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Pension Brief: POBs See Increasing Activity In Low-Interest-Rate Environment

With record low interest rates, pension plan sponsors are increasingly turning to pension obligation bonds (POBs) for a variety of reasons. At S&P Global Ratings, we understand the importance of monitoring not only expected interest savings, but also the risks associated with market volatility. (See Related Research for links to other articles with our views on pension-related obligation bonds.) 

 

Between Jan. 1, 2018, and Oct. 1, 2020, S&P Global Ratings has rated 25 new POB issuances in the public sector totaling nearly $3 billion--22 by cities and three by fire districts.  

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Table 1

22 City POBs--Averages
  Pre-POB (%)  Post-POB (%)  Result (%)
Affected pension funded ratios  69  96  +27 
Net direct debt as % of government revenues  132  244  +112 
Pension + OPEB contributions as % of government expenditures  12.5  4.8  (7.7) 
Debt service as % of government expenditures  5.3  12.1  +6.8 

 

Some Sponsors Have Used Expected POB Savings To Speed Up Funding Progress 

Directly comparing the 7.7-point decrease to contributions against the 6.8-point increase to debt service might lead to a conclusion that expected savings are overhyped and represent less than 1% of government expenditures in cost savings, but this comparison is not necessarily apples-to-apples since the debt repayment schedule may not mimic that of the pension amortization. Many sponsors are repaying the bond on a more conservative schedule than the pension amortization by either shortening the amortization length or shifting from an increasing level percent of pay basis to that of a level dollar, which pushes formerly-deferred costs forward in the schedule. Annual savings in such cases are expected to grow over time. 

 

For example, Baldwin Park, Calif., issued $54 million in POBs in January 2019 to nearly fully fund its CalPERS Miscellaneous and Safety liabilities. The city structured the POBs using a 25-year, level dollar amortization, which we noted to be three years shorter than the combined pension amortization lengths as well as more front loaded than the increasing pension payment schedule. 

 

A vast majority of the POBs we rated are from California, where CalPERS Miscellaneous and Safety plans amortize unfunded liabilities using a layered approach that amortizes new unfunded liabilities individually each year as a new "base." POBs have been used in California as a means to smooth volatile contributions. Additionally, CalPERS recently switched from a 30-year level percent of pay basis to 20-year level dollar, which pushes previously deferred costs forward to be addressed more quickly, but this only applies to new bases going forward. When the POB is amortized under a level dollar approach, it applies to all current and future bases being paid down and has a broader impact on the budget as well as plan funding. 

 

California Issuers Get A New Lease On Life By Using Streets To Fund Pensions 

A POB is defined by where the money goes, such as a pension trust, and not how it is being repaid. S&P Global Ratings assigns ratings to POBs based on the issuer's repayment pledge. Typically, POBs are rated on par with the general obligation (GO) or general creditworthiness of the issuer if all legally available resources, or its full faith and credit, are used to secure the bonds. In California, as an effort to speed up and simplify POB issuances, some cities are securing them with lease appropriations which are often easier to issue. The cities of West Covina and Torrance leased certain streets valued above the desired POB par amount to fund pension obligations for the cities, structured in a way that there would be no material risk to street ownership or abatement risk. However, S&P Global Ratings views lease appropriations as weaker than a GO or legally available funds pledges, and begin our rating analysis at least one notch below that of an issuer's GO rating. Both Torrance and West Covina lease appropriation bonds were rated one notch below our view of their general creditworthiness to account for appropriation risk. 

Table 2

POBs Rated By S&P Global Ratings Jan. 1, 2018-Oct. 1, 2020
Issuer State Rating date Amount (Mil. $) Pension plan Issue rating

Riverside

CA 5/21/2020 432 CalPERS Misc & Safety AA/Stable

Torrance

CA 9/23/2020 349 CalPERS Misc & Safety AA/Negative

Tulare County

CA 5/18/2018 251 TCERA AA-/Stable

Ontario

CA 5/7/2020 237 CalPERS Misc & Safety AA/Stable

Pomona

CA 8/6/2020 220 CalPERS Misc & Safety AA-/Negative

West Covina

CA 7/17/2020 204 CalPERS Misc & Safety A+/Stable

Arlington

TX 7/9/2020 192 TMRS AAA/Stable

Montebello

CA 5/15/2020 153 CalPERS Misc & Safety A+/Negative

Hawthorne

CA 9/11/2019 122 CalPERS Misc & Safety AA-/Stable

El Monte

CA 5/26/2020 119 CalPERS Misc & Safety A+/Negative

Bridgeport

CT 9/24/2019 117 Public Safety Plan A A/Stable

Carson

CA 6/4/2020 108 CalPERS Safety AA-/Stable

Inglewood

CA 6/11/2020 102 CalPERS Misc & Safety AA-/Stable

Azusa

CA 9/9/2020 70 CalPERS Misc & Safety AA-/Stable

Glendora

CA 8/13/2019 64 CalPERS Misc & Safety AAA/Stable

Baldwin Pk

CA 1/23/2019 54 CalPERS Misc & Safety AA-/Stable

La Verne

CA 7/16/2018 54 CalPERS Misc & Safety AA+/Stable

Wauconda Fire Protection District

IL 9/14/2020 26 Firefighters plan A+/Stable

Monterey County Regional Fire Protection District

CA 11/13/2019 20 CalPERS Misc & Safety AA-/Stable

North County Fire Protection District

CA 6/4/2020 20 CalPERS Safety AA-/Stable

Larkspur

CA 3/18/2020 19 CalPERS Misc & Safety AAA/Stable

Grass Vy

CA 2/20/2020 16 CalPERS Misc & Safety AA/Stable

Marysville

CA 9/5/2019 15 CalPERS Misc & Safety A/Stable

Chowchilla

CA 4/17/2020 11 CalPERS Misc & Safety A+/Stable

Rogers City

MI 6/3/2019 6 MI MERS (A) A/Stable

Related Research 

Pension Obligation Bonds' Credit Impact On U.S. State And Local Government Issuers, Dec. 6, 2017

OPEB Brief: The Credit Impacts Of OPEB Obligation Bonds, March 11, 2019

This report does not constitute a rating action.

Primary Credit Analyst:Todd D Kanaster, ASA, FCA, MAAA, Centennial + 1 (303) 721 4490;
Todd.Kanaster@spglobal.com
Secondary Contacts:Timothy W Little, New York + 1 (212) 438 7999;
timothy.little@spglobal.com
David G Hitchcock, New York (1) 212-438-2022;
david.hitchcock@spglobal.com
Li Yang, San Francisco (1) 415-371-5024;
li.yang@spglobal.com

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