New Jersey COLA case could lead to downgrade, budgetary pressure

This piece first published March 16, 2016, Debtwire Municipals

New Jersey risks a rating downgrade and increased budgetary pressure if the state’s Supreme Court upholds an appellate court’s ruling, reinstating cost of living adjustments (COLAs) for the state’s pensioners, said Lisa Kreiling, senior analyst at PNC Capital Advisors.

Arguments are scheduled for Monday before the New Jersey Supreme Court. Estimates show the state’s unfunded pension liabilities increase by 33% if COLAs are reinstated for retirees, Kreiling said. COLAs were frozen with Governor Chris Christie’s (R) pension reform in 2011 – unions agreed to sacrifice COLAs and raise the retirement age in exchange for a set funding schedule after years of missed annual required contributions (ARC) but when the governor didn’t uphold his end of the bargain, deviating from the funding schedule after budget problems, pensioners challenged the COLA freeze.

“Other aspects of the state budget get squeezed to make pension payments and meet debt service obligations,” Kreiling said. “The pension problem is growing and at this point, they don’t have the budget flexibility to make the increased ARC. They won’t be able to make the full ARC without straining the budget.”

An increase in liabilities translates into an increase in the state’s ARC, Kreiling said. New Jersey has not made a full ARC payment in decades – Christie’s FY17 budget proposal includes a USD 1.86bn contribution, about a USD 500m increase over FY16, but only about 40% of the ARC.

Increasing the contribution is certainly better than the alternative, but the contributions are not keeping pace with the growing liabilities, Kreiling said. If the court rules to reinstate COLAs, those liabilities increase more rapidly, which could lead to a day of reckoning for the system, she said.

The state says reinstated COLAs could result in a USD 17.5bn increase to pension liabilities, as reported.

Some estimates show that at least one of New Jersey’s funds could have asset depletion by 2024, Kreiling said. Overturning the COLA freeze means the timeline is accelerated, she said.

“This is no longer a long-term, 30-year problem,” Kreiling said. “This is a near-term situation. If the state gets to a situation where they’re funding pensions on a paygo basis, that’s a real hit to their budget and a real problem. Time is working against the state at this point, and they need to come up with a long-term solution.”

Since deviating from the funding schedule stipulated in the 2011 law, Christie demonstrated he isn’t making the best choices for the state’s credit, said a buyside analyst who covers New Jersey.

If COLAs are reinstated, a downgrade is all but certain – the impact on the budget will be tremendous, the analyst said.

“I don’t have confidence in management,” the analyst said. “The ARC could increase by USD 1bn or USD 2bn, which is significant as the current ARC is USD 4.3bn and not fully funded by the governor. I’m staying away from Jersey, waiting for this judgment or even another governor who might be more disciplined or at least have a plan.”

New Jersey is rated A2/negative by Moody’s Investors Service and A/stable by Standard & Poor’s and Fitch Ratings.

A USD 28.74m tranche of Series 2014 general obligation bonds last traded in round lots at 119.311 to yield 3.091% on 11 March.

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