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Item 12 - Visual Slideshow provided by Staff at MeetingADOPT A RESOLUTION APPROVING A PRELIMINARY OFFICIAL STATEMENT IN CONNECTION WITH THE SALE OF TAXABLE PENSION OBLIGATION BONDS NOVEMBER 16, 2021 •Taxable form of debt issued by governmental employers to retire all or a portion of their Unfunded Accrued Liability (“UAL”) with the goal of reducing future liability •Designed to take advantage of an “arbitrage” opportunity whereby the issuer borrows at a lower rate in the fixed income market than what can be earned by investing bond proceeds at a higher rate in the pension fund (a balanced portfolio), including a variety of investment vehicles, predominantly equity investments •Interest is not exempt from federal income tax due to arbitrage structure •POB debt service payments would replace the refunded UAL payments •Does not factor in City’s need to continue making 100% of its normal cost payments and remaining UAL payments not funded with POBs 2 What are Pension Obligation Bonds (“POB”)? Funding Level 100%100%85%85% Discount Rate 7.0%6.5%7.0%6.5% Calculated Likelihood of Success 72%75%71%75% 3 Risk Analysis Summary 75th Percentile: $22.6M 50th Percentile: $8.9M 25th Percentile: ($1.7M) Average: $14.0M 100% | 7.0% 100% | 6.5% 75th Percentile: $18.6M 50th Percentile: $8.5M 25th Percentile: $154.0K Average: $11.0M 85% | 7.0% 75th Percentile: $12.1M 50th Percentile: $5.0M 25th Percentile: ($1.1M) Average: $7.0M 85% | 6.5% 75th Percentile: $9.9M 50th Percentile: $4.6M 25th Percentile: $23.3K Average: $6.0M Financial Analysis (Proportional) Proportional Debt Service 100% Funded Scenario Metrics Proportional Structure Bonds Bond Issuance Amount $46,730,000 UAL Payoff $46,240,644 CalPERS Funded Ratio 100% Term Final Maturity 2049 (27 Years) Average Life1 10.63 Years Debt Service Maximum Annual Debt Service $3,710,609 Average Annual Debt Service $2,248,230 Potential Savings All-in True Interest Cost 2.88% Gross Savings $19,046,084 Present Value Savings2 $14,462,932 Average Annual Savings (First 13 years)$1,036,906 Average Annual Savings (Last 14 years)$397,593 4 1.Length of time the principal is expected to be outstanding which is used by investors as ameasureofriskandtodeterminehowquicklytheycanexpectreturns.In general,investorspreferashorteraveragelifeastheywillachievetheirfinancialreturnsearlier. 2.Savings represented in today’s dollars. UAL: $46.2M Discount Rate: 6.80% Credit Rating: ‘AAA’ Funded Status: 100% Financial Analysis (Modified) Modified Debt Service 100% Funded Scenario Metrics Proportional Structure Bonds Bond Issuance Amount $46,730,000 UAL Payoff $46,240,644 CalPERS Funded Ratio 100% Term Final Maturity 2049 (27 Years) Average Life1 11.57 Years Debt Service Maximum Annual Debt Service $3,185,699 Average Annual Debt Service $2,308,515 Potential Savings All-in True Interest Cost 3.02% Gross Savings $17,410,676 Present Value Savings2 $14,086,075 Average Annual Savings (First 13 years)$1,220,697 Average Annual Savings (Last 14 years)$110,115 5 1.Length of time the principal is expected to be outstanding which is used by investors as ameasureofriskandtodeterminehowquicklytheycanexpectreturns.In general,investorspreferashorteraveragelifeastheywillachievetheirfinancialreturnsearlier. 