Bonds

Kansas bill would fund tender offer for pension bonds sold in 2021

Less than two years after selling $504.5 million of taxable pension bonds, Kansas is considering buying back a chunk of the debt from bondholders using surplus revenue.

House Bill 2102 would appropriate $250 million for the state treasurer to repurchase $300 million of term bonds due in 2051 through a tender offer. 

State Treasurer Steven Johnson told a House committee last week the bonds have been trading lower  in the secondary municipal market, providing an opportunity to buy them back at a cheaper price and giving bondholders the ability to get out of an underperforming investment.

The bonds, which were priced at par in August 2021 to yield 2.774%, changed hands on Jan. 31 and Feb. 7 in two trades of more than $2 million at prices of 72.253 and 73.28 cents on the dollar to yield 4.44% and 4.52%.

If all the bonds were tendered, the state would save an estimated $177,445,984 in interest costs, as well as payments to Build America Mutual, which insured the term bonds, according to state officials.

Kansas Budget Director Adam Proffitt said the proposed transaction aligns with Democratic Gov. Laura Kelly’s plan to reduce state debt. 

“This is the type of transaction that the governor was looking for when we were putting together the budget — trying to use our current budget surplus to try to eliminate debt or pay for one-time expenditures,” he said at the hearing. 

Amid stronger-than-expected revenue growth, the state poured more than $1 billion into KPERs last year, redeemed callable bonds, and funded some capital projects with cash.

Proffitt said the $250 million for the tender offer would come out of a $2 billion ending balance projected in the governor’s fiscal 2024 budget recommendation.

A tender offer would be a first for the Kansas Development Finance Authority, which issued the pension bonds in a deal headed by Citigroup, according to Jim MacMurray, the agency’s executive director.

With disclosure expected to take two months, MacMurray told state lawmakers market moves in the interim could make the transaction more attractive or less attractive to bondholders, while the process will incur costs for legal and other services the state will have to pay even if a tender deal is not accomplished. 

William Glasgall, Volcker Alliance’s senior director of public finance, said: “Using some of the surplus — a one-time revenue source — to retire bond debt is a perfectly fine technique and in line with the Volcker Alliance principle that one-time expenditures should be funded by one-time revenues.”

The state previously sold $500 million of pension bonds in 2004 and $1 billion in 2015 at higher interest rates than in the 2021 issue and had nearly $1.68 billion of this debt outstanding at the end of 2022. The issues were aimed at reducing the unfunded liability of the Kansas Public Employees Retirement System, which invested the proceeds with the hope of earning more than the interest rates on the bonds.

Municipal Market Analytics in a report last year cited the 2021 pension deal as an example of the “critical” importance of timing for the investment of pension bond proceeds, given a subsequent decline in the S&P 500 and other asset classes. 

“Here, the money they put in was probably at the height of the market,” said Lisa Washburn, a managing director at MMA. “The interest rate is lower, but the performance of investments is much worse. “

As for the tender office, Washburn said, the bond proceeds invested by KPERS will still go up and down based on future investment returns, but the state will no longer pay debt service on tendered bonds. 

 KPERS had an investment loss of 9% last year, according to Johnson. A change in its assumed investment rate of return to 7% from 7.75% boosted the 2021 unfunded actuarial liability to $9.8 billion from $8.5 billion in 2020.

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