CNMI Cautioned Over Pension Obligation Bond Strategy

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Consultant says bonds will lead to millions in interest payments

By Alexie Villegas Zotomayor

SAIPAN, CNMI (Marianas Variety, Aug. 3, 2012) – Experts agree that the Commonwealth of the Northern Mariana Islands (CNMI) government should err on the side of caution in floating a pension obligation bond (POB).

Retirement Fund investment consultant Maggie Ralbovsky cautions the CNMI from making this move as floating a $300 million bond leaves the government with $30 million a year debt.

She reiterated to Variety what she told the lawmakers last year when she discouraged the floating of a POB as a solution to the Fund’s problem.

"Well, 10 percent interest is $30 million a year," said Ralbovsky.

She said that the $30 million a year is for interest payments alone and "not considering the eventual repayment of the principal."

Asked on the interest, she said, "10 percent is an example. The CNMI may or may not be able to float a bond at that pricing. It depends on the credit rating, liquidity and market conditions."

Last year, Ralbovsky stated that POBs are taxable municipal bonds, and with CNMI government as the issuer, the interest rate would be at least 10 percent per year.

She earlier said that this would create a negative arbitrage – "There is no way the Fund can invest to get more than this return. Therefore, the CNMI government is creating a negative arbitrage in this event – meaning destroying value by doing so."

Variety learned from online source Investopedia, that a negative arbitrage is, "the opportunity lost when municipal bond issuers assume proceeds from debt offerings and then invest that money for a period of time (ideally in a safe investment vehicle) until the money is used to fund a project, or to repay investors. The lost opportunity occurs when the money is reinvested and the debt issuer earns a rate or return that is lower than what must actually be paid back to the debt holders."

In a joint session of the Legislature in Aug. 2011 where Ralbovsky responded to questions and concerns of the lawmakers, Ralboksky explained how it wouldn’t be advantageous to float a bond.

For Ralbovsky, assuming that the rate is 10 percent for a 10-year bond, and if the government wants to issue $200 million in debt, "the annual interest payment would be $20 million."

She said, "Investors will see clearly that the CNMI government cannot afford such payment and therefore, nobody would be willing to lend to you and only see you default on the obligation."

Moreover, Ralbovsky said that if the government is successful in floating a $300 million bond at 10 percent interest, it will be paying $30 million interest every year for the next 20 years if it is a 20-year bond.

"As for the interest payable for the life of bond, say if it is a 20-year bond, you pay interest every year until it matures, at which time the principal is due to be repaid," she said.

Floating a POB raises the issue of the CNMI credit worthiness.

The CNMI government has yet to pay $325 million in judgment which was originally the $231 million ordered by Associate Judge Kenneth L. Govendo in 2009.

Despite closing the defined benefit plan and opening the defined contribution plan to new government employees in 2007, the government also has to meet its pension obligations to retirees and future retirees.

Based on Ralbovsky’s presentation to the Fund board in Feb. 2012, the Fund’s unfunded liability stood at close to $1 billion.

Based on the actuarial valuation made by Buck Consultants for fiscal year 2009, total present value of accrued benefits for both vested and non-vested was $911,188,782 and the Fund was then 38.8 percent funded.

Ralbovsky earlier told the lawmakers that there’s no silver bullet to the Fund crisis and that investment alone just doesn’t cut it.

As for investment returns at 2.81 percent as of June 30, this would not even cover half of the interest of 10 percent if the CNMI were to float a $300 million bond.

Variety learned that the CNMI may face a similar predicament with the other states and cities in the U.S. which issued pension obligation bonds.

Online sources reveal that Philadelphia issued a $1.3 billion bond in 1998; however, investment returns have not been able to match the 6.9 percent in interest it owes the bondholders.

Consequently, Philadelphia saw a drop in its investment returns and rise in its unfunded liabilities which led to it increasing its pension contributions and at the same time pay its obligations with the bondholders.

According to Standard & Poor, if they don’t make their investment returns, they’re going to have to pay not only debt service on the bonds but increased contributions for new unfunded liabilities.

The CNMI Senate has deferred action on House Legislative Initiative 17-5 introduced by House Minority Leader Rep. Joseph P. Deleon Guerrero, R-Saipan, that will allow the government to float a bond.

The initiative has to be passed by the Senate on or before Aug. 8 for the initiative to be placed on the Nov. 6 ballot.

The previous initiative, H.L.I. 17-1 did not garner enough votes.

The Commonwealth Retirement Association believes this could be done with 10 percent tax on pensions as guarantee for bond payment in the event of a default by the government.

But experts like Ralbovsky, PIMCO CEO Brian P. Baker, William Stewart, and even the Boston College’s Center for Retirement Research believe that floating of POB’s should be handled with caution and states and cities must be wary of the inherent risks.

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