$1B Pension Bond Bill Awaits House Approval in Kansas

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DALLAS — The Kansas House of Representatives is considering a bill to authorize $1 billion of pension obligation bonds; the bill has already passed the state Senate with the backing of Gov. Sam Brownback.

The measure is part of a package of bills designed to ease a $600 million deficit in the fiscal year beginning July 1 following a nearly $300 million budget fix in the current fiscal year.

Senate Bill 168 anticipates that proceeds from pension bonds would improve the state's funded ratio to 66% from the current 60.7%. The unfunded actuarial liability is expected to fall to $6.28 billion from $7.26 billion.

The Senate bill supplants a similar House measure that would have authorized $1.5 billion of pension bonds.

According to an actuarial analysis for the Kansas Public Employees Retirement System, the $1 billion of bonds could produce savings of $1.8 billion from all funding sources. The present value of the savings is estimated at $1 billion.

"Based on budget system expenditure data, the amount of state general fund resources used to finance state and school employer contribution payments is approximately 85%," according to a fiscal note.

"If this percentage is applied to the long-term savings figure, reduced employer contributions totaling $1.5 billion from the State General Fund could be created by the bill," the note said.

Debt service would be payable from appropriations. The interest rate of the bonds would not exceed 5%, according to the fiscal note.

The bonds' principal and interest would be an obligation of the Kansas Development Finance Authority. The Department of Administration and KDFA would be authorized to enter into contracts to implement the payment arrangement after the bonds are issued.

Kansas Budget Director Shawn Sullivan, who is part of the Brownback administration, promoted the bonds as a way to relieve the current budget deficit.

"For FY 2015, it is estimated that savings of $52.1 million from the State General Fund and $58.0 million from all funds would result from the budget plan that reduces the employer contribution rate for the last six months of the fiscal year," Sullivan wrote.

The pension system projects a $9.8 billion shortfall in funding for retirees' benefits through June 2033. Lawmakers have moved in recent years to close the gap, but the bill would give KPERS an infusion of funds quickly.

The measure anticipates the state taking 10 years longer, until 2043, to close the shortfall while reducing the state's annual costs.

Some lawmakers questioned the wisdom of replacing a liability with a debt, even though the invested proceeds of the bonds could grow at a faster rate than the interest, especially at the historically low rates available in the current bond market.

The hypothetical scenario calls for selling 30-year bonds at a rate below 5% while earning pension-fund returns of 8%, according to state officials.

Since 2012, most public pension bond deals have priced well below 4%, except for some maturities around 2032 that got rates around 5%, according to information supplied to The Bond Buyer by Interactive Data.

In 2003, the Kansas Legislature approved a $500 million bond issuance for KPERS, whose investment returns exceeded interest payments by $174 million, according to state officials.

The Kansas pension bond issue would be one of the largest since Illinois sold $3.7 billion in 2011. Kentucky's legislature is considering a pension bond issue of up to $3.3 billion. Pennsylvania Gov. Tom Wolf on March 3 proposed issuing $3 billion in pension obligation bonds.

Oakland, Calif., sold the first pension obligation bonds in 1985. Since then, cities and states have issued about $105 billion of the bonds, according to the Center for Retirement Research. The deals have produced an average annual real internal rate of return of 1.5% since 1992, the center has reported.

Facing a $600 million shortfall in the fiscal year beginning July 1, Brownback has proposed delays in planned future income tax cuts while increasing taxes on tobacco and alcohol.

Duane Goosen, former budget director for the state and now an analyst for the Kansas Center for Economic Growth, has written several articles criticizing Brownback's attempt to close the budget gap while cutting tax rates.

"Kansas does not have a stable revenue stream nearly large enough to cover regular, normal expenses," Goosen wrote in an op-ed piece distributed to Kansas newspapers.

Goosen has been particularly critical of Brownback's cuts to education, including a nearly $28 million reduction announced in January. Brownback has also sought to bolster the state pension fund and classroom spending through block grants over two years that bypass the state's complex funding formula.

The block grants are designed as an interim solution to the state's funding problems while lawmakers rewrite the school formula.

Brownback and his conservative allies in the Legislature believe the existing formula is flawed because it has led to forced spending increases.

"The dramatic increase in state education funding that has occurred over the last four years is unsustainable," Brownback, a Republican, said in a statement announcing his budget cuts. "School districts are estimated to have approximately $381 million in reserve fund balances to help them offset the smaller than expected increase in state funding."

Studies indicate that the interim funding plan would increase total state spending for public schools to more than $4.2 billion for the 2016-17 school year. That's about $333 million, or nearly 9%, more than what was allocated in 2013-14.

"It doesn't help Kansas schools or Kansas students, but it does help staunch a budget crisis created by a dramatic loss of income tax revenue," Goosen said in a recent commentary. "School finance is the largest item in the state budget, putting school funds directly in the firing line when state finances deteriorate."

Ratings analysts are watching how the state deals with its structural budget deficit.

"Standard & Poor's Ratings Services believes two recent credit developments for the state of Kansas - a lower court ruling that could require substantially higher education funding if upheld on appeal, and the state's projection of a substantial fiscal 2015 shortfall - raise additional obstacles for Kansas to achieve structural budget balance in fiscal 2016 and potentially beyond," S&P analyst David Hitchcock wrote in a Jan. 9 report.

The ratings agency downgraded the state's general obligation rating to AA from AA-plus in August and retained a negative outlook. Since then, the budget imbalance has grown, Hitchcock wrote.

"Although Kansas will likely make adjustments to bring its general fund balance back to a marginally positive level at fiscal year-end 2015, we remain concerned about the one-time nature of most of the budget fixes, and the large fund balance drawdown on a budgetary accounting basis," Hitchcock said.

Moody's Investors Service said in a February report on a $227 million highway revenue bond deal that the state's recovery has been slower than many of its peers.

Moody's Analytics estimates that the state only regained the jobs it lost to the recession in late 2014. Unemployment is relatively low at 4.3% versus the national average of 5.8% as of December 2014, but employment growth remains sluggish, Moody's analyst Lisa Heller said.

Both are due in part to the state's slow population growth, Heller said. Aviation manufacturing continues to be a key sector in the state and has aided the state's payroll recovery.

"Kansas' below average issuer rating reflects the use of non-recurring measures to balance its budget, its relatively sluggish economic recovery compared with peers, revenue reductions (resulting from tax cuts) which have not been fully offset by recurring spending cuts, and an underfunded retirement system for which the state is not making actuarially determined contributions," Heller wrote Feb. 4.

Moody's assigns Kansas its Aa2 issuer rating, with a stable outlook.

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