HomeMy WebLinkAbout09-City Administrator
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CITY OF SAN BERNARDINO - REQUEST FOR COUNCIL ACTION
From: Fred Wilson, City Administrator
Subject: Set a workshop of the Mayor and Common
Council for Monday, October 17,2005 at 5:00 p.m.
in the MIC Room, 6" Floor City Hall, to discuss
and take possible action concerning issuance of
Pension Obligation Bonds.
Dept: City Administrator's Office
Date: September 21, 2005
MICC Meeting Date: October 3, 2005
Synopsis of Previous Council Action:
February 23, 2005 - Ways and Means Committee forwards the CSCDA Pension Obligation Bond
program proposal, along with Public Financial Management's (PFM) review and the PERS actuarial for
consideration by the Mayor and Council
April 4, 2005 - Mayor and Council adopt a resolution authorizing the issuance of one or more series of
Pension Obligation Bonds, approving the form of and authorizing the execution and delivery of a Trust
. Agreement, and authorizing a validation action
June 16, 2005 - Mayor and Council approve selection of Lehman Brothers (underwriter), PFM (financial
advisor), and Orrick Harrington Sutcliffe (legal counsel) as the City's financing team for POB's
September 21,2005 - Ways and Means Committee recommends approval of staff's recommendation to
issue Pension Obligation Bonds to fund 65% of the City's unfunded actuarial accrued liability (UAAL)
Recommended Motion:
That the Mayor and Common Council set a workshop for Monday, October 17,2005, at 5:00 p.m. in the
MIC Room, 6'" Floor City Hall, to discuss and take possible act' n co erning issuance of Pension
Obligation Bonds.
Contact person: J:r..ri Wilc::nn
Phone:
5122
Supporting data attached: staff rapor!
Ward:
all
FUNDING REQUIREMENTS:
Amount:
Source: (Acct. No.)
(Acct. Description)
Finance:
Council Notes:
Agenda Item No. 3
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STAFF REPORT
Subiect:
Set a workshop of the Mayor and Common Council for Monday, October 17, 2005 at 5:00
p.m. in the MIC Room, 6th Floor City Hall, to discuss and take possible action concerning
issuance of Pension Obligation Bonds.
Backeround:
On Monday, March 7, 2005, a workshop was held with the Mayor and Council to discuss the
possibility of issuing Pension Obligation Bonds (POB). In summary, the issuance of POBs
allows the City to use a lump sum deposit of the proceeds of the POBs to fund a portion or all of
the City's PERS unfunded actuarial accrued liability (VAAL). This transaction can result in
cash flow savings to the City, but also bears some risk. This issue was discussed in great detail
at the workshop.
The matter was referred to the Ways and Means Committee for further analysis and discussion.
On March 23, the Committee examined various issues, including the potential benefits of issuing
variable rate bonds, and the percentage amount of the City's VAAL that might be funded
through POBs. City Treasurer David Kennedy participated in the discussion. The Committee
recommended that the matter be forwarded to the Mayor and Council for further discussion and
direction at a later date. On April 4, the Mayor and Council approved various documents to
initiate a validation action, which is an important first step in the issuance ofPOB's.
In May, the PFM Group (the City's financial advisor) assisted in the preparation and distribution
of a Request for Proposals seeking underwriting services for a possible POB issuance. Staff
from this office and the Finance Department, as well as City Treasurer David Kennedy and
Councilmember McCammack, all met with Peter Shellenberger of PFM on several occasions to
discuss the proposals and the qualifications of the various firms. Based on their experience and
qualifications, Lehmann Brothers was determined to be the best choice to serve as the
underwriter, contingent upon the satisfactory conclusion of negotiations concerning their fees.
Lehmann Brothers (underwriter), PFM (financial advisor), and Orrick Harrington Sutcliffe (legal
counsel) were selected on June 16 by the Mayor and Council to make up the City's financing
team, along with City Treasurer and City staff. The financing team then began to determine
how the bond issuance should be structured to achieve the most long-term savings while
minimizing risk to the City.
The financing team has met in person and via conference call to discuss possible POB
structuring options over the last several months. The attached memo from the City's financial
advisor, Peter Shellenberger, explains the final two (2) options that were considered by the
financing team.
On September 21,2005, the Ways and Means Committee met with the financing team and heard
a presentation concerning this matter. The Committee recommended that the Mayor and Council
approve the recommendation to issue Pension Obligation Bonds to fund 65% of the City's
VAAL.
