City of Stockton Pension Obligation Bonds 101 August
City of Stockton Pension Obligation Bonds 101 August 31, 2006
Overview of City’s Pension Funding Situation Pension Funding & POB Overview u Unfunded Actuarially Accrued Liabilities City contributes to 2 Cal. PERS benefit pension systems: – Miscellaneous Plan – Safety Plan u City currently has an unfunded liability of $152. 21 million – $46. 9 million Miscellaneous Unfunded Actuarially Accrued Liability (UAAL) – $105. 2 million Safety UAAL u Current UAAL reflects phase-in of unrecognized losses and changes in actuarial assumptions (8. 25% to 7. 75% as well as reduction in COLA) ______________ 1. Source: John Bartel & Associates. 1
Understanding the Cal. PERS Changes Pension Funding & POB Overview Due to Cal. PERS’ new amortization methodologies, UAAL balance is likely to have grown Previous 30 -Year “Fresh Start” Amortization 1 u Cal. PERS charges the City annual interest rate of 7. 75% on its UAAL – Under prior methodology, payment grew by 3. 25% annually to match expected growth in payroll – UAAL was fully amortized over a finite 30 Year term u Cal. PERS changed the actuarial assumptions it uses to amortize its UAAL New Cal. PERS “ 30 -Year Rolling” Amortization 1 – Amortization is now calculated on a 30 -year “rolling” basis – UAAL balance continues to grow because accumulated balance in Year 2 is reamortized over a new 30 -year term which has a negative amortization Balance grows to $216. 7 million – Absent earnings greater than 7. 75%, balance is expected to grow to $216. 7 million in 2037 ______________ 1. Source: John Bartel & Associates. 2
“Rolling” vs. “Fresh Start” Amortization 1 Pension Funding & POB Overview u City’s annual payment is lower on a 30 -year Rolling Amortization vs. the prior 30 year “Fresh Start” methodology u “Fresh Start” amortizes entire UAAL over 30 years – u Current PERS’ Policy 30 -Year “Rolling” Amortization Prior PERS’ Policy 30 -Year “Fresh Start” Amortization No remaining balance Rolling Amortization leaves City with a $216. 7 million unamortized UAAL balance in 2037 – Annual payment on a Rolling Amortization is too small to cover both principal and interest – City will not pay down any principal and balance will continue to grow Unamortized UAAL Balance ______________ 1. Source: John Bartel & Associates. 3 Unamortized UAAL Balance
Why are Unfunded Liabilities a Credit Issue? Pension Funding & POB Overview Required increase in employer contributions may “crowd out” other priorities, reducing financial flexibility u From the City’s perspective, once a UAAL has been incurred there are only four ways out: “As part of Standard & Poor’s rating analysis, the status of an employer’s pension plans is an important factor. Any competing obligations that could weaken the ability of the employer to meet bond debt service requirements may be a negative credit issue. . . Thus, pension liabilities, which include ongoing, annual servicing requirements in the form of contributions from employers, must be managed so as to not adversely affect the employer’s credit profile. To the extent that pension funding problems act to decrease an [issuer’s] financial position or flexibility, and these issues are not addressed, they could exert downward pressure on creditworthiness at least over the intermediate term. ” – Contribute more – Cut benefits (unlikely) – Earn more (unlikely) – Increase mortality (not recommended!) u From a rating agency perspective, unfunded liabilities are considered tantamount to debt u Funding ratios below 80% are a potential credit negative – Miscellaneous Plan is 87. 9% funded, however Safety Plan is 79. 5% funded u - Standard & Poor’s February 22, 2006 Rating agencies generally view POBs as an acceptable tool for reducing the cost of an already existing liability 4
What Are POBs and How Can they Help the City? Pension Funding & POB Overview u Pension Obligation Bonds (POBs) are taxable bonds issued by states and local municipalities (Plan Sponsors) to refund, in the capital markets, all or a portion of their Unfunded Actuarially Accrued Liabilities (UAAL) u POBs are not issued by pension systems, nor are the pension systems liable for the bonds u The City would use bond proceeds to retire all or a portion of the UAAL, with savings resulting from the lower taxable bond market rates vs. the pension system’s actual earnings rate, which is effectively the City’s interest cost – Debt service derived from taxable bond market rates is lower than the actuarially projected City’s contributions that reflect the higher plan earnings assumption 5
Understanding the Mechanics of POBs Pension Funding & POB Overview u The City is essentially exchanging one liability, the Unfunded Pension Liability, for another liability, the Pension Obligation Bonds (POBs) – Legally and financially no new “net debt” is created by the issuance of POBs – The POB liability will now be recorded on the balance sheet instead of in the pension plan reports u The Bonds will have an interest cost lower than the rate charged by Cal. PERS for the City’s UAAL – 7. 75% at Cal. PERS versus 5. 81% with POBs u Any change in benefits for new employees will not impact existing benefit levels and the associated liabilities 6