2.Savings represented in today’s dollars. UAL: $46.2M Discount Rate: 6.80% Credit Rating: ‘AAA’ Funded Status: 100% •100% UAL funded status is an estimate and moving target •Discount rate changes •Actuarial assumption changes •Investment returns •CalPERS Meetings •Investment Committee: Nov. 15th •Select new discount rates •Finance & Administration Committee: Nov. 16th •Review experience study (i.e. actuarial assumptions) 6 Financial Analysis Financial Analysis (Modified | Alternate) Modified Debt Service | Alternate 100% Funded Scenario Metrics Proportional Structure Bonds Bond Issuance Amount $54,525,000 UAL Payoff $50,005,078 CalPERS Funded Ratio 100% Term Final Maturity 2049 (27 Years) Average Life1 11.57 Years Debt Service Maximum Annual Debt Service $3,617,163 Average Annual Debt Service $2,759,960 Potential Savings All-in True Interest Cost 2.95% Gross Savings $23,880,826 Present Value Savings2 $18,803,189 Average Annual Savings (First 13 years)$1,605,870 Average Annual Savings (Last 14 years)$214,609 7 1.Length of time the principal is expected to be outstanding which is used by investors as ameasureofriskandtodeterminehowquicklytheycanexpectreturns.In general,investorspreferashorteraveragelifeastheywillachievetheirfinancialreturnsearlier. 2.Savings represented in today’s dollars. UAL: $50.0M Discount Rate: 6.50% Credit Rating: ‘AAA’ Funded Status: 100% •Financing documents •Preliminary official statement •Continuing disclosure agreement •Debt management policy •Pension reserve and funding policy •Support the City’s financial sustainability •Ensure flexibility to respond to changes in future service priorities, revenue levels, and operating expenditures •Support the City’s creditworthiness •Help protect the City’s service to residents •Standard & Poor’s credit rating •Judicial validation process 8 Pension Obligation Bonds 9 Assemble Key Financing Team Members •Financial Advisor •Actuarial Consultant •Bond Counsel •Bond Underwriter Engage Policy Makers and Stakeholders with Plan of Finance Month 1 Month 2 Month 3 Month 4 Month 5 Month 6 Affirm the City’s Pension Structuring Goals and Finalize Pro Forma Model 90 -Day Validation Process 30 -Day Protest Period Sell POBs POB Next Recommended Steps Aug. 3rd Council Meeting Nov. 9 th Signed Judgment Nov. 16th Council Meeting to consider POB Issuance Dec. | Jan. Potential Issuance •Affirm authorization to issue POBs •Approve form of preliminary official statement and continuing disclosure agreement •Approve pension reserve and funding policy •Approve agreements with Fieldman, Rolapp & Associates, Inc. and Stradling Yocca Carlson & Rauth •Direct staff to refinance “100%” of UAL using a modified debt service structure 10 Recommendations QUESTIONS? 11 Section I.History of City of Poway Pensions II.Review of Pension Obligation Bonds III.Pension Obligation Bond Financial Analysis IV.Pension Obligation Bond Risk Analysis V.Judicial Validation VI.Recommendation Table of Contents SECTION I HISTORY OF CITY OF POWAY PENSIONS •Most cities in California, including Poway, contract with CalPERS for their employees' retirement benefits. •CalPERS provides for and manages the City's employee pension plans. •Poway has 2 CalPERS pension plans: •Miscellaneous Plan •Safety Plan 14 City of Poway Pension Plans 15 Info About City of Poway Plan Group Plan Tier 1 "Classic" (Hired prior to 1/9/12) Tier 21 "Classic" (Hired prior to 1/9/12) Tier 3 "PEPRA" (Hired on/after 1/1/13) Miscellaneous 2% @ 55 (FAE 1)2,3 2% @ 60 (FAE 3)4 2% @ 62 (FAE 3) Safety 3% @ 50 (FAE 3)3% @ 55 (FAE 3)2.7% @ 57 (FAE 3) 1.Tier 2 employees are employees that have actively worked for a participating CalPERS agency or agency with a reciprocity agreement with CalPERS and have not had a break in CalPERS service greater than 6 months. 2.The PARS supplemental benefit increased the Miscellaneous benefit to 2.7% @ 55 for eligible employees. 3.FAE 1 means the single highest year of earnings (typically final) is used to calculate the employee's salary pursuant to the applicable benefit formula. 4.FAE 3 means the highest three years (typically the final three) of average earnings is used to calculate the salary used in the applicable benefit formula. 