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It is recommended that a workshop be held with the Mayor and Council to allow the financing
team to make presentation and answer questions regarding POB issuance prior to any action by
the Mayor and Council. Should the Council chose to do so, the appropriate resolutions can then
be adopted at that workshop to approve the POB issuance. Timing is an issue, because long-term
interest rates have been slowly increasing.
Financial Imnact:
None by this action. If POB's are issued in accordance with the recommendation, this will
provide estimated cash flow savings of $700,000 for five (5) years and result in payoff of a
significant portion of the City's VAAL.
Recommendation:
That the Mayor and Common Council set a workshop for Monday, October 17, 2005, at 5:00 .
p.m. in the MIC Room, 6th Floor City Hall, to discuss and take possible action concerning
issuance of Pension Obligation Bonds.
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The PFM Group
September 19, 2005
MEMORANDUM
To: Fted Wilson, City Administrator
Cit)' of San Bernardino
From: Petet Shellenberger, Senior Managing Consultant
Pub/it Finantia/ Management, Inc.
Re: Proposed Pension Obligation Bond Financing Strategy and Recommendation
Over the last several months, Public Financial Management ("PFM") has worked closely with the City of San
Bernardino (the "City'') staff and the City's fInancing team to review the City's unfunded pension liability -
i.e., the Unfunded Actuarial Accrued Liability ("UAAL'') - and evaluate funding alternatives using Pension
Obligation Bonds ("POBs"). After reviewing numerous fInancing options with the fInancing team, City staff
has narrowed the candidate fInancing strategies to two, both of which provide budgetary savings to the City
and reduce the UAAL in an economically effIcient manner. This memorandum provides an overview of the
City's pension status and current UAAL, describes two potential POB funding scenarios for the City
Council's consideration, and describes the fInal recommendation identifIed by City staff and the fmancing
team.
The City's Pension Status and Current UAAL
The required contributions to CalPERS are actuarially determined based on a set of factors including
projected retirement rates, payroll growth, inflation and the actuarial value of assets held by the pension plan.
The unfunded actuarial accrued liability (the "UAAL'') is created when the normal contributions are not
suffIcient to cover the projected future pension obligations. It is defmed as the present value shortfall
(assuming a discount factor of the actuary's assumed investment yield, now 7.75%) between the future benefIt
stream owed to employees (past and present) and the resources expected to be available to pay benefIts when
due. A UAAL exists when employer contributions, changing assumptions or investment performance fail to
keep pace with a growing benefIt stream. Given the variable nature of investment performance and
occasional changes in actuarial assumptions, the UAAL is a moving target that is defIned for the City when
actuarial valuations are performed. Despite its changing nature, the UAAL represents a real liability of the
City. Currently the UAAL for the City's Safety Plan is $77.05 million as of June 30,2005.
In April 2005, the governing board of CalPERS approved policy changes to the methodology for calculation
of employer contribution rates. These changes, briefly stated are: .
(1). Changing the smoothing methodology for market asset value losses/gains from a three year horizon to
a IS-year horizon;
(2). L'sing a 30-year rolling amortization of previously unamortized gains and losses in annual calculating
employer rates;
(3). Increasing the actuarial value of assets corridor to between 80-120% of actual market value of assets
from a corridor of 90-110%; and
(ol). Setting a minimum normal employer contribution rate of the normal cost less a 30-year amortization of
any plan surplus (Elimination of rate holidays).
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City of San Bernardino
POB Financing OvclView & Recommendation
September 19. 2005
Pa~2
The policy changes were implemented with the goal of reducing volatility in annual contributions which in
turn increases budgetary stability for CalPERS participants. There is also an overall effect of a reduction in
the annual required contribution towards the VAAL. However, the reduced annual contribution comes at
the expense of reducing the VAAL over time. That is, the minimum payment defined by CalPERS on the
U..\AL balance is insufficient to cover the interest coming due on the VAAL and, as such, the VAAL
increases over time. For example, the current 30-year rolling amortization will cause the City's VAAL to
increase from its present amount of $77.05 million to $121 million by FY 2036 under the current set of
actuarial assumptions.
POB Financing Objectives
In general the VAAL can be funded in one of three ways,
(1) A lump sum deposit by the City from currently available resources;
(2) Payment of the VAAL over time based on the actuarially determined amortization; or
(3) .\ lump sum deposit from the proceeds of POBs. The City would then be responsible for paying debt
service on the bonds.
The first method, a deposit from available funds, assumes both that the City has the means to make a large
one-time payment towards the VAAL and that there is no more efficient use of the City's available funds.
