MuniLand: $13.5 Billion JACKPOT!

Congratulations New Jersey! Your lottery assets are worth $13.5 billion! What are you going to do with the money?

The Garden State will use these assets to support its heavily underfunded public pension systems. New Jersey has transferred the state’s lottery system, estimated in value at $13.5 billion, as well as the lottery’s $1 billion in annual revenues to the state’s three largest pension systems for the next 30 years. The move is a credit positive and demonstrates the state’s ability and willingness to make decisions to address its pension issues. The NRSROs’ downgrades of the State of Illinois, Connecticut, Kentucky and New Jersey indicate that unsustainable and accelerating pension obligations and subsequent annual required contributions are credit drivers. No matter how you look at New Jersey’s decision (creative accounting or accounting gimmick), increasing funding ratios and lowering annual required contributions are a near-term credit positive.

Utilizing the lottery asset transfer is like paying down – but not off – a credit card with a large balance. As you pay down the credit card debt, your minimum payment decreases and your total available credit improves. Citi estimates that the pension funding ratio for all pension plans based on annual net pension liability (ANPL) would increase to 65% from 55%. Another way to analyze pension debt uses unfunded actuarial accrued liability (UAAL). Analyzing UAAL assumptions and funding ratios would result in an improvement to ~49% from ~30%. Fitch estimates funding ratios would improve to 58.9% from 44.7%. As the total UAAL decreases, annual required contribution (ARC) will decline, creating room in the general fund budget to fund operations absent the lottery revenues. 

Fitch recently reported that states are getting creative in addressing their pension burden and used New Jersey’s experiment as an example. Citi cites the New Jersey Attorney General arguing that the “experiment” has sound legal authority under the state constitution, because the lottery proceeds are used for education and state institutions. The three pension funds qualify as education and state institutions, as teacher pensions "constitute state aid for education," and some members of PERS and PFRS work at state institutions or public universities. 

In all, the “lottery game” does not change the state’s long-term structural budget issues. The state economy continues to lag national trends, population growth is in the low single digits, and the per capita tax burden is high. However, the lottery game is a near-term credit win and demonstrates, yet again, the state’s ability and willingness to make decisions to address its pension issues.

Source: SNW Fixed Income Research, Citi, Fitch and Bloomberg News