Bill to require voter approval of California pension bonds is shelved
Legislation to require voter approval of pension obligation bonds has been shelved for the year in the California legislature
Senate Bill 1067, which was introduced by Sen. John Moorlach, R-Costa Mesa, in February, would have required local governments seeking to issue POBs with maturities longer than 36 months to go before voters.
The Legislature's operations have been significantly reshaped by the COVID-19 pandemic. Moorlach said leadership has been asking lawmakers to withdraw bills not related to averting wildfire danger, the housing crisis or coronavirus efforts, he said.
Moorlach, vice chair of the Senate’s Governance and Finance Committee, got the call May 23 from Sen. Mike McGuire, D-Healdsburg, the committee’s chair, asking him to withdraw the bill.
“He was calling everyone and asking for a reduction [in the number of bills], so this is the bill he asked me to drop,” Moorlach said. “I told him that I would, and that I would spend time crying after I hung up. This is quite a unique year.”
Moorlach plans to reintroduce the bill next year, he said. First he must win re-election in November.
Moorlach said he and his staff spent quite a bit of time researching the bill and speaking with city finance officials before it was introduced. They also amended the bill to exclude short-term notes.
California has seen a resurgence in POB issuance. Riverside County sold one of the largest deals, pricing $719.9 million in April. The City of Riverside has its own deal of $430.9 million set to price June 3.
The California Debt and Investment Advisory Commission highlighted the state’s POB issuance in a publication earlier this month.
California issuers have sold $25 billion in POB debt over the past 35 years, according to the report penned by CDIAC analyst Tara Dunn.
“It was interesting, because when I was first promoted to this job in January, we had a conversation about it,” said Robert Berry, CDIAC’s executive director. “I had not seen any trends around POB issuance at that point, but as the year progressed it came up at several conferences.”
It was a topic on several panels at the California League of Cities and the California Society of Municipal Finance Officers conferences earlier this year, he said. Both conferences were held before California Gov. Gavin Newsom issued the stay-at-home order in late March in an effort to slow the spread of the coronavirus.
The pandemic has brought a sudden reduction in tax revenue to state and local governments, while threatening equity and real estate investments held by public pension systems.
“Once we get past this liquidity issue between now and the end of the year, there will be another looming crisis relative to pensions next year,” he said. “So, if we get through this storm, there is another storm behind it."
One of the “solutions” people have been talking about is the issuance of debt, he said.
“We know there are advantages and disadvantages to issuing POBs, so I wanted to look at what kind of activity we had seen,” Berry said of his decision to have CDIAC publish a piece in its monthly "Debt Line."
Moorlach’s bill was mentioned in the report because the bill had been introduced and it seemed appropriate to mention it, Berry said.
“It is a strategy that people have been discussing; CDIAC is not taking a position on it,” Berry said.
CDIAC has noticed that the “idea of trying to create some sort of cash flow and expenditure savings by issuing bonds is beginning to come around again,” he said.
The city of Montebello would not have considered issuing POBs if it did not have a line on its property tax that is dedicated to making pension payments, said Michael Solorza, the city’s director of finance.
Its $152.8 billion deal priced Wednesday, with Cabrera Capital Markets as lead manager, Hilltop Securities as financial advisor and Norton Fulbright as bond counsel.
“They priced very well,” Solorza said.
The interest rates on the bonds averaged 4% across maturities, he said.
The longer bonds out to 2035 and 2045 were very popular, Solorza said.
“I think we were pushing seven times oversubscribed. There was a lot demand across all maturities, but people were really interested in the out years," he said. "In these conditions, I think people are trying to lock in some returns.
S&P Global Ratings assigned its A-plus rating and negative outlook to the deal and affirmed its A-plus issuer rating of the city of 62,000.
After years of financial stumbles, Rene Bobadilla, former city manager of Pico Rivera, was hired in July to help Montebello turn things around and execute on recommendations State Auditor Elaine Howle issued in 2018.
“When the new city manager came on in July, his first priority was to deal with some of the big ticket items in the auditor’s report; one of those was pension costs,” Solorza said.
The city predicts it will save $53 million by making the bond payments versus making pension payments at the 7% discount rate of the California Public Employees Retirement System currently.
Investors were less interested in asking questions specific to the pension obligation bonds and more interested in asking questions related to a potential hit to the city’s sales tax revenues and risk to the lease revenue bonds issued for two hotels, Solorza said.
Investors were “hyper-focused on the short-term impacts of the pandemic to our revenue and our operations,” he said.
Mike Meyer, a vice president with NHA Advisors who runs his company’s pension group, said there are several reasons that POBs are becoming more popular now. Meyer is the financial advisor on the City of Riverside’s upcoming bond deal.
One of those reasons is the low POB interest rates of 4% or less, compared to CalPERS assumed rate of return of 7%, Meyer said.
The biggest reason is the ability to “re-shape” payments to remove the “shark fin” that every PERS member faces over the next 15 years. The diagram of nearly every agency's current unfunded accrued liability is a steep peak, followed by an abrupt drop off, Meyer said.
Other motivating factors are flexibility in optimizing the size, shape and maturity of the debt to fit within the city’s overall fiscal sustainability/budget objectives without crowding out other near and mid-term priorities, Meyer said.
A POB also offers enhanced budgetary predictability and affordability by creating a more level overall repayment structure, he said.
He added that the Government Finance Officers Association's 2015 guidance is only partially applicable now because issuers are not using swaps anymore, many are issuing with call features for flexibility if feasible, and rating agencies have been fairly neutral and understand the merits of reshaping the debt in the discussions that NHA has had, he said.
For almost all of the deals NHA advises on, the cities are not “kicking the can down the road” by deferring principal, Meyer said.
“Nearly all we have seen are amortizing principal immediately and maintain similar maturities to the UAL being paid off,” he said. “With that said, GFOA is totally correct that there is reinvestment and market timing risk.”
NHA typically performs stress testing to quantify the risks of POBs, so its clients and their stakeholders can evaluate this strategy with eyes wide open to make a prudent decision, Meyer said.
“Clearly, whether it is Moorlach or the GFOA, or us at NHA, it is a clear, and very important fact that there is a long-term reinvestment risk, as well as short-term market timing risk when an agency does a POB,” Meyer said. “Simply put, an agency will save money on a POB issuance if PERS earns more on average than the rate paid on the bonds through maturity.”
Historical returns for PERS are 9% for the last 10 years, 5.8% for the last 20 years and 8% for the last 30 years, Meyer said.
“Of course, it is going to be slightly lower after this year’s COVID-19 impacts,” Meyer said. “And, while history doesn’t guarantee future results, it does seem likely PERS will earn above a 4% bond rate. With more assets exposed to the market right after a POB issuance, gains or losses are also magnified, and this needs to be evaluated as well.”