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HomeMy WebLinkAbout11/1/2006 - STAFF REPORTS - 5.E.��ppLM Sp� i2 u _ n .n * `\ M h �. Mfory�� 1 9LIFOR��� CITY COUNCIL STAFF REPORT DATE: November 1, 2006 New Business SUBJECT: Authorize Application to California Communities Financing Program to Issue Pension Obligation Bonds FROM: David H. Ready, City Manager BY: Department of Finance and Treasury SUMMARY The City has the opportunity to save approximately $300,000 a year by issuing Pension Obligation Bonds through the California Communities Financing Program. Under this program, the City would be able to issue approximately $19 million in bonds which would reduce the City's unfunded accrued actuarial liability by 50%. This action only authorizes the City to submit an application to participate in this program and in no way obligates the City to issue bonds. The City Council must still approve a resolution, a purchase agreement and a Preliminary Official Statement prior to the issuance of any bonds. These actions will be brought back to the City Council in December. RECOMMENDATION: 1. Adopt Minute Order No. _ authorizing staff to submit an application to the California Communities Financing Program to issue Pension Obligation Bonds in its next available pool; and 2. Direct staff to come back with the necessary resolutions and agreements to begin the validation process. STAFF ANALYSIS: California Communities offers a Pension Obligation Bond Program (POB) to California local governments. The POB Program provides an alternative way to finance Unfunded Actuarial Accrued Liabilities (UAAL) with a local agency's pension system. UAALs arise when pension system assets are below the aotuarially determined future liabilities of the system. UAALs are typically ITEM NO. �5' �' amortized by pension systems at an interest cost equal to the assumed earnings rate on the pension system's assets. When the assumed earnings rate used by a pension system is higher than rates available to local governments through the capital markets, pension bonds are an attractive financing alternative. The California Communities POB Program is structured as follows. Each participating local agency issues underlying pension bonds that are sold to California Communities to finance all or a portion of its UAAL. The individual underlying local agency obligations are pooled together by California Communities, and California Communities offers pooled POBs to investors. The interest cost of the pooled POBs is equal to the interest cost on the underlying local agency POBs. Each local agency is responsible for the debt service on its POBs only. No agency is responsible for any other agency's obligations under the program. Staff has met with representatives of the California Communities Financing Program to discuss the possible savings the City might receive if it issued POBs through the California Communities Financing Pool. In addition, staff has met with Suzanne Harrell of Harrell and Associates, the City's Financial Advisor, to discuss several levels of funding and their possible impacts on the City's debt ratio. After reviewing the different financing options, staff is recommending that the City participate in the California Communities Financing Program and issue approximately $19 million in POBs through the Pool. This amount would increase the City's funded level of pension costs to approximately 90%. Moreover, this would decrease the City's unfunded accrued actuarial liability by 50%. With the present interest rates and the current formula used by CAL PERS to calculate the City's unfunded liability costs, it is estimated the City would realize an annual savings of approximately $300,000 in pension costs to CAL PERS. Staff met with the Council Finance Subcommittee (Oden/McCulloch) on October 25, 2006 to review the proposal. Attached is a copy of the material presented to the Finance Subcommittee and a memorandum from Suzanne Harrell, the City Financial Advisor, outlining various components of pension obligation bonds, the advantages and potential risks, how the risks are mitigated and recommendations. Staff is seeking City Council authorization to submit an application to California Communities to participate in the POB Program. By approving the submittal of an application, the City is not committed to issuing POBs. A separate resolution authorizing the issuance of the bonds and a trustee and purchase agreement will be brought before the City Council in December. Approval of this resolution and agreement will obligate the City to participate in validation action which is necessary to approval the issuance of the POBS. The validation action will take between 60-90 days to complete. The cost of the validation process is approximately $7,500 and, if the bonds were issued, would be paid by bond proceeds. Once the validation process is complete, the bond underwriters, RBC Capital Markets, will update its financial analysis with the most current interest rate pricing projections- If the updated analysis is deemed satisfactory, the underwriters and bond counsel will prepare the Preliminary Official Statement for final approval by the City Council. FISCAL IMPACT: IFinance Director Review: There is no cost to the City to file the application. If the City proceeds to the validation action there is a cost of approximately $7,500 to have the bond counsel prepare the necessary documents and to file the