City of HaywardCalPERS Update and Information Related to UAL Cost Management Strategies and Restructuring Concept March 16, 2022
Executive Summary
City’s CalPERS projected Unfunded Accrued Liability (UAL) is currently $493 million UAL debt has increased 75% over the past 8 years from $282M UAL payments have more than doubled: $17 million (2017) to $34.5 million (2022) CalPERS currently charges 6.8% interest rate on this debt CalPERS FY 2020-21 returns of 21.3% and key assumption changes will change the “shape” of City’s UAL repayment schedule UAL balance may drop to $414 million
However, potential underperformance in FY 2022 may drive UAL back higher Restructuring the UAL at a lower interest rate will be explored in this presentation, including potential benefits, risks, and potential next steps if the City wishes to evaluate further
Historical and Projected UAL PaymentsProjected based on CalPERS 21.3% Returns & New 6.8% Discount Rate The City’s UAL is projected to decrease from $493M to $414M due to the following:
FY 2020-21 returns of 21.3%
Discount rate reduction to 6.8%
Annual payments (dark blue line) projected between $38M and $39M for next 6 years Payments could rise back up again if CalPERS underperforms in FY 2022 (given recent stock market declines) $477M UAL if CalPERS earns 0%
$524M UAL if CalPERS earns -5%
Normal Cost payments (not pictured here) will jump from $15M per year to $17M per year in FY 2024 due to discount rate reduction
Cost-Containment Strategies – Not Mutually Exclusive*
Restructuring UAL using Debt
What is it? Borrow money to pay off all or a portion of UAL with CalPERS (i.e. very large ADP) Pension Obligation Bond (POB) is typically utilized
Unsecured debt (no collateral required)
“Court Validation” process required to confirm UAL is a “debt” that can be refinanced Typically takes 3-4 months
Alternative is using a lease revenue bond structure
Pros:
POB rates significantly lower than CalPERS rate (currently 6.8%) Current market: 3.50% to 4.00% (dependent upon term and credit rating) Restructuring the annual payments into a smoother, predictable schedule is core objective Cons:
Re-investment risk and market timing risk of bond proceeds sent to CalPERS
Market Update – Recent UAL Restructurings
85+ agencies ($7.5B+) have issued UAL Restructuring bonds since 2020 ≈75% as POBs; remainder as LRBs
2020 → Most deals between 3.50% and 4.25%
2021 → Most deals between 2.50% and 3.50%
2022 → Uptick in rates due to inflationary concerns
1/12 La Habra (AA+): 3.04% rate
1/19 Lakeside Fire (AA-): 3.35%
Current: Est. POB rates between 3.50% and 4.00%
Recent Restructurings: Unique Approach for Each IssuerNo “One Size Fits All” 7 Interest Rates (30Y UST)Recent Volatility Due to Fed Statements and Russia/Ukraine Conflict
POB Rates: Recent Upticks in Rates and Spreads
Note: Spreads and interest rates should be considered best estimates. Rates reflect estimated TIC or all-in TIC.
Significant Credit Spread Tightening due to Demand > Supply Recent upticks in TSY rates & spreads
Est. Current Market
Preliminary UAL Restructuring Option for City of Hayward22-Year Term with Level Payments Note: Preliminary estimates shown for illustration and assume current market rates – actual rates to be determined at pricing; assumes CalPERS earns 6.8% investment earnings.
Preliminary UAL Restructuring Option: Savings Analysis
Estimated Present Value (“PV”) savings of $97.1M
23.5% of refunded UAL
Savings over next 10 years estimated at $112M
$11.2M annually on average
Note: Preliminary estimates shown for illustration and assume current market rates – actual rates to be determined at pricing; assumes CalPERS earns 6.8% investment earnings.
Metrics
22-Year POB
UAL Funded ($)
$413,980,000
% UAL Funded (Current Asset Valuations)
84%
Funded Ratio (Current Asset Valuations)
94%
% UAL Funded (Projected After FY 2021 Returns & 6.8% Discount Rate) 100%
Funded Ratio (Projected After FY 2021 Returns & 6.8% Discount Rate) 100%
Maturity
22 Years
Average Life
12.8 Years
All-In Interest Rate
3.65%
PV Savings (%)
23.45%
PV Savings ($)
$97,063,737
Cumulative Savings
$112,261,872
Savings (2023-2032)
$111,669,628
Average Annual Savings (2023-2032)
$11,166,963
Refining the Options (Next Steps if Strategy Pursues Further)Using UAL Restructuring as a Tool to Meet Multiple Objectives Sizes: 50% of UAL? 75%? 100%?
Term: 20 Year? 25 Year? 30 Year?
Longer maturities have slightly higher interest rate BUT generate more cash flow savings in next 15-20 years AND enhance City’s resiliency (capacity to absorb future UAL shocks/increases) Repayment Shape:
Level vs. Escalating
Utilize City’s financial forecast to clarify budgetary challenges/constraints and other needs (reserves, CIP, etc.) and tailor UAL repayment options “Stress-Test” options to quantify risks for stakeholders and ensure that there is sufficient resiliency in structure to absorb future UAL shocks (see next slide re: Risks)
UAL Restructuring Pros & Cons Summarized
These risks should be quantified through a stress testing process to better understand the impacts of potential poor investment performance by CalPERS What if CalPERS only earns 5%?
What if there is another 2008-like recession?