16 Info About City of Poway Plan (cont.'d) Group Plan Tier 1 "Classic" (Hired prior to 1/9/12) Tier 2 "Classic" (Hired prior to 1/9/12) Tier 3 "PEPRA" (Hired on/after 1/1/13) Miscellaneous 2% @ 55 2% @ 60 2% @ 62 Employer1,2 9.25%12.10%7.03% Employee2,3 7.00%7.005 7.005 UAL4 21.73%21.73%21.73% Total 37.98%40.83%35.76% Safety 3% @ 50 3% @ 55 2.7% @ 57 Employer2 22.48%20.64%13.13% Employee2 9.00%9.00%13.00% UAL4 23.91%23.91%23.91% Total 55.39%53.55%50.04% Source: CalPERS actuarial valuations, the most recent being as of June 30, 2019. 1.Miscellaneous employer rates are blended at 8.74% per the actuarial report and estimated at the rates shown based on the Normal Cost by Benefit Group detail in the actuarial report. 2.The employee rates are the contracted CalPERS rates and do not reflect the additional 1.00% employee pickup agreed to through the labor bargaining process for Tier 1 and Tier 2 employees. Each Tier 1 and Tier 2 employee currently contributes an additional 1.00% towards the cost of the CalPERS retirement benefits. 3.Miscellaneous Tier 1 and Tier 2 employees will begin contributing an additional 1.00% towards the cost of the CalPERS retirement benefits beginning the first full pay period in July 2024. 4.The UAL represents a blended rate for the three retirement tiers and is an employer only cost. 17 Info About City of Poway Plan (cont.'d) Group Plan Tier 1 "Classic" (Hired prior to 1/9/12) Tier 2 "Classic" (Hired prior to 1/9/12) Tier 3 "PEPRA" (Hired on/after 1/1/13) Miscellaneous1 47 N/A N/A Miscellaneous 12 13 96 Safety 24 2 18 Total 83 15 114 1.Represent miscellaneous employee also eligible for the PARS supplemental benefit formula. 18 Info About City of Poway Plan (cont.'d) # of Members As of 6/30/2019 Safety Misc.Total Active Members1 51 184 235 Transferred Members2 29 113 142 Separated/Terminated Members3 15 105 120 Retired Members4 50 270 320 TOTAL 145 672 817 1.Current employees enrolled in CalPERS. 2.Former employees that are still employed at another CalPERS employer. 3.Former employees that are not working at another CalPERS employer and are not retired. 4.Former employees that are now retired from the CalPERS system. Does not necessarily mean they retired from the City of Poway. 19 Info About City of Poway Plan (cont.'d) CalPERS Funded Status Miscellaneous: 69.53% Safety: 73.52% Source: CalPERS actuarial valuations, the most recent being June 30, 2019. Poway Pension Funding Situation •City contributes to 2 CalPERS benefit pension systems: •Miscellaneous Plan •Safety Plans •City currently has an aggregate UAL of approximately $57.2 million1 •Combined normal cost and UAL annual Payments have increase by 62% over the past five years •Additional UAL balance from 2020 Investment loss estimated at $3.7 million2 20 Info About City of Poway Plan (cont.'d) 1 Source: Most recent CalPERS actuarial valuation reports as of June 30, 2019, for fiscal year 2021-22. 2 Source: Bartel Associates, LLC. UAL Balance 6/30/2017 6/30/2018 6/30/2019 6/30/2020 6/30/2021 5-Yr Increase Miscellaneous Plan $32,284,316 $37,858,596 $37,862,343 $38,161,265 $38,098,445 $5,814,129 18% Safety Plans $15,188,201 $17,619,912 $18,659,611 $18,982,012 $19,090,825 $3,902,624 26% Total $47,472,517 $55,478,508 $56,521,954 $57,143,277 $57,189,270 $9,716,753 20% UAL & Normal CostAnnual Payments 6/30/2017 6/30/2018 6/30/2019 6/30/2020 6/30/2021 5-Yr Increase UAL Miscellaneous Plan $1,603,752 $1,950,836 $2,339,449 $2.643,161 $2,890,493 $1,286,741 80% Safety Plans $643,147 $823,801 $1,024,473 $1,179,349 $1,394,617 $751,470 117% UAL Total:$2,246,899 $2,774,637 $3,363,922 $3,822,510 $4,285,110 $2,038,211 91% Normal Cost Miscellaneous Plan $904,392 $984,422 $1,058,935 $1,179,779 $1,162,383 $257,991 29% Safety Plans $905,523 $907,517 $1,014,462 $1,135,518 $1,141,660 $236,137 26% Normal Cost Total:$1,809,915 $1,891,939 $2,073,397 $2,315,297 $2,304,043 $494,128 27% Total $4,056,814 $4,666,576 $5,437,319 $6,137,807 $6,589,153 $2,532,339 62% Info About City of Poway Plan (cont.'d) Source: Most recent CalPERS actuarial valuation reports as of June 30, 2019, for fiscal year 2021-22.