Baltimore County officials say they can close a gap in pension funding while saving taxpayers hundreds of millions of dollars. But their planned strategy is one that carries considerable risk, experts say.
County Executive Kevin Kamenetz has proposed borrowing $255 million through pension obligation bonds and repaying the money over the next three decades. Administration officials have acknowledged the bonds would carry risk because the borrowed money would be invested in the stock market.
But they say the time is right, with interest rates at very low levels. As long as the return on the market investments is higher than the interest rates on the bonds, the county would save money — a projected $250 million over 30 years, they say.
"It's a very risky transaction for a local government," said Jeffrey Michael, a professor at the University of the Pacific's Eberhardt School of Business who formerly taught at Towson University. "For a county that touts itself for its conservative budgeting, this would be a strange move."
The proposed borrowing plan was announced after the county retirement board lowered its projections for pension investment earnings this summer. That move means county taxpayers must contribute an extra $15 million a year to the pension system starting in 2013.
"The system is dependent upon increased contributions from the county, and that really is the catalyst," County Administrative Officer Fred Homan told the council at a briefing last week.
Proponents say the county is well-positioned for the move because of its fiscal stability. The proposal is expected to win County Council approval at a Monday evening meeting.
The county expects to borrow the money at an interest rate of 4.25 percent to 4.5 percent. The pension system's 10-year-average rate of return on investments was 7.4 percent as of July.
Most governments that have issued pension obligation bonds have been fiscally strained, said Jean-Pierre Aubry, assistant director of state and local research at the Center for Retirement Research at Boston College. While there's nothing intrinsically wrong with pension obligation bonds, many of the governments were not fiscally healthy enough to withstand the risk, the center found.
"The locality or state had no other options and were really up against the wall," Aubry said. "Plans have to be very cautious and make sure they have the appetite for the risk."
Baltimore County budget officials say the county is much more stable than some jurisdictions that have turned to pension obligation bonds.
The county has AAA bond ratings, which helps the county save money with lower interest rates when it borrows. The county also fully funds pension contributions, unlike some governments, and is required by county law to do so, budget director Keith Dorsey said. He added that the county also has taken steps to control pension costs through increased employee contributions and other measures.
Fitch Ratings reported in June that the pension system was adequately funded at 73 percent, meaning it has enough funding to cover that level of future benefits due. In 2010, the average funding level for local government plans was 77 percent, according to the Center for Retirement Research.
The Government Finance Officers Association first issued an advisory about pension obligation bonds in 1997, revising the advisory in 2005. The group does not consider such bonds to be a best practice, and urges caution in issuing them.
"From a purely financial perspective, issuing pension obligation bonds can produce savings for a government if the interest rate paid on the bonds is less than the rate of return earned on proceeds placed in the pension plan," the association advises. "However, governments issuing pension obligation bonds must be aware of the risks involved with these instruments and have the ability to manage these risks."
Michael, the former Towson University professor, believes the risks associated with the bonds are "are much higher than they appear." He's been a critic of the use of the bonds in California, where the city of Stockton — which is now in bankruptcy — lost big when the value of assets bought with revenues from pension obligation bonds declined as the market crashed.
Other municipalities that have run into trouble with these bonds include Oakland, Calif., and New Orleans.
Councilman Tom Quirk, who is also an investment adviser, said most municipalities are not in a position to issue pension obligation bonds, but he thinks Baltimore County is different, citing its bond ratings.
"For most counties, this would not be the right strategy," said Quirk, a Catonsville Democrat. "For weaker counties, this would probably not be a good move."
But Quirk said he thinks it's "highly probable that we'll be saving the taxpayers a significant amount of money going forward."
"I would never vote for the pension obligation bonds if I thought we were kicking the can down the road, or if we were passing debt on to future generations," he said. "If interest rates were a lot higher, I would probably be against this. If Baltimore County weren't so exceptionally strong, I probably would be against this."
The transaction would likely not change the county's bond ratings, said Mike Rinaldi, senior director of the U.S. Public Finance group at Fitch.
"On the surface of things, it does not appear that this transaction in and of itself would result in any change in on our position on the county," said Rinaldi, whose agency reported this year that the county has moderately low debt levels because of prudent policies and a history of pay-as-you-go capital financing.
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