Approximately 85 to 95 agencies have restructured their UAL through debt financing since the Spring of 2020. NHA has worked with approximately 25 of these agencies and kept abreast of broader market trends. As market timing and re-investment risk are the two largest concerns for giving CalPERS large, lump-sum proceeds to invest at a given time (see our recent pension bond NHAlerts: Dec 2021 & Nov 2019), the past two years of high market volatility have magnified recent gains and losses for pension bond issuers.
For instance, for pension bonds issued in FY 2020/21, the strong gains from that fiscal year were also applied partly to the bond proceeds deposited with CalPERS, which would have reduced an issuer’s UAL (and increased funded ratios) by even more than if such Agency had not issued the bond. Accordingly, the losses from FY 2021/22 will be magnified (and funded ratios will be further lowered) for issuers of pension bonds prior to June 30, 2022. Gains and losses attributable to POB proceeds are based upon the length of time the proceeds are invested with CalPERS so the closing/timing of deposit factors in significantly.
However, from analyzing several cases of pension bond issuances since the Spring of 2020, NHA has found that most, if not all, pension bond-issuing agencies during this time have noted significant benefits from their respective bond issuances, even for those with magnified losses in FY 2022. This net benefit is attributable to the wide differential between the CalPERS discount rate of 6.8% and the interest rates of issued pension bonds, which have generally ranged between 2.5% to 4.5% in recent years. These interest rate spreads created a significant amount of cushion and ability for issuing agencies to withstand CalPERS investment performance volatility, especially in the near term, post-issuance.
As an example, many issuers at their transaction close projected robust present value (PV) savings between 20-30% from their pension bond over the term of the financing (commonly 20-25 years). For pension bonds issued in the period after the FY 2021 gain and before the FY 2022 loss (basically, a worst-case market timing), currently estimated PV savings over the term of the financing is likely to drop significantly, possibly to the 10-15% range. These savings still project to be robust by traditional refunding standards, but are now lower than expected at issuance. Agencies who issued in 2020 and/or early 2021 likely will see very little change to expected PV savings, since the FY 2022 losses are largely offset by the extremely strong gains of FY 2021. Issuers of POBs who closed in very late in FY 2022 won’t see any significant magnification of losses since POB proceeds were only on deposit with CalPERS for a brief part of the fiscal year. As noted before, the timing of the deposit of proceeds to CalPERS impacts these nuanced calculations in significant ways, so it is difficult to broadly analyze the performance of all POBs without taking all these factors into account. Of course, the actual PV savings/cost won’t truly be fully realized until the final term of the bonds in all of these cases.
In addition, one of the key benefits of UAL restructurings, the ability to smooth over an Agency’s projected UAL payment peaks to lower payment levels, has helped issuers be in a more advantageous cash flow position for the next several years, with lower total pension-related payments post-issuance, even if their pension bond was subject to magnified recent losses.
Many pension bond issuers, though policy adoption, also have strategically used guaranteed near-term savings from their pension bond to fund reserves to higher levels, often via a Section 115 Trust dedicated to pensions. This balance sheet asset can function as a shock absorber and fiscal sustainability tool when rising pension payment increases are projected to impact the budget in a few years.
Certain pension bond issuers may also notice a large reduction in payments for FY 2024 and FY 2025 if they received the timing benefit of FY 2021 gains. While this is a great result for those issuers, NHA would encourage these agencies to continue budgeting conservatively and utilizing such savings to continue addressing pension costs in light of the impending UAL increases – either through funding of 115 Trusts, ADPs to CalPERS, or other cost management strategies.