Orange County Rewarded as Pension-Bond Issues Boom: Muni Credit

Orange County, California, which has rebounded from the second-biggest U.S. municipal bankruptcy, is set to tap into the largest wave of pension-bond sales since 2008.

Across the U.S., from the seaside city of Fort Lauderdale, Florida, to Oakland, California, localities sold $980 million of the taxable securities in 2012 to finance public-worker retirement obligations, data compiled by Bloomberg show. That’s up from $670 million in 2011, spurred in part by demand for extra yield with municipal interest rates touching 47-year lows.

Taxable city and state debt beat the broader $3.7 trillion local market the past three years. The segment earned 11.1 percent in 2012, compared with 7.3 percent for all munis, according to Bank of America Merrill Lynch data. Orange County, home of Disneyland, is offering pension debt this week. A similar sale last year drew bids that outstripped supply, said Suzanne Luster, public-finance manager for the community about 35 miles (56 kilometers) southeast of Los Angeles.

“With yields this low, it’s a very attractive time to borrow,” said Bud Byrnes, president of RH Investment Corp., a muni trading company in Encino, California. “It’s a great time to put your books in order, to take care of unfunded obligations that you have on your books.”

Lingering Deficit

States and cities nationwide are contending with a pension-funding crisis left over from the 18-month recession that ended in 2009. The Standard & Poor’s 500 Index fell about 38 percent in 2008, the most since 1937.

U.S. states’ retirement plans had a median funding ratio of about 72 percent in 2011, down from 74 percent the prior period, data compiled by Bloomberg show. More than 30 had less than 80 percent of assets needed to meet obligations, leaving the plans below the threshold considered sustainable.

Orange County’s pension was 67 percent funded as of December 2011, Luster said from Santa Ana. Annual required contributions have risen to about $311 million, from $201 million in 2006, bond documents show.

In two of the biggest pension-debt deals of 2012, Fort Lauderdale issued about $338 million in September, while Oakland sold $213 million in July. That offer included a 13-year part priced to yield 4.68 percent, when benchmark Treasuries yielded about 1.5 percent, data compiled by Bloomberg show.

Limited Options

Some localities selling the bonds bet investment earnings will exceed borrowing costs. A 2010 review of such bonds by the Center for Retirement Research at Boston College in Chestnut Hill, Massachusetts, showed most lose money for the communities.

“There’s nothing inherently inappropriate about issuing” pension-obligation bonds, said Jean-Pierre Aubry, an assistant director at the center. “The majority of plans that are doing it, they really have no other option. They needed some cash and the pension bills are looming.”

Orange County sought protection from creditors in 1994 after its treasurer lost about $1.7 billion on derivatives. It was the nation’s biggest municipal bankruptcy until Jefferson County, Alabama, filed in 2011 with about $4.2 billion of debt, according to James Spiotto, a partner in Chicago at law firm Chapman & Cutler LLP.

Discount Chance

Now, the economy of the county of 3.1 million is outperforming California and the nation, Fitch Ratings said.

The county’s median household income is about $76,000, compared with about $53,000 nationwide and $62,000 for California, according to Census Bureau data.

The municipality is selling about $269 million of bonds to take advantage of a discount from its retirement system if it makes its annual pension contribution early, Luster said. The $311 million payment for the fiscal year beginning in July is reduced to $287 million if paid this month, she said.

“This is an 18-month bond specifically to take advantage of a discount,” she said. “It’s paid the same way we would normally pay our contribution. Every two weeks, we’re still collecting from county departments like we always do and putting those funds aside to repay this debt.”

Moody’s Investors Service rates the pension bonds Aa3, fourth-highest and two levels below the county’s rank. Holders of pension securities, which are backed by available funds, are more at risk than those owning bonds backed by a general-obligation pledge, Moody’s said.

Higher Risk

Pension bonds may not appeal to all investors, said John Flahive, director of fixed income at BNY Mellon Wealth Management, which manages $22 billion in munis. One concern is how localities would pay for promises to workers and how the debt would fare in California. Stockton, California, which sold the bonds in 2007, last year became the biggest U.S. city to go bankrupt.

“There’s more apprehension about the term pension in taxable munis than” for anything non-pension related, Flahive said from Boston.

In Stockton, pension bondholders and the insurers backing their claims may not be repaid in full. In court documents, the city has argued the bonds are an unsecured liability that may not be entitled to full repayment. Bond insurer Assured Guaranty Corp. has asked the judge overseeing Stockton’s bankruptcy to throw the case out of court.

In muni trading yesterday, benchmark 10-year debt was little changed, yielding 1.83 percent, Bloomberg Valuation data show.

Before it's here, it's on the Bloomberg Terminal.