Title
Adoption of Resolution Authorizing the Issuance of One or More Series of Pension Obligation Bonds (POB) to Refinance Outstanding Obligations of the City to the California Public Employees’ Retirement System, Authorizing the Initiation of a Judicial Validation Action by the City Attorney, and Approving and Directing Related Matters. (Finance 10024051)
Body
To: Honorable Mayor and Members of the City Council
EXECUTIVE SUMMARY
The City of Alameda’s (City) 2020 CalPERS Unfunded Accrued Liability (UAL) was approximately $297 million for both miscellaneous and public safety retirement programs. This report provides an overview of potential funding strategies evaluated by Urban Futures, Inc. (UFI) to address the City’s UAL and recommends the City Council authorize the issuance of one or more series of pension obligation bonds to refinance the City’s UAL owed to CalPERS.
BACKGROUND
In 2019, the City Council & City Manager identified a need to further study the City’s growing pension liabilities, to evaluate pension funding strategies, and to assess the risks associated with the issuance of pension obligation bonds. In May 2020, City Council authorized an agreement with UFI to complete a customized pension model and to assist the City with evaluating pension funding strategies. UFI was selected following a competitive request-for-proposal (RFP) process. Now that UFI has completed its review of funding options available to the City, staff is recommending that the City Council authorize the issuance of pension obligation bonds.
Attached as Exhibit 2 to the staff report is additional, more detailed information on the various pension funding strategies examined by UFI, including pension obligation bonds as one of the strategies.
DISCUSSION
Annual Pension Costs
CalPERS bifurcates annual pension costs into two component parts:
Normal Costs - are the costs attributable to pension benefits earned by active employees during the then current year. These costs are based on a percentage of payroll: 10.22% on average for Miscellaneous Plan employees and 20.08% on average for Safety Plan employees.
Unfunded Accrued Liability (UAL) - represents the funding shortfall for benefits previously earned by current employees and retirees. The UAL is effectively a “past due payment”, which is equal to the difference between the projected total benefits payments or accrued liability (in today’s dollars) less the market value of assets held and invested by CalPERS. CalPERS requires fixed dollar payments to repay this unfunded liability over a specified number of years.
This report will focus solely on addressing the City’s UAL.
Unfunded Accrued Liability (UAL)
As of the most recent CalPERS actuarial reports dated June 30, 2020, the City has a $297 million UAL. The City’s UAL is separated into two employee plans: Miscellaneous Plan and Safety Plan. The Miscellaneous Plan is better funded at 71.0% with a $92.4 million UAL, while the Safety Plan is 59.4% funded, with a $204.4 million UAL.
The UAL grew by nearly $20 million from the prior (June 30, 2019) actuarial report of $277 million. The majority of this increase was attributable to an investment under-performance in FY 19-20 whereby CalPERS reported a 4.70% return (~4.50% after expenses), which represents a 2.50% shortfall from the 7.00% annual investment target which CalPERS assumes will be earned each year when calculating the UAL.
Pension Obligation Bonds (POBs)
POBs are taxable bonds that effectively refinance the City’s UAL payments (which are based on a 7.0% interest rate set by CalPERS), at a lower interest rate available in the municipal bond marketplace. Since POBs are taxable bonds, meaning the interest received by the holders of the bonds is subject to federal income tax, they carry a higher interest rate than traditional tax-exempt municipal bonds where such interest is not subject to federal income tax (e.g., 3.0% vs 2.25%). In the current low-interest-rate environment, therefore, POBs provide considerable interest costs savings and a compelling option to partially address the City’s existing UAL.
To provide certainty that the City has the legal authority under the California Constitution to issue POBs payable from the General Fund without obtaining voter approval, the City can pursue a judicial validation action. This is standard practice for these types of bond issuances.
Potential Savings - Although the use of reserves, tax-exempt exchange and leveraged refunding offer a greater level of savings (see Exhibit 2), these financing options are limited in scale. Moreover, pays cuts, reduction in service or staffing cuts may also reduce the UAL, they are difficult options due to the pressures they place on services the City is providing to residents and businesses. On the other hand, in the current (historically) low-interest-rate environment, POBs present a compelling level of savings.
