MuniLand: Why We Like to See Pension Obligation Bonds

Done correctly, pension obligation bonds can increase transparency and show that municipal finance managers have a plan of action to pay for future pension liabilities. The current system of pension funding allows municipal managers and political decision makers significant leeway to fund (or not fund) a pension plan. For example, the City of Chicago in fiscal year 2013 only contributed 25.4% of their pension’s actuarially determined annual required contribution (ARC). Low credit quality states like Illinois and New Jersey have persistently underfunded their ARC payments and now have aggregate pension funding ratios below 40%. Even high credit quality states like Maryland are failing to fund ARCs adequately. Opponents of POBs argue that they just increase leverage. We at SNWAM disagree with that statement because the leverage associated with a POB is not new, but merely a change in the nature of an existing liability. By bonding off-balance sheet liabilities, the entity is not only bringing the obligation on balance sheet, but is also effectively committing to a funding schedule. POBs may not be for all municipal entities, and issuance needs to be timely. However, POBs do show that management is serious about making long-term decisions, supporting current employees and pensioners, and communicating to bond credit analysts a plan of action.