by James A. Bacon

Moody’s Investor Service may revise its rules for rating municipal bonds, and the news could be bad for states and local governments with large unfunded pension liabilities. The company  is proposing to increase the weighting of  pension liabilities and other long-term debts from 10% to 20% in its scorecards for General Obligation (GO) bonds and to lighten the weighting for economic strength from 40% to 30%, reports Governing magazine. (Governance/ management factors account for 20% and financial strength for 30%.)

The changes could create winners and losers in Virginia, where local governments tout their bond rating as a sign of fiscal rectitude. New rules from the Government Accounting Standards Board (GASB) are requiring local governments to report unfunded pension liabilities on their balance sheets for the first time in recognition of the long-term claim on fiscal resources. Under that rule, Fairfax County would have to acknowledge nearly $2.7 billion in unfunded liabilities; another 15 Virginia cities and counties would report $200 million or more.

Making matters worse, reflecting the lower financial returns on pension portfolios in a zero-interest rate environment, Moody’s might apply a lower discount rate on investments. Most retirement systems assume their portfolios will generate returns of 7% to 8% per year. In recent years, 3% to 6% has been more typical. If portfolios are assumed to earn less money, state and local governments will face much higher liabilities.

Another change that could hurt fast-growth localities is Moody’s decision to downplay economic strength, a composite of economic growth trends, the type of economy, workforce profile and socioeconomic/demographic profile. This revision, reports Governing’s Liz Farmer, recognizes that some local governments are either unwilling or unable to capitalize on the strength of their local economies by raising taxes.

Virginians pride themselves on their fiscal probity. The Commonwealth of Virginia has a AAA bond rating, as do several cities and counties. The favorable rating keeps borrowing costs low. But the situation is surprisingly murky. There has been a proliferation of debt in Virginia under the aegis of independent authorities. Bond rating companies may be on top of the situation but the public is in the dark. How much total debt is out there — not just GO bonds, for which governments are legally obligated, but Moral Obligation bonds, for which governments are morally obligated to back up. How many bonds are issued by independent authorities which would cause economic distress if they were defaulted upon?

… which brings us to the topic of roll road debt. Moody’s also is concerned about rising levels of toll-road debt. Nationally, average debt per roadway-mile increased from $18.9 million in fiscal 2012 from $14.3 million in fiscal 2011, the company stated in a press release earlier this month. The average toll per transaction increased over the same period from $1.82 to $1.96.

Steady toll rate increases will be necessary to support a growing debt burden, says Moody’s, although the unfettered ability to increase toll rates could face mounting political pressure in an economy that is growing slowly. One reason Moody’s continues to have a negative outlook for the US toll road sector is the weak and uneven pace of the economic recovery.

Under the McDonnell administration, Virginia has been a national leader in financing highway infrastructure through tolls, often through Public Private Partnerships. The technique has allowed the state to build roads it could not have otherwise. But no one, to my knowledge, has analyzed what level of financial risk the state might be exposed to if toll revenues faltered and bond payments were missed.

… and university debt. Virginia’s public universities also are heavily indebted, incurring debt to finance the construction of buildings and dormitories. Colleges and universities have enjoyed nothing but enrollment growth and rising tuition and fees for decades, but there are signs of increasing consumer resistance and the number of entering freshmen may have peaked. Enrollments are leveling off nationally, and some institutions are seeing declines. How leveraged are Virginia institutions, and what obligation does the Commonwealth have to stand behind them in case of default?

Then there’s the Virginia Housing Development Authority, the Small Business Finance Authority, water-and-sewer authorities, and various authorities critical to the economy such as the Metropolitan Washington Airports Authority, the Virginia Port Authority, other airport authorities, industrial development authorities, special tax districts and community development authorities.

Everything may be hunky dory. But there may be systemic risks that nobody recognizes. Five years ago, no one was concerned about unfunded pension liabilities. Now everyone is. What other land mines lurk out there? What is our exposure? We just don’t know.  We need to find out.