GASB 68 dead ahead POB bonds?

    A series of articles highlight the pressure on Government officials facing severe pension under funding and the recognition of the long awaited GASB 68 fix. Below are some examples:

                                                                             

 November 20,2015

$3 Trillion Municipal Pension Burden

It’s About Time:

Public Pension Reform Needs Space to Work

by

Joseph H. Arnall

Arnall is managing partner of Public Pension Consultants, LLC and is a former Rules Committee Chairman in the Florida House of Representatives.

428 Words

              The growing public pension funding crisis facing most of our cities and states leaves the important decision-making constituencies – elected officials, fund managers, and union representatives - in the precarious position of “we have to do something, but what?”

              Political expediency, inefficiencies built into the pension process, and inaction are contributing to the $3 to $4 trillion unfunded liability problem now facing cities and states.  Municipalities and states are also confronted with a perfect storm in which new accounting rules, sub par investment results and lack of reform have merged. 

Additionally, much like NOAA posts storm warning days ahead of landfall, the Governmental Accounting Standards Board (GASB) and the rating agencies forecasted several years ago what would befall government-sponsored defined benefits plans if they did not make rapid and certain changes.

Employee unions are often portrayed as the culprit, yet neither fund fiduciaries nor plan sponsors are without fault.  At this point, the cooperation of all parties will be needed, along with the political will to develop a plan that will work for current and future benefit recipients.  So how do we buy the time necessary for long-term reform to work?

One of the more promising new solutions is the asset backed contract.  The contract places a major asset within a defined benefit plan that is paid for in digestible budget installments without an offsetting liability.  This low-cost method places a GASB-defined asset  in the plan which will help stabilize credit and allow plan investment advisors to re-balance existing plan assets in favor of lower risk investments.

Another important benefit of the asset backed contract plan is that it should help stabilize agency ratings because it presents a consistent and reasonably brief time period in which to solve a large portion of pension liabilities.  Likewise, it compares favorably with a pension obligation bond (POB) currently being considered by several states because the asset is placed inside the plan and there is no corresponding billion-dollar bond liability and no risks inherent in an arbitration play (POB proceeds placed inside the plan must outperform the interest charge on the bonds).  And, such borrowing threatens future credit ratings.

              If anyone in a decision-making capacity in government has ever said, “If I knew 15 years ago what I know now, I know that I would have voted differently on pension plan administration,” this new concept offers a mulligan and buys the space needed to enact corrective pension reforms.  The light these important constituencies see at the end of the budget tunnel will be a better tomorrow and not a train.  It’s about time!

Joe Arnall  is right!!!!

 Pension Obligation Bonds are never a good idea, rather they are almost always a last resort. But now with accounting rules slowly forcing balance sheet recognition of Pension and OPEB (healthcare) liabilities combined with historically low interest rates Wall Street will be pitching these POB bonds. Pension Obligation Bonds  are a fantasy solution and first governments in line to use them are almost always the least capable of paying them back. The market adjusts for this  risk by charging cities or states with poor economics higher interest rates eliminating what first appears to amateur finance directors as an arbitrage.

   The reasoning goes like this ..."Hey, with interest rates so low why don't we borrow at zero percent and invest at our predicted return rate of 8.25%." 

Don't laugh, this discussion is going on in cities all over the U.S. First the reality is Providence RI cant borrow at 3% much less zero and would likely have to pay more than 5%. Second they are not likely to earn 8.25% and  could lose money. What then? If that scenario were to play out then Pension Obligation bond debt  would eventually further crowd out the local services funded by taxpayers such as public safety,transportation and sanitation. 

As John Corzine said about POB's  before he blew out MF Global: 

 " It's the dumbest idea I ever heard,” Jon Corzine told Bloomberg.com in 2008 when he was still governor of New Jersey. “It’s speculating the way I would have speculated in my bond position at Goldman Sachs.”

No doubt Rhode Island voters will be facing this issue head on. If Providence wanted  to issue these bonds in order to rescue their pension plan the state assembly would have to allow the issuance. There would be no vote by the People of Providence or Rhode Island but the liability clearly will be on State Taxpayers. Given the proclivity of Mattiello and Raimondo to casually issue debt without a public vote we have to consider this possibility as very real. 

