PROVIDENCE – Whether selling city bonds to investors is a creative solution to the seemingly intractable Providence pension problem or an overly risky venture with potentially devastating consequences depends who you ask.
Mayor Jorge O. Elorza made his pitch to the House Finance Committee on Wednesday on the proposed $704 million pension obligation bond, based on legislation sponsored by Rep. Scott Slater, D-Providence. The 25-year, fixed interest-rate pension obligation bond requires legislation to bypass state laws that limit the amount of debt municipalities can take on relative to their assessed property value.
Elorza acknowledged the risks involved in what many financial experts consider a controversial borrowing plan, but insisted it was better than the alternative of a woefully underfunded pension saddled with ballooning annual payments and court-ordered mandates that limit alternatives.
“The risk of a pension obligation bond is negligible compared to the risk of doing nothing,” Elorza said.
The city currently faces a $1.2 billion unfunded pension liability and escalating annual payments that, according to city projections, would hit $227 million by 2040. City Solicitor Jeffrey Dana said the city is far more at risk of bankruptcy for failing to meet these pension payments than for not defaulting on the pension obligation bond.
Borrowing money would bring the pension fund up to 65% funding the day the bond closes, reaching 78% by 2033, according to city projections. It would also decrease the city’s annual pension payments, beginning by shaving off $10 million from its fiscal 2022 payment.
Elorza also highlighted the opportune timing provided by low interest rates, which allow the city to turn a profit in the margin between borrowing costs and investment returns.
But timing was also an issue of concern for some detractors.
Michael DeBiase, CEO and president of the Rhode Island Public Expenditure Council, in a letter to the House Finance Committee described pension obligation bonds as “a bet on timing of capital markets,” and that low interest rates were offset by high stock market valuations.
That the bond is more than the entire city operating budget also increases risk for “substantial loss, which the city has little cushion to absorb,” DiBiase wrote.
R.I. General Treasurer Seth Magaziner recommended against the proposal in written testimony. Magaziner pointed to analysis by the state investment consultant that the city faces a 35.1% risk of higher overall costs, based on current asset allocations and a 4.5% return on investment.
The city’s analysis is based on its current 7% return rate, though city stress tests presented Wednesday showed a net positive result as long as returns hit or exceeded 4.47%.
Elorza also said the city was willing to be flexible in details such as the borrowing amount, the amortization period and the schedule of bond payments, which were among Magaziner’s concerns.
Whether the bond is the only option left was also a source of disagreement.
Elorza insisted it was, noting that even after a decade of meeting its annual pension obligation payments, the fund is still suffering due to the structure of payments to retirees. A 2020 R.I. Supreme Court decision also limits the city’s ability to negotiate terms of these payouts that were set under a 2012 settlement.
“There is not a single serious alternative proposal that has been put forward,” Elorza said.
DiBiase, however, criticized the plan for its lack of structural reforms. He suggested reducing benefits or increasing employee contributions as potential alternatives to solve the pension crisis in the long term. The bond plan would “remove any incentive to address these structural issues for the foreseeable future,” DiBiase wrote.
Not to be forgotten was the botched pension obligation bond that still haunts Woonsocket nearly 20 years after it issued its own $90 million pension obligation bond. A stock market crash and poor investment decisions created what Steven Frias, Rhode Island’s Republican National Committeeman, described as a “financial meltdown” in an op-ed for The Cranston Herald that was also submitted to the House Finance Committee. The pension plan is still about 70% unfunded, according to Frias.
Seeking to differentiate the Providence proposal from its failed Woonsocket predecessor, Elorza pointed to a 10-year par-call provision in the city’s proposal that allows for refinancing. Favorable market conditions and a more conservative rate of return also guarantee a better spread for Providence, Elorza said.
Finance committee members questioned Elorza and city financial advisers on details of the proposal, with several mentioning the Government Finance Officers Association’s recommendation against issuing pension obligation bonds as a potential concern. The committee voted to hold the bill for further study.
Companion legislation introduced in the R.I. Senate has not yet been scheduled for a hearing. Leadership in both chambers, as well as Gov. Daniel J. McKee, have not weighed in on the legislation.
Nancy Lavin is a PBN staff writer. You may reach her at Lavin@PBN.com.
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