Pension obligation bonds are land mines municipal issuers should avoid, according to Janney Capital Markets.
"From a short-term perspective, POBs provide budgetary breathing room. But short-term relief is also an illusion," Janney municipal analyst Tom Kozlik said in a
The concept of such bonds "is one of the more ambiguous and misunderstood in a nuanced sector that is often very misunderstood," said Kozlik.
The use of taxable pension obligation bonds has revived of late.
States such as Kansas, Kentucky and Pennsylvania have been considering selling billions of these bonds to balance budgets amid credit deterioration related to unfunded pension liabilities.
Kansas is seeking underwriters for its first issue out of $1 billion lawmakers authorized this year.
In Kentucky, efforts to shore up the $14 billion unfunded liability for the Teachers' Retirement System stalled. Pennsylvania Gov. Tom Wolf has proposed issuing $3 billion in pension bonds as part of his $30 billion budget proposal. A lengthy pension-overhaul counterproposal from Pennsylvania's Senate is due out soon.
At the local level, Hamden, Conn., sold $125 million of pension bonds in February when the town's pension plan was about 10% funded. The financing only lifted the funding level to a still-low 37%.
"Hamden will not regain structural balance unless it takes the difficult steps toward raising revenues and cutting expenditures," Janney said.
The markets, said Kozlik, "are still deciding whether they are a feasible financing and arbitrage instrument, a harmful Wall Street-devised product, or a tactic used by distressed and procrastinating governments to punt off into the future the need to make decisions in the here and now."
The Government Finance Officers Association in January urged state and local issuers not to issue pension bonds in a best-practices advisory.
In a counterpoint view, the Center for Retirement Research at Boston College reported that as of February 2014, the majority of pension obligation bond issues have produced positive returns due to the large market gains that followed the 2008 crisis.
Illinois and New Jersey, whom Kozlik called the "state-sector poster [children] for fiscal procrastination and political shenanigans when it comes to pension-related expenditures," have had long-standing problems that the issuance of pension bonds has worsened. Evidence of Illinois' pension insolvency dates to 1917.
For teetering Puerto Rico, the timing could not have been worse. The commonwealth sold almost $3 billion of pension bonds in 2008, shortly before the great recession.
Kozlik sees what he considers another alarming trend in the use of "pension contribution holidays" in which an issuer takes a break from making its annual required contribution, often to divert funds elsewhere, because a perception of adequate pension funding exists.
Such holidays, said Kozlik, defeat the purpose of the pension bond strategy and ultimately creates a larger fiscal hole in an issuer's credit profile.
"The potential for this to occur is one of the leading reasons for our negative-leaning view on POBs," he said.
