Pension bonds are staging a comeback in California
SAN FRANCISCO — Low interest rates and the push to reduce pension liabilities have driven an increased interest from California cities in issuing pension obligation bonds.
The financing vehicle had fallen out of favor after a series of municipal bankruptcies gave poor treatment to holders of pension obligation bonds.
In Detroit and San Bernardino, California, in particular, pension obligation bondholders took a haircut.
California issuers have sold 136 pension obligation bonds over the past 20 years, but the largest portion came with 60 sold totaling $5.3 billion between 2004 and 2007, Carmen Vargas, a senior vice president with Ramirez & Co. said Wednesday at the Bond Buyer’s California Public Finance Conference.
Recently, low interest rates have driven a new influx of issuance, Vargas said.
The wave started in May 2017 when the city of Riverside refunded a $31.9 million bond anticipation note, she said.
Between May 2017 and September, nine California cities from Brawley to Chowchilla have issued nearly $700 million in POBs, according to information Vargas presented at the conference. The largest was a $251.2 million deal sold by Tulare in central California. Most of the bonds secured double-A ratings with the lowest rating at A-minus.
Though there was a sell-off in the treasury market by 30 basis points in the last month, Vargas said, Ramirez just underwrote the City of Hawthorne’s $120 million of taxable POBs at a true interest cost of 3.58%.
Most issuers are using pension obligation bonds to cover the current contribution due or to pay off a portion of their unfunded liability, Vargas said.
“We are starting to see a growing list of cities looking into it,” Vargas said.
There are a number of ways the bonds can be structured, said Vargas, who cautioned that given the complexities involving pensions a lot of discussion needs to happen before cities use the financing tool.
“It is not something folks should just jump into,” she said.
Audience member Marc Joffe, an analyst with the Reason Foundation, asked Vargas if POBs are a good idea for issuers when interest rates are low, but returns on the pension portfolio are low as well.
Vargas emphasized that a lot of discussion needs to occur between city officials, financial advisors and underwriters about the potential long-term risks.
If a city is paying the pension liability upfront through bond issue, it needs to make sure there is room in the budget to make those payments, she said.
The bonds being issued today are not as restrictive as they were in the past, and have more flexibility built in, such as including call options, Vargas said. Some of the bonds that have been issued since 2017 have shorter maturities than the standard 30 year, she said.
Moody's Investors Service doesn't look at POBs as a bad or a good thing, but views the bonds as neutral at best, because they are swapping one form of debt for another, said panelist Thomas Aaron, a senior analyst with Moody's Investors Service.
"It does carry an interest risk if the arbitrage play doesn't work out," Aaron said.