Riverside County’s planned USD 730m POB issuance is a ‘Band-Aid’, expert says

Riverside County, California plans to issue up to USD 730m in pension obligation bonds (POBs) this week, and although it may be a successful issuance, timing-wise, the county is making a huge mistake by not making adjustments to retiree benefits, said California Senator John Moorlach (R) in an interview with Debtwire Municipals.

 

Moorlach is a senator for Orange County, California, and a local government finance expert; he successfully predicted Orange County’s bankruptcy in 1994.

 

“For market timing, this is a good time to do a POB, but you’re making a bigger mistake by not addressing the systemic problem, then you haven’t diagnosed what’s wrong,” Moorlach said. “This is a Band-Aid, and a gimmick, and it won’t fix the problem.”

 

Riverside County has a USD 3.5bn unfunded accrued actuarial liability (UAAL), and a 70% funded ratio of its two pension systems, catering to public safety and miscellaneous employees. The issuance will reduce up to 25% of the UAAL.

 

“I’m not personally a fan of POBs, they’re an arbitrage play, a risk arbitrage,” a California-based municipal advisor said. “About 70% of the time, they work out for the borrower, looking historically. But there’s so much timing risk. If you sold in February, what a disaster. But arguably, this could be a great time to put money into equities and pension portfolios because they (recently) lost a bunch of value. But the idea of market timing being a consideration is uncomfortable to me. There’s not a huge consensus in their favor, but a large minority of folks think they’re a reasonable tool, and they apparently live in Riverside County.”

 

“The timing might be excellent right now, the problem is they’re going to be funding a defined benefit plan that is unsustainable and they should be modifying the plan first before issuing a POB,” Moorlach said. “Underwriters need business. And they’re not seeing any other solution to the unfunded liability issue, but a POB is a gimmick, and not a solution.”

 

The California Public Employees’ Retirement System (CalPERS) decided in 2016 to assume a more realistic rate of return and began reducing the discount rate incrementally to 7% in FY20 from 7.5% in FY16. The more conservative investment assumptions force higher annual contributions from local governments.

 

By issuing POBs, local governments say they can smooth out the liability, providing additional freedom in the general fund for annual expenses. A municipality is assuming that the rate of return on the investment of the bond proceeds will exceed debt service costs. But in a year with low investment performance—or losses—the municipality will pay for debt service and will need to increase annual contributions to the pension system.

 

POB skeptics say that the debt instrument is merely a risky way of shifting the obligation to a fixed debt service cost from the annual actuarially required contribution.

 

Instead, pension benefits need to be renegotiated, and that is going to be difficult because unions are unlikely to accept modifications to collective bargaining agreements, Moorlach said.

 

The county is allowed to borrow up to USD 730m, with an all-in cap on the true interest cost of 3.5%, according to an investor road show.

 

The bonds will be issued in tranches, with the deals completed on a day-to-day basis, with a common closing date of 13 May.

 

Inclusive of this issuance, Riverside County has USD 3bn in debt outstanding, including approximately USD 2bn in lease revenue debt. The county anticipates issuing USD 325m in tax and revenue anticipation noes in June. That includes USD 218.83m in already outstanding POBs.

 

A representative for Riverside County did not return a request for comment.

 

 

Flat points in the graph represent periods without active trading. 

 

by Maria Amante