(1)Miscellaneous normal cost projections are based on the 8.74% of the total Miscellaneous salary assuming an annual growth rate of 2.75%. Safety normal cost projections are based on the 22.48% of the total Safety salary assuming an annual growth rate of 2.75%. Normal Cost contributions will be made as part of the payroll reporting process. If there is a contractual cost sharing or other change, this amount will change. $0 $1 $2 $3 $4 $5 $6 $7 $8 $9 $10 202120222023202420252026202720282029203020312032203320342035203620372038203920402041204220432044204520462047MillionsCombined (1) Safety Normal Cost Safety UAL Payments Miscellaneous Normal Cost Miscellaneous UAL Payments 21 Current Payment Amortization -Miscellaneous and Safety Plans 22 Info About City of Poway Plan (cont.'d) Options for Managing Pensions Identify new sources of revenue Regional service delivery Section 115 Trust Additional discretionary payments CalPERS Fresh Start Reprogram capital reserves Pension obligation bonds SECTION II REVIEW OF PENSION OBLIGATION BONDS •POBs fall under an exception to the constitutional debt limit because of a public agency’s obligation to fund its pension system payments. •Bond counsel requires that POB documents are “validated” in Superior Court. •Validation does not obligate the City to issue bonds, nor even to have agreed on a specific plan of finance. •First step in the validation process is the preparation of bond documents. The documents can be prepared with maximum flexibility regarding bond structure and terms to position the City to move quickly if it decides to issue POBs at a future date. •Validation action generally requires approximately 90 days from the date of filing, and an additional 30-day appeal period. 24 Court Validation Process 25 Potential Benefits of POBs Potential Benefits of POBs Tool for fiscal sustainability Budgetary savings Interest rate savings from arbitrage Market timing Time value of money Maturity modification Reserve/service levels preservation 26 Potential Risks of POBs Potential Risks of POBs Converts obligation from "variable" to "fixed" Future UAL can still change Investment risk (arbitrage risk) Low pension fund returns "Too much of a good thing" Market timing risks Increased bonded debt and credit risk Judicial validation process Political process 27 Objectives of a POB Issuance Increase financial sustainability Achieve savings Increase funded ratio with CalPERS Objectives of a POB Issuance •If the City issues POBs, it has many options it can choose from, depending on its unique situation •Key considerations include, using savings to further reduce CalPERS UAL •Set aside some or all of the savings in a separate trust •Make an additional CalPERS contribution each year in the amount of some or all of the POB savings •Use savings to stablize CalPERS normal costs •Use savings for other City budget priorities •Some combination of these strategies 28 What to do with POB Savings •Arcadia •Auburn •Azusa •Baldwin Park •Carson •Chowchilla •Chula Vista •Coachella •Corte Madera •Covina •Downey •El Cajon •El Monte •El Segundo •Gardena •Glendora •Grass Valley •Hawthorne •Huntington Beach •Inglewood •Larkspur •Manhattan Beach •Marysville •Montebello •Monterey Park •Ontario •Orange •Pasadena •Placentia* •Pomona •Redondo Beach* •Ridgecrest •Riverside •Torrance* •West Covina* •Willows 29* Structured as a Lease Revenue Bond. Approximately 36 Cities have issued POBs since 2019 Recent POBs by other CA Cities SECTION III PENSION OBLIGATION BONDS FINANCIAL ANALYSIS •Sell POBs to finance a portion of UAL •Hypothetical scenarios to target 85% and 100% funded ratios •CalPERS allows ability to payoff individual bases •Bases selection determined by individual UAL balance amount