validation- The cost of the validation can be paid out of the bond proceeds if the bonds are issued. If the City issues approximately $19 million in bonds, it is projected the City will have an annual savings of $300,000 in its pension costs. Crai . Craves,'Director of Finance and Tr' surer David H. Ready, City ger 1 L. Butz I,sistant City Ta ger-Ad it i t ative Services Attachments: 1. Presentation to Council Finance Sub -committee 2- Memorandum from Suzanne Harrell 3. Minute Order IVAII gU11410].U1a0.40 W AUTHORIZING STAFF TO SUBMIT AN APPLICATION TO THE CALIFORNIA COMMUNITIES FINANCING PROGRAM TO ISSUE PENSION OBLIGATION BONDS IN ITS NEXT AVAILABLE POOL I HEREBY CERTIFY that this Minute Order, authorizing staff to submit an application to the California Communities Financing Program to issue Pension Obligation Bands in its next available pool, was adopted by the City Council of the City of Palm Springs, California, in a meeting thereof held on the 1$t day of November. 2006. JAMES THOMPSON City Clerk 4 PALM V vCi, • Cq��FORN�P PENSION OBLIGATION BONDS �n 1. Overview a. Sponsored by the League of California Cities and the California b. State Association of Counties c. Bonds Issued under California Communities Pool d. Underwriters are RBC Capital Markets e. Bond Counsel is Orrick, Herrington and Sutcliffe f. Six entities currently projected to be in proposed pool Approximately seventy cities and counties have issued POBs 2. Why Pension Obligation Bonds a. To totally or partially fund an organization "Unfunded Accrued Actuarial Liability" ("UAAL or "Unfunded Liability") Unfunded liability is the amount determined to be insufficient to meet the future payment obligations of the employer b. The City of Palm Springs unfunded accrued actuarial liability as of June 30, 2004 was $38,764,868 c. The City of Palm Springs was funded with CAL PERS at approximately 82% as of June 30, 2004. d. The City can receive cash flow savings since prior liability is amortized at CALPERS actuarially assumed investment rate of 7.75% and the projected current 30 year taxable bond pension bond rate is approximately 5.69% e. The city can save between and estimated $300,000 to $600,000 yearly on annual pension costs depending on the level of funding the unfunded liability 3. Potential Risks a. PERS investments are lower than interest rate on POB°s b. Strong investment returns may result in participant over funding or surplus c. Issuing of more bonds does increase formal debt ratio 4. Mitigating Risk Factors a. New 15 year smoothing formula of CAL. PERS of gains and losses allows for fewer swings in average rate of return on investments b. With 15 year smoothing formula using the time period of 1984- 2005, actuarial returns have not dropped below 7.75% c. Significant enough spread between current actuarial rate of 7.75% and projected bond rate of 5.69% d. Partial funding of unfunded liability allows for future savings if investment return increases above 7.75% 5. Recommendation to consider Partial Funding a. If city funds 50% of unfunded liability, the city would see an annual savings in pension costs of approximately $300,000. b. Increases City's funded pension obligation to approximately 90% c. Keeps City overall City debt approximately 11.5%, which is an acceptable level of debt. d. Allows City to enjoy additional savings if investment earning are higher than projected CALPERS rate of 7.75% over 15 years smoothing period Next Steps a. Adopt Resolution authorizing Issuance of Bonds, Approving Trust and Purchase Agreement, and authorizing Validation Action b. Authorize $7,500 in legal costs for Validation Action, which can later be paid from bond proceeds c. City files POB Enrollment Form d. Validation Action filed with 90 day validation period e. Interest rates are established, if rates are not acceptable City can withdraw from process, f. If rates are acceptable, City Council must approve a Preliminary Official Statement, Official Statement and other closing documents. g. Bonds are sold. October 22, 2006 To: David Ready Troy Butzlaff Craig Graves From: Suzanne Harrell Re: Pension Obligation Bonds You asked that I provide my opinion on the financing options presented to the City regarding the unfunded actuatial liability (UAL) that currently exists in your PERS pension plan. As of June 30, 2004, the City's pension plan was approximately 82% funded for both safety and miscellaneous personnel. Because the PERS invesunerit returns have been generally good and the reporting of the UAL lags by a year, I suspect your funding stains Trill be a little higher when you recuve the June 30, 2005 numbers. The table below shows the funding status for a number of cities in Southern California with population in the same general range as Palm Springs, as well as some of your neighboring communities. City (Population). Misc Employees Fundins* Statue Safetv Emtnlove.cs Funding Status La Mirada (50,000) 89.6% N/A Azusa (48,000) 90 2% 82.2% Covina (49,000) 102.1 % 109.2% Indio (71,000) 100.6% 101.7% Palm Desert (49,000) 83.1% N/A La Quinta (38,000) 89.2% N/A As you can see, it is not miusual for a city to be less than 100% funded. Typically, funding of the pension obligation is around 90%, regardless of the size of a city_ I believe this is the range of funding that Palm Springs could consider. Based on the RBC numbers, financing approximately $$19 million of the UAL will achieve at least 90% funding and provide