Ratings Agency Isn't Buying City of Dallas' Proposed Pension Fix
What do bond rating agencies know about credit, anyway?
Late Friday, Moody's Investors Service announced that, for the third time in less than two years, it was downgrading the city of Dallas general obligation bonds. In layman's terms, that means that the city's credit rating — its ability to borrow money through the sale of bonds — has taken another hit. This unwelcome news comes despite the city's new plan to battle its $3 billion-plus pension shortfall through increased city payments and cuts to benefits for pension members.
According to Moody's the downgrade directly stems from the city's ongoing battle to fix the Dallas Police and Fire Pension System. Because of nearly $500 million in recent cash withdrawals by pensioners enrolled in the city's Deferred Retirement Option Program (DROP), the ratings agency says, the system's overall liquidity is under threat.
As a consequence, the city's credit rating has dipped from Aa3, Moody's fourth highest tier, to A1, the company's fifth highest. Just last year, Moody's rated the city of Dallas as an Aa1 credit risk, the service's second highest ranking. Friday's drop also means that Dallas' credit comes with an "upper medium grade" from Moody's, rather than a high grade.
The most damning materials released with the Moody's downgrade is the agency's evaluation of the city's proposed fixes for the pension system's multi-billion dollar unfunded liability. Rather than taking the city at its word that clawing back interest from DROP participants and slowly refunding the ailing system will bring DPFP back up to par, Moody's questions whether the fixes will even happen at all.
"The city's recently announced reform plan includes actuarial projections that the [pension system's] unfunded liability will be amortized in 30 years. However, it has significant implementation risk because it relies heavily on actions of the state legislature and includes only modest increases in cash contributions to improve funding levels," Moody's prospectus says.
According to financial analysts, troubled pensions can become especially detrimental to a city's credit rating when they threaten to create political instability. That's happened in Dallas, where the mayor has sued the DPFP in his capacity as a citizen and gone to Austin to stress that, left unchecked by the legislature, the DPFP and the potential legal resolution of a series of pay referendum lawsuits filed by cops in the 1990s could bankrupt the city of Dallas.
"Investors are becoming a lot more sensitive to headline risks related to pensions, because pensions can create political instability. The debate about pensions can have a meaningful impact on how the city does business. Investors have been far more cautious on this topic than almost any other," Matt Fabian, a municipal finance analyst with Municipal Market Analytics told the Observer after the city's last Moody's downgrade. "If the city lets things fester and get worse, a penalty that it pays could easily become much larger and the rating downgrades could accelerate. [The ratings cut] is a clarion call to the city to take action."
After the city's downgrade from Aa1 to Aa2 last November, Rawlings lauded a recent sale of bonds by the city at a low interest rate by questioning the work of Moody's and other ratings agencies at a city council briefing.
“It seems like the ratings grades are a little bit different from the ways the markets are acting,” Rawlings told the briefing room. “I will say one of the reasons for the Great Recession was their making some big mistakes, the rating agencies, so from a historical standpoint I think it’s good to realize that.”
Clarification December 13, 10:23 a.m.: This story initially said that Rawlings told the legislature that the DPFP could bankrupt the city of Dallas. It has now been clarified to say that Rawlings said the DPFP and the potential resolution of a series of police pay lawsuits filed in the 1990s could bankrupt the city.