A dissenting voice to California's pension bond resurgence
The architect of Orange County, California’s recovery from its 1994 bankruptcy is taking aim at what he considers an alarming resurgence of pension obligation bond issuance in California.
Sen. John Moorlach, R-Costa Mesa, introduced Senate Bill 1067 on Feb. 18, which would require POBs with maturities longer than 36 months to go to voters.
This is a fight he tried — and failed — to win in the courts with a lawsuit he filed in 2007.
POBs are exempt from a California law that requires that long-term debt be approved by voters, Moorlach said. That is because the courts have ruled that POBs are “refunding” bonds because they refinance debt that already exists in the form of pension liabilities.
But there are some contradictions in the rulings where the courts have treated POBs as if they are not refundings, he said.
“I say they need to be consistent, and if it is not a refunding, then voters need to approve it,” he said.
Moorlach’s bill comes at a time when the state has seen a resurgence of pension obligation bonds.
California cities have issued $2.2 billion in POBs since 2015, according to data from the California Debt and Investment Advisory Commission. There was a surge in issuance in 2018 approaching $700 million, according to data CDIAC provided to The Bond Buyer.
POB issuance came back in California even though such bonds were bloodied in the bankruptcies of Stockton, San Bernardino and Detroit.
What a pension obligation bond does is transfer the risk of today’s pension obligation to tomorrow’s taxpayers, said Matt Fabian, partner at Municipal Market Analytics.
A government that sells a POB today is committing future taxpayers to that decision, he said.
“The shorter the maturity on the pension bond, the better it is from a generational perspective,” he said.
The modification in newer POBs of call dates allows, in theory, for the issuer to refinance if interest rates ball, but you already made the bad choice of borrowing a bunch of money to pick a chance on the stock market, Fabian said.
The real issue, he said, is to look at why a government is issuing a pension obligation bond.
If it is actually doing a pension bond to improve its pension costs, and that is the only reason, not to create upfront savings, that would make sense, he said. In theory, the best POB is to have all the savings at the longest maturities.
Among the POB structures that MMA is less skeptical of are those backstopped with a tax levy specific to the bond.
“So to the extent that POBs underperform, there would be a property tax levy that would backfill the pension fund,” Fabian said.
That would enable the city to cover any investment losses, so the city would not suffer as a result of having sold the bonds.
“So there is no compounding of losses,” he said. “Now, if you lose 20% of the value this year, the pension funds can’t make that up. If you lose 10% one year, you need to add 1% to the investment fund every year. Either hire a magician, or add a lot of risk to the investment profile.”
Fabian opined that investors will be fine, because they will scrutinize each bond closely and they will be priced according to risk, and bonds issued by cities and counties are generally considered safe, because there have been so few defaults. It’s the taxpayers that will be left holding the bag if the issuer has to raise taxes and/or cut services to make payments, he said.
Most POBs are structured for immediate savings with increasing payments, which saves the issuer in the near term, but commits future revenues to paying down debt, Fabian said.
“I think it’s important to pause before you start to issue these bonds, before you even think about investing in them,” said Richard Ciccarone, president and chief executive officer of Merritt Research Services. “We found the security seemed to be an inferior security [during the municipal bankruptcies of 2012-15.] They did not put you in a strong position in bankruptcy.”
And you can imagine what would happen in the case of severe fiscal stress, Ciccarone said.
He also cited some exceptions, such as a POB done with appropriate security — not just a promise to pay but some collateral, or a lien, or something that is guaranteed by legislation that would be part of the repayment process if the issuer doesn’t have the money at the moment.
It would have to be a strong security and part of a broader plan that speaks to a holistic solution for a government that needs to borrow to fund pensions, Ciccarone said.
“The unique situation is we don’t know how this pandemic will affect the community,” he said. “I believe making payroll for essential workers is paramount right now, in order to maintain health and safety and keep the government working.”
Issuers of POBs need to be sincere about how they are going to pay debt obligations and how they fit in the hierarchy of needs, Ciccarone said.
“I don’t want to see POBs done like they were done in California in 2008, where they were repaid as an annual appropriation,” he said. When that is the case, they end up competing against whatever is considered to be a more important capital need than funding actuarial payments.
SB 1067 was introduced in January, but the Legislature recessed when California Gov. Gavin Newsom ordered the state shutdown in mid-March to slow the spread of the coronavirus pandemic.
Moorlach and other lawmakers are continuing to work remotely.
Sen. Toni Atkins, D-San Diego, the Senate pro-tem has asked that lawmakers reduce their proposed legislation to one or two bills for this session, Moorlach said. Similar action was requested by the Assembly leadership.
Moorlach and his staff have been working on amendments to SB 1067, a bill that would require that bond measure go before voters. It would require a 55% vote of the local electorate in order to issue pension bonds.
The bill attempts to clarify that POBs are not considered refunding bonds, and must be approved by voters. It is currently in the Senate Finance and Governance committee.
Moorlach is one of 11 Republicans in the 40-member Senate.
The amendments would require voter approval for POBs with a maturity date of 36 months after the date of issuance, thus exempting bonds like the annual 18-month maturity bonds issued by Orange County to pre-pay pensions.
“We do not want to negatively impact locals for prepaying pensions,” Moorlach said.
Moorlach introduced the concept to Orange County of selling 18-month notes to pre-pay pensions when he was county treasurer.
“It would save a lot of money,” Moorlach said. “That is why we have the three-year exclusion.”