and amortization period combined with the goal of shortening the overall average life, POB interest expense, and risk profile •Shorter amortization periods will have a lower POB interest expense, but the shorter time period decreases the chance of realized savings •Longer amortization periods will have a higher POB interest expense, but the longer time period increases the chance of realized savings 31 POB Financial Analysis: UAL Potential Funding Scenarios POB Assumptions •Current Taxable Interest Rates •S&P “AA” category underlying rating •Optionally callable in 10 years •No Reserve Fund •No Extension of Final Maturity Annual Payment Scenarios •Proportional •Level •Combination •85% Funded Ratio and 100% Funded Ratio 32 POB Financial Analysis: Summary of Assumptions Group Plan Total Accrued Liability UAL Balance Estimated Additional 2020 UAL Balance Estimated Total UAL Balance Before POBs Funded Ratios After POBs Funded Ratios Miscellaneous $122,086,611 $38,098,445 $2,362,495 $40,460,940 66.9%85%/100% Safety $66,035,742 $19,090,825 $1,328,903 $20,419,728 69.1%85%/100% Total $188,122,353 $57,189,270 $3,691,398 $60,880,668 67.6%85%/100% A B C D =(A-D)/A •The UAL of the Miscellaneous and Safety Plans are compromised of individual amortization bases •Amortization bases can vary by term length, annual payments, and as a credit or a liability •CalPERS annually adjusts UAL and any changes in actual vs expected results in new bases •Bases that are negative are treated as a credit to the City’s required contributions •Miscellaneous and Safety have 74 Amortization Bases •Miscellaneous Plans: 23 •Safety Plans: 51 33 POB Financial Analysis: UAL Amortization Bases -$2 -$1 $0 $1 $2 $3 $4 $5 MillionsCity of Poway Miscellaneous Plan UAL Payments by Amortization Bases -$1 -$1 $0 $1 $1 $2 $2 $3 $3 MillionsCity of Poway Safety Plans UAL Payments by Amortization Bases •CalPERs Rates: •Current Actuarial Earnings Rate Assumed at: 7% •Historical Rate of Return over the past 30 years at: 8% •30 Year Treasury rate as of July 20, 2021 is 1.88% •POB All-In True Interest Cost (“TIC”) assumed at 3.37% to 3.90% •POBs are sold at a spread to treasuries 34 POB Financial Analysis: Investment Earnings Key Historical CalPERS Rate of Return •POB Proportional Annual Debt Service •Years 1 -24 35 POB Financial Analysis: 85% Funded Scenario,Proportional Savings Profile 1 1 Estimated. Actual savings numbers will depend on the final POB interest rates achieved and the CalPERS actual investment performance over the life of the POBs to final maturity. The CalPERS performance rate will fluctuate, and the City has no control over CalPERS’ investment performance. 36 POB Financial Analysis: 85% Funded Scenario,POB Savings Summary 1 85% Funded Scenario Metrics Proportional Structure Bonds Bond Issuance Amount $33,150,000 UAL Payoff $32,681,167 CalPERS Funded Ratio 85% Term Final Maturity 2045 (24 Years) Average Life 13 Years Debt Service Maximum Annual Debt Service $2,418,460 Average Annual Debt Service $2,065,750 Potential Savings All-in True Interest Cost 3.85% Gross Savings $19,480,087 Present Value Savings2 $13,221,481 Average Annual Savings $799,594 1 Estimated. Actual savings numbers will depend on the final POB interest rates achieved and the CalPERS actual investment performance over the life of the POBs to final maturity. The CalPERS performance rate will fluctuate, and the City has no control over CalPERS’ investment performance. 2Savings represented in today's dollars. •POB Proportional Annual Debt Service •Years 1 -24 37 POB Financial Analysis: 100% Funded Scenario,Proportional Savings Profile 1 1 Estimated. Actual savings numbers will depend on the final POB interest rates achieved and the CalPERS actual investment performance over the life of the POBs to final maturity. The CalPERS performance rate will fluctuate, and the City has no control over CalPERS’ investment performance. 