POB bonds are not issued as tax exempt. The Tax Reform Act of 1986 ended that strategy by prohibiting state and local governments from reinvesting for profit the money from tax-free bonds. When the concept resurfaced in the late 1990's, the strategy called for states or localities to issue a taxable bond and leverage the higher interest rate of that bond against higher return but riskier equity market plays. So long as markets boomed, the new tactic seemed savvy.

Later, in the last decade , several cities that had recently issued pension obligation bonds subsequently filed for Bankruptcy protection. Examples include Stockton and San Bernadino in California and Detroit Michigan. http://www.governing.com/gov-data/municipal-cities-counties-bankruptcies-and-defaults.html

The  pressure on poorly funded local pension plans to "do something" will ramp up as GASB 68 calculations are released to the public for the first time. One way or another poorly rated cities and States will need to tap credit markets and could push all municipal rates higher, The timing of this potential flood of borrowings is of concern as the Fed for the first time in 7 years is about to tighten.

Consider the timing in the case of Oakland California the original POB issuer.

 "In 1997, Oakland followed up its 1985 invention of the POB with a $417 million pension bond. the bond was designed to buy the city a 15-year “holiday” from its police and fire pension contributions.

The timing was poor. As noted earlier, bonds issued in 1997 were, on average, underwater in 2007, even before the stock market crash. And so was Oakland’s. In 2010 Oakland’s city auditor did a careful analysis of the 1997 POB and found that “the amount still owed by the City is approximately $250 million higher than the scenario where the POBs were not issued in 1997 and the same payments were made to the pension fund instead.”

With the “pension holiday” over, Oakland’s City Council approved a new $210 million POB to be paid off in 2026 -- once again borrowing money -- cash that it would have had in hand had it not borrowed the last time."

                                         Bankruptcy in Providence 

Before we discuss why Providence, RI  is among  the walking dead, we need a primer on Bankruptcy. This Article provides a background for discussion:

http://www.pewtrusts.org/en/research-and-analysis/reports/2015/08/after-municipal-bankruptcy

A full discussion of Providence will begin in our next RIshrugs blog.

Providence Rhode Island defaulted ..Does Moody's care?

        Over the last few weeks Providence Rhode Island defaulted on a $62 million dollar loan to the City Pension Plan. They did it without notice or disclosure to investors,taxpayers,beneficiaries or the public.
            In my attempts to have regulators and law enforcement investigate I have been stonewalled and blackballed. Those who live in Rhode Island are likely not surprised by the treatment I have received and  those who are not from Rhode Island and are considering moving here  should read this as a cautionary tale of corruption and abuse that you or your business can expect upon arrival. The Governor , the Treasurer , the Speaker of the House are all aware of the issues in Providence, they know it is on the verge of bankruptcy and has been lying about its financial condition, yet they participate in silent approval of the illegal and misleading reports that come from Providence and are imbedded in State Reports.

I have contacted the Attorney Generals Office, the Providence Town Council, the Mayor and the entire council were cc'd on a letter from Auditor General Hoyle, No one can say they didnt know of Providence default on June 30 th. Governor Raimondo knew as did State Treasurer Seth Magaziner. Yet they remain silent. Where is the leadership?

Below I have reprinted three letters. the first is my letter  to the projo  ,which was rejected immediately without explanation. The second letter is one that I received from State Auditor General Dennis Hoyle where he cc's everyone in Providence Government. This letter was reprinted in a column for WPRI reporter Dan Mcgowan. The third letter is my response to Hoyle which was returned to him on the same day within an hour.

Here is the Editorial or letter sent to the Providence Journal, it was immediately rejected with the comment "no thanks".

sent July 7, 2015

 Dear Sirs,

      Last week, worldwide concern over the economic fate of Greece and the US territory of Puerto Rico dominated the news cycle. Both were deeply in debt and facing default.  But a disturbingly similar story about Providence Rhode Island has not made much news at all.

