As part of the process to evaluate the possibility of issuing Pension Obligation Bonds, that the City Council "APPROVE AND ADOPT RESOLUTION NO. _____ ENTITLED:  A RESOLUTION AUTHORIZING THE ISSUANCE AND SALE OF BONDS TO REFUND CERTAIN PENSION OBLIGATIONS OF THE CITY, APPROVING THE FORM AND AUTHORIZING THE EXECUTION OF A TRUST AGREEMENT, AUTHORIZING JUDICIAL VALIDATION PROCEEDINGS RELATING TO THE ISSUANCE OF SUCH BONDS AND AUTHORIZING ACTIONS RELATED THERETO" to have the option of issuing Pension Obligation Bonds at a future date to refund some or all of its CalPERS Unfunded Accrued Liability, in an amount not to exceed $94.0 million, to approve the form and authorize execution of a Trust Agreement relating thereto and to engage Fieldman, Rolapp & Associates as Municipal Advisor and Quint & Thimmig LLP as Bond/Disclosure Counsel.

In February 2021 the City engaged Fieldman, Rolapp & Associates to act as the City's municipal advisor to study options for funding the City’s CalPERS unfunded actuarial liability (UAL).  Based on the study results, the City has limited options to effectively fund its pension liability without the allocation of additional funds from its annual operating budget or reserves.  Because the City lacks sufficient financial resources to fund its $91.7 million UAL with reserves, a financing option was further studied and presented to the City Council at a Study Session held on April 8, 2021. Based on current taxable municipal bond rates, City staff and its financing team believe the City could fund some or all its UAL through the issuance of Pension Obligation Bonds (POBs) and realize a substantial savings.
 
The first step required prior to the issuance of traditional POBs is to obtain a judicial validation.  California public entities do not have specific authority to issue POBs and the California Constitution requires municipalities to obtain a two-third approval of the electorate in order to issue debt obligations payable from the general fund of the entity.  However, the local agency refunding law authorizes all local public entities in California to refund prior bonds or “other evidence of indebtedness.”  The City’s obligation to the CalPERS pension system is considered indebtedness and therefore, can be refunded by POBs under the local agency refunding law.

In California, POBs have generally been designed to be valid without voter approval, under a judicially created exception to the State Constitutional debt limitation.  In order to obtain authorization to issue POBs, the City is required to file a validation action with the Orange County Superior Court.  Unless challenged, the judicial validation proceedings are largely an administrative matter managed by Bond Counsel.

Before the validation action can be filed, the City must first adopt a resolution: 1) authorizing the City to issue the POBs to refund its CalPERS Unfunded Accrued Liability (UAL); 2) approve a trust agreement; and 3) authorizing judicial validation proceedings related the issuance of such POBs.

It is important to note that approval of the resolution does not obligate the City Council to issue POBs either now or at a later date. If the validation process is successfully completed, the ultimate decision to consider and/or approve POBs will be made by the City Council during a meeting held at a later date.  At that time, the City Council would consider and either approve the required legal and financing documents to issue POBs or table the matter for future consideration.

Background
In order to authorize the sale of POBs, it is necessary to establish a not-to-exceed amount for the bonds.  As of the June 30, 2019 actuarial valuation, the City had a total UAL of $91.7 million, comprised of approximately $31.9 million for Miscellaneous employees and approximately $59.8 million for Safety employees:
 

Therefore, the bond authorization is estimated at $94.0 million to include the UAL and provide for costs associated with issuance and contingency.  It is important to note that at the April 8, 2021 Study Session, the City Council was presented with the option to pay-off 85% of the City’s UAL rather than to pay-off 100% of the currently outstanding debt.  The ultimate decision to pay-off either 85% or 100% of the City’s UAL will be made by Council at a later date.  Staff recommends establishing a 100% not-to-exceed amount in these documents to provide Council with maximum flexibility when the final decision is made regarding the potential issuance of POBs.
 
Fieldman, Rolapp & Associates and City staff continue to monitor market conditions and evaluate the most efficient and financially beneficial approach to refunding some or all of the City’s UAL through issuance of the POBs.  As part of those efforts, the team retained the bond counsel services of Mr. Brian Quint of Quint & Thimmig LLP.  Mr. Quint is an experienced Bond Counsel who has completed numerous POB for California cities and his expertise guiding the City through the judicial validation proceedings is an important element of the process.

Approval of Legal Documents - Trust Agreement
If approved, the POBs will be issued pursuant to a Trust Agreement to be entered into between the City and The Bank of New York Mellon Trust Company, N.A., as Trustee, in substantially the form submitted to the City Council.  If the transaction is approved by Council at a later date, the Trust Agreement will be finalized following the pricing of the debt issuance to reflect the final terms of the POBs.

Validation Proceedings

The validation proceedings require a seven-step sequential process, which can take 90 days or more in Orange County.  The process and estimated timeline are outlined in the Attachment No. 3.

Legal documents must be in substantially final form and the City must determine a not-to-exceed par value (recommended at $94 million).  Bonds can be sold after the 30-day Appeal Period has ended and only after the City Council approves the Official Statement for the Bonds and the final structure.

Preliminary Official Statement
In the event the City Council authorizes issuance of the POBs, City staff and the financing and legal teams will work toward completion of the validation proceedings, including preparation of a Preliminary Official Statement (“POS”) for the POBs, as well as seek an underlying credit rating and select an underwriting firm.  The POS is the offering document with respect to the POBs and must contain all material information to enable investors to determine whether to purchase POBs. 

The POS will likely be presented for review and consideration by the City Council in November 2021.  At that time, the City Council will be asked to make the final decision whether to issue POBs and, if so, in what amount. If City Council approval and authorization is granted at that time, the POBs could be issued a few weeks afterwards.

 

These amounts are good faith estimates based on a projected par amount of POBs of $92,645,000 given market conditions as of June 17, 2021; the actual amounts will be determined if the bonds are authorized by Council for issuance, and when the POBs are priced; therefore, they will vary from these estimates.

Quint & Thimmig LLP has included the cost to represent the City in the validation proceedings as part of their Bond Counsel fee to be paid at closing.  The underwriter, financial advisor, rating agency, and bond and disclosure counsel are paid from the proceeds of the POBs which are estimated at $766,638; the financing team is not paid unless the POBs are sold, with the exception of fees paid to the rating agency.

If approved, the issuance of POBs would refinance the City’s existing CalPERS UAL payments, which have a fixed dollar repayment schedule and operate similar to a series of loans at a 7% interest rate.  POBs are taxable bonds that refinance the City’s UAL ($91.7 million) at a lower interest rate, approximately 3.74% based on current market conditions, which will continue to fluctuate.  As a result, the potential net present value savings are more than 34% and can provide significant cash flow relief to the City over time.

Based on a financing plan that would repay 100% of the current $91.7 million unfunded liability, the City would issue $92.5 million in POBs, which would result in $44.1 million in total cash flow savings (UAL payments) over the next 20 years (the term of the POB).  To pay-off 85% of the current unfunded liability, the City would issue $48.0 million in POBS, which would result in $28.1 million in total cash flow savings over the next 20 years.

In both scenarios, the POBs would carry an average interest rate expense of 3.74%, based on current interest rates as of June 17, 2021. It is important to note these are estimates subject to bond market fluctuations and will not be finalized until the POBs are sold in late November.