38 POB Financial Analysis: 100% Funded Scenario,POB Savings Summary 1 100% Funded Scenario Metrics Proportional Structure Bonds Bond Issuance Amount $61,490,000 UAL Payoff $60,880,668 CalPERS Funded Ratio 100% Term Final Maturity 2045 (24 Years) Average Life 11 Years Debt Service Maximum Annual Debt Service $4,909,029 Average Annual Debt Service $3,701,100 Potential Savings All-in True Interest Cost 3.73% Gross Savings $25,567,228 Present Value Savings2 $17,929,886 Average Annual Savings $1,041,169 1 Estimated. Actual savings numbers will depend on the final POB interest rates achieved and the CalPERS actual investment performance over the life of the POBs to final maturity. The CalPERS performance rate will fluctuate, and the City has no control over CalPERS’ investment performance. 2Savings represented in today's dollars. SECTION IV PENSION OBLIGATION BONDS RISK ANALYSIS •To evaluate a potential POB, Bartel Associates measured the projected change in the City’s future cash flows with and without a POB •“Debt Service” –The City will pay off POBs over time on a fixed schedule •POB funds will be paid directly to CalPERS •City’s CalPERS unfunded liability will be reduced •City’s future required contributions to CalPERS will (usually) be reduced. •Future required CalPERS contributions depend on actual future investment return •All calculations based on present value now, to account for time value of money 40 POB Costs and Savings •Actual calculation of savings will depend on future years’ CalPERS investment return •It will not be 7% every year, and usually not close to 7%. •Bartel Associates ran 1,000 simulations modeling possible scenarios •In most scenarios, the City’s cash flow with POB will be lower •CalPERS charges 7% interest on UAL; Debt service will be less than 7% •In some scenarios the City’s cash flow with POB will be higher, if: •CalPERS investment return is very bad •CalPERS investment return is very good 41 POB Costs and Savings (cont.’d ) •Bartel Associates calculated how likely the City’s cash flow is to be reduced •How much are the savings likely to be? •If cash flows increase, how much is the additional cost likely to be? •Bartel Associates repeated this modeling for different POB amounts designed to pay off different percentages of the unfunded liability •Typically, the success rate is different for each scenario 42 POB Costs and Savings (cont.’d ) •Bartel Associates’ calculations showed, for different POB amounts: •How likely is it that future cash flows will be reduced compared to no POBs being issued •What the savings are likely to be •What the expected future CalPERS contributions/cash flows are likely to be •The modeling gave the City information needed to select a POB amount, considering: •What level of risk the City is comfortable with •What level of reduction in future CalPERS required contributions (if any) is desired 43 Selecting Size of POB Risk Analysis 44 Risk Analysis (cont.'d) •Capital Market Assumptions for investments in CalPERS PERF: •Based on study of investment consultant and investment bank 2017 short and long-term capital market assumptions adjusted for long-term trends in investment returns •Inflation –2.5% Asset Class PERF Policy Target Geometric Real Average Return Standard Deviation Geometric Nominal Average Return Public Equity 50%4.82%17.84%7.44% Fixed Income 28%1.47%4.24%4.01% Real Assets 13%4.81%12.55%7.43% Private Equity 8%6.19%25.50%8.84% Liquidity 1%0.06%0.97%2.56% 100% 45 Risk Analysis: 7% Scenario 46 POB Costs and Savings 47 -100 +150 +300 +500 +15-200 POB Costs and Savings (cont.’d ) 48 -100 +150 +300 +500+15-200 POB Costs and Savings (cont.’d ) 49 +300 -200 +500 -100 +15 +150 Risk Analysis: 7% Scenario (cont.'d) 50 Present Value of Contributions without