By SNW Asset Management via Iris.xyz
Last week the City of Houston came to market with a $1.0 billion voter-approved pension obligation bond or POB. As a refresher, POBs are issued in the taxable market by local and state governments for the purpose of paying unfunded pension liabilities. Key to the success of POBs is the ability to arbitrage the cost of debt versus the returns for the pension assets and reasonably managing future pension costs.
If the issuer cannot earn enough relative to the cost of the debt, as well as manage the pension plans in a manner that reduces the pension liability, then the outcome will likely be credit underperformance and potential rating downgrades.
Enter the City of Houston and its notable pension reforms and POB bonds. Houston pension reforms are notable because of the implementation of “cost corridors” on pension benefits for current and retired fire, police and municipal employees. In Houston’s case, market risk was transferred from the City of Houston to the retirees and employees.
There was also a reduction of the assumed rate of return on pension assets to 7.0% from 8.0% or 8.5%, the implementation of a fixed 30 year amortization period and, finally, the City’s request of its voters (through a ballot referendum) for a $1.0 billion bond to stabilize the pension plans. The level of compromise between voter, employee, retiree and the city can only be described as impressive.
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