Analysis: Rising returns give U.S. public pension funds chance to reform

By Tim Reid

Thu Aug 22, 2013 8:05am EDT

n">(Reuters) - Many U.S. public pension funds are benefiting from double-digit annual returns in fiscal 2013 that are giving them breathing space to try to implement reforms and fix gaping deficits.

A raft of pension reforms since the financial crisis by many U.S. state and local governments have not repaired their pension debt, a factor in the bankruptcies of Detroit, Michigan, and the California cities of Stockton and San Bernardino.

A 20 percent gain on the U.S. stock market in the twelve months to June is, however, alleviating acute funding gaps in many areas.

"It is a marathon, not a sprint," said Keith Brainard, at the National Association of State Retirement Administrators. "I do not think any one-year returns are likely to affect the thinking about pension reforms but we have seen very strong returns since the low point of the equity market in 2009 and it is encouraging," he said.

Recent reforms by many U.S. cities and states have seen retirement benefits for new hires cut, and their contributions into pension plans raised. It will be several years before these reforms start to have an effect on gaps in pension funding.

As well as stock market gains, pension funds are being helped by relatively low exposure to the struggling bond market.

In the last decade bonds held by public pension funds fell from around one third to around one fourth of assets as yields declined.

According to Wilshire Associate U.S. public pension funds have about 25 percent of assets invested in bonds, compared to an average of 37 percent for corporate funds.

In the longer run, higher yields could even provide a boon for pension funds because of higher returns.

FUNDING GAP COULD SWELL UNDER NEW RULES

Funds will need higher returns as they adapt to new accounting rules set to begin taking effect next year.

Alicia Munnell, at the Center for Retirement Research at Boston College, co-authored a report last month showing U.S. state and local public pensions would have been a paltry 60 percent funded in 2012 if measured by the new rules. That compares with an estimated 72 percent for fiscal 2012 under old rules.

The new rules have been issued by the Governmental Accounting Standards Board (GASB). One key provision is to slash projected rates of return for pension funds' unfunded portions from roughly 7.5 percent to a much lower market level. The move will greatly increase the amounts at which unfunded liabilities are calculated and the money states and cities will have to pay into their funds.

Munnell's study showed that if current projected return rates for public funds are reduced nationwide to five percent, the unfunded figure for America's public pensions jumps from $1 trillion currently to $2.8 trillion.

Still, Munnell is warning against alarmism.

"Public plan sponsors have made numerous changes to reduce their pension costs in the wake of the financial crisis and ensuing recession. The market has performed well in the last few years. Let's give the plans the time and space to work their way back to more comfortable funding limits," Munnell said. The funded ratios of state and local pension funds was at 103 percent in 2000, after a decade-long bull market.

RETURNS COULD MAKE OR BRAKE REFORMS

So far this year, plans such as the California Public Employees' Retirement System, Florida's state fund, Ohio state teachers and Connecticut have reported returns well above 11 percent. Most others are expected to follow suit.

A recent report by Wilshire Associates found that in the 12 months preceding June all public funds had a median return of 12.4 percent, although that declined in the last quarter to just 0.24 percent.

Similar results are reported by Callan Associates, the San Francisco-based investment consulting firm.

A report by the credit rating agency Standard & Poor's said there are signs of stabilization in public pension underfunding.

John A. Sugden, primary analyst on the report, said signs were encouraging but warned against over-optimism.

"Good returns are a positive development," Sugden said. But he said recent reforms, where many states and cities have curbed benefits and increased contributions for new hires, will take a long time to produce results.

Rachel Barkely, a municipal credit analyst at Morningstar, said the new GASB accounting system and the stock market "are the two key factors that will drive the pension conversation for governments over the next few years."

Barkley said stock market returns could change if the Federal Reserve eases off its expansionary policy known as quantitative easing.

"There is a lot of uncertainty on whether and how financial markets will keep delivering good results," Barkley said.

(Editing by Andrew Hay)

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Exclusive: China's banks to take next step in rate reform push - sources

A woman walks past a sign of Bank of China at its branch in Beijing March 26, 2013.

Credit: Reuters/Kim Kyung-Hoon

By Shengnan Zhang and Hongmei Zhao

BEIJING/HONG KONG | Thu Aug 22, 2013 6:41am EDT

BEIJING/HONG KONG (Reuters) - China's top banks are expected to win approval for the issuance of tens of billions of yuan in negotiable certificates of deposit (NCD) as early as next month, in another step towards developing market-determined interest rates.

NCDs would enable banks to access large amounts of funds at relatively stable costs, providing some alternative to borrowing from the inter-bank market, where the cost of funds can be volatile, as seen in June when a liquidity squeeze briefly sent short-term money market rates to nearly 30 percent.

Bank of China, the Industrial and Commercial Bank of China, Agricultural Bank of China, China Construction Bank and Bank of Communications, have submitted their plans for NCDS to the central bank, people familiar with the development told Reuters.