California POB Market Update Pension Funding & POB Overview To date, 48 different California local governments issued over $14 billion of POBs California POB Financings City of Santa Rosa City of Richmond Market Overview Sacramento Metropolitan Fire District City of Oakland Union City of Berkeley City of Fresno City of Burbank South Coast Air Quality Mgmt. District City of Pasadena San Diego Metro. Transit Dev. Bd. City of Pomona City of Bell City of South Gate City of Long Beach City of Chula Vista ______________ 1. Includes 7 issuers in CSCDA pooled financing. 7
POBs are an Interest Rate Sensitive Opportunity Pension Funding & POB Overview u Inflationary pressures remain high impacting the likelihood the Federal Funds rate will reach 5. 75% by 4 Q 06 – – u 10 Year and 30 Year Treasury Rates Two more 25 bps rate hikes expected by the end of 2006 4. 95% 4. 81% Outlook driven by slowing growth, low consumption growth and a slight increase in business investment, exports and government spending Rates are expected to continue to increase Lehman Brothers’ Interest Rate Outlook S&P 500 1, 298. 82 8
Potential Risks of POBs Pension Funding & POB Overview u New benefits and other actuarial dynamics can create a new UAAL u Becoming fully funded could increase the pressure for new benefits u Underperformance of Cal. PERS investments vs. POB Cost of Funds – The benefit of POBs can only be determined by comparing Cal. PERS’ average return from POB issuance to the final maturity of the POBs with the all-in interest cost of the POBs Cal. PERS’ Historical Investment Return vs. 7. 75% Earnings Assumption 5 -Year Cal. PERS Historical Return for period ending 6/30/06: 7. 60% 7. 75% 5. 81% ______________ • 5. 81% represents an assumed fixed rate bond yield. • Historical average is a geometric average based on all available Cal. PERS' published returns data. Beginning 6/30/02 performance figures are reported as gross of fees. Source: Cal. PERS 9
Potential POB Solutions for City Debt service can be shaped to achieve the City’s budgetary needs $755 K of Savings for 5 Years, 100% of UAAL Pension Funding & POB Overview $566 K of Savings for 5 Years, 75% of UAAL u Fund entire $152. 2 MM unfunded liability using Current Interest Bonds u Fund $115. 0 MM of unfunded liability using Current Interest Bonds u Average annual savings of $755, 000 from 2007 -2012 with minimal savings thereafter u Average annual savings of $566, 000 from 20072012 with minimal savings thereafter u POBs can save the City $4. 7 MM in cashflow and completely eliminates $216. 7 MM UAAL balance in FY 2037 u POBs can save the City $3. 4 MM in cashflow and reduce final UAAL balance by $163 million u All-in interest cost of 5. 82% – All-in interest cost of 5. 81% – 2006 POB Debt Service vs. 30 -Year Rolling UAAL $52. 9 MM of unbonded UAAL in FY 2037 2006 POB Debt Service vs. 30 -Year Rolling UAAL 10
Summary of Financing Results Pension Funding & POB Overview Absent a POB financing, using the current Cal. PERS methodologies, City would have a $216. 7 million balance in 2037 Comparison of Financing Results in 2037 Payment Savings of: $4. 7 million versus Rolling Amortization Payment Savings of: $3. 5 million versus Rolling Amortization 11
Validation is the Next Step in the Process Pension Funding & POB Overview u In order to consider the issuance of POBs, City must complete a validation action with the courts, validating that it has a pension liability – City Council will approve Resolution authorizing staff to move forward with validation process u Validation process takes approximately 3 months u Process does not obligate City to issue POBs, but provides it with the ability to issue POBs in the future if it chooses DATE September 14 September 15 September 27 October 3 October 12 November 13 RESPONSIBILITY City/BC BC BC City/UW City/BC BC UC UW City/BC December 5 December 11 -12 December 20 -21 December 22 December 28 January 3 January 4 ACTIVITY u Council approves resolution authorizing validation action u File validation complaint with Superior Court u Receive order authorizing publication of summons u Council Pension Bond Study Session u First publication of summons u Expiration of answer period (+ 31 days) u Begin drafting POS u Begin preparing rating agency presentation u File request for default judgment u Receipt of default judgment u Commence 30 -day appeal period u Distribute credit package to rating agencies u Rating Agency/Bond Insurer Meetings u Receive ratings u Receive insurance commitment u Appeal period expires u Conference call to finalize POS u Final Council Approval January 5 u Electronic UC/UW January 10 January 11 u Indication November 14 November 28 posting of POS Period u Pricing (Finalize Spreads & Set Coupons) u Sign Bond Purchase Agreement u Finalize and mail OS u Pre-Close Series 2006 Bonds u Deposit Funds with Cal. PERS January 16 January 17 January 18 BC = Bond Counsel UC = Underwriter’s Counsel UW = Underwriter 12 UW City/UW BC Working Group City UW/City UC/UW Working Group City
Appendices
Scenario 1: Bond 100% of UAAL – Financing Results 13
Scenario 2: Bond 75% of UAAL – Financing Results 14
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