Advisors, Municipal Bond Managers Eye Governor Races In Swing States

U.S. voters' readiness to face tough issues such as pension reform rather than simply kick the can further down the road will be put to the test next week as two-thirds of state governor posts go up for election.

A handful of the Nov. 4 races such as the dead heat in Illinois, possibly the most fiscally dysfunctional state, shape up as de facto referendums on reform and their results could make municipal bond investors alter their bets.

"People are not so much voting for governor in some of these states but how they want the pensions addressed," said Craig Brandon, Co-Director of Municipal Investments at Eaton Vance in Boston.

Investors want to see the states tackling chronic underfunding of pension plans that over-promised and failed to deliver in the wake of the 2008-2009 global financial crisis.

Out of 36 races scheduled alongside mid-term congressional elections investors will focus on those that involved big issuers and could change the state's budget fortunes.

Over the past two decades, California, New York, Texas, Florida, Illinois, Pennsylvania, New Jersey, Massachusetts, Ohio and Michigan -- and public entities in those states -- have been the top issuers in the $3.7 trillion municipal debt market, according to Thomson Reuters data. All but New Jersey are holding governor elections next week.

The estimated funding shortfall for current and future payouts of top 25 U.S. public defined benefit pension plans has tripled to at least $2 trillion in less than a decade, Moody's ratings agency said last month.

"If you've got pension fund costs going up at an astronomical rate and revenues going up at a much more reduced rate - you can't get blood from a stone," said John Mousseau, director of fixed income at Florida-based Cumberland Advisors. "Everyone's got to share in the solution."

Tax Dilemmas

Raising taxes is one such solution and whether the states follow that route could be a deciding factor in some races.

In Illinois, which has the most underfunded retirement system among U.S. states with a $100 billion uncovered pension liability, incumbent Democratic governor Pat Quinn wants to turn a temporary income tax rise enacted in 2011 into a permanent one.

His Republican opponent Bruce Rauner wants to phase it out and suggests savings instead, such as ending the practice of ramping up state employees' pay before they retire to boost their pensions.

"The permanence of that tax increase would make it a better credit," said Peter Hayes, Head of BlackRock's Municipal Bonds Group, which holds a variety of Illinois-based debt. Hays said that could potentially make the group notch up its exposure to the state's debt.