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Pension Obligation Bond Issuances Continue To Increase In 2021

POB Issuance Accelerates

The prevalence of debt issuances to address unfunded pension liabilities continues to increase in the current low-interest-rate environment. From Jan. 1, to Sept. 15, 2021, S&P Global Ratings rated 64 new POB issuances in the USPF sector totaling nearly $6.3 billion; this is a 113% increase in rated POB issuance over the $3.0 billion issued in the entire calendar 2020.

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California is still the state that has issued the most POBs, although its share has decreased now that other states have increased their new issuances. We expect continued issuance accelerations as issuers compare peers' seemingly successful transactions with their own large and growing unfunded liabilities, and some issuers might anticipate the end of record low interest rates. The recession and economic disruptions associated with the COVID-19 pandemic serve as reminders of the importance of monitoring volatility in both markets and major revenue streams. Issuers are working to stabilize annual pension and OPEB costs through debt issuance. They are also finding this an opportune time to restructure or revise plan assumptions and contribution methodologies to reduce cost deferrals. While POB issuances appear aimed at fixing annual costs associated with pension plans, only time will tell if plan assumptions, including investment return benchmarks, can be realized and if the issuances themselves will provide long-term cost savings.

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The Unique Credit Risks Of POBs And OOBs

POBs and OOBs are taxable obligations that U.S. states, local governments, and other public entities use as a means to address unfunded pension liabilities by issuing debt to fund them and attempting to capture returns between portfolio investments and debt service costs. Rather than oversimplify our credit viewpoint of obligation bonds by expressing a generalized positive or negative view, we look at the individual issue at hand. With an understanding of why the bond is being issued, we analyze the changing credit picture and review management plans to mitigate the associated risks, including changes to plan benefits, contribution methodology, and actuarial assumptions.

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POB issuance does not absolve the issuer of pension plan risks. Generally, we believe transactions seeking to refund a pension liability for present-value savings will often not result in savings given the likelihood of poor investment performance, experience, or other changes that could generate new liabilities greater than projected at the time of issuance. In addition, an increased spread does not mean free money; it indicates increased exposure to market volatility risk when proceeds are deposited into the pension trust. Below, we evaluate how an issuer might assess and incorporate the risks associated with market volatility and detail some of the risks involved both with pensions and the debt financing pensions Often, we see some of the expected interest savings from issuance used with the intention of offsetting some of these risks.

Market timing risk

A significant amount of money placed into the market increases exposure to near-term market movement. If markets do not perform to expectations, pension liabilities could grow, potentially defeating the purpose of issuance. Some mitigation techniques we've seen include spreading out the deposit to reduce the likelihood that the deposit is made at a low point in the market and establishing a set-aside reserve fund, often an IRC Section 115 trust dedicated to pensions, to supplement planned contributions and ease the impact on the general fund. The most well-defined set-aside funds tend to have strict definitions of when the balance can be drawn and how funds are invested, and include replenishment clauses as well as dissolution guidelines as the plan approaches full funding.

Cost escalation risk

Pension contributions could escalate over time in the form of either planned amortization payments that increase with expected payroll growth or unplanned increases due to poor experience against risky assumptions. Cost escalation can be a budgetary challenge for issuers to incorporate into their long-term budget planning. With bond issuance, this risk is often mitigated in part by defining the bond repayment schedule to not only be shorter than the pension amortization, but also closer to level dollar. These changes address costs earlier than under the current pension amortization schedule. Long-term cost savings typically stem from either plan changes or the creation of a cheaper new benefit tier for new hires.

Budgetary flexibility risk

Obligation bonds reduce debt capacity as well as create fixed cost burdens that typically have less flexibility than pension and OPEB annual contributions. This could create budgetary constraints and negatively affect an issuer's ability to manage unforeseen near-term liquidity needs.

Political risk

Pension plans that appear to be overfunded, even when calculated using a high discount rate, might result in the issuer facing calls to increase benefits that are perceived to be "affordable" despite risk to the sponsor. Some higher-rated issuers have set the bond issuance to fund to less than 100% while combining de-risking efforts with issuance to reduce the likelihood of appearing overfunded.

We Expect States Will Continue To Issue Obligation Bonds While Interest Rates Are Low

As we review credit concerns for each issuance we see, and its associated risks to the issuer's budget, we anticipate that low interest rates and accelerating pension costs will continue to spur USPF POB and OOB issuance.