As illustrated in the chart below, if the City were to issue 20-year POBs for the entire $297 UAL ($298 million in bonds) with level annual payments, the City could realize significant savings. The bond would require annual debt service payments of approximately $18 million, which is $4 million less than the FY21-22 required UAL payment to CalPERS. More importantly, the City would be able to stem the rising annual pension costs - avoiding $75 million in future UAL payments over the next 20 years.
The Safety Plan’s funding level is a particular point for concern and warrants consideration in any funding plan that the City develops.
Since 2017, there have been 53 POBs issued in California totaling over $6.6 billion in par value. The market for POBs and the decision-making behind the recent surge of POBs issued in California have evolved. All of the POBs have been issued as fixed-rate bonds, with level annual debt service, and a standard 10-year call (with the exception of the County of Riverside). The rating agencies have taken a “neutral position” on POBs - the majority of POBs issued in California have been in the “AA” category or better. More importantly, agencies are taking the time to study their pension liabilities and to understand the risks and avoid the poor financial management decisions of the past. As a result, California agencies are making more informed decisions, developing long-term plans and implementing multiple pension funding strategies simultaneously, instead of pursuing the issuance of POBs as a stand-alone approach. Nonetheless, market timing risk associated with large prepayments to CalPERS is still a potential risk to contend with (see Exhibit 2 for more details).
Sample Schedule/Next Steps
Staff recommends the City Council approve the attached resolution authorizing the issuance of POBs, in one or more series from time-to-time, to refinance its outstanding obligation owed to CalPERS, and to authorize the City Attorney to initiate a judicial validation action related thereto. Following a successful validation action process, which is expected to take 4-6 months, staff and financing consultants would return to the City Council to present the final POB structuring options and related documents (including a preliminary official statement and bond purchase agreement for the POBs) for City Council for approval. Only following successful validation proceedings and further City Council action could POBs be issued to address the City’s current UAL.
ALTERNATIVES
• Authorize issuance of Pension Obligation Bonds (POBs) to refinance outstanding obligations to CalPERS and for the City Attorney to initiate judicial validation action related to POBs
• Request additional information from staff.
FINANCIAL IMPACT
Assuming the successful issuance and sale of Pension Obligation Bonds by the City in 2022 to address the current Unfunded Accrued Liability (UAL) owed to CalPERS, the City could anticipate, based on current market conditions, aggregate savings of approximately $131.5 million in total UAL savings, with a net present value savings of $94.9 million or 32%. Additional details regarding potential savings from the issuance of POBs is found in Exhibit 2 Legal costs would be provided to the Council confidentially in closed session or by confidential communications.
MUNICIPAL CODE/POLICY DOCUMENT CROSS REFERENCE
This action is in conformance with the Alameda Municipal Code and all policy documents.
ENVIRONMENTAL REVIEW
This activity is not a project and is exempt from the California Environmental Quality Act (CEQA) pursuant to section 15378(b)(4) of the CEQA guidelines, because it involves governmental fiscal activities which do not involve any commitment to any specific project which may result in a potentially significant physical impact on the environment.
CLIMATE IMPACT
There are no identifiable climate impacts or climate action opportunities associated with the subject of this report.
RECOMMENDATION
Authorize the Issuance of Pension Obligation Bonds to Refinance the City’s Obligations to CalPERS and for the City Attorney to Initiate Judicial Validation Action Related to Pension Obligation Bonds
CITY MANAGER RECOMMENDATION
The City Manager recommends authorization of the issuance of Pension Obligation Bonds. The City Manager anticipates if authorized that there will be further steps taken with City Council prior to a final decision to issue POB’s in the future.
Further, part of the strategy recommended would be to set 50% of the savings through the POB on an annual basis to create a sinking fund to be able to stabilize any risks in the future as well as to pay down future pension obligations.
Respectfully submitted,
Annie To, Finance Director
By,
Julio Morales, Managing Director, Urban Futures, Inc.
Financial Impact section reviewed,
Annie To, Finance Director
Cc: Eric Levitt, City Manager
Gerry Beaudin, Assistant City Manager
Exhibits:
1. Indenture of Trust
2. POB Technical Information
3. Good Faith Estimates