Pension risks point to higher 2016 borrowing costs for some U.S. cities

Tue Dec 22, 2015 1:54pm EST
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By Hilary Russ

NEW YORK (Reuters) - Some U.S. cities may have to pay higher interest rates to borrow money in 2016 as they contend with a host of new pressures on their underfunded public pensions, including new reporting rules and the impact of this year's tepid investment returns.

The recession-era ghost of public pensions problems will continue haunting the $3.7 trillion U.S. municipal bond market next year, investors and analysts told Reuters.

Investors are expected to demand greater compensation, especially for financially weak municipalities that for the first time will have to move unfunded pension liabilities from the footnotes of financial statements to their balance sheets.

"A lot of local (general obligation bonds) don't have, in my opinion, the cheapness to compensate for this new information flow we're going to get," said R.J. Gallo, senior portfolio manager at Federated Investors in Pittsburgh.

When interest rate spreads widen on a city's general obligation (GO) debt, its existing debt underperforms and usually leads to higher rates for new borrowing.

Investment losses during the last U.S. recession - which ended in 2009 - laid bare the fact that many states and cities shortchanged their public employee retirement systems for years. In the third quarter of 2015, unfunded liabilities rose nationally to a near three-year high of $1.71 trillion combined, according to Federal Reserve data.

To be sure, municipal bonds outperformed every other U.S. fixed income product in 2015, returning 3.23 percent as of Dec. 21, according to Barclays' Municipal Bond index.

But well-known pension problem spots like Chicago, and states such as Illinois, New Jersey, Pennsylvania, Connecticut and Kentucky will continue to be causes for investor concern.   Continued...

A view from New York Harbor shows the Lower Manhattan, New York City skyline and the One World Trade Center tower (R) just after sunset May 19, 2015.  REUTERS/Mike Segar