The TEXPERS Blog

Cost-saving measure no longer permitted to pay off bonds doesn't impact pension obligation bonds

By Allen Jones, TEXPERS Communications Manager

State and local governments are no longer allowed to use one bond to pay off another unpaid bond, a method state and local governments once used to reduce borrowing costs. Although the new law could have some far-reaching effects on how state and local governments raise money, it won’t impact bonds issued by municipal governments for payment of obligations to their employee pension funds.

Known as tax-exempt advanced refunding, the mechanism allowed the issuance of a new bond at a lower interest rate than the original outstanding bond, according to Investopedia, an online financial investment news and educational portal. The cost-reduction mechanism was nixed as part of last year’s U.S. tax overhaul.

The law only prohibits the practice for tax-exempt bond issuances, Marc Chytil, an investment analyst with the Texas Pension Review Board, stated in an email to TEXPERS. The law became effective Jan. 1.

Bonds are fixed income investments. Investors loan money to corporate or governmental entities that borrow the funds for a defined period of time at a variable or fixed interest rate, according to Investopedia. Bonds allow governments to raise money and finance a variety of projects. Government borrowing at the state and local levels pay for infrastructure like roads, municipal service buildings, and schools.

Bonds are sometimes sought to pay public pension obligations, such as what the city of Houston recently did through its pension reform bill passed last year by the state legislature. As part of the reform, the city of Houston sold $1 billion in bonds, a measure approved by Houston voters in November. Houston police and municipal employee pension funds are to receive the bond’s proceeds in acceptance of benefit cuts.

Here’s how pension obligation bonds work: bond proceeds, when invested with pension assets in higher-yielding asset classes, achieve a rate of return that is greater than the interest rate owed over the term of the bonds. The bonds do involve investment risk, however, according to the Government Finance Officers Association, a membership organization that represents public finance officials through the U.S. and Canada.

In Houston’s case, the pension obligation bonds were a taxable issuance and federal tax reforms have no impact on that series of bonds, says Tantri Emo, the city’s director of finance, in an email to TEXPERS.

“Prior to reform, as well as post-reform, the city will be able to refund certain maturities of the bonds that have a call feature as a taxable issuance on an advanced basis,” she says. 

About the Author:

Allen Jones is the communications manager for the Texas Association of Public Employee Retirement Systems. Email him at allen@texpers.org or call 713-622-8018.