The NCD, or large denomination certificates of deposit tradeable on the interbank market, would be offered with maturities from three to six months and be priced with a premium over the Shanghai interbank offered rate (SHIBOR), the sources said.

Each bank is planning an NCD issuance of more than 10 billion yuan ($1.63 billion), one of the sources said. The likely face value of single certificates was unknown.

"The instrument could be rolled out soon, which not only opens up a liquidity channel for banks but also pushes forward interest rate reforms by gradually loosening controls on deposit rates," said a source close to the banking regulator.

The People's Bank of China (PBOC), the central bank, could give its approval as early as September, according to the sources, who all requested anonymity due to sensitivity over the issue.

The central bank, under the helm of reform-minded Zhou Xiaochuan, has been trying to promote the role of the SHIBOR as the benchmark for short-term borrowing costs.

The PBOC has been following a step-by-step approach in liberalizing interest rates, shifting its focus on loosening controls on bank deposit rates after it freed up bank lending rates in July.

Last month's decision to remove the floor on bank lending rates was seen as a largely symbolic prelude to removing caps on deposit rates, a much more difficult task that will take time.

Interest rate reforms are part of a broader effort of China's new leadership to steer the world's second-largest economy towards a growth model that relies more on domestic consumption and gradually scale back controls and directives and allow market forces to play a greater role.

The introduction of NCDs may have limited immediate impact on money market rates that are already moving in line with market supply and demand, but the pilot is widely seen as a heralding the eventual dismantling of controls on bank deposits rates.

The sources said that permission for NCDs will be expanded to other banks and non-banking institutions, paving the way for launching certificates of deposit for corporate and individual investors.

The central bank was not immediately available for comment.

The central bank has said that more preparations, including a deposit insurance scheme, are needed before a move on deposits. Economists said its caution also reflected concerns that freeing up deposit rates would squeeze banks' profits.

In 2012, the central bank gave lenders freedom to set a ceiling for deposit rates at up to 110 percent of the benchmarks set by the PBOC. The current benchmark for a one-year deposit, for example, is 3 percent. Analysts expect the PBOC to remove the ceiling slowly and cautiously in order to reduce risks to the banking system. ($1 = 6.1234 Chinese yuan)

(Writing and additional reporting by Kevin Yao; Editing by Simon Cameron-Moore)

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Stocks suffer as China seeks to reform industry

LONDON (AP) — Stocks mostly dropped on Friday on concerns that a brusque overhaul of China's industrial sector could cause a sharp slowdown in the world's second-largest economy.

Beijing has ordered companies to close factories in 19 industries where overproduction has led to price-cutting wars, affirming its determination to push ahead with a painful makeover of the economy. That move followed weak manufacturing data on Wednesday.

Communist leaders are trying to reduce reliance on investment and trade. But a slowdown that pushed China's economic growth to a two-decade low of 7.5 percent last quarter had earlier prompted suggestions they might have to reverse course and stimulate the economy with more investment to reduce the threat of job losses and unrest.

China's Shanghai Composite dropped 0.5 percent to 2,010.85.

Japan's Nikkei 225 index fell even further, closing 3 percent lower at 14,129.98, due to a big rise in the yen, which risks making the country's exports less competitive on international markets.

Japan on Friday said consumer prices rose in June for the first time in more than a year, an early sign Prime Minister Shinzo Abe's stimulus policies are working. While that is a promising sign in the long-term, the signs of inflation suggest interest rates could eventually also increase — higher rates tend to strengthen a national currency. The dollar was down 0.6 percent against the yen, at 98.67 yen.

In Europe, Britain's FTSE 100 index was down 0.3 percent to 6,571.71 while Germany's DAX was 0.5 percent lower at 8,258.18. France's CAC-40 bucked the trend, rising 0.4 percent to 3,973.45, thanks to a 5.7 percent rise in the shares of LVMH, the luxury goods maker, after it reported higher earnings.

Wall Street was expected to drop slightly on the open, with S&P 500 futures down 0.3 percent and Dow futures 0.2 percent lower.

Overall, trading has been quiet in recent days as a lot of people wait for next week's meeting of the Federal Open Market Committee in the U.S. for guidance on the tapering of U.S. government bond purchases, he said.

Since late last year, the U.S. Federal Reserve has been buying $85 billion in Treasury and mortgage bonds a month — a move that has kept long-term rates near record lows and supported economic recovery.

Elsewhere in the region, Australia's S&P/ASX 200 rose 0.1 percent to 5,042. Stocks in South Korea and New Zealand finished slightly higher while benchmarks in the Philippines, Malaysia, Indonesia and Taiwan fell. Hong Kong's Hang Seng was up 0.3 percent to 21,968.95

In energy trading, benchmark crude was down 75 cents at $104.74 a barrel in electronic trading on the New York Mercantile Exchange. It rose 10 cents to close at $105.49 on Thursday.

The euro was little changed at $1.3275 from $1.3277 late Thursday.

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Teresa Cerojano in Manila, Philippines, contributed to this report.

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