Hoping to defer until well into the future the increasingly hefty burden the City of Upland’s pension debt entails, city officials there are on the verge of issuing pension obligation bonds.
Upland, which is a mid-range city population-wise in San Bernardino County, in the 2001/2002 timeframe substantially increased the pension benefits of its employees after prognosticators predicted that the California Public Employees Retirement System’s investment pool would function magnificently on a consistent basis going into the future. The State of California, cities and other governmental entities participating in that system continually endow it with contributions on behalf of their employees. The system, based on the input from its financial advisors, places that money in a host of diversified financial instruments, including stocks, bonds, treasury notes and real estate. The constant influx of money from its agency contributors and the returns on those investments provide California Public Employees Retirement System with a never-ending revenue stream to provide those governmental retirees involved in the system with their pensions.
A presumption in the California Public Employees Retirement System’s charter is that the investment pool will experience on a yearly basis a 7.5 percent return or greater on those investments. When the 7.5 percent return is achieved and the payments from the governmental entities that employ or employed the system’s participants continue to flow in, the system is self-sufficient and self-sustaining. When the 7.5 percent earning goal is not reached, those governmental entities must increase their contributions into the system. With the massive downturn in the U.S. economy that began in 2007 and the seven straight years of sluggishness that ensued, known in some circles as “The Great Recession,” the California Public Employees Retirement System’s investment returns diminished, igniting a public pension crisis in California that has continued ever since, as the individual governmental entities saw their pension debt, referred to as an “unfunded pension liability,” mount.
In Upland, the pension debt crisis was exacerbated by the action of John Pomierski, who was mayor for more than a decade, from December 2000 until March 2011, at which point he was indicted by a federal grand jury on political corruption charges, including bribetaking, for which he was eventually convicted and imprisