Fitch Ratings downgrades Austin as its pension debt increases

(The Center Square) – Fitch Ratings downgraded the city of Austin’s credit rating, assigning it a ‘AA+’ less than a year after the city received a downgrade from Moody’s Investors Service. The downgrade is ahead of the city’s plan to sell $328 million worth of debt, of which roughly half is public interest bonds.

Moody’s downgraded Austin’s rating last fall ahead of its sale of $271 million in bonded debt. The city is scheduled to sell bonds in a competitive sale on Sept. 14.

Proceeds will finance various public improvements and equipment purchases and will refund a portion of the city’s outstanding tax-supported debt for interest savings, Fitch notes.

Both rating agencies cite the city’s growing debt burden and increasing long-term pension liabilities as reasons for the downgrade.

An analysis of Austin’s fiscal 2019 audited financial reports by the nonprofit Truth in Accounting found that “Austin’s financial problems stem mostly from unfunded retirement obligations that have accumulated over the years. Of the $9.4 billion in retirement benefits promised, the city has not funded $2.9 billion in pension and $2.4 billion in retiree health care benefits.”

TIA gave Austin a “D” grade for fiscal health, saying its elected officials “repeatedly made financial decisions that have left the city with a debt burden of $2.1 billion” – well before the state’s year-long lockdown and coronavirus-related costs were incurred.

Fitch Ratings downgraded Austin’s $159.5 million public improvement and refunding bonds, series 2021; its $37.8 million certificates of obligation (COs), series 2021; its $28.3 million public property finance contractual obligations (PPFCOs), series 2021; its $82.4 million public improvement and refunding bonds, taxable series 2021; and its $20.1 million COs, taxable series 2021.

Fitch also downgraded the city’s Issuer Default Rating (IDR) to ‘AA+’ from ‘AAA’; $1.5 billion outstanding public improvement bonds, COs and PPFCOs to ‘AA+’ from ‘AAA’; and $3.3 million Mueller Local Government Corporation (Mueller LGC) contract revenue bonds, series 2006 to ‘AA’ from ‘AA+’.

The public improvement bonds, COs, and PPFCOs are direct debt obligations, paid for through an ad valorem tax limited to $2.50 per $100 of assessed valuation, levied against all taxable property in the city. The Mueller LGC contract revenue bonds are paid for by a lien on pledged revenues related to a grant agreement with the city.

“The downgrade of Austin’s IDR and limited tax bond rating reflects continued employee pension challenges and weakened expenditure flexibility,” Fitch states. “The ratings also consider the city’s very strong revenue profile and future growth prospects, moderate long-term liability burden and the highest level of financial resiliency.”

This year, the Texas Legislature approved a reform package that Gov. Greg Abbott signed into law related to the city’s police pension plan. While this was a good step, Fitch notes, “the city has not addressed the underfunded municipal employee pension plan with a reform proposal.”

While the city manager plans to submit reform legislation during the next legislative session, which convenes January 2023, “annual contributions to both the police and municipal plans still fall short of actuarial requirements,” Fitch states.

Another issue is the consequence of a union-backed Austin Fire Department agreement, Fitch notes. The city’s “erosion in spending flexibility results from a recently approved charter amendment that requires binding arbitration between the city and Austin firefighters (if requested by either party) in the event of a future contract negotiation impasse. Fitch believes longer-term workforce controls are materially weaker under a binding arbitration framework.”

In response to questions about the downgrade, a City of Austin spokesperson told The Center Square, “The primary reasons for the Fitch downgrade are their continued concerns over the City’s pension liabilities and a new concern over the approval of Proposition A last May, which provides for binding arbitration on labor contract negotiations with the Austin Fire Association, and in their view could negatively impact the City’s budget flexibility. Fitch also expressed concerns about the potential further erosion in budget flexibility should Proposition A on the upcoming November ballot – relating to minimum police staffing levels – be approved by voters.

“We are very much aware of rating agencies’ concerns about pension liabilities. That’s why we have worked diligently over the past year to improve the long-term sustainability of the Police and Employees Retirement Systems. It is important to note that even with this downgrade, the City of Austin’s credit remains among the highest of all major Texas cities. Austin’s booming and diverse economy, a healthy overall financial position, and prudent financial management practices continue to make the City’s bonds a highly attractive investment.”

Chuck DeVore, vice president of National Initiatives at the Texas Public Policy Foundation, told The Center Square that Austin’s downgrade “is the natural consequence of city leaders promising more than the taxpayers can reliably deliver. Whether through billions in borrowing and higher taxes for government rail projects or agreeing to more generous pensions for city employees while not setting aside the money to pay for it, the cost will be borne by taxpayers through higher interest rates on the bonds sold by the city.”

Bill Bergman, director of research at TIA, also told The Center Square, “Austin has been growing relatively rapidly in the last decade, and its city government has been pretty ambitious. But employee pension and especially health care benefit liabilities have been growing rapidly as well, and the city’s overall financial position deteriorated significantly in recent years despite what used to be a favorable economy. With credit rating changes, you always have to ask the question whether the horses were already escaping the barn before the rating was downgraded. A significant financial services executive once said, ‘The role of the credit rating agency is to go out on the battlefield after the battle is over, and shoot the wounded.’ Time will tell if Austin’s ambitions were misplaced, and if so, how much it will cost.”

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