NEW YORK--(BUSINESS WIRE)--As part of its continuous surveillance effort, Fitch Ratings has affirmed the pension funding bonds issued by the Employees Retirement System of the Commonwealth of Puerto Rico as follows:
--$2.989 million senior pension funding bonds at 'BBB+'.
The Rating Outlook is Stable.
SECURITY
The bonds are a limited, non-recourse obligation of the pension system, payable from and secured by a pledge of statutorily required employer contributions to the system.
KEY RATING DRIVERS
--The rating reflects the strength of the pledged revenue stream, which consists of employer contributions into the employees retirement system by the commonwealth, associated public corporations, and municipalities. Fitch rates the commonwealth's general obligation (GO) bonds 'BBB+'.
--There is a strong legal obligation for employers to make contributions to the retirement system, a long history of timely payment and legal protections against the legislature making changes to the system that would reduce the system's funded status.
--Pledged revenues provide satisfactory coverage of debt service requirements and coverage will increase over the next 10 years as the commonwealth implements contribution rate increases to address funding deficiencies in the system.
--The debt structure is somewhat weak with a very long final maturity (50 years) and rising debt service profile.
CREDIT PROFILE
The 'BBB+' rating reflects the strong legal obligation for employers to make the contributions to the system, the long history of timely payment of pension contributions to the system, and the satisfactory coverage of debt service requirements by pledged revenues. In addition, Puerto Rico Supreme Court decisions provide protection against the commonwealth legislature lowering the statutory contribution rate that was assumed in the sizing of the bond program. Offsetting these credit strengths are the very long final maturity of the bonds (50 years) and the rising debt service profile.
The ERS is a trust that was created in 1951. Eligible participants are employees of central government agencies, municipalities, and most public corporations. Employees hired before Jan. 1, 2000 are covered under a defined benefit plan, while those hired on or after this date receive no defined benefit or employer contribution. Nevertheless, employer contributions are made to the system based on the payroll of all employees, including those hired on or after Jan. 1, 2000, and all contributions go towards funding of the defined benefit obligation. Employer contributions are payable to the ERS pursuant to the 1951 act that created the system and are based on a statutorily, rather than actuarially, defined rate. Through fiscal 2011, the statutorily required employer contribution rate was 9.275% of covered payroll, a rate which had been in place since 1990.
The issuance of the bonds was an attempt to rectify a longstanding pension funding problem, also partially addressed through the closing of the defined benefit plan. Despite these efforts, pension funding remains exceptionally low: as of June 30, 2010, the ERS had a funded ratio of just 8.5%, with an unfunded accrued actuarial liability (UAAL) of $17.8 billion (30% of 2010 personal income).
Recently enacted legislation begins to address the longer term funding of the system, with a one time deposit of $162 million and a requirement to incrementally increase contributions 1% of payroll per year for five years followed by 1.25% per year for the subsequent five years. By the end of the 10 year ramp up period, pension contributions will have increased from 9.275% of covered payroll to 20.525%, all of which is pledged to bondholders, strengthening the credit. The commonwealth will cover the increased cost for municipalities for the first three years and has included this additional expense in the fiscal 2012 budget.
Covered payroll increased significantly through the last decade, from $2.5 billion in fiscal year (FY) 2001 to $4.3 billion in FY 2009. With cutbacks in government spending from a fiscal stabilization plan, covered payroll dropped 11% to $3.8 billion in FY 2010 and an estimated 5.5% to $3.6 billion in FY 2011. An increase is projected for FY 2012 to $3.75 billion. In FY 2011, the statutory employer contribution of $335 million provided 2 times (x) coverage of annual debt service but only 0.78x coverage of maximum annual debt service (MADS; $429 million in FY 2028). The contribution rate increases included in the pension reform legislation will substantially increase coverage going forward. Coverage will more than double over the next 10 years as the rate increases are implemented.
Although there are over 200 contributing employers to the system, providing some diversification, the predominance of commonwealth central government agencies in employer contributors (about 61% of the total) as well as the interrelationships between the commonwealth and other participating employers link this credit to the commonwealth's general credit. Payments to the system require appropriation and are subordinate to general obligation debt payments. Although subject to appropriation, the contributions are appropriated annually along with appropriations for employee compensation and have a legal payment priority after only public debt.
The ERS has entered into a security agreement with the fiscal agent whereby it pledges, and grants a security interest in, employer contributions made after the date of issuance of the bonds. There is no retirement system asset or commonwealth backstop on the bonds, and no claim on employee contributions. A forward-looking additional bonds test (ABT) requires that projected contributions in each year (based on an independent forecast) provide at least 1.4x coverage of senior bond debt service, and 1.25x total debt service, in that year. A debt service reserve is funded based on a rolling calculation of 50% of average annual debt service for the next five years. A general reserve account is funded from excess revenues at a minimum of 10% of the next bond year's debt service.
Bondholders have a first claim on employer contributions each year. Contributions are made along with payroll as part of an employer's payroll cycle (15 days or monthly), with about 50% of total contributions made through the commonwealth's Department of Treasury payroll system. ERS will transfer all employer contributions to the fiscal agent once a month on the last day of the month. Excess employer contributions will flow back to the system once the general reserve is funded at more than 25% of the next bond year's debt service or at the end of the bond year.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Tax-Supported Rating Criteria', dated Aug. 16, 2010;
--'U.S. State Government Tax-Supported Rating Criteria', dated Oct. 8, 2010
Applicable Criteria and Related Research:
Tax-Supported Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=648898
U.S. State Government Tax-Supported Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=648897
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