POB less with POB Combined Miscellaneous & Safety Plans –85% Funding | 7% Discount Rate Present Value of Contributions without POB less with POB Combined Miscellaneous & Safety Plans –100% Funding | 7% Discount Rate Risk Analysis: 6.5% Scenario 51 Risk Analysis: 6.5% Scenario (cont.'d) 52 Present Value of Contributions without POB less with POB Combined Miscellaneous & Safety Plans –85% Funding | 6.5% Discount Rate Present Value of Contributions without POB less with POB Combined Miscellaneous & Safety Plans –100% Funding | 6.5% Discount Rate Risk Analysis Summary: 7% Scenario 53 Plan Likelihood of Success Average 30-Year Present Value Impact Average of Successful Trials Average of Unsuccessful Trials Overall Average Miscellaneous 72%$8,000,000 $ (3,000,000)$5,000,000 Safety 69%4,000,000 (2,000,000)2,000,000 Combined 71%12,000,000 (5,000,000)7,000,000 Plan 30-Year Present Value Impact 25th Percentile 50th Percentile 75th Percentile Miscellaneous $(589,790)$3,638,314 $8,326,866 Safety (484,927)1,347,002 3,799,537 Total (1,074,717)4,985,316 12,126,403 85% Funding | 7.0% Discount Rate Plan Likelihood of Success Average 30-Year Present Value Impact Average of Successful Trials Average of Unsuccessful Trials Overall Average Miscellaneous 73%$15,000,000 $ (6,000,000)$10,000,000 Safety 69%8,000,000 (4,000,000)5,000,000 Combined 71%23,000,000 (10,000,000)14,000,000 Plan 30-Year Present Value Impact 25th Percentile 50th Percentile 75th Percentile Miscellaneous $ (651,581)$6,330,462 $15,001,123 Safety (1,049,354)2,584,235 7,586,489 Total (1,700,934)8,914,697 22,587,612 100% Funding | 7.0% Discount Rate Risk Analysis Summary: 6.5% Scenario 54 Plan Likelihood of Success Average 30-Year Present Value Impact Average of Successful Trials Average of Unsuccessful Trials Overall Average Miscellaneous 77%$6,000,000 $ (3,000,000)$4,000,000 Safety 73%3,000,000 (1,000,000)2,000,000 Combined 75%9,000,000 (4,000,000)6,000,000 Plan 30-Year Present Value Impact 25th Percentile 50th Percentile 75th Percentile Miscellaneous $153,140 $3,266,563 $6,832,053 Safety (129,856)1,320,621 3,078,405 Total 23,284 4,587,184 9,910,458 85% Funding | 6.5% Discount Rate Plan Likelihood of Success Average 30-Year Present Value Impact Average of Successful Trials Average of Unsuccessful Trials Overall Average Miscellaneous 77%$11,000,000 $ (5,000,000)$8,000,000 Safety 74%6,000,000 (3,000,000)4,000,000 Combined 75%17,000,000 (7,000,000)11,000,000 Plan 30-Year Present Value Impact 25th Percentile 50th Percentile 75th Percentile Miscellaneous $392,581 $5,881,107 $12,408,928 Safety (238,615)2,631,185 6,211,509 Total 153,966 8,512,292 18,620,437 100% Funding | 6.5% Discount Rate Risk Analysis Summary 55 SECTION V JUDICIAL VALIDATION PROCESS If City Council adopts the recommendation authorizing judicial validation proceedings, the expected next steps in the judicial validation process include: 1.Filing the Validation Complaint (within a week of City Council approval) 2. Seeking permission from the San Diego Superior Court (“Court”) to publish the summons so the Court can gain subject matter jurisdiction over the validation (usually 7-10 days following filing of the Validation Complaint) 3. Publish the summons (once a week for three consecutive weeks, totaling 21 days) 4. Response period to file an answer (10 days following completion of publication) 5. Clerk of the Court’s Entry of Default Judgment if no answer to Complaint is filed 6. File “points and authorities” seeking entry of default judgment 7. Hearing on judgment and Judge’s execution of judgment 8. Begin 30-day appeal period 9. After 30-day appeal period, return to Council for adoption of a resolution approving Preliminary Official Statement and confirm size and structure of POBs 10. Issue POBs Superior Courts have been impacted significantly by COVID-19 and the Judicial