Central California city pursues pension obligation bond deal

The Central California city of Chowchilla is planning to issue pension obligation bonds to cover its $10.2 million unfunded liability.

The small town of 18,000 residents, about 40 miles northwest of Fresno, is the latest California city looking to the strategy – which the Government Finance Officers Association has cautioned against – as a way to address its growing retirement costs.

Signage stands outside the offices of the California Public Employees' Retirement System (CalPERS) in Sacramento on Sept. 13, 2010
California Public EmployeesÍ Retirement System (CalPERS) offices, in Sacramento, California, U.S., on Monday, September 13, 2010. Photographer: Ken James/Bloomberg

Chowchilla officials say it could save as much as $3.5 million over the 28-year life of the bonds.

The City Council agreed to begin proceedings for a bond issuance at its Aug. 28 meeting. The city will put out a request for proposal for a broker and return in a few months to the council for final approval to go ahead with the bonds, said Rod Pruett, the city’s finance director.

The city began looking at POBs after the California Public Employees’ Retirement System last year revised downward its expected rate of return for investments – requiring its members to pay more to make up the difference. The interest rate is now 7.25% but will go down to 7% in a couple years.

Under the city plan, if it pays down its pension liability now and issues POBs with an interest rate of 4.5% it will save $145,000 a year with a 28-year amortization. “We get a 2.5% savings just in interest,” Pruett said. “That savings is what generates the reason why we’re looking at doing this.”

The savings will be put back into city operations, he said. The city, which has a general fund budget of $7.8 million, can’t sustain pension cost increases and needs the savings to remain balanced, Pruett said.

The Government Finance Officers Association has recommended caution for government agencies considering pension obligation bonds citing risks including potential underfunding and lack of flexibility during economic uncertainty.

They’ve also been risky for investors who have taken haircuts in municipal bankruptcy cases in San Bernardino, Stockton and Detroit.

Pruett said Chowchilla officials are aware of the ‘bad connotations” POBs have but in doing their research he believes the problem for some cities has been in looking to them as an investment strategy. Chowchilla’s plan is to only use bond proceeds to pay off its unfunded liability, he said.

“We recognize what the problems with the POBs were in the past and we’re specifically not going to do that,” Pruett said. “It’s just a refunding is the way I look at it.”

Chowchilla has hired Wulff Hansen & Co. as its municipal advisor and retained Quint & Thimmig as bond counsel.

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