CHANGES TO MUNICIPAL BOND ISSUER ACCOUNTING RULES

what it means for community banks that own Muni bonds

January 2015 - The Government Accounting Standards Board (GASB) recently finalized and released 2 new important Statements designed to improve pension accounting, reporting, and transparency (GASB 67, GASB 68).

GASB’s new requirements are welcome news to investors focused on pension measurement and disclosure and could result in sizeable increases in Liabilities as Net Pension Liabilities are added to the balance sheet, and sizeable decreases in Net Revenues as Pension Expenditures are added to the income statement.

KeyState’s Municipal Credit Review (MCR) service has been at the forefront of providing banks more transparency for investors in government pension disclosure, measurement, and evaluation. KeyState’s proprietary credit evaluation models measure and evaluate pension liabilities coming from issuer’s defined-benefit pension plans and Other Post-Employment Benefits (OPEB), which covers medical and dental plans for retirees. Our evaluation models measure these liabilities relative to the issuer’s Net Total Expenditures and against the Covered Payroll (defined as the total payroll expenses of those covered by the plan). We also include any Pension Bonds in the calculation of total debt, debt per capita, any unused debt capacity calculation, and debt to assessed or equalized valuation ratios.

GASB’s new rules will assist our efforts, particularly as it pertains to school districts and other “cost-sharing employers”, which until now have only reported pension contribution rates, and have rarely reported proportionate shares of any pension liability. Greatly impacting this will be the Funding Ratios of state-run plans. The 3-state region of WI, IL, & IN provide an interesting illustration to the potential impact of these new rules. Wisconsin’s near-100% funding ratio (the nation’s best) would likely have a limited impact on WI issuers. Illinois’s 39% funding ratio (the nation’s worst) would likely have a significant impact on IL issuers, while Indiana’s 65% funding ratio (slightly below median) would likely have a moderate impact on IN issuers.

Investors will continue to have difficulty navigating the potential impact of pension liabilities of municipal issuers due to stale asset valuations and the potential misuse of actuarial assumptions. While GASB’s new requirements will significantly help investors, the municipal market faces even newer issues regarding pensions recently surfacing with the bankruptcy settlements of Detroit, MI and Stockton, CA. In both instances, bankruptcy judges declared that pensioners hold senior-credit-status over general obligation debt holders, threatening the long-held market view of GO holders as most senior.

KeyState will continue to focus on municipal pensions and will adjust measurement techniques and standards as necessary given these disclosure efforts. As such, if you should have any questions related to this or any other important topic, please contact Larry Wood at 702.598.3738.

GASB STATEMENT 67 HIGHLIGHTS

Requires 2 new municipal Financial Statements: Statement of Fiduciary Net Position and Statement of Changes in Fiduciary Net Position.
Requires Notes to Financial Statements to include descriptions of plan(s), types of benefits provided, classes of plan members covered, composition of pension plan’s board, info on plan’s investments, policies, fair values, investment concentrations, returns, contributions, reserves, and allocated insurance contracts.
Requires Supplementary Information to include past 10 years’ of sources of changes in Net Pension Liability, and components (and changes to) Net Pension Liability.
Requires Net Pension Liability to be measured every 2 years.

GASB STATEMENT 68 HIGHLIGHTS:

Establishes standards for measuring and recognizing pension liabilities.
Requires actuarial valuations of the Total Pension Liability to be performed every 2 years.
Requires issuers to include a Net Pension Liability in the balance sheet.
Requires issuers to include Pension Expenditures in the income statement reflecting amounts paid to pensions by employer and change in beginning and ending balances of amounts of Pension Expenditures.
Requires Notes to Financial Statements to include current year’s sources of changes in Net Pension Liability, significant assumptions used to calculate Total Pension Liability, and date of actuarial valuations used to determine Total Pension Liability.
Requires Supplementary Information to include sources of changes in Net Pension Liability and components of Net Pension Liability, including Funding Ratio.
Requires “Cost-Sharing Employers”, such as local school districts that contribute to a state-run pension plan for teachers, to recognize its proportionate share of the Net Pension Liability and its proportionate share of Pension Expenditures on the issuer’s financial statements.