Shortfall forces retroactive pension cut, tobacco bond gimmick

Mark J. Magyar | April 1, 2014 | Budget, Politics
Moody’s says Christie administration’s reliance on short-term savings that add to future costs reflects budgetary weakness

Credit: NJTV
David Rousseau, budget analyst at New Jersey Policy Perspective, a liberal think tank.
While the biggest news out of today’s Senate Budget Committee hearing will be whether Treasury and the nonpartisan Office of Legislative Services disagree substantially in their revenue projections for next year’s budget, Treasurer Andrew Sidamon-Eristoff will also face tough questions on the fiscal maneuvers he used to fill an $800 million gap in this year’s Fiscal Year 2014 budget.

Baye Larsen, vice president at Moody’s Investor Services, said yesterday that the Christie administration’s decision to retroactively cut pension payments by $93.7 million and to give up future tobacco bond revenue in exchange for a $92 million upfront payment to help balance the budget this year reflected the state’s continuing budgetary weakness.

David Rousseau, budget analyst at New Jersey Policy Perspective, questioned the wisdom of the move.

Essentially, the state gave up $400 million in tobacco revenue bond payments owed to it over a seven-year period from FY17 to FY23 in exchange for a single $92 million lump sum payment.

This means that over 10 years the state is giving up more than $4 in future revenue for each $1 it receives now.

The Treasury Department generated the $92 million windfall — called a “bond premium” — by agreeing to reduce future revenue payments that the state would receive from bondholders responsible for paying the remainder of the money owed from a 1998 legal settlement in which tobacco companies agreed to reimburse states for healthcare costs associated with smoking.

“The state’s not giving up any revenue in FY2015 or FY2016, but we’re giving up $50 million to $60 million each year from 2017 to 2022 and $20 million more in 2023, ” Rousseau, who served as state treasurer under Democratic Gov. Jon Corzine, pointed out.

“There are a lot of questions about this one. Who’s really profiting from this?” Rousseau asked, noting that Barclays, which represents the bondholders, suggested the refinancing plan to the state. “If the bondholders were willing to pay $92 million upfront, they wouldn’t do so unless they were getting more than that in value.”

Treasury’s decision to give up a combined $120 million in tobacco settlement revenue from Gov. Chris Christie’s last two budgets and another $280 million from his successor’s next five budgets is just the latest in a series of debatable fiscal gimmicks used to fill midyear shortfalls in the last three state budgets.

Financial Weakness

“As a result of recurring budget gaps and increasingly limited options, the state continues to use one-time fixes that indicate above-average financial weakness,” Larsen wrote in a critical report published last Friday in Moody’s U.S. Public Finance Weekly Credit Update. The report was entitled “New Jersey’s Reduced Pension Contribution Reflects Persistent Budget Pressure.”

The week before, Fitch Ratings lowered New Jersey’s credit outlook from “stable” to “negative.”

Moody’s had already lowered New Jersey’s credit rating to “negative” in December, and Standard & Poor’s had done so in September 2012. All three rating agencies lowered New Jersey’s overall bond rating during Christie’s first term (AA- in the S&P and Fitch ratings, Aa3- in Moody’s), making New Jersey the third-lowest rated state in the nation. A lower bond rating increases a state’s interest costs.

The Moody’s report noted that New Jersey’s “non-recurring budget solutions include debt restructurings for debt service savings.” The debt restructurings included the refinancing of Transportation Trust Fund bonds to generate $250 million in upfront bond premium payments in past years that, like the tobacco bond changes, will require the state to pay more money in the future.

The Moody’s report also cited the Christie administration’s decision to push off payment of property tax rebates in 2013 from May until August. The result is “a one-time shift in Homestead Benefit payments that crossed fiscal years” and thus created a $390 million one-shot savings to plug most of a $400 million hole in the FY2013 budget last spring.

“The state’s fiscal 2014 budget-balancing actions reflect the credit negative strain of New Jersey’s (Aa3 negative) persistent budget gaps and indicate that the state has already exhausted some of the easiest spending reductions,” Larsen wrote in her analysis.

Compounding the challenge is the state’s low surplus, a consequence of Sidamon-Eristoff being forced to take more and more money each year out of the state surplus to cover recurring shortfalls.

“The state’s current estimate for its fiscal 2014 ending fund balance remains consistent with its original projections at $300.6 million, a narrow 0.9% of revenues,” Larsen wrote. “These fund balances provide minimal liquidity and protection against contingencies, and are much lower than the $873 million (or 3% of revenues) fiscal 2011 fund balance and a current 50-state median fund balance of approximately 5%.”

Treasury Department spokesman Christopher Santarelli did not respond to a series of detailed questions submitted last week on the $694 million in budget maneuvers used to balance the FY14 budget, saying that Sidamon-Eristoff would address all questions on the FY14 and FY15 budgets in his testimony before the Senate Budget Committee today and the Assembly Budget Committee tomorrow.

Standard Practice

Joseph Perone, Treasury’s new communications director, last week defended the decision to recalculate the state’s pension formula. He asserted that the new formula reflects the “standard practice in the industry” of using increased pension contributions by current employees to reduce the amount that employers — in this case, the state and local governments — would have to contribute.

Perone said there was no “agreement, either explicit or informal, with the Legislature” that required the state to continue to allow the increase in pension payments by state workers — which rose from 8.5 percent to 10 percent for police and firefighters, and from 5.5 percent to 6.93 percent currently for teachers and other nonuniformed state and local government employees — to be used to reduce the size of the state’s unfunded pension liability.

Larsen said in an interview yesterday that Moody’s view of the state’s decision to change the pension formula — which will result in the state putting $900 million less into its pension system over the next four years and would decrease the funded ratio of the state’s pension system by 10 percent over a 30-year period — is shaped by the overall state of New Jersey’s pension systems.


“When we’re thinking about New Jersey’s pension-funding position, New Jersey already has a large unfunded pension liability, and that is incorporated into the rating,” said Larsen.

Moody’s cited New Jersey’s pension problems when it lowered the state’s credit outlook from “stable” to “negative” in December, and “we’re anticipating declines in the funding ratios as the state ramps up to full funding by Fiscal Year 2018,” she said, because the state will not be making the full actuarially appropriate contribution until then.

“The lower state contributions are consistent with minimum legislative requirements,” Larsen acknowledged in her report. “However, the need to retroactively recalculate the amounts indicates that the state’s financial position is weaker than expected and that more typical budget-balancing solutions have already been exhausted. Additionally, while the changes provide budgetary relief through fiscal 2018, pension costs will be higher in later years than they would have been without the adjustment.”

Christie said during his Budget Speech that the state’s unfunded pension liability would be $54 billion in FY2018, the year that New Jersey would begin paying the full amount it owes on an annual basis based on actuarial calculations.

Marcy Block, senior director of Fitch Ratings, Inc., said yesterday that Fitch’s decision to lower New Jersey’s credit outlook from “stable” to “negative” 11 days ago also was based on the overall health of the state’s pension system.
“On the pension side, it was more the overall burden we were looking at, rather than the impact of the pension changes on the current fiscal year,” Block said. “What is more concerning to us is how much that change in the formula will add to the accrued liability at the end of the day.”

Asked if she considered a 10 percent increase in the unfunded pension liability over 30 years to be significant, Block said emphatically, “I would say so!”