pension obligation bonds

Former NY Lieutenant Gov: Kansas’ Pension Bond Plan a “Dreadful Idea”

Kansas Gov. Sam Brownback last month proposed issuing $1.5 billion in bonds to help cover the state’s pension funding shortfall.

The bonds would allow Brownback to go through with another proposal – lowering state payments to the pension system by $39 million in fiscal year 2015-16 and by $92 million in fiscal year 2016-17.

But pension bonds don’t come without risks. Over the weekend, a former New York lieutenant governor called Brownback’s plan “a dreadful idea”. From the Wall Street Journal:

Richard Ravitch, the former New York lieutenant governor who helped save New York from bankruptcy in the 1970s and now sits on the board of The Volcker Alliance, called Kansas’ plan “a dreadful idea.”

“If you cover current obligations by borrowing money, you’re on an unstable course,” said Mr. Ravitch.

There are other criticisms of pension obligation bonds, as well. The states and municipalities that issue them, for example, are frequently in ill-equipped to deal with the fallout if pension investment returns don’t exceed bond interest rates.

From the Wall Street Journal:

The state would make a decades-long bet that pension-fund returns will exceed current interest rates for taxable municipal bonds. Kansas officials said interest rates near historic lows make the bonds an attractive way to help manage retirement obligations.

If examined from the stock market highs at the end of 2007, such deals returned an average of 0.8%, the Center [For Retirement Research] said in a report last year. By 2009, however, most pension bonds were a net drain of -2.6%. Thanks to stock market gains following the recession, however, most of the deals were back in positive territory by 2014, returning an average of 1.5%.

Pension-bond deals made at the end of the market run-up in the 1990s, or right before the crash in 2007, have produced negative returns, the report said. Many of the bonds have a 30-year lifespan, meaning the final results won’t be known for years.

“This should be a tool in a well-functioning governments arsenal,” said Alicia Munnell, the Center’s director. “Unfortunately, those that use them tend to be cash-strapped and desperate.”

Read the Center for Retirement Research report on pension obligation bonds here.

Photo credit: Lendingmemo

Kansas Pension Officials: State’s Plan to Delay Pension Payments Could Cost Billions in Long-Run

Kansas Gov. Sam Brownback in December diverted a $58 million payment from the pension system and used the money to plug holes in the state’s general budget.

The governor is seeking to delay more state payments to the pension fund, and is also looking to offset some of the costs by issuing pension obligation bonds.

But pension officials told lawmakers Tuesday that such a decision could end up costing the state between $3.7 billion and $9 billion in the long run.

From the Kansas City Star:

Changes to the state’s pension system proposed by Gov. Sam Brownback could cost Kansas $3.7 billion in the long run, lawmakers learned Tuesday.

The governor seeks to delay payments intended to shore up the state’s pension system to save money in the short term.

The Kansas Public Employees Retirement System faced an unfunded liability of $9.8 billion at the beginning of 2014. The state was on pace to pay it down to zero by 2033 because of reforms enacted during Brownback’s first term.

Instead, Brownback proposed Friday to pay down the unfunded liability more slowly, by 2043, to save money during the ongoing state budget crisis.

“It’s like the mortgage on your house. If you pay less, you’re going to pay longer and you’re going to pay more,” Alan Conroy, the executive director of KPERS, told the House Appropriations Committee.

The delay would increase costs overall by $9.1 billion. But Brownback proposes issuing $1.5 billion in bonds, and the profits from the interest on those bonds would partially offset that cost.

Rep. Kathy Wolfe Moore, a Kansas City, Kan., Democrat, said the state was undoing the progress it had made in reforming the pensions system.

“It costs us $9 billion with a B (to enact the governor’s plan). … So we’re doubling what we have now? We’re doubling our unfunded actuarial liability?” Wolfe Moore said. “We’re going in exactly the wrong direction as far as I can see.”

Kansas PERS was 56.4 percent as of the end of 2013.

Photo credit: “Seal of Kansas” by [[User:Sagredo|Sagredo]][[User talk:Sagredo|⊙☿♀♁♂♃♄]] – http://www.governor.ks.gov/Facts/kansasseal.htm. Licensed under Public Domain via Wikimedia Commons – http://commons.wikimedia.org/wiki/File:Seal_of_Kansas.svg#mediaviewer/File:Seal_of_Kansas.svg

San Bernardino Sued By Creditor For Favoring Pension System During Bankruptcy

The bankrupt city of San Bernardino, California has been sued by one of its bondholders for favoring pensioners over creditors during its bankruptcy.

San Bernardino has largely kept up with its payments to CalPERS. But the lawsuit claims the city has not extended equal favor to its bondholders.