The second method represents the default method or "do-nothing" scenario where the City pays the
actuarially determined minimum payment to CalPERS from available resources. As noted previously, the
minimum payment on the VAAL balance is insufficient to cover the interest coming due on the VAAL and,
as such, the VA.\!- increases over time. While it results in a modest annual payment, contributing the
mmimum payment does not likely represent an effective strategy for the City towards reducing the VAAL
over time. In the case of the third method, the use of POBs can not only reduce the City's VAAL but
potentially create General Fund cash flow savings in comparison to payment of the actuarially determined
amortization. By replacing a liability amortized at the actuarial rate of 7.75% for debt service that would be
amortized at approximately 5.30%, the City can realize significant savings.
The City's POB financing strategy incorporates economic and strUctural considerations and has been
de\Teloped with three primary ohjecti,res:
(1) Reduce the City's VAAL at a lower cost of capital than the assumed actuarial rate of7.75%;
(2) Realize annual budgetary savings for the City; and
(3) Maintain flexibility to restrUcture the VAAL payments in the case of future policy changes implemented
by CaIPERS.
The first objective is achieved due to the current low interest rates in the municipal bond market which allows
the City to effectively amortize their VAAL at an estimated interest rate of 5.30% using POBs, compared to
the actuanal assumed rate of 7.750/0. As noted above, the implementation of a 30-year rolling amortization
has the effect of lowering annual payments even as the UAAL balance continues to increase. Due to the
lower annual payments, it is challenging to create significant cash flow savings in comparison to a rolling
amortization in the current market. The second objective has been achieved by strUcturing debt service on
the rOBs to generate significant budgetary savings in the first five years of the analysis, and neutral savings
thereafter.
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City of San Bernardino
POB Financing Overview & Recommendation
Sc:ptcmber 19. 2005
Page: 3
Structural flexibility regarding the VAAL payment -the third objective-was identified as an important
objective by City staff. The issuance of bonds introduces a firm commitment on the part of the City to pay
debt service. Essentially, the City is trading in the "soft" annual payments to CalPERS for "hard" debt
service which must be paid to bond holders on time and in full. Structural flexibility is accomplished by
purchasing a 10-year "call option" on current interest bonds and through the use of a "make-whole" call
provision. This allows the City to refinance and restructure those bonds, as needed, in the future. Structural
flexibility is also obtained by only financing a portion of the VAAL (e.g. 65% of the VAAL) with POBs. This
effectively keeps a portion of the VAAL a "soft" liability as ongoing cash payments to CalPERS.
POB Scenarios and Recommendation
After reviewing numerous potential POB sizings and structures, the City staff and the financing team have
identified two scenarios for consideration by City Council. Both scenarios meet each of the three objectives
identified above. Additionally, both scenarios utilize fixed-rate bonds, as opposed to variable rate bonds,
reflecting an effort to capture the historically low fixed rates currently prevailing in the municipal bond
market and to establish certainty associated with the future POB payments.
The two candidate scenarios identified by City staff and the financing team, along with an overview of results
are listed below.
Scenario 1 - Funding 65% of VAAL with non-callable bonds
Scenario 2 - Funding 100% of VAAL with callable bonds
O\CC\'ICW of Results
Scenario Results Scenario 1 Scenario - 2
UA.:\L Financed $ 50,081,000 S 77,048,000
U","-\L Remaining in 2006 26,967,000 0
UA:\L Remaining in 2036 42,358,000 0
Financin~ Obiectives
Cost of Capital- TIC 5.29% 5.30%
Total Budgetarv Savings 3,570,000 5,326,000
Annual Budgetary Savings:
FY 2007 - 2011 700,000 1,000,000
. 65% of UAAL fmanced with . 10-year par call
POB . "Make whole" call provision
Structural Flexibility . Make whole call orovision
Scenario-I provides the City with the most flexibility by only funding 65% of the UAAL with POBs.
Budgetary savings under scenario-I total $3.57 million over the first five years of the funding analysis, or
$700,000 annually from FY 2007 through 2011. (It should be noted that the City has already paid, in full,
their FY 2006 CalPERS payment and, as such, the analysis begins with the FY 2007 payment.) While
structural flexibility is preserved by funding only 65% of the UAAL, the remaining portion of the UAAL
increases from $26.9 million in 2006 to $42.4 million in 2036, accruing interest at 7.75%, based upon the
CalPERS 30-year rolling amortization methodology. However, it should be noted that the City could elect to
make larger annual cash contributions to reduce the VAAL or, alternatively, CalPERS could change their rate
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Ciry of San Bernardino
POB Financing Overview & Recommendation
September 19, 2005
Page 4.
setting methodology which would increase the City's minimum payment in the future and similarly reduce the
VAAL over time.
