DALLAS - Kansas' Wednesday sale of $1 billion of pension obligation bonds will do little to solve the challenges surrounding its poorly funded state-administered pension fund, according to a report from Moody's Investors Service.
"Even if the state's pension bonds work as designed, contributions must rise in order to address growing unfunded liabilities; contribution requirements (in dollars) will still rise by 4% annually, if all assumptions hold, due to the increasing payment structure used by the pension plan," according to the report by a team of analysts led by Dan Seymour.
The taxable bonds from the Kansas Development Finance Authority priced Aug. 12 through book runner Bank of America Merrill Lynch & Co. with maturities of 2017 through 2045. The bonds are rated Aa2 by Moody's with a stable outlook and AA-minus by Standard & Poor's with a negative outlook.
Coupons on the long end were 4.927%, just below the 5% threshold set by the law that authorized the issue. That is 215 basis points over Treasuries.
“We saw the heaviest demand on the short end of the curve and were able to tighten 15 basis points in the first five maturities of 2017-2021,” said Jim MacMurray, vice president for finance at KDFA. “Demand tapered off with the longer maturities with the deal clearing the market.”
S&P made comments similar to those of Moody's in maintaining the negative outlook.
"We view the sale of the pension bonds and the decrease in general fund contributions as an incremental investment risk and a possible indication of reduced commitment to funding future ARC payments," S&P analysts led by David Hitchcock noted. "To the extent that the state pension fund does not meet its relatively aggressive 8% rate of return assumption, or further delays increases in employer contribution levels
in future years, projected funded levels will be worse than the state's current projection of a 100% pension funded level in 20 years."
Unlike the "soft" obligation to meet pension payments in the future, the debt locks in an inflexible fixed cost that cannot be renegotiated or modified without defaulting, Moody's noted.
"By contrast, an unfunded pension liability can sometimes be modified through benefit reforms or funded over a longer timeline without defaulting," analysts said.
Kansas's pension problem is based on 1993 legislation that limits growth in pension contributions to about 1.2% of payroll annually. Actuarially required contributions, or the contributions that would result in full pension funding over time, frequently grow by more than 1% of payroll.
As a result, the state's statutorily permitted contributions have been lower than actuarially determined contributions for years. Since 2001, the state on average has made 72% of its actuarially determined contributions, according to Moody's.
Since the state amortizes its unfunded pension liabilities using a steeply increasing payment schedule, actuarial requirements under the plan's assumptions will not be sufficient to prevent unfunded liabilities from growing each year until the fiscal 2018 payment, Moody's explained.
"At that point, the state's amortization payments will cover all of the annual interest on its unfunded liabilities, plus some principal," the report said. "Unlike the annually escalating pension amortization payments, debt service payments for the POBs will be level each year.
"The use of POBs in this way would not necessarily be negative, except that in the legislation authorizing the POBs (SB 228) the state reduced its contribution rates in anticipation of the bonds," the report said.