Validation could take 4-7 months depending on Court impacts 57 Judicial Validation Process SECTION VI RECOMMENDATIONS •Receive and file the POB report and presentation •Authorize staff to initiate a Court Validation process at a cost of approximately $25,000 •Direct staff to proceed with the additional evaluation of potential Pension Obligation Bonds for City Council consideration once the Validation Process is complete 59 Recommendations 60 Assemble Key Financing Team Members •Financial Advisor •Actuarial Consultant •Bond Counsel •Bond Underwriter Engage Policy Makers and Stakeholders with Plan of Finance Month 1 Month 2 Month 3 Month 4 Month 5 Month 6 Affirm the City’s Pension Structuring Goals and Finalize Pro Forma Model 90 -Day Validation Process 30 -Day Protest Period Sell POBs POB Next Recommended Steps Aug. 3rd Council Meeting Oct. 18th Signed Judgment Nov. 16th Council Meeting to consider POB Issuance Nov. | Dec. Potential Issuance QUESTIONS? 61 •Issue less than 100% of the current estimate of the UAL •Minimizes the lump sum amount invested at one time and avoids the budgetary pressures that could be caused from a potentially over-funded system •Consider issuing multiple POBs over multiple years, assuming favorable market conditions •Represents a form of “dollar cost averaging” to help mitigate market timing risks •Timing issuances at key Market Cycles (during low equity market cycles and low interest rate environment) •Mitigation of market/credit risks •Ensure adequate spread between borrowing rate and assumed earnings rate •Avoid riskier bond structures, such as variable rate debt and interest rate swaps •Be Prepared to Issue POBs, when time is right •Prepare financing documents, establish minimum savings target and wait for favorable market conditions 62 Strategies Available to Mitigate POB Risks •City Council Study Session •Stakeholder Outreach •Expect opposition 63 Other Considerations for POBs •Investment risk (Arbitrage risk)is the principal risk –if the pension plans earn less over the life of the bonds than the interest paid on the POBs, then the POB program becomes a net cost to the City •Overfunding Risk –Too high of a pension funding level may cause labor groups to ask for increased benefits from the new annual cash flow savings •Flexibility/Option Risk -Flexible UAL liability is replaced with comparatively inflexible municipal bonds •Recent POB issuances have sold with a 10-year optional call •Credit Risk –S&P Global Ratings views POBs in environments of fiscal distress or as a mechanism for short-term budget relief as a negative credit factor •Political Risk •An issuer may get a reputation for being too risky by gambling on future market returns; negative reputation due to well publicized bankruptcies (Detroit, Stockton & San Bernardino) •Government Finance Officers Association’s (GFOA) website states that it “recommends that state and local governments do not issue POBs” 64 Potential Risks Associated with POBs Recommends state and local government do not issue POBs for following reasons: •Invested POB proceeds may fail to earn more than interest rate owed over bond term thereby increasing overall liabilities, rather than decreasing overall costs •Complex POB instruments carry considerable risk especially if derivative products are utilized •Issuing taxable debt increases jurisdiction’s bonded debt burden potentially using debt capacity that could be used for other municipal purposes •If POBs are structured with deferred principal amortization or repayment longer than actuarial amortization period overall borrowing costs will increase •Rating agencies may not view as credit positive, especially if not part of more comprehensive plan to address pension funding shortfalls 65 Government Finance Officers Association (GFOA)Pension Obligation Bond Advisory