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* Pension overhaul proposal due in 30-60 days
* Moody's says pension bonds are often a red flag
* Quick changes needed, newly named officials say
By Michael Connor
Dec 17 (Reuters) - Puerto Rico's incoming government aims to roll out early in 2013 a proposed overhaul of the severely underfunded retirement system for government workers that may include selling pension obligation bonds.
David Chafey, a banking executive named last week as chairman-designate of the Caribbean island's Government Development Bank, told reporters on Monday the taxable bonds, also known as POBs, may be a possible source of funds.
"We need to look at that as a real option," he said.
POBs have been mostly shunned in recent years by government policymakers, with critics arguing that the possible savings and extra earnings they can deliver often come with outsized financial risks for governments.
In July, Standard & Poor's Ratings Services said it was considering a ratings downgrade on $2.9 billion of Puerto Rico's senior pension funding bonds because governments and other employers may not keep up timely contributions.
Last week, another leading Wall Street ratings agency, Moody's Investors Service, knocked Puerto Rico's overall credit rating down to near-junk status and warned it was considering future downgrades.
Moody's decision affected $38 billion of outstanding debt and was linked to Puerto Rico's weak economic outlook and worries about the pension system.
After the downgrade, Puerto Rico's 30-year yield spread over top-rated bonds in the municipal market widened in secondary trading and closed on Friday at 258 basis points above an AAA-rated 30-year issue, a record high for 2012, according to Municipal Market Data.
The spread, which investors demand for riskier borrowers, has widened steadily for the last year. Its yield stands at 160 basis points more than an AAA-rated issue a year ago.
In a recent research report, Moody's said that issuance of pension obligation bonds can be negative for an issuer's credit rating.
"If bond proceeds substitute for annual contributions to pension plans or are used to pay pensioners, we consider it a deficit borrowing and would view the financing as credit negative," the rating agency said in its report on Dec. 11.
"Pension bonds are often a red flag associated with greater rigidity of long-term obligations, failure to find sustainable solutions to pension funding and a pattern of pushing costs off into the future. For this reason, most pension bonds have, at best, a neutral impact on our overall assessment of an issuer's credit quality".
In a conference call with reporters, Chafey and Javier Ferrer, the GDB's president-designate, described talks on pensions as well underway but said most particular changes had not been decided or presented to Governor-elect Alejandro Garcia Padilla.
"We are looking at all potential options to address pension reforms," Ferrer said. "We understand that time is of the essence. Moreover, we also understand that it is time for decisive action."
Chafey said proposals were expected within 30 to 60 days.
Moody's last week said it cut Puerto Rico's debt rating in part because its analysts saw few growth drivers in the island's long-moribund economy, a decline in population and unemployment nearly double that of the mainland United States.