    Here is the Providence story that we should all be concerned about. On April 28 the Actuary Segal Co declared that Providence and Providence Officials had for some period of time carried a “Phony Asset” on the balance sheet of their pension plan. Segal suggested that if Providence did not pay back the pension plan $62 million by June 30, 2015, the actuary would no longer consider it an asset, as the city had stated for years, and Segal would remove the asset from the Pension plan. The truth was parsed out that meeting by Finance Chair John Igliozzi. We learned that Segal Co. had warned the prior year, in January 2014, that the assets were overstated in the Pension Plan. I warned the city the same thing 6 months earlier in the fall of 2013.  Segal Co. suggested the previous actuary Buck Consultants was at fault and Segal had not researched the questionable accounting to find out when it began and for how long it has existed.  Finance Chair Igliozzi correctly followed through with questions about the $62 million dollar “write off” and any possible interest owed to the pension Plan by the City of Providence. The total cost to pension plan may approach $200 million.

       Let’s step back and look at this accounting decision.  As of June 30 2014. Providence showed the following items in documents officially submitted to ratings agencies, investors, the State Auditor General, MSRB and the SEC.  The CAFR stated a current liability on the City Balance Sheet known as “Payable to retirement plan

 $ 53,907,000” This extremely unusual line item indicates that Providence believes that they owe the Pension Fund $53.9 million. There are three sets of beneficiaries in the City Pension Fund: Class A employees, Class B fire and Class B police.  Since the Payment is listed as a “current Liability” it is due by June 30 2015. Not paying is a technical default.  At the same time the Pension Plan Assets were overstated by $62 million and called “other”. Because I am deeply involved in pension accounting issues and as part of a 2013 Stanford Business School project I looked into exactly the subject of accounting for Pension plan assets. Providence is the only City in America that I could find with this type of accounting. The accounting seemed entirely illegal to me but I pressed forward with research before making my recent charges. I asked Lawyers and accountants if Providence could borrow from the pension plan. Could they do it without the Plans approval? What was the interest rate? When was it due? Were there any documents at all? Where were the trustees or fiduciaries of the plan? Why didn’t they balk when no money came in to invest?   The list of questions took up several pages in my outline.

     Here’s the amazing part, this has been going on for decades and thus Providence has been illegally representing an asset in the Pension Plan that doesn’t exist. They have overstated their pension Funding ratio every year and understated the unfunded pension liabilities to investors, rating agencies and regulators.  Clearly a lax or nonexistent system of checks and balances allowed a cover up to exist. But where was the Auditor General?  Were the public statements made by David Cicilline and Angel Taveras about fixing the pensions untrue or misleading or both. Were elected officials misled by employees or outside accountants or both? Where was Governor Raimondo’s Pension Crisis Commission? They accepted official reports and funding improvement plans for all the cities including Providence.  Dennis Hoyle was on that Committee. Actuary Dan Sherman, who was with Buck until Providence fired Buck, was the committee’s actuary. Gina Raimondo was on the commission. None of them saw this accounting?

         Clearly Providence has misled Municipal markets and bond Investors. That is a federal Crime. Shouldn’t Mayor Elorza disclose this to the pension beneficiaries or the people of Rhode Island? Should Treasurer Magaziner be aware or should Ms. Raimondo, who formerly declared the Municipal pension problem to be twice as big as the State pension problem, take interest? I am asking for an investigation. I believe the People of Providence and Rhode Island deserve answers. $62 million was literally stolen from the pension plan and there should be consequences.

Michael G Riley 

Narragansett 

Here is the Letter from Mr Hoyle 

June 16, 2015

VIA EMAIL ONLY

Michael G. Riley mgriley1929@yahoo.com

Dear Mr. Riley:

             

I have read your frequent posts on GoLocalProv.com regarding the City of Providence and their locally administered pension plan including your most recent post dated June 16, 2015.

I wish to offer my perspective on the situation since much of which you have written deals with whether the City’s financial statements are misleading – a matter that I have both interest and oversight responsibility as the State’s Auditor General.