a moderate budget savings of $300,000 annually. While funding of 100% of the UAL would provide double the budget savings, it does have an adverse affect on the City's debt ratios. Doubling the bond size to $39 million would increase the debt per capita by another $417, bumping your General Fund -only debt per capita over $3,000 (the City's aggregate debt per capita ratio is apptodmately $1,000 higher if the tax allocation bonds and airport bonds are included). Palm Springs already has a high debt burden due to the financing of the convention center and airport, and I feel that keeping the General Fund per capita figure under $3,000 is prudent. The City Tower, 333 Ciry Boulevard Wesr, Suite 1430, Orange, California 92868 Tel:714.939.1464 Faw 714.939.1462 Page 2 October 22, 2006 In addition, financing 50% of the UAL increases your debt service on bonded debt as a percent of the General Fund budget to 11.5% from the existing 10.1%. Financing 100% of the UAL would increase this percentage to 12-2'G, which again, is higher than most averages. The City of Palm Springs has convention center and airport debt service that causes your averages to be higher than most cities of your sirs and budget, and that has to be considered in any decision to covert non -bonded obligations to bonded debt. I reference the S&P rating report fox the Convention Center Expansion financing in 2004. The City's above - average wealth levels, low unemployment, strong assessed value growth and good historical financial performance were positive credit factors in determining the City s General Fund "A" rating. However, these strengths were offset by the local economy's dependency on tourism and the City's high per capita debt levels after the issuance of the 2004 Bonds_ The reporr also states that the City expects minimal bonding needs in the near to medium future as a factor in the stable financial outlook. We know that the [JAL is taken into account in any credit rating process. However, it is a not one -Fox -one relationship. Reference to the S&P rating criteria shows that non -bonded UAL is not included in their debt ratio calculation. Further based on the 5&P report, I expect that the negative impact of the increase in the debt per capita figure from a $39 million issuance to fund the entit•e UAL will more than offset any positive impact of having the City's pension obligation funded at 100%. The following is the S&P discussion of this factor, from their January 20, 2004 research report: The risk of adding too much leverage is another factor for POB issuers to consider. Borrowing for any purpose increases leverage, and incurring debt to pay unfunded liabilities is no different. While the issuer is substituting one type of long-term liability (POB) for another (UAAL), there is a difference. In most cases, bond debt service is a 'harder" obligation than the "softer" contribution payments used to amortize the UAAL Bond debt service must be paid in full and on time or the issue falls into default, with wide ramifications. For certain employers, contribution payments, on the other hand, may be temporarily deferred or reduced without serious negative consequences. Therefore, the size of the POB relative to the total debt structure of the issuer must be measured in terms of what level of debt service can be managed if actual future investment retums do not meet the original POB plan projections." Given all the concerns for the City's credit rating described above, I would recommend limiting the funding of your: UAL to 90%, and issuing $19 million or less in Pension Obligation Bonds. I feel this is an acceptable compromise giving the level of budget savings offset by the possibility of the negative credit impacts of funding the entire obligation. I believe that Palm Springs is unique in the fact that, with a population of approximately 50,000, you operate an airport and convention center, and have financed those facilities. I don't think those unique facts have been given enough consideration in the proposal to fund 100% of your UAL. I would be happy to answer any additional questions you may have concerning this information. I have attached the S&P Pension Obligation Bond research report fox your reference. The City Tower, 333 City Boulevard Wust, Suite 1430, Orange, Califonila 92868 Tel: 714-939.1464 Fax 714.939.1462 California Communities Financing Programs • Variation in Actuarial Return on Assets from 1998-2005 — 3 year smoothing ranges from -3.1 % in 2003 to 18.3% in 1998 — 15 year smoothing ranges from 9.7% in 2002 and 2003 to 14.8% in 1999 • With 15 year smoothing using data from 1984-2005, actuarial returns have not dropped below assumed return of 7.75% Risk Mitigating Factors 15 Year smoothing of gains and losses — Mitigates the investment risk associated with POBs CaIPERS Smooihed Refdrns " - �o 20 15 — ------------------------------ 0 1998 1999 2000 2001 2002 2003 2004 2005 7.76%Assumed Earnings Hate 3 Year Smoothed Returns — 15 Year Smoolhed Retums 0 California Communities Financing Programs • POBs Eliminate Negative Amortization • Reduce Annual Pension Costs POBs Compared to CaIPERS .amortization POB Bond Balance c6mpaked'to'29Year Fkastl-Stffi't Aniortizatiori 12,000 10,000 — 8,000 6,000 4,000 2,000 o& d`° o'` NIII oNb o`er o`Po o`l 00 o`��O o0 03° o`� dk o`��5 0\ ro roo 0O R\ 0� 0O 0� 0� 0� 0� 0� 00 t\, 0� 0\ com Fresh Start Payment PO Debt SeNca Fresh Start Balance —POB Balance 12