BRADENTON, Fla. – Fort Lauderdale, Fla. plans to sell $338 million of taxable pension obligation bonds this week in a deal designed to entice and reassure investors by limiting the city’s ability to enhance future employee benefits.
The 20-year bonds are expected to price Thursday, if the Citi-led deal complies with the city’s requirement of achieving an all-in true interest cost of 4.5% or less.
The deal is expected to be sold with serial bonds maturing from 2013 to 2027, and a $79.3 million term bond in 2032. The maturities are designed to wrap around outstanding debt, according to city manager Lee Feldman.
Bond proceeds will be used to discharge $300 million, or 75%, of the city’s unfunded actuarially required liability over the next 20 years for its two pension plans – the general employees’ plan and the police/fire plan.
Another $16.1 million of bond proceeds will be used to reimburse the city for a loan last year that pre-funded a portion of the police/fire plan’s annually required contribution, or ARC.
The bonds primarily will be secured by non-ad valorem revenues consisting of utility, communication and business taxes as well as state-guaranteed entitlement revenues.
Other available city revenues, excluding property taxes, will serve as a back-up pledge, which will terminate if the primary source of security exceeds 175% of the maximum-annual debt service for three consecutive years.
The special obligation bonds are rated A1 by Moody’s Investors Service and AA-minus by Standard & Poor’s. Both agencies assigned stable outlooks.
Fort Lauderdale is funding less than the 100% of its ARC as one of two incentives to keep a lid on increasing pension benefits.
The city hopes to avoid pitfalls some other governments encountered when they fully funded pension plans, which then led unions to seek increased benefits, Feldman said.
The city believes that leaving 25% of the unfunded liability to be paid annually will reduce the risk that “unions will come back and ask for more benefits,” he said.
For investors in the city’s pension obligation bonds, Fort Lauderdale has included a covenant restricting – though not prohibiting – future city councils from increasing benefits or providing new benefits without providing full funding up front.
A supermajority vote of the City Commission would be required to increase benefits, and provide for full payment upfront.
To increase benefits and not provide full payment upfront requires a unanimous vote of the full commission, or a default occurs.
If a default occurs, 10% of bondholders can enforce remedies. In addition, the covenant restricting benefits can only be changed with the approval of a majority of bondholders.
“We will see how [the covenant] appeals to investors,” Feldman said.
Moody’s viewed the potential limits on future benefits “favorably.”
S&P said it recognized the intent of the provision to prevent future impairment of credit quality on the bonds, though “we note that the city is not amending its charter to reflect this stipulation, thus future city commissions are not bound by its limitations.”
When asked about S&P’s concern, Feldman said, “We take our bond covenants very seriously. We think the bondholders would have to agree to deviate from it.”
He also said that getting a unanimous vote of the full commission would be “difficult to achieve.”
Matt Fabian, a managing director at Municipal Market Advisors, said he believed the covenant could hamstring future boards.
“It could lead to political conflict later and create a policy vulnerability of its own accord,” he said.
Fabian argues that the ability to increase pension benefits is a tool that governments can use, though he said “it hasn’t been well used all the time.”
Fabian said he does not care for pension obligation bonds because they are a “gimmick” for elected officials to deal with immediate budget problems instead of raising taxes or cutting expenses.
“Instead of making hard decisions, they are taking on added risk through more debt,” he said. “That speaks to the issuers’ willingness to pay.”
Not everyone believes POBs are a bad deal. The nonprofit Pew Center on the States, which is helping Kentucky deal with its $30 billion pension liability, has said that using pension bonds as an element of a comprehensive reform effort is a tool that state should consider.
Fort Lauderdale officials have admitted that they expect budgetary relief by using POBs. The deal has been controversial among local opponents who view it as risky because the success of using pension obligation bonds depends on investing proceeds at a higher rate than the interest payments on the bonds.
The benefits of issuing the bonds exceed the risks because current market conditions are so favorable, Commissioner Romney Rogers said when he voted to approve the sale two weeks ago.
Over the 20-year life of the bond deal, the city expects to achieve present-value savings of $83 million that “we won’t have to pay from the general fund,” he said. “This money shouldn’t be spent on any new benefits. That’s obviously why we put the covenants in there.”
Dick Larkin, director of credit analysis who follows pension bonds at Herbert J. Sims, said recently that he has never heard of a covenant similar Fort Lauderdale’s, and he believed that it should benefit bondholders because the city will be less likely to extend benefits that it cannot afford to pay.
Larkin has also said that issuing POBs could bring more discipline to a city because the amortization of the bonds is fixed by the due dates and maturities. Bond payments must be made on a regular schedule whereas pay-as-you-go pension fund contributions can be postponed.
As long as the returns on the pension bond proceeds are greater than the cost of borrowing, Larkin said a POB deal is “a smart move.”
Fort Lauderdale is the seat of Broward County, and has a population of 165,500. It is about 32 miles north of Miami and 46 miles south of West Palm Beach.
The city has historically paid its annually required contribution toward pension costs. Currently, the combined unfunded actuarial accrued liability of the city’s two plans is about $400 million, and their market value funding ratio is 60.1%.
The city is required annually to pay 7.5% to 7.75% in interest on the unfunded liability.
City officials are betting that money managers handling pension funds will be able to invest bond proceeds at higher rates than the interest costs on the bonds, resulting in an annual savings.
In 2011, the employee’s plan averaged returns of 7.6% over 20 years and 4% over three years, while the police and fire plan averaged 8% over 20 years and 2.5% over three years, according to historic investment returns that the city presented to rating agencies.
Fort Lauderdale’s financial advisor is First Southwest Co.
Along with Citi, the syndicate consists of Bank of America Merrill Lynch, JPMorgan, and Morgan Stanley.
Squire Sanders LLP is bond counsel. Steve E. Bullock PA is disclosure counsel. Underwriters are represented by Greenspoon Marder PA.