             

As you know, I was a member of the City’s Municipal Finances Review Panel formed in January 2011 to review the City’s finances.  Subsequently, I have been in ongoing contact with the City, in concert with the Department of Revenue’s Division of Municipal Finance, to monitor key financial issues, most notably, eliminating threatened operating deficits and the resolution of prior deficits.  The timing of the City’s contributions to its pension plan has often been discussed.

My objective in writing is to correct the record on some of the issues highlighted in your GoLocalProv.com posts.  

             

The issue essentially is one of timing and cash flow.  At some time in the past (I’m not sure it has been definitively determined as to when this commenced) the City’s contribution to its pension plan was made after the close of the fiscal year.  Ideally, contributions to a pension plan are made periodically throughout the year.  For example, the General Laws require contributions to the plans administered by the Employees’ Retirement System of Rhode Island be made by the 15^th of the month following the applicable payroll period.   All would agree that the timing of the City’s contributions to its pension plan is not the norm or desirable.

             

However, my perspective is that the City has appropriately accounted for these events consistent with generally accepted accounting principles.  The City budgets and accounts for the annual required employer contribution for its employees.  Such amounts are reflected as a fund level expenditure.  At June 30, when the actual transfer of cash has not been made to the pension trust fund, a liability is recorded on the City’s General Fund.  Accordingly, a receivable for the contributions owed is recorded as an asset on the pension trust fund.  This practice is consistent with generally accepted accounting principles.   Such amounts are not a “false asset” as suggested but represent a valid receivable from the General Fund to be Michael G. Riley

Page 2 

June 16, 2015

  

collected within the next 90-120 days.  Whether this receivable is an actuarial asset at the valuation date for actuarial valuation purposes is a different issue - this has been addressed by the City’s actuary.

             

In recording a liability for such contributions on the General Fund balance sheet – the City and its auditor must consider whether it is appropriately considered a current liability to be liquidated with current available resources.   Generally, that would require that the liability would be liquidated/satisfied within a year of the balance sheet date.   The City’s practice has been to make the contribution by October following the fiscal year ended June 30 – which allows this to be reflected as current liability of the General Fund.   This is not inconsistent with other amounts, which are recorded as fiscal year expenditures but paid or liquidated subsequent to fiscal year end such as accounts payable, accrued payroll, and other interfund payables.  

For purposes of illustration, if the City did not record an expenditure (and a related liability to the pension trust fund) during a given fiscal year because the cash transfer to the pension trust fund had not been made, the City’s General fund would reflect a fund balance of more than $60 million perhaps suggesting that such amounts were available for appropriation and subsequent expenditure.  This “fund balance” would result from not reflecting an expenditure for required pension contributions.  I would argue that the City’s current practice of budgeting and recording the full required contribution to the pension fund is preferable even if actual transfer is delayed.   From the actuarial pension funding perspective, the actuary is factoring in the effect of the delayed contribution and the attendant interest component.

The City’s actuary has appropriately revised its consideration of this receivable as an actuarial asset within the actuarial valuation performed for funding purposes.  This is different from the presentation of the City’s financial statements in accordance with generally accepted accounting principles.  My understanding is that the actuary does not include the receivable (amounts due from the General and other funds) as part of the actuarial value of assets   in determining the actuarial funded status of the plan and the City’s actuarially determined contribution.

I don’t believe it is fair or appropriate to characterize the City’s accounting for this matter as a “scam and fraud”.   While the timing of the City’s contributions to the pension fund is problematic and worthy of attention, it is a function of available cash flow.  Due to the large dollar amount involved, I believe it is unlikely that a complete resolution is at hand although I do believe incremental progress to improve this timing is possible.

             

The City’s financial statements are audited each year by a licensed firm of certified public accountants with experience in auditing governmental entities.  The City’s selection of an auditor is approved by this Office and we receive the audit report upon completion.  One of the principle objectives of an audit is to assess whether the financial statements are free from material misstatement and conform to generally accepted accounting principles.   The City’s auditor has opined on the fairness of presentation in conformance with generally accepted accounting principles.  

             

In sum, my point is not to endorse the City’s practice of making its pension contribution subsequent to year-end.  However, I believe it is important to not mischaracterize the situation unfairly.  My goal is to continue to work with the City to explore options, which may ultimately allow such contributions to be made on a more normal and frequent basis during the fiscal year. 

