Fort Lauderdale, Florida, a seaside resort city stung by the real-estate crash and a growing pension-fund gap, is placing a wager few localities are willing to make this year: borrowing to speculate in financial markets.
The city this week cleared the sale of $340 million of taxable debt to fund its retirement plans. The plan is a bet that with municipal yields at four-decade lows, its investment earnings will exceed the cost of the loan. Still, local governments are selling the smallest amount of so-called pension bonds since at least 2007, data compiled by Bloomberg show.
Municipalities including Oakland, California, have issued about $492 million of new pension debt this year, down from $5.2 billion in 2011, data compiled by Bloomberg show. It marks a retreat from a strategy that backfired for some governments when stocks sank during the longest recession since the 1930s. Stockton, California, sold the bonds in 2007, only to default this year as it became the biggest U.S. city to go bankrupt.
“It’s taking a gamble,” said Alicia Munnell, director of the Center for Retirement Research at Boston College in Chestnut Hill, Massachusetts. “Nobody has that good a sense of the performance of either the stock or the bond markets.”
The Standard & Poor’s index fell about 40 percent in the 18-month recession that ended in June 2009, helping push some states and cities to borrow to recoup investment losses in their pensions. U.S. states’ public retirement funds had $757 billion less than they needed as of 2010 for pension payments they had promised workers, according to the Pew Center on the States.
In Fort Lauderdale, a city of 168,500 about 30 miles (48 kilometers) north of Miami, revenue dropped 11 percent from 2007 through 2011 amid declining property tax collections. With investments trailing targets, the deficit in its two pension funds has nearly doubled to $400 million since 2007, according to bond documents. As a result, contributions to the pensions rose to $52 million in 2011, up $17 million from 2008.
The city’s debt to the pension grows by as much as 7.75 percent annually, the amount actuaries assume the money would earn if it were invested.
Lee Feldman, the city manager, said Fort Lauderdale can cut that obligation by borrowing at about 4 percent through the taxable pension bonds. He says he is confident of earning at least enough on the investments to cover interest payments. In the last 20 years, annual returns on its two pensions have averaged 7.6 percent and 8 percent.
“If we don’t return 4 percent on our pension investments, then we’re going to be dealing with bigger problems,” he said.
Pensions count on investment income to help pay promised benefits. When returns fall short of annual targets, typically 7 percent or more, governments need to set aside more money. Such contributions totaled $83 billion last year for the 100 largest U.S. pension funds, 22 percent more than in 2008, according to Census Bureau data.
The increases are straining governments that were forced to lower spending to make up for tax revenue lost during the recession. Public pensions gained a median 1 percent in the year through June, according to Wilshire Associates.
Fort Lauderdale plans its offer as soon as this month. It would be the year’s biggest sale of such debt. The city would benefit from the biggest rally in taxable municipal debt in 18 years. The higher yields on the securities relative to tax-exempts have lured investors as Europe’s debt crisis pushed municipal interest rates to the lowest in a generation.
Investors demanded as little as 0.58 percentage point of extra yield last month to hold taxable munis rather than tax-free borrowings, data compiled by Bloomberg show. It was the smallest gap since at least June 1994, when the data collection began.
Investing borrowed money can be risky. New Jersey sold $2.8 billion of such bonds in 1997, only to see its pension-fund shortfalls re-emerge as it skipped payments, raised benefits and the Internet bubble collapsed.
In 2003, Illinois sold $10 billion of the bonds, which wound up boosting its costs when it suffered investment losses in 2008 and 2009, according to bond documents. By 2010, it still had less than half what it needed to cover promised pension benefits.
The borrowing drop may also turn out to be a pause. In Kentucky, unions and other groups are pushing lawmakers to sell as much as $4.3 billion of pension debt, the Bond Buyer reported.
Matt Fabian, a managing director at Concord, Massachusetts-based Municipal Market Advisors, said he had expected more sales of pension bonds this year. The slowdown may be a result of local governments growing more wary of banking on financial markets, he said.
“Part of the reason this hasn’t happened may be that advisers can no longer present those 5 to 8 percent projected long-term equity market returns with a straight face anymore,” he said.
The success of the deals also depends on timing. A 2010 study led by Boston College’s Munnell of such debt sold by 236 governments found that most led to higher costs by mid-2009.
Older deals or those done during “dramatic” stock-market declines produced positive returns, it said. “All others are in the red.”
The S&P 500 has risen 13.9 percent this year.
In Fort Lauderdale, Commissioner Bobby DuBose said at the Sept. 5 meeting that he was concerned that the city was taking on too much risk and voted against it. The deal passed 3 to 2.
“This, to me, is someone that really enjoys gambling,” he said. “That’s what it is at the end of the day, I don’t care how you look at the market. Things aren’t 100 percent. Nothing’s guaranteed.”
Following are pending sales:
ILLINOIS plans to sell $50 million of debt as soon as Sept. 13 through competitive bid, data compiled by Bloomberg show. Proceeds will finance information-technology projects, according to bond documents. Standard & Poor’s last week downgraded the state one level to A, its sixth-highest grade, after lawmakers failed to reduce retirement costs during a special session. (Added Sept. 7)
ARKANSAS is set to issue $225 million of general-obligation bonds as soon as Sept. 11 through competitive bid, Bloomberg data show. The bonds are secured by Federal Highway Grant Anticipation and Tax Revenue and will help finance interstate highways, according to bond documents. (Updated Sept. 7)