Risk Assessment/Stress Testing: Preliminary (Non-Actuarial)Impact to Savings if CalPERS Underperforms Annual Underperformance
Bar chart shows PV savings generated from POB assuming various CalPERS returns (2% up to 9% Market Timing Risk
Table below shows PV savings if CalPERS loses significant amount in 1st year after POB
6.9% - CalPERS 20-Year Average Return
8.4% - CalPERS 30-Year Average Return
Market Crash Scenarios
Actual CalPERS Returns
Actual PV Savings ($)
Actual PV Savings (% of Par)
-10.0%
$36,227,176
8.7%
-15.0%
$17,110,022
4.1%
-20.0%
($2,007,132)
-0.5%
-25.0%
($21,124,286)
-5.1%
Government Finance Officers Association (GFOA) Critique of POBS
Integrated into a comprehensive reserve policy
Provides direction and prioritization to use surplus funds for “filling up” City reserves and other important accounts Detailed projections that account for positive POB cash flow benefits under different CalPERS performance assumptions is a good planning tool Also, a “credit positive” by rating agencies
Beyond economic contingency reserves, surpluses may also be targeted towards funding Section 115 Trusts for additional future smoothing, if needed, of pension or OPEB costs Finally, funding an early redemption account of POBs, as well as other priority capital project funds may be considered General Fund Operating Reserves (15% General Fund Expenses) Pension Reserve Fund (Up to 15% General Fund Expenses)
Economic Contingency & Catastrophic Event Reserves
75%
25%
Surplus
Surplus
Surplus Funds
CIP Fund Reserve
POB Bond Call Reserve
Surplus
50%
50%
Recommendation: Adopt a Pension Funding PolicyHypothetical Example Shown in Graphic Note: Policy Graphic is provided for illustrative purposes only. Each agency should consider its unique needs and constraints for its own Pension Funding Policy.
Hypothetical Timetable if Strategy Pursued Further
Validation preserves option for the City to issue a POB in 2022 or anytime in the future City Council must approve POS and other documents before any bonds can legally be issued
Conclusion
The City’s CalPERS Pension Liability (UAL) is its largest General Fund debt A UAL Restructuring may be a strategic and thoughtful approach to enhancing budget predictability, future resiliency and creating additional cash flow for other City priorities If City desires to evaluate a UAL restructuring further, it is recommended that a comprehensive evaluation process be continued to ensure that decision makers and stakeholders understand the pros and cons, including risks, in order to make an informed decision that is in the best interests of the City Workshops and Q&A can continue for as long during the process as is needed for a full evaluation by the City Council and community stakeholders Initiating the court validation process and doing the workshops in parallel would be most efficient use of time and resources and give City best chance of locking in lower interest rates if UAL restructuring was ultimately desired A Pension Funding Policy should be adopted by City Council regardless of whether the UAL is restructured or not
Appendices: Case Studies
Enhanced Financial Resiliency: Results of “What-If” stress-testing / risk assessment demonstrates that Town can now better absorb increased payment shocks from CalPERS underperformance Comprehensive & Inclusive 18-month Evaluation Process: Considered wide array of options, GFOA/stakeholder objections, opportunities and risks Pension Funding Policy: Commits Town towards financial path to address pension challenge Includes dedicating POB savings towards reserves, Section 115, CalPERS ADPs and early POB pay off Credit Rating Upgrade to “AAA”! Town upgraded from AA+ to AAA based on improved financial performance, new financial policies and multipronged pension funding strategy Savings! $12,400,000 estimated savings over next 15 years Over $6,500,000 present value (35% of Refunded UAL) savings overall* * Projected savings assumes CalPERS earns 7.0% investment earnings; navy blue line represents combined POB debt service and unrefunded UAL. UAL figures sourced from 6/30/2019 CalPERS Actuarial Valuation reports.
Metrics
2021 POB Savings*
UAL Funded (%)
88%
Est. Funded Ratio
96%
Avg. Life
15.0 Years
True Interest Cost (TIC)
2.97%
Cumulative Savings
$6,490,751
Present Value Savings ($)
$6,586,376
PV Savings (% of UAL)
34.98%
Cumulative Savings (2022-2036)
$12,399,032
Avg Annual Savings (2022-2036)
$826,602
$18,955,000Town of Corte Madera2021 Pension Obligation Bonds (POBs) – “AAA” RatedSold: April 29, 2021 @ True Interest Cost: 2.97%
CASE STUDY
Case Study: $432M Riverside 2020 POBsEducation, Options, Risk Assessment & Holistic Strategy
$350,025,000City of Chula Vista2021 Pension Obligation Bonds (POBs) – “AA” RatedSold: February 11, 2021 @ All-In Cost: 2.54% Savings! $15 million average annual savings over next 15 years; Over $150 million net present value (44% of Refunded UAL)* Enhanced Financial Resiliency: City can now better absorb increased payment shocks from CalPERS underperformance Inclusive 15-month Evaluation Process: Considered wide array of options, objections, opportunities and risks Pension Funding Policy: Commits City towards detailed roadmap to address this challenge; Includes dedicating POB savings towards reserves, Section 115 and early POB payoff
CASE STUDY
https://www.chulavistaca.gov/departments/finance/pension-obligation-bonds
General Fund Operating Reserves (15% General Fund Expenses) Pension Reserve Fund (Up to 15% General Fund Expenses)
Economic Contingency & Catastrophic Event Reserves
75%
25%
Surplus
Surplus
Surplus Funds
CIP Fund Reserve
POB Bond Call Reserve
Surplus
50%
50%
Examples of Two Pension Funding/Reserve PoliciesCorte Madera and Chula Vista General Fund Operating Reserve
(20% General Fund Expenses)
Maintain $2.5 million Emergency Sales Tax Override Fund (Separate from Operating Reserve) OPEB Trust,
Park Madera Center Fund,
Additional allocation to Operating Reserve
50%
50%
Surplus Funds
OPEB Stabilization Trust
Annual Savings from issuing POBs
Pension Stabilization Trust
CalPERS/Unfunded Liability
Town of Corte Madera
City of Chula Vista