From BusinessWeek:

Pension-bond holder Erste Europaische Pfandbrief- und Kommunalkreditbank AG sued San Bernardino yesterday in federal bankruptcy court in Riverside, California, claiming equal status with Calpers. The company, which holds about $50 million in pension obligation bonds, didn’t name Calpers in the suit.

“Any payment of the Calpers pension obligation portion requires equivalent payment of the bondholder pension obligation portion,” the company, a unit of Frankfurt-based Commerzbank AG (CBK), said in the filing.

Cities often issue bonds to raise money to bolster their pension obligations. In San Bernardino’s case, the money was used to fill a hole in its pension fund, which is administered by Calpers. The city also makes regular payments on behalf of its employees to Calpers, which in turn pays retired city workers.

[…]

The lead bankruptcy attorney for the city, Paul Glassman, referred questions to San Bernardino’s elected city attorney, Gary Saenz, who didn’t immediately respond to an e-mailed request for comment on the suit.

San Bernardino filed bankruptcy in 2012. Although it stopped paying CalPERS for a period of a few months, it has since resumed payments so that no pension benefits would be cut as part of its bankruptcy.

Kentucky Teachers’ Pension Asks Lawmakers For Funding Help; Will Present Bond Proposal

The Kentucky Teachers’ Retirement System is seeking help from the state legislature in easing its pension obligations. The plan involves the state issuing bonds.

Details on the proposal are sparse, but KTRS officials will present their plan to lawmakers on Wednesday.

From the Courier Journal:

The Kentucky Teachers’ Retirement System is proposing that the state issue a new bond to help shore up underfunded teacher pensions.

Officials from KTRS will present the proposal to lawmakers on the Interim Joint Committee on State Government on Wednesday afternoon. An official said last week that the plan will center on using existing revenue streams that will soon become available once the state retires debt service on older bonds.

According to the 2013 valuation, KTRS faces more than $13.8 billion in unfunded liabilities and has only 52 percent of the money it needs to pay out pension benefits in coming decades.

The system has asked the state to provide around $400 million in additional funding each year to keep the system solvent.

The plan could well be for the state to issue “pension obligation bonds”. Governing magazine explains the concept of POB’s:

Pension Obligation Bonds (commonly referred to as POBs), allow governments to issue taxable bonds for the purposes of putting money toward or fully paying off the unfunded portion of a pension liability. The proceeds from the bond issue go in the pension fund. The theory is that the rate of return on the investment will be greater than the interest rate the government pays to bond investors so that the transaction is favorable to the government; it makes money off the deal.

KTRS manages $17.5 billion in assets. The system is about 51 percent funded.

Louisiana Pension Borrowing Proposal Shot Down

Louisiana lawmakers were floating a plan to borrow money and buy out the pensions of thousands of “vested” retirees – paying them a lump sum payment up front in order to reduce the state’s future pension obligations.

But experts and stakeholders testified that the plan was not a good idea.

From the Advocate:

A proposal to borrow money to help reduce state pension system debts got shot down quickly Monday.

The idea was to borrow money that would be used to pay one lump sum and buy out the pensions of vested retirees who have not yet begun to draw their benefits. Waiting before drawing on a pension allows the retiree’s pension to increase in value. Paying off the benefits of those retirees would reduce the state’s $20 billion long-term debt obligations, called the unfunded accrued liability.

But a state treasury official, the Legislature’s actuary and two state retirement system chiefs all testified that the idea was plagued with problems.

Just how many vested retirees could take part in such a program, if approved, is unclear. However, the Teachers Retirement System of Louisiana has 6,336 vested but inactive members, and the value of their pensions is $283 million.

Maureen Westgard, executive director of the Teachers Retirement System, said her board “has viewed (the idea of borrowing) as highly risky” in the past.

According to testimony, the aspect of the plan that called for borrowing money was the most problematic. The option of issuing pension obligation bonds was floated. From the Advocate:

Goldman Sachs pitched the idea of “pension obligation bonds,” and he wanted to see if the idea was a viable one, said Pearson, R-Slidell.

“Pension obligation bond history has not been very favorable,” said legislative actuary Paul Richmond, who noted a disaster involving the New Orleans firefighters retirement system.

First Assistant State Treasurer Ron Henson said the state is restricted in its ability to issue debt by a limit on the money it can spend annually in debt payments.

Further, he said, borrowing is already planned for state and local projects that legislators and their constituents want. “Our debt capacity will not allow the luxury of issues like these,” Henson said.

Louisiana State Employees Retirement System Executive Director Cindy Rougeou said it’s uncertain whether the idea would produce a savings or a cost.

“The overall debt is not being reduced. It’s just restructuring part of the overall UAL debt for a hard bond debt,” she said. “It’s almost taking out a second mortgage.”

Louisiana’s pension systems were collectively 58 percent funded in 2013, according to a 2014 Bloomberg analysis. That ranked 8^th-worst in the country.

Michigan To Sell Record Number of Bonds to Finance Pension Shortfalls

640px-Kalamazoo — Kalamazoo is just one Michigan city considering a historic bond offering to cover pension obligations.

It’s a strategy that’s becoming increasingly common—municipalities, straddled with outstanding pension obligations, issue bonds to cover near-term funding shortfalls.

In a particularly risky iteration of the practice, cities and states will take the proceeds from selling the bonds and re-invest them into the market.

That’s exactly what Michigan is gearing up to do, according to Bloomberg:

The Detroit suburb of Macomb County plans a $270 million sale of municipal debt, its biggest ever, to finance retiree health-care costs, while Kalamazoo is considering a historic $100 million bond offer for similar expenses. Bloomfield Hills plans to borrow a record $17 million for pensions. The law allowing the practice expires Dec. 31.

U.S. states and cities are struggling with how to pay for promises to workers after the recession ravaged their finances. Yet few communities see debt as the answer — sales of revenue-backed pension bonds have tallied $356 million this year, data compiled by Bloomberg show. Interest rates close to five-decade lows are making it more attractive to pursue the risky strategy of investing borrowed funds in financial markets.

“We can’t afford to wait,” said Peter Provenzano, Macomb County finance director. “Timing the market is difficult. You could sit on the sidelines and miss out on an opportunity.”

It’s a risky strategy that’s been covered many times before, perhaps best by the Center for Retirement Research’s recent brief.

The gist: If a city is going to re-invest proceeds from issued debt, they better hope the market produces returns that exceed the cost of servicing the debt.

The problem is, most cities that turn to this practice are already in dire straits fiscally. If the bet doesn’t pay off, it leaves cities even worse off.

At least one Michigan city is shying away from the practice: Grand Rapids.

“The best way to have odds in your favor is to do this when stock prices are depressed,” Scott Buhrer, the city’s chief financial officer, told Bloomberg. “We’re in the latter stage of a bull market.”

Photo: “Kalamazoo” by User Mxobe on en.wikipedia – own-work. Licensed under Public domain via Wikimedia Commons

Pennsylvania Weighs Risks, Rewards of Pension Obligation Bonds

Pension reform has been the talk of Pennsylvania politics these last few months, and the reasons are equally political and practical: if retirement costs keep rising, the state’s fiscal handcuffs will keep tightening—and they are already uncomfortably snug. That leads eventually to budget-cutting maneuvers, many of which are sure to be politically unpalatable.

But a recent analysis from the actuaries for the state’s Public Employee Retirement Commission presents a policy tool to save the state money. The tool: pension obligation bonds (POBs), the controversial bonds that carry big risks and big rewards for the states that issue them.

The actuarial analysis stated that the state could save $24.5 billion over the next 30 years if they issued just $9 billion in POBs. The state’s PSERS system could reduce costs by $19.8 billion with POBs, according to the analysis.

The University of California Retirement System Is Scrambling to Cover Funding Shortfalls

When a pension system gives employees and employers a 20-year contribution holiday, you can bet it’ll run into some funding troubles down the line. University of California’s retirement system has been knee-deep in that harsh reality for years now. That has led to the borrowing of billions of dollars to cover funding shortfalls. And the University system has now taken out another massive loan.

From Ed Mendel at CalPensions:

UC regents last week approved borrowing another $700 million internally to help close a pension funding gap, bringing the total borrowed to $2.7 billion in a pension bond-like strategy with risks or rewards, depending on investment earnings.

Five years ago University of California employers and employees were paying nothing into the pension system. In a remarkable contribution “holiday” that began in 1990, payments into the system dropped to zero and stayed there for two decades.

After restarting in 2010, the employer contribution to the UC Retirement Plan increased from 12 to 14 percent of pay this month and most employee contributions increased from 6.5 to 8 percent of pay, a total of nearly $2 billion a year.

But the steady increase of contributions that were once zero still falls short of closing the pension funding gap. Last year UC Retirement had only 76 percent of the actuarially projected assets needed to pay pension obligations over the next three decades.

To help close the funding gap, UC borrowed $1.1 billion from its own Short-Term Investment Pool in 2011 and $937 million from external sources. The $700 million loan approved last week is from the short-term pool.

The UC Retirement fund, with assets valued at about $50 billion, expects to earn an average of 7.5 percent a year, the same as the California Public Employees Retirement System. Critics say the earnings forecast is too optimistic and conceals massive debt.

In what some call arbitrage, money borrowed at a low interest rate from the UC short-term pool (which earned 1.7 percent last year) and invested in the pension fund earns a profit if the return is the expected 7.5 percent or even a little less.

“I do feel we are on a little bit of a slippery slope here,” said Regent Fred Ruiz. “I think we have to be very cautious … The market changes from year to year, and if we don’t get the returns we need to have, then we are in great trouble.”

This is the same concept, essentially, as Pension Obligation Bonds. And, just like POBs, the outcome of this borrowing can either be of great benefit or great harm to the U of C pension system. Whether this turns out good or bad depends on future investment returns.

STUMP blogger Mary Pat Campbell gives her take on the dangers of U of C’s decision:

One should always match one’s borrowing to one’s accrual of expenses. It’s okay to finance the acquisition of an asset (such as a car or a house) with a loan that amortizes over the life of the asset. It’s not okay to take out a 30-year-loan to pay for a trip to Disney. The first is based on good financial principles, the second indicates you are living way beyond your means.

Short-term financing for operational expenses is fine if one has “lumpy” cash flows (which the UC system may have, depending on how they pay their staff. I get paid for my adjunct teaching only during the semester.) But even though they’re calling it a short-term pool, it sounds to me like what they’re doing is borrowing under short-term limits, but keeping rolling over the debt, as if it were a longer-term loan.

I really don’t like the sound of that.

That is something that could escalate rapidly should interest rates start to rise.

Bottom-line: borrowing money for a fake arbitrage is bad finance. The 7.5% return is just an assumption, not a sure thing. Real life returns vary a lot the way they invest it — and the loan interest is a sure thing, just as the pension benefits are a (supposed) sure thing.

We won’t know for years how this decision ultimately plays out for the University of California system. But you can bet the Regents have their fingers crossed.

Pension Obligation Bonds Help Some Governments But Hurt Many More, Says New Report

New Jersey, Illinois, and California.

Those are the states that, more than any others, have frequently scrambled to pay down their pension obligations by issuing a financial tool called Pension Obligation Bonds (POBs). Over the last three decades, those three states have issued a total of $25 billion worth of POBs in an attempt to ease the heavy burden of their pension systems’ on state finances.

But what are POBs, and do they work as advertised? A new report from the Center for Retirement Research sheds light on that question and suggests that POBs may not be beneficial, after all. But first, what exactly is a POB? From Governing:

The tool, called Pension Obligation Bonds (commonly referred to as POBs), allows governments to issue taxable bonds for the purposes of putting money toward or fully paying off the unfunded portion of a pension liability. The proceeds from the bond issue go in the pension fund. The theory is that the rate of return on the investment will be greater than the interest rate the government pays to bond investors so that the transaction is favorable to the government; it makes money off the deal.

The concept is simple enough. And, in theory, it’s pretty clever. But in practice? Well, let’s just say timing is key. And many state and local governments have failed to get the timing right. It has cost them dearly, as Liz Farmer summarizes:

The report noted that the governments more likely to issue POBs are ones that have pension plans that represent “substantial obligations.” The governments have large outstanding debt and are short of cash. However, rather than necessarily relieving such governments of financial pressures, the bonds actually create a more rigid financial environment. Issuing bond debt to pay off a long-term obligation like a pension liability turns a somewhat flexible pension obligation into a hard and fast annual debt payment. Thus, “governments that have issued a POB have reduced their financial flexibility,” the study says.

POBs’ net returns (what the investment has earns after making bond payments) has varied, depending on when the bonds were issued. According to the center’s research, the net rate of return has averaged in the low, single digits for most years (the 30-year average is 1.5 percent). Governments that issued Pension Obligation Bonds in 1998, 1999, 2000 and 2007 actually lost money on their investment. Detroit, for example, issued debt at the peak of the market in the mid-2000s to fund its pension plan and did so using a complicated interest rate swap deal. The result was that the deal went the wrong way for the city. Detroit was still on the hook to pay bondholders and though its pension was well funded, it had even less day-to-day cash to meet its financial obligations. That debt played a key role in Detroit’s decision to file for bankruptcy last July.

Illinois, New Jersey, Detroit—that’s not the kind of company you want to keep if you are a local government trying to curb the burden of pension obligations. Though, the reputation of POBs may not be completely deserved. After all, just because struggling governments use them unwisely doesn’t mean POBs aren’t an effective tool when used the right way.

Although examples are hard to come by, POBs can be used effectively. In 2002 and 2003, Winnebago County and Sheboygan County in Wisconsin issued POBs to the tune of $7 million. They paid a 3 percent interest on that debt, but earned 20 percent returns on investments made with the borrowed money. Unfortunately, it doesn’t always work that way.

You can read the CRR’s full report on POBs here.

Photo by Miran Rijavec Stan Dalone via Flickr CC License