Brockton issues pension obligation bonds to reduce unfunded liability

The city of Brockton recently issued $300 million in pension obligation bonds in an effort to resolve its unfunded pension liability and save taxpayers money in the process.

In early October, the state approved Brockton’s request to issue $301,835,000 in bonds, $300 million of which would go toward the city’s pension fund, with the remainder covering bond costs. Over a period of 15 years, the city hopes to fully fund its pension liability, repay the bonds and save $90 million, according to Troy Clarkson, Brockton’s chief financial officer.

To realize savings, Brockton seeks to capitalize on the difference in the interest rates between the money it borrows and the money it invests. The city will have a 2.62% interest rate on its bond payments, Clarkson said, and hopes to get at least a 6.75% rate of return from the $300 million that the Brockton Retirement Board invests.

“This is part of an overall plan to really set the city up for a more stable financial future,” Clarkson said.

Pension obligation bonds have their critics, however. In 2015, a Government Finance Officers Association advisory warned state and local governments against issuing the bonds, citing market volatility, among other risks. The current low interest rates, however, have renewed interest in the bonds.

Brockton has issued pension obligation bonds previously, and has learned from the experience, Clarkson said. It issued such bonds in 2005, a few years before the financial crisis of 2008. Ultimately, the overall investment performed well over the long term, Clarkson said, but the downturn had an impact.

“The most important lesson we learned from that is, you just never know what’s going to happen,” Clarkson said. “So build in those safety valves to prevent that sort of catastrophic impact to the initiative.”

Starting in late 2020, a team of Brockton officials and outside experts, some of whom were involved in the 2005 process, met weekly for almost a year to plan for the bonds and prepare their proposal to the City Council, which approved the loan order in August.

To protect the pension fund, Clarkson said, Brockton has established a contingency reserve fund, which it didn’t have for the 2005 bond. It plans to pay $20 million into the fund the first year, and then $5 million annually until the fund reaches $40 million. In addition, Brockton’s bond payments will be lower than the pension payments it otherwise would have been making, giving the city a budgetary cushion, he said.

The city settled on borrowing $300 million, less than its $350 million unfunded liability, to avoid overborrowing and paying back additional principal and interest, Clarkson said. Instead, he said, Brockton hopes the investments perform well enough to help close the remaining gap. The city expects to fund its liability several years ahead of the 2040 deadline for municipalities to do so.

“We played out dozens of risk scenarios and looked at how much we should borrow, what the impact would be on a change in interest rates, what the volatility of the market might be,” Clarkson said.

Brockton’s bond team also presented its plan to the Executive Office for Administration and Finance, and the city promised to give the state annual updates about its contingency reserve fund, Clarkson said.

In a letter dated Oct. 4, Administration and Finance Secretary Michael Heffernan approved the city’s request to issue the bonds. But he noted, “As you are aware, the use of POBs may increase the potential losses associated with pension fund investments.” He added that municipalities, and not the state, are responsible for any losses associated with the issuance of the bonds or deficient investment returns.