BRADENTON, Fla. – West Palm Beach, Fla. will issue $60 million of pension obligation bonds to boost a police pension plan that is already 83% funded.
The strategy met with mixed reviews from market experts who weighed the risk against the relatively small benefit.
POB proceeds would bring the police pension plan almost to full funding.
City commissioners approved the pension obligation bond offering Monday, along with $90 million in tax-exempt bonds. The bonds will be issued next month.
West Palm Beach, a wealthy city along Florida's east coast, has planned for well over a year to issue POBs, assuming that investment returns on the proceeds will be higher than the interest the city will pay on the taxable debt.
Finance Director Mark Parks said the city has evaluated the risks of the financing strategy for the $259 million police pension plan.
From the city's perspective, Parks said it's important to bring the funded ratio of the plan to almost 100% to stabilize the city's annual payments.
"I know people have concerns about pension obligation bonds," Parks told The Bond Buyer. "We really did our due diligence to educate the commission and the community. We were very cautious and made sure everyone knew about the risk."
By using POBs, the city plans to move the actuarially funded ratio of the pension plan to 97.9%.
Closing such a small gap in a well-funded plan is questionable, said Municipal Market Analytics partner Matt Fabian.
"It's an odd choice using a very risky technique so as to be conservative," Fabian said. "I don't understand why they'd sell POBs, unless someone is pitching some 'can't-lose-investment-product' to them."
Dick Larkin who became director of municipal credit analysis at Stoever Glass & Co. this month, says the borrowing strategy could work well for West Palm Beach even though it will come to market amid heightened scrutiny of troubled pension plans nationwide.
Pension bonds are not popular now since Detroit's bankruptcy, in which pension debt took a substantial haircut, and now Puerto Rico is "trying to cut them loose," Larkin said, adding that investors could be hesitant about buying West Palm Beach's bonds because of that.
Many public pension plans are far from the 83% current funding level of the West Palm Beach police plan, according to a
In 2014, 63% of such plans were less than 80% funded, a level deemed at-risk for private-employer pension plans under the Pension Protection Act, the institute found.
Another 20% of plans were funded at less than 40%.
In some cases, the funded status of plans have also worsened in recent years due to increased reporting standards imposed by the Governmental Accounting Standards Board's Statement 68, which requires long-term pension liabilities to be disclosed on balance sheets.
Parks said West Palm Beach's desire to use POBs is not being driven by the city's recent implementation of GASB 68, even though it reduced the beginning net position in the city's three pension plans by $96 million, according to the 2015 comprehensive annual financial report.
He also said that the city has made all annual required contributions.
"We are at a good level of funding," he said. "We are really trying to be pro-active…and smooth out annual payments."
The Government Finance Officers Association advises against the use of pension bonds for a number of reasons. In a January 2015 advisory opinion, the group described them as "complex instruments that carry considerable risk."
"The invested POB proceeds might fail to earn more than the interest rate owed over the term of the bonds, leading to increased overall liabilities for the government," GFOA said.
As of Tuesday, West Palm Beach's finance team estimated that the pension bonds would sell at a true interest cost of 4.6%.
The West Palm Beach Police Pension Fund assumes an 8% annual investment return, according to plan documents.
While his research revealed few positive articles about pension bonds, Parks said, "there are some success stories."
From 1984 through January 2016, $75.76 billion of POBs were sold in 641 issues, according to Thomson Reuters data.
In January, Orange County, Calif., issued $334.31 million of AA-rated taxable pension obligation bonds with short-term maturities to prepay the county's projected unfunded actuarial accrued liability and normal contribution to its retirement system for fiscal 2017.
A tranche of $95 million maturing in 2017 sold at a rate of 1.18%, a spread of 54.4 basis points.
Larkin maintained that pension bonds could work for West Palm Beach.
"There is some investment risk, but that risk would be there even if the pension plan was 100% funded without debt," he said. "It will be a success as long as investment returns exceed interest costs."
Even if returns fail to exceed costs in the short run, investments usually recover after a bear market, Larkin said, adding that long-term returns for the S&P 500 over the last 20 years still exceed 10% despite losses between 20% and 30% from 2008 to 2009.
Larkin also said that both Detroit and Puerto Rico issued appropriation bonds without a firm revenue or government pledge or guarantee.
"Credit standing will be important" for West Palm Beach, he said.
The city POBs will be structured as 30-year special obligation bonds secured by non-ad valorem revenues with a covenant to budget and appropriate debt service annually, according to bond documents.
The covenant to budget and appropriate does not create a lien on or pledge of revenues.
The city's special obligation bonds are rated AA-minus by Standard & Poor's and Fitch Ratings, and Aa3 by Moody's Investors Service.
Larkin does not believe that rating analysts should be troubled by the pension bond offering, which should be rated the same as the city's other special obligation bonds.
West Palm Beach had $150 million of long-term governmental debt outstanding as of Sept. 30, 2015, including $7 million of general obligation bonds.
The GOs are rated AA-plus by Fitch, Aa2 by Moody's, and AA by S&P.
The city also had $224 million of outstanding water, sewer, and stormwater bonds.
In addition to the pension borrowing, the City Commission Tuesday also approved the issuance of $40 million in tax-exempt new money special obligation bonds to fund various capital projects.
The city will also issue $45 million of advance refunding bonds to refund all or a portion of special obligation bonds issued in 2006.
The refunding is expected to generate net present value savings of $4.89 million, or 11.68% of refunded par.
All of the bonds are expected to price by negotiation on May 25 with Morgan Stanley & Co. as the book-runner.
Other firms on the deal are Estrada Hinojosa & Co., Raymond James & Associates Inc., and Ramirez & Co.
Public Financial Management Inc. is the city's financial advisor.
Squire Patton Boggs is bond counsel. Steve E. Bullock PA is disclosure counsel. Locke Lord LLP is counsel to the underwriters.
