Recently, a number of our clients have reached out to us regarding the accounting treatment for pension obligation bonds. Specifically, people want to know about any accounting treatment they should consider when factoring in GASB 68. Even though GFOA advises against governments issuing pension obligation bonds, it is clear that the interest rates on taxable bonds has dropped so low that governments feel the risk related to pension obligation bonds is mitigated against the speculative nature of those higher-yielding assets the bond proceeds will ultimately be invested in when contributed to the pension trust. Translation, if the markets drop for a long enough period of time, the invested assets in the pension trust may not provide a high enough rate of return needed to keep the pension funded over the payback period of the bonded debt.
Oh, but wait they say, that is why part of our bond proceeds will be stashed away in a restricted cash reserve account, in case this negative market scenario happens. That may be true, so long as you have enough cash stashed away to make it through the period you still owe on the bonds and the market returns remain low. The very reason these types of bonds are taxable, is because of the arbitrage concept in which the bond proceeds are meant to earn more in the markets than is paid in interest expense on the bond repayments.
This is why you should “stress test” these scenarios against your specific financing package and restricted cash reserve amount set aside. When considering whether to move forward with a pension obligation bond, it behooves you to obtain an objective opinion from an outside source regarding the period of time your restricted cash reserve would last under unfavorable market conditions, and ensure your decision makers, such as a city council or board, are made aware of those risks and how long your reserves would last before you would have to start pulling money from other sources to pay back both the bonds and the unfunded pension.
What about the accounting impact? It is important to educate your council or board on what this will look like for the financial statements? Most Arizona governments are using the bonds to pay off their public safety net pension liabilities. This means they are exchanging soft debt for hard bonded debt. Since Arizona public safety pension contributions tend to get paid from governmental funds, like the General Fund, and these proceeds aren’t for capital projects, and they aren’t specific enough revenue streams to be its own special revenue fund, odds are you are reporting your bond proceeds in the General Fund.
Also, in the first year, GASB 68 tells us to report based on the measurement date. With a measurement date of 12 months behind your fiscal year end date, the first year you report this activity on the government-wide statements will show both the new bonded debt liability, and the old pension liability of 12 months ago, and the offset will be a very large deferred outflow of pension contributions. Therefore, to an untrained eye, it will look like you doubled your liabilities because you will not have removed the pension liability until the second year of the bonds. This is something specific to GASB 68 that will need to be clearly explained to users of the statements, especially if your disclosures say you issued new debt to pay off pension liabilities, but you still show pension liabilities that first year. On the General fund statements, you will show a very large pension contribution expenditure in your payroll expenses for public safety, but the offsetting inflow will be bond proceeds in the other financing sources section. All of this will be Greek to most users who do not understand the underlying effects of the transaction.
In the end, don’t rush into a complex pension obligation bond transaction without doing your homework, stress testing and communicating clearly with the council or board and your financial statement stakeholders. I understand rates are low, and you want to get in on the trend while it is still available, but don’t get stuck with too little restricted cash reserve or an angry stakeholder later down the road.
If you have any questions or need assistance, please contact your Henry+Horne Advisor.
Brian Hemmerle, CPA, CFE