsylvania is downgraded, "spreads would likely widen out to reflect the increased amount of perceived risk," said Janney Capital Markets credit analyst Tom Kozlik in an email. "Therefore, costs are going to go up for the Commonwealth's borrowing costs, but investors will still be interested in (Pennsylvania) debt."

The credit spread of Pennsylvania's 10-year general obligation debt over triple-A rated municipal bonds grew from 18 basis points in January to 28 basis points on June 12, the widest in at least two decades, according to Municipal Market Data.

Over that same period, the state's yield spread has averaged about 12 basis points, according to MMD, a unit of Thomson Reuters.

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