Scenario-2 provides the City with the greatest budgetary savings, totaling $5.3 million over the fIrst fIve years
of the funding analysis, or approximately $1 million annually from FY 2007 through 2011. However, there is
less structural flexibility under Scenario-2 as 100% of the VAAL is funded with POBs. There is room for
structural flexibility under Scneario-2 by purchasing a 10-year call option and attaching a "make-whole" call
provision to the bonds. The POB structure includes both current interest bonds (CIBS) and capital
appreciation bonds (CABs). Only CIBs are eligible to be called and restructured. As a 10-year par call is
costly to purchase for taxable bonds, only $6.9 million in CIBs have been structured with a 10-year par call.
This amount of CIBs, structured with a 1O-year par call, has been targeted so as not to materially exceed
expected savings in the first five years of the analysis. That said, additional CIBs could be structured with a
IO-year par call, although the impact on annual savings would have to be closely monitored so as not to
exceed the City's expected savings. Additionally, $52 million in CIBs have been structured with a "make-
whole" call provision that does not generate savings at the time of refinancing, but does allow the City to
restructure for payment structure purposes, if need be.
Based upon the City's objectives conveyed by staff during the review of numerous POB fInancing structures,
Scenario-1 was identifIed as the recommended fInancing structure for the City to implement to fund its
VAAL. Scenario-1 enables the City to significantly reduce its VAAL by 65% today and provides maximum
flexibility to address future VAAL funding needs as they arise and as CalPERS policy changes. Scenario-1
results in an estimated borrowing cost of 5.29% to the City and generates total savings of $3.57 million, or
$700,000 annually from FY 2007 through 2011. It should be noted that these annual savings targets are
estimates and are subject to change based on interest rate movements in the municipal bond market. As
such, it is further recommended that City Council set a "minimum savings" thresh-hold (e.g. $700,000
annually for the first fIve years) and permit the City Administrator to instruct the financing team to sell the
proposed POBs only at such time when market rates support the minimum savings thresh-hold.
I t is important to note that the savings analyses for POBs represent estimated savings benchmarked against a
full set of assumptions made by CaIPERS, including VAAL amortization methodology, investment earnings,
etc. As the actuarial assumptions change, so too will the actual savings results. That said, it is worth noting
that the current VA.\L amortization methodology used by CalPERS -i.e. the 30-year rolling amortization-
represents a minimum payment that is insufficient to pay interest on the VAAL balance. As such, it is
unlikely that the minimum payment would decrease. Consequently, actual savings stemming from CalPERS
amortization changes in the future would not likely lead to decreased savings when compared to the POB
payments described in this memorandum.
Next Steps
Interest rates in the municipal bond market continue to be near historic lows and the fInancing team is
prepared to move quickly to execute a transaction on behalf of the City, upon City Council approval. The
next steps include finalizing the legal documents, presenting them for City Council approval and pricing the
bonds.
The method of sale recommended for the City to pursue is a private placement of the City's bonds, versus a
public offering. A public offering involves rating agency requirements, the solicitation and purchase of bond
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City of San Bernardino
POB Financing Overview & Recommendation
September 19. 2005
Page 5
insurance and the preparation of an official statement. These activities involve significant staff time and
increased cost of issuance. Alternatively, the City may elect to privately place these bonds with Lehman
Brothers soliciting bids from their investor base, or directly purchasing bonds from the City. It is PFM's
responsibility, under a private placement, to monitor market conditions and establish objective criteria, prior
to the sale of the bonds, to ensure that the bonds have been competitively placed and have received a fair
market interest rate. A private placement is a cost-effective and streamlined way for the City to sell their
POBs, should it decide to execute the transaction. Furthermore, as a streamlined process, a private
placement is an effective method to mitigate interest rate risk and manage the rate volatility present in today's
market.
The proposed next steps are listed below.
Proposed Financing Schcduk
~
ctivi
A rove Plan of Finance for POBs
Ci Council a roves Final Documents
Price Bonds
Pre Closin
Closin
Se tember 21
October 17
October 18
October 25
October 26
We hope the City finds this analysis, prepared with the collaborative effort of the City staff and the fmancing
team, helpful and informative. If you have any additional questions or comments on the proposed
information herein, please do not hesitate to call Peter Shellenberger at (415) 982-5544.
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