Fitch: Pension Bonds Not Likely to Have Positive Impact on Issuer’s Credit Outlook

A major credit rating agency weighed in this week on the topic of pension obligation bonds (POBs) and what they mean for the credit quality of the issuer.

Fitch released a report this week that concluded POBs are not likely to have a positive effect on the issuer’s credit quality, but nor are the instruments necessarily a credit negative, either, according to the report.

The agency said context is important – the credit impact of POBs depends on numerous factors, including the severity of the issuer’s pension debt and the issuer’s general fiscal situation.

Several states – including Kansas and Pennsylvania – are weighing whether to issue pension bonds.

From Fitch:

Pension obligation bonds (POBs), which some issuers have pursued in response to weak funded ratios, are likely to have a neutral to negative impact on the issuer’s credit quality, according to a Fitch Ratings report. Issuing POBs may affect the issuer’s overall liability burden and financial flexibility, and always adds investment risk. Likewise, the issuer’s underlying pension situation before and after POB issuance are important considerations when assessing the credit impact of POBs.

‘The rating on a POB issuer incorporates these varying–and often offsetting–contextual factors to assess the extent to which issuing POBs results in a net change to the issuer’s risk profile’ said Douglas Offerman, Senior Director at Fitch.

When POB proceeds add to a system’s assets, they effectively replace one long-term liability with another and, thus, have no net impact on the total liability burden assessed by Fitch. However, if proceeds are used to offset actuarial contributions made from budget resources, or not made at all, Fitch views the POB to be a deficit financing. Fitch also assesses the repayment profile of the POBs compared to the pension contributions being replaced, and the issuer’s track record of making full actuarial contributions.

Read Fitch’s full comment on POBs, titled ‘Pension Obligation Bonds: Weighing Benefits and Costs, by clicking here [subscription required].

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