WASHINGTON — The executive board of the Government Finance Officers Association has approved best practices on pension funding, bank loans, and the investment of bond proceeds.
The GFOA best practices provide guidance for public finance officials on these topics, which have become increasingly hot in recent months. The pension and bank loan practices are new, while the bond proceeds practice updates guidance adopted in 2007.
The GFOA best practice on pensions recommends that all government entities that offer defined benefit pensions “adopt a funding policy that provides reasonable assurance that the cost of those benefits will be funded in an equitable and sustainable manner.”
To reach that goal, each entity should get an actuarially determined contribution at least every two years to serve as the basis for plan contributions, GFOA suggests. The contribution should be calculated to fully fund the plan’s promised benefits over the long-term, while balancing the need to keep contributions stable and equitably allocate the cost.
The asset smoothing method, used to spread the effects of a plan’s gains or losses over a longer period of time, should be the same one used for gains and losses and focus on periods of five years or less, according to GFOA. Amortization periods should never exceed 25 years.
Governments considering entering into bank loan agreements, an increasingly popular alternative to traditional debt financing, should consult with their financial advisors and counsel and develop policies and procedures beforehand, GFOA recommends in another best practice.
The government should ask a number of questions before pursuing bank loan financing, including whether it is allowed by law to do so, whether it is getting the best available terms, and whether a bank loan makes more sense than a bond issuance, given the particular situation.
GFOA also recommends governments disclose bank loan information via the Municipal Securities Rulemaking Board’s EMMA website, even though it is not actually required.
“In order to enhance communication to its citizens and other parties interested in reviewing a government’s credit profile, governments should voluntarily disclose information about bank loans,” the best practice states. “While disclosure of bank loans currently is not required under Securities and Exchange Commission’s Rule 15c2-12, any voluntary disclosure may be held to same standards of materiality and timeliness as information disclosed under Rule 15c2-12.”
Rule 15c2-12 is the SEC’s rule on muni securities disclosure.
In the other best practice, GFOA recommends that governments investing bond proceeds should understand the risks involved and develop policies designed to minimize the risk of those investments defaulting, losing value over time, or having to sell them at reduced value prior to maturity.
“Issuers should consider actions to mitigate these risks,” the GFOA said. “These include establishing guidelines for permitted investments to reduce credit risk, developing good cash flow estimates to reduce market risk, and integrating knowledge of prevailing and expected future market conditions with cash flow requirements to reduce opportunity risk. As with investment decisions made with other public funds, the balance is weighted heavily towards avoiding risk; accordingly safety first, liquidity second, and yield third.”
State and local government series securities are the preferred investment for escrows for advance refunding bonds under GFOA guidance, but the recommendation adds that issuers need to be aware of times when the federal government stops selling SLGS securities and have an alternative investment strategy prepared. The Treasury Department reopened the SLGS securities window Thursday after having closed it in May as part of the “extraordinary measures” it used to maintain financial flexibility while federal lawmakers worked out a deal to raise the debt ceiling and allow the U.S. to resume borrowing.
Issuers need to take care to make sure that the investment of bond proceeds takes place in the state or local government’s best interest, and be certain that the individuals responsible for the investments know their roles and are equipped to ensure that all investments conform to statutory and regulatory requirements. Issuers should also be wary of potential conflicts of interest arising from underwriters involved in the sale of bonds also being involved in the investment of bond proceeds. Municipal securities rules do not allow an underwriter to provide advice on the investment of those bond proceeds.