PURPOSE

The purpose of this report is to request authorization to issue and sell bonds to refund certain pension obligations of the City, approving the form and authorizing the execution of a bond purchase agreement, authorizing judicial validation proceedings related to the issuance of such bonds, and authorizing related actions.

BACKGROUND

The City�s Public Employees Retirement System (PERS) obligation consists of two parts: (1) the normal cost which is the cost of the current pension benefits offered by the City and (2) an amortization of the Unfunded Accrued Actuarial Liability (UAAL).  The UAAL is the difference between the liability of current pension benefits earned compared to the actuarial value of assets on hand.  The UAAL is typically amortized over a 20 year period.  PERS amortizes the UAAL using an 8.25% interest rate.  A pension obligation bond (POB) simply refunds the UAAL and is considered a general obligation of the City.  This is similar to the City refunding its bonded indebtedness. 

The POB is backed by the General Fund of the City.  The City�s credit rating by Standard & Poor�s is �AA�.  Since the POB refunds an existing obligation to pay retirement costs, it does not require voter approval.  The bonds are issued pursuant to Section 53570 of the California Government Code, which provides general authority to issue refunding bonds.  Because there is no explicit authority to issue POB, each issue in California has been validated. Each prior validation action has been upheld, but the City is not able to rely on those prior adjudcations.  The validation action validates the specific transaction approved by the bond resolution. 

A POB, if used prudently, should only be issued if there is a positive spread between the interest rate of the POB and the 8.25% PERS amortization rate over the same term as the UAAL is being amortized.  The Police and Fire Safety UAAL is $24,946,810 as of the latest PERS actuarial date of June 30, 2002.  Current interest rates in the taxable markets combined with PERS investment earnings to-date during the FY 2003-04 create an opportunity to generate a positive spread on refunding the UAAL.  To explore the financing options the following financing team was selected:

Peter Ross, Ross Financial                         Financial Advisor

Brian Quint, Quint & Thimmig                      Bond Counsel

John Bartel, Bartel & Associates                Actuary

Based on the review of financing options available the Financing Team recommends the issuance of variable rate POB of not to exceed $25.15 million.  To provide an internal hedge of the risk of increasing interest rates the following is recommended:

• The savings between the variable rate debt service versus a fixed rate will be used to prepay bond principal.  This will reduce the exposure to interest rates increasing as principal should be paid more quickly.

• $10 million will be set-aside as a reserve for the POB within the General Fund.  Interest associated to the $10 million will be credited to the POB reserve.  As short-term interest rates rise, interest earned on the $10 million reserve fund will increase as well.  The City would also have the flexibility to use the $10 million reserve fund to prepay the variable rate POB every 30 days.

The $10 million POB reserve fund will be funded from the Redevelopment Agency paying the City $6 million (Hilton note proceeds) related to City Centre debt with the General Fund and $4 million from the BWP UUT and In-lieu taxes set-aside fund.

ANALYSIS

The financing team received fee quotations from underwriters, bond insurers and liquidity providers related to the issuance of variable rate debt. Based on the results of these proposals the financing team recommends a direct bond purchase by DEPFA Bank.  A direct bond purchase simplifies the proposed transaction which leads to lower costs of issuance and a lower all in annual borrowing cost.  DEPFA Bank has offered a direct bond purchase at a spread of 30 basis points over the 30 day LIBOR interest rate with a 20 year maturity.

The direct bond purchase eliminates cost of issuance fees related to underwriting, rating agencies, bond insurance, trustee and printing costs.  Ongoing fees associated with remarketing, liquidity facilities, trustee, rating surveillance and continuing disclosure are also eliminated.  The total estimated cost of issuance fees of $175,000 are significantly less than the estimated fees of $480,000 related to a publically offerred insured variable rate demand bonds.  The 30 basis point spread over the 30 day LIBOR interest rate compares favorably to a 40 basis point estimated spread related to insured variable rate demand bonds.

Attached to this report is a comparison of the annual savings anticipated by refunding the UAAL with a fixed rate pension obligation bond compared to the proposed direct bond purchase with DEPFA Bank.  The analysis includes prepayment of variable rate debt with annual savings and assumes a rather large increase in short-term interest rates after the initial years.

For the last 10 years the taxable variable rate debt interest has averaged approximately 4.55%.  During this same period PERS has earned 8.7% on its investment portfolio.  PERS accomplished this even without achieving its 8.25% actuarial rate of return during the last three fiscal years.  PERS investment return this fiscal year through January 31, 2004 is 14.25% which is significantly greater than the assumed 8.25%.

The proposed financing is estimated to generate average annual savings of approximately $900,000, based on the interest rates assumed in the analysis as measured against the PERS actuarial rate of return.  As the City will only be reducing its PERS rate obligations based on a fixed rate scenario the average annual savings of $530,000 will lead to budgetary savings.  The $530,000 savings represents a 2.2% reduction in the PERS rate paid by the City related to the Police plan and a 2.0% reduction related to the Fire plan.

In additional to the above savings, it is anticipated that additional savings above the $530,000 will payoff the bonds one year earlier than a fixed rate bond issue.

The judicial validation proceedings are necessary to validate the approved transaction prior to the issuance of the bonds.  These proceedings provide protection to all parties in the transaction.

Section 18 of article XVI of the California Constitution (�Section 18�) provides in part that no city �shall incur any indebtedness or liability in any manner or for any purpose exceeding in any year the income and revenue provided for such year, without the assent of two-thirds of the voters of the public entity voting at an election to be held for that purpose�� An exception to the constitutional debt limitation are obligations imposed by law. The California Supreme Court held that debt limits only apply to discretionary borrowing. For example, obligations such as tort damages or state and federal mandates may exceed current revenues; yet, local governments are not required to obtain voter approval to finance such obligations. This exception developed because local governments cannot refuse to pay obligations mandated by law, therefore voters� approval or disapproval cannot affect the required expenditure. Here the City is obligated to pay the PERS agreement, and therefore this issue falls within the �obligation imposed by law� exception to the constitutional debt limitations of Section 18.

FISCAL IMPACT

The proposed direct bond purchase funds the entire UAAL for the Police and Fire Safety Plans as of June 30, 2002.  The difference between the interest rates charged by PERS and the anticipated variable rate computes to a net present value savings of approximately $11 million which represents a 43% savings factor.  The payment of the UAAL reduces the percentage paid for FY 2004-05 PERS rates for the Police and Fire Plans by 2.2% and 2.0% respectively. 

RECOMMENDATION

Staff recommends that the City Council approve a resolution entitled;

�A RESOLUTION OF THE COUNCIL OF THE CITY OF BURBANK AUTHORIZING THE ISSUANCE AND SALE OF BONDS IN A PRINCIPAL AMOUNT NOT TO EXCEED $25,150,000 TO REFUND CERTAIN PENSION OBLIGATIONS OF THE CITY, APPROVING THE FORM AND AUTHORIZING THE EXECUTION OF A BOND PURCHASE AGREEMENT, AUTHORIZING JUDICIAL VALIDATION PROCEEDINGS RELATING TO THE ISSUANCE OF SUCH BONDS AND AUTHORIZING ACTIONS RELATED THERETO�

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