Appendix
Issuer State Rating date Amount (mil. $) Pension plan Issuer type Security pledge
Apache Cnty AZ May 2021 15 PSPRS Local government Pledged revenue
Arizona Fire and Medical Auth AZ Mar 2021 38 PSPRS Protection District Lease appropriation
Bullhead City Fire Dist AZ Feb 2021 35 PSPRS Protection District Lease appropriation
Casa Grande AZ May 2021 63 PSPRS Local government Pledged revenue
Central Arizona Fire and Medical Auth AZ Feb 2021 58 PSPRS Protection District Lease appropriation
Coconino County AZ Apr 2021 18 PSPRS Local government Pledged revenue
Copper Canyon Fire and Medical Dist AZ Feb 2021 7 PSPRS Protection District Lease appropriation
Cottonwood AZ Apr 2021 20 PSPRS Local government Pledged revenue
Douglas AZ Apr 2021 39 PSPRS Local government Pledged revenue
Glendale AZ May 2021 253 PSPRS Local government Lease appropriation
Golder Ranch Fire Dist AZ Jan 2021 28 PSPRS Protection District Lease appropriation
Highlands Fire District AZ Jan 2021 9 PSPRS Protection District Lease appropriation
Kingman AZ Apr 2021 39 PSPRS Local government Pledged revenue
Oro Valley AZ Apr 2021 18 PSPRS Local government Pledged revenue
Pima County AZ Apr 2021 300 PSPRS Local government Pledged revenue
Pinetop-Lakeside AZ Apr 2021 7 PSPRS Local government Pledged revenue
San Luis AZ Apr 2021 9 PSPRS Local government Pledged revenue
Superstition Fire and Medical District AZ Jan 2021 29 PSPRS Protection District Lease appropriation
Tempe AZ May 2021 364 PSPRS Local government Lease appropriation
Verde Valley AZ May 2021 10 PSPRS Local government Lease appropriation
Auburn CA Sep 2021 18 CalPERS (M/S) Local government GO
Buena Park CA Sep 2021 96 CalPERS (M/S) Local government GO
Central Marin Police Authority CA Mar 2021 27 CalPERS (M/S) Protection District GO
Chula Vista CA Sep 2021 349 CalPERS (M/S) Local government GO
Commerce CA Aug 2021 30 CalPERS (M/S) Local government GO
Corona CA Aug 2021 283 CalPERS (M/S) Local government GO
Corte Madera CA Aug 2021 19 CalPERS (M/S) Local government GO
Covina CA Aug 2021 73 CalPERS (M/S) Local government GO
Downey CA Aug 2021 114 CalPERS (M/S) Local government GO
El Segundo CA Jul 2021 152 CalPERS (M/S) Local government GO
Huntington Beach CA Jul 2021 364 CalPERS (M/S) Local government GO
Livermore Area Rec & Park Dist CA Apr 2021 13 Alameda County ERA Park District GO
Manhattan Beach CA Jul 2021 91 CalPERS (M/S) Local government GO
Monterey Park CA Jul 2021 109 CalPERS (M/S) Local government GO
Orange CA Jun 2021 286 CalPERS (M/S) Local government GO
Red Bluff CA Jun 2021 20 CalPERS (M/S) Local government GO
Redondo Beach CA May 2021 213 CalPERS (M/S) Local government Lease appropriation
San Anselmo CA Jun 2021 9 CalPERS (M/S) Local government GO
San Fernando CA Jun 2021 40 CalPERS (M/S) Local government GO
Sanger CA Jun 2021 22 CalPERS (M/S) Local government GO
Santa Ana CA Jun 2021 421 CalPERS (M/S) Local government GO
Santa Cruz County CA Jun 2021 124 CalPERS (M/S) Local government GO
Stanislaus Consolidated Fire Proctection Dist CA Mar 2021 11 CalPERS (M/S) Protection District GO
Whittier CA May 2021 144 CalPERS (M/S) Local government GO
Willows CA May 2021 9 CalPERS (M/S) Local government GO
Naugatuck Borough CT Jul 2021 61 Employee & Firemen's Plans Local government GO
West Hartford CT Jun 2021 324 Local plan Local government GO
Addison Fire IL Apr 2021 38 Local plan Protection District GO
Bensenville Fire Protection District No. 2 IL Mar 2021 15 Local plan Protection District GO
DuQuoin IL Aug 2021 8 City Police/Fire Plans Local government GO
Elmwood Park IL Jul 2021 63 City Police/Fire Plans Local government GO
Geneseo IL Jul 2021 4 Police (SE) Local government GO
Wheaton IL Jun 2021 50 Local Police & Fire plans Local government GO
Kansas KS Jan 2021 503 KPERS State GO
Calhoun Cnty MI Sep 2021 24 Local plan Local government GO
Ishpeming MI Jul 2021 9 MERS Local government GO
Roosevelt Park MI Jun 2021 3 MERS Local government GO
Vassar MI Jun 2021 5 MERs Local government GO
Westland MI Jun 2021 82 MERS Local government GO
Bridgeton MO Nov 2021 14 Local plan Local government Appropriation
Portland Public Schools OR Jan 2021 397 OPERS School District GO
Dauphin PA Aug 2021 55 Local plan Local government GO
Upper Chichester Township PA Aug 2021 32 Local pension and OPEB Local government GO
Norfolk VA Jun 2021 211 Local plan Local government GO
PSPRS-- Public Safety Personnel Retirement System. CalPERS--Calfiornia Public Employees' Retirement System. ERA--Employees' Retirement Association. KPERS--Kansas Public Employees Retirement System. MERS--Municipal Employees' Retirement System. OPERS-Oregon Public Employees' Retirement System. OPEB--Other postemployment benefits. GO--General obligation.

Related Research

This report does not constitute a rating action.

Primary Credit Analysts:Todd D Kanaster, ASA, FCA, MAAA, Centennial + 1 (303) 721 4490;
Todd.Kanaster@spglobal.com
Andy A Hobbs, Dallas + 1 (972) 367 3345;
Andy.Hobbs@spglobal.com
Secondary Contacts:Alyssa B Farrell, Centennial + 1 (303) 721 4184;
alyssa.farrell@spglobal.com
Daniel Golliday, Dallas 214-505-7552;
daniel.golliday@spglobal.com
Christian Richards, Washington D.C. + 1 (617) 530 8325;
christian.richards@spglobal.com

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