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New Jersey Grapples With Cost of Pension Bonds Issued in ’90s

In 1997, New Jersey issued $2.8 billion of pension bonds to shore up its underfunded retirement system.

The success of such a plan depends on investment returns outpacing interest payments. But the ensuing dot-com crash threw a wrench into the plan’s efficacy, and more than 15 years later, New Jersey is now dealing with the cost of the bonds.

More on the mounting debt service payments, from Bloomberg:

The payments on the debt, which was sold in 1997 to bolster the public-employee pension plans, are set to grow to almost $500 million in 2020 from $342 million this year, according to a Feb. 13 report released by the state treasurer. The annual cost will remain close to that level until the debt is paid off at the end of next decade.

“The pension debt service is skewed to the out-years,” said Richard Keevey, a fellow at Rutgers University in New Brunswick, New Jersey, who was budget director for former Governor Jim Florio, a Democrat. “It starts out low and rises sharply.”

[…]

Interest and principal payments on debt will rise 15 percent next year to $3.99 billion.

Investors demand additional yield to buy New Jersey debt. An index of 10-year New Jersey bonds yielded about 2.8 percent Tuesday, 0.63 percentage point above AAA munis, data compiled by Bloomberg show. The yield gap reached 0.64 percentage point Feb. 18, the most since at least January 2013.

The pension bonds carry yields as high as 7.65 percent on debt maturing in 2026. Most can’t be repurchased from investors before they mature, which prevents New Jersey from refinancing to take advantage of lower interest rates.

The pension bonds will cost $350 million in FY 2015-16 and $397 million in FY 2016-17, according to the state treasurer’s report.

Photo credit: Lendingmemo via Flickr CC License

Pennsylvania Gov. Wolf Proposes $3 Billion Pension Bond

Pennsylvania Gov. Tom Wolf unveiled his budget proposal on Tuesday, and it contained a number of pension-related items.

The biggest was undoubtedly the proposed issuance of $3 billion in pension bonds, to be used to pay down the liability of the Public School Employees Retirement System (PSERS).

As is always the case with pension bonds, the state runs the risk of worsening its financial position. But if PSERS’ investment returns exceed the bonds’ interest rates, the state will come out on top.

Kansas Treasurer Considers Pension Obligation Bonds Amidst State Plans to Cut Annual Pension Payment

Kansas Gov. Sam Brownback announced plans this week to cut nearly $60 million from the state’s annual pension contribution and use the money to plug budget holes elsewhere.

In light of that news, Kansas Treasurer Ron Estes is considering issuing bonds to help fund the state’s pension system.

From Bloomberg:

Brownback, a Republican who starts his second term in January, last week proposed shortchanging the state’s pension contributions by $58 million to close a $280 million budget hole caused in part by tax cuts the governor championed. Kansas, with the fifth-weakest pension system among U.S. states, had its issuer ratings downgraded by Standard & Poor’s and Moody’s Investors Service this year.

To close a $7.35 billion funding shortfall, the state needs to keep commitments that were part of a 2012 pension overhaul, said Estes, a Republican who also won re-election last month. The plan called for more funding from the state, including revenue from casinos it owns, and raised the amount employees pay.

“We need to keep working on our pension reforms passed two years ago or we’ll fall further behind,” Estes said in an interview from Topeka.

Kansas can take advantage of interest rates close to five-decade lows to raise cash, increase the funding level and create fixed payments, Estes said. The state issued $500 million of pension bonds in 2004; a proposal to sell another round stalled in the legislature last year.

[…]

The [Kansas PERS] system supports issuing bonds or any measure that boosts its funding, said Kristen Basso, a spokeswoman.

“Pension bonds would reduce our unfunded liability and improve our funded ratio,” she said in an e-mail.

But the bonds aren’t a problem-free solution. From Bloomberg:

The debt, which is typically taxable, carries risk. The strategy is to invest the proceeds, usually in stocks, and earn more than it costs to repay bond investors. The approach can backfire if issuers borrow when equities are at historic highs, said Jean-Pierre Aubry, assistant director of state and local research at the Center for Retirement Research at Boston College. The S&P 500 Index this week posted its best two-day gain in more than three years.

“There are instances where they can work, but they can be risky financial tools for cash-strapped borrowers,” Aubry said in a phone interview. “They’re gambling on the market and should be undertaken by those with the appetite for the risk and the ability to absorb the risk.”

Kansas’ state pension systems were collectively 56.4 percent funded as of 2013.

Photo credit: “Seal of Kansas” by [[User:Sagredo|. Licensed under Public Domain via Wikimedia Commons

Fixed-Income ETFs Gain Traction With Canadian Funds

Exchange-traded funds are becoming an increasingly popular investment vehicle for institutional investors around the world, but that trend is especially true among Canadian pension funds, according to a new study.

One type of ETF was particularly popular: fixed-income.

The study, which interviewed public and corporate pension funds as well as foundations and endowments, found that 57 percent of institutional asset managers are using fix-income ETFs in 2014. In 2013, that number was 45 percent.

The report, produced by Greenwich Associates, offered some reasons for the growing popularity of bond ETFs. From the Financial Post:

“Increasingly, institutional funds and asset managers are viewing ETFs not simply as useful tools for making tactical adjustments to portfolios, but rather as efficient methods for implementing new investment strategies.”

“In particular, ETFs appear to be steadily gaining traction in fixed income — a trend that could reflect investors’ search for better and more efficient approaches to the asset class in a shifting interest-rate environment.”

“Institutions’ heavy usage of passive strategies is helping to drive the growth of ETFs in fixed income,” the study said. “Virtually all the institutional funds and asset managers employ passive strategies in fixed income, and nearly a quarter invest more than half of fixed-income assets in index strategies.”

Interestingly, this is a relatively recent phenomenon. Of the Canadian institutions holding fixed-income ETFs, more than 20 percent said they had started using the vehicles less than two years ago.

Even more popular than fixed-income are equity ETFs, which are employed by the vast majority of Canadian institutional investors. From FP:

Despite this growing penchant for bond funds, equity-related issues remain the most popular ETF investment among institutions, with nearly 80% using the funds in their domestic stock portfolios and 85% employing them to gain U.S. equity exposure.

ETFs are primed to continue their upward trend. According to the study, 40 percent of institutions are planning to increase their allocation to ETFs next year. Only 2 percent of respondents said they plan to reduce allocations.