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By Jeremy Glaser and Rachel Barkley | 09-11-2013 02:00 PM

Muni Investors Should Keep an Eye on State Pensions

With vast differences in funding levels across states, muni investors need to carefully consider the impact of pension obligations when assessing muni-credit worthiness, says Morningstar's Rachel Barkley.

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. We recently released our state pension report, and I am here today with Rachel Barkley, a municipal credit analyst, to see which states came out on top, which came out on bottom and why investors should care.

Rachel, thanks for joining me.

Rachel Barkley: Thank you for having me.

Glaser: Let's start and talk a little bit about why investors should be interested in pensions or the state of pensions across the country. What is the potential impact on municipal credit?

Barkley: The impact could be very broad. And we look at state pensions particularly for a number of reasons. One is obviously that they impact the states themselves directly. Pensions falls under one of our four main pillars, when we are looking at states, under the debt and liabilities pillar.

Additionally states very commonly provide pension plans that cover local entities, as well. If you are looking at the fiscal health of one pension plan, that might say a lot about the fiscal health of pensions for entities in the state as a whole. These days we've even seen pensions become more in the spotlight. The cost of pensions and the liabilities have been escalating in past years which [have also seen], as you can imagine, contributions from these entities to the pension plans in a time when governments are really still recovering from recession and extra revenues are scarce. This can become a pressure.

In some rare circumstances we've seen pension liabilities be a driver for municipalities filing for bankruptcy. Obviously, this can't happen on a state level since states aren't allowed to file for bankruptcy, however, it's still something we need to look at the municipal level.

Glaser: Therefore, if you are trying to say that the creditworthiness of a bond you really need to have pensions in mind?

Barkley: Definitely.

Glaser: What are some of the big findings that you found this year, and what have some of the changes been from when you looked at state pensions just a year ago?

Barkley: Overall, we are still seeing the general funded level in aggregate fall. Although it's been a slight fall, pensions as a whole for the states are a little over 72% funded this year and that's just slightly over a 2% decline from the prior year. However, we'd like to point out that there are very wide disparities in the pension-funded levels among these groups and that they shouldn't be looked at in just a collective basis.

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