The three major credit rating agencies say they are watching how Orange County’s looming pension problem is handled on the eve of a big bond sale.
None of the agencies,Standard & Poor’s, Fitch Ratings and Moody’s Investors Service,have lowered their credit ratings on the county. But how the county deals with an estimated $2.3 billion in unfunded pension liabilities is critical, they said.
“It’s better not to have a liability than to have one,” said Standard & Poor’s David Hitchcock, a director in the New York-based agency’s public finance group. “How they address it will affect their credit quality. It’s a concern and is something we are looking at closely.”
The county is looking to refinance about $577 million in debt related to the 1994 bankruptcy by issuing new bonds. The move would retire the bankruptcy debt a decade early and save $110 million.
But the offering is taking place against a backdrop of concern about the county’s pension plan. More generous benefits that went into effect last month stand to bring “financial strains,” according to Amy S. Doppelt, Fitch’s managing director in San Francisco.
“Fitch views the county’s upcoming significant increase in retirement system contributions as resulting in long-term financial challenges that will need strong fiscal discipline and resolve to manage,” Doppelt said.
The county already has been running in the red for the past three years, said Dari Barzel, credit analyst with Moody’s Investors Service in San Francisco. Higher retirement costs and state budget cuts have spurred county deficits, including with the $4.9 billion budget for the fiscal year that started July 1.
“These deficits were not unanticipated, as the county’s budget plan included a drawdown in departmental reserves over the course of several years,” Barzel wrote in a report. “Nonetheless, the trend is a credit negative, particularly as significant future challenges remain.”
Moody’s stable outlook on the county’s rating presumes it will deal with higher pension and other costs in coming years, Barzel said.
How the county plans to deal with the pension issue started surfacing last week.
Chief Executive Thomas Mauk asked county department heads to look for ways to cut their operations, a move that could go beyond a current hiring freeze to include layoffs.
In a memo earlier this month, Mauk told department heads to come up with ways to meet a $129 million shortfall in pension costs coming due in the fiscal year starting July 1, 2006.
“We’ve asked our department heads to jump-start their budget planning for next year and respond about how they plan to absorb their department’s share,” Mauk wrote in a statement to the Business Journal. “We have fine people running our departments, and I expect they’re sharpening their pencils.”
Mauk’s request starts the budget planning process for the county at one of its earliest stages ever,a sign of the seriousness of the situation, according to observers.
“In order to immediately begin conserving resources and because freezing additional positions may be part of your funding plan, no vacant positions in departments within the general fund will be unfrozen until your funding plan is received in the budget office,” Mauk wrote to department heads.
The hiring freeze covers positions recently left by July retirements,estimated at about 400 workers. The exodus placed an even greater strain on the pension system because the retirees now are collecting benefits, according to Keith Bozarth, chief executive of the Orange County Employees Retirement System.
The financial impact of the latest wave of retirees hasn’t been calculated yet.
As for how the county will deal with pension costs, Bozarth said, “I suspect it will be painful. Layoffs are one possibility.”
The county has roughly 24,000 active workers and retirees who are part of the pension plan. The plan gets 75% of its contributions from the county and the rest from other agencies, such as the Orange County Transportation Authority.
The prospect of cutting in response to what many see as a crisis surely brings back memories of the 1990s at the Civic Center.
In December 1994, OC slipped into bankruptcy on the heels of a failed strategy by former county Treasurer Robert Citron, who used money borrowed from Merrill Lynch & Co. and others to bet on the direction of interest rates by purchasing longer-maturity derivatives.
The strategy, which first drew high returns, backfired as rates rose in 1994, resulting in losses of $1.6 billion and the county’s bankruptcy.
The county has had to live with belt-tightening ever since, even as OC’s population has grown 18% to more than 3 million people since then.
The county’s employment fell nearly 9% from before the bankruptcy to a low of 14,803 people in 1995.
Still, hiring has been steady since then. As of July, employment is up 11% to 16,441 people from the low of 10 years ago.
Treasurer-Tax Collector John Moorlach, a critic of the more generous pension benefits and a candidate for supervisor, said he doesn’t see much fat to cut.
“This is not an easy fix,” Moorlach said. “I have cut my department to the bone. There’s not much more to cut. I’ve got fewer full time employees now than when I got here, and there’s been a (sizeable) increase in population growth. Go pick on somebody else, because I didn’t create this.”
Fitch’s Doppelt said she has her eyes on the 2008 fiscal year, when the most current labor pacts expire.
“The county will need to demonstrate financial discipline and prudence negotiating labor agreements for fiscal 2008,” she said.