             

Feel free to contact me if you would like to discuss further.

Michael G. Riley

Page 3

June 16, 2015

  

                                                                          Sincerely,

CC:         Mayor Jorge O. Elorza

            Council President Luis A. Aponte

            Tony Simon

            Brett Smiley

            Lawrence Mancini

 Michael D’Antuono  Matthew M. Clarkin, Jr.  David Sullivan

 Susanne Greschner  James Wilkinson

             

My immediate response printed below.

There was no response from the City or Auditor General Hoyle.

Dear Mr. Hoyle,

     Thank you for your interest, I appreciate your role in assuring Rhode Islanders and Rhode Island bond holders receive municipal and state financial documents that accurately portray their financial condition. For the record, none of the people cc'd in your communication have ever attempted to respond to me or contact me. If you recall I brought this subject up with you personally a few years back. I'm sure you won’t be surprised to hear that there are CPA’s , auditors, actuary’s and accountants who disagree with your characterization of accounting for pension funds in Providence. I would be happy to see this mess cleared up through an independent investigation into how this highly unusual accounting came about and what efforts have been made in the 13 years that I can ,so far ,trace of misleading  and malfeasance  in order to correct the problem.

         Specifically, I am troubled by the fact that every year since at least 2006 , the assets in the pension fund were knowingly overstated by tens of millions of dollars. It’s unlikely these amounts would be  just one month or quarter of delayed payments. It appears as though the cash flow problems may have caused the city to skip almost all payments to the pension plan for an entire year, before then giving an "IOU" and paying four months late. And then the city then rolled that missing year forward for over a decade, never quite catching up. It appears that the city owes $62 million by this June 30 th or they are defaulting on an unauthorized loan that sits on the city balance sheet as a current liability. In my opinion on June 30 the city defaults on this unauthorized loan.. This default should have  have taken place years ago had the city actually arranged a legitimate loan from the pension plan. They did not. They also did not notify the pension board or beneficiaries or the municipal bond holders. To this day , years of overstated assets have misled bondholders, producing fantasy funding ratios and affecting all manner of actuarial calculations.The ratings agencies have also been misled.  Materially misleading bondholders is a violation of federal Securities law as you know. The $62 million that Segal proposes to "write off" and remove from the assets of the pension plan on July 1 upon technical default of the city (means they once again did not pay) is most certainly "material". The asset known as "other" represented as much of 25% of the reported actuarial assets in the pension fund.Not only is this outrageously high, i don't see any evidence i n any other town of this type of accounting.I also find it difficult to believe that no one was alarmed by this number  or asked about this anomaly. On really nagging item points to fraud and coverup . Why in the world would the City repeatedly effectively borrow every year for a period of time at 8.5% from the pension fund? This is either criminal or stupid but it is not fully disclosed and i think would be materially relevant to Municipal bondholders buying the city's paper at 3% This is not the first time I have pointed this out. I started writing about this in the fall of 2013. The Taveras administration was also  well aware of my charges and they were warned in January 2014 by Segal and then the city did literally nothing about it. They then suddenly amended a bond document in June 2014 reflecting  the Segal Co January comment. After Kate Nagle and I pointed out their lack of disclosure in GoLocalProv.

 All that being said, I would be happy to speak with you in person to better understand your explanation of why my analysis is wrong. May I also say that in the process of investigating this highly unusual accounting that I could not find any pre-2006 city documents. There were no pre-2006 CAFR or actuarial valuations on the city transparency portal. On my visit to the Archives I found that no one had even inquired about these documents ( 2006 and earlier). They were in the basement. This tells me that no one even bothered to look into my charges in the last few years including this administration. There exists a very lax, arrogant attitude in that city. However, thanks to the hard work of the archivists at City Hall I now have many city documents dating back to 1990 and after reviewing them I would be very surprised if anyone will be able to easily track down what’s going on in Providence Accounting. Hence my suggestion regulators be brought in. I should think you would want to know the whole story.

 Sincerely

Michael G Riley

my office # removed 

I am available midday tomorrow.