CHICAGO — Saginaw County is set to become the first local government in Michigan to issue bonds to cover its unfunded pension liability when it comes to market this month with up to $75 million of taxable debt.
The county will become the first in the state to take advantage of a new law that allows qualified local governments to issue long-term bonds to cover their retiree obligations. Governments can also borrow to cover their other post-employment benefits, or OPEBs, under the new law.
Triple-A rated Oakland County, which issued $570 million of taxable certificates in 2007 to cover its pension liability, is expected to be next in line to take advantage of the law when it restructures its certificates into long-term bonds later this year.
Local government officials across the state are watching the Saginaw County transaction, according to officials.
“There are definitely other counties looking at this,” Saginaw County Treasurer Tim Novak said. “It’s pretty exciting to be in on the front end and lock costs in and be able to manage the financials moving forward with fixed costs instead of something that’s going to be rising and unpredictable.”
The state still needs to approve the deal.
The law, which sped through the Michigan Legislature last summer, requires that governments meet certain criteria to be eligible to bond for their obligations. Issuers have to be rated in the double-A category and prove that they can cover debt payments with general fund dollars, among other restrictions.
The law also requires governments to close their defined-benefit plans. They can switch to a 401(k)-style defined-contribution plan, but cannot increase the benefit levels of the closed defined-benefit plan once the bonds have been issued.
The law is part of Republican Gov. Rick Snyder’s push for local governments to switch to the 401(k)-style plans as a way to bring down retirement obligations. Snyder signed Senate Bill 1129 into law in October 2012.
Saginaw County closed its defined-benefit plan in the late 1990s.
If the state approves the deal, Saginaw hopes to head to market before the end of April with roughly $64 million of taxable, 20-year pension obligation bonds structured with level debt-service payments over the life of the debt.
Fifth Third Securities Inc. is the senior manager. Bank of America Merrill Lynch and Stifel Nicolaus & Co. are co-managers. Public Financial Management Inc. is the county’s financial advisor on the deal and Dickinson Wright is bond counsel.
Proceeds would be deposited into the state’s Municipal Employees Retirement System, or MERS, to pay off the county’s entire liability. The county expects to save $15.6 million over the 20-year life of the bonds with the deal.
Saginaw County’s annual required contributions increased by 53% from 2010 to 2012 and are expected to continue to increase over the next several years.
The payments are projected to total $6.2 million in 2014, rising to $10.3 million in 2026, before dropping off steeply starting in 2027 and stopping altogether in 2030.
Debt service on the bonds is expected to total around $4.6 million assuming an interest rate of 3.6%, according to a financial analysis on the county website.
The bonds will be payable through 2033, though the county’s pension payments are projected to drop to $600,000 in 2028 and 2029 and then to zero by 2030.
“For us, it offers stability for budgeting purposes versus a variable amount that changes every year,” said county Controller Robert Belleman. Bond payments are expected to be at least $1.6 million a year less than pension payments.
“That’s where the savings is achieved, and it offers us stability in budgeting,” the controller added. “One of the concerns from the county’s perspective is how do you budget for something that could jump unexpectedly?”
The finance team is keeping its fingers crossed that interest rates remain low enough that it makes sense to do the borrowing.
Belleman said the county will likely pull the deal if it appears it will have to pay more than a 4.25% interest rate.
“That’s a ceiling where the projected savings will not be achieved, and we’ll have to step back,” he said.
As of early February, the finance team was estimating an interest rate of around 3.6%. Saginaw County’s unfunded pension liability totaled $63.8 million as of Feb. 8, 2013.
Moody’s Investors Service assigned Aa3 ratings to the bonds ahead of the deal, in line with the county’s limited-tax general obligation bonds. Moody’s maintains a Aa2 rating on Saginaw’s unlimited-tax GO bonds. The central risk to the issue is that a declining rate of return would cause the investment to drop again below funded status. Then the county would be stuck making payments on the bonds as well as the pension liability. MERS assumes an 8% investment return on the pension fund.
It’s a risk, but not enough of one to warrant a rating lower than the Aa2 rating maintained on the rest of the county’s limited-tax GO bonds, Moody’s said.
“Moody’s position has always been that pension obligation bonds are at best credit neutral and could be a credit negative depending on the magnitude of risks following the issuance of the bonds,” analyst Matthew Butler said, adding that the chief risk is that the actual rate-of-return assumption turns out to be lower than projected. “In Saginaw County, we view it as at best a credit neutral, but it does carry some risk, but the risks that are posed are not great enough to merit downward pressure on the rating.”
Belleman said the County Board, which approved the bond deal last month, considered the future risks involved. “Based on the market performance, we always run the risk that there may be a future need to continue to fund the liability,” he said. “It was given some consideration and we believed the benefits outweigh the cons.”
In Michigan, pensions are mandated as part of the constitution, and Saginaw County officials said they view both the annual required contributions and pension obligation bonds as hard, or fixed, liabilities.
Butler, however, said the pension liability is “somewhat softer” than long-term bonds because failure to make a pension payment is not considered a default while failure to pay a limited-tax GO bond is considered one.
“The risks going forward are ones that apply not only to the county but to any local government that moves forward with something like this,” the analyst said.
Belleman said the county has considered issuing bonds for its other post-employment benefits, but said it’s less compelling because the OPEB liability is not constitutionally mandated.
“It’s a variable that we have, the annual required contribution, but it’s not required under state law,” Belleman said.
If the deal goes well, it’s likely other local governments will take advantage of the law.
“Other counties are interested and want to see how this goes,” said Kelli Lambrix, senior managing consultant at Public Financial Management Inc. “We’ve received inquiries from other clients looking at this from the standpoint of whether it makes financial sense.”
She said the county hopes to be able to take advantage of the new law while bond market interest rates remain favorable. “The process has been very smooth so far, and the feedback from the underwriters has been positive,” Lambrix said. “We have our fingers crossed that market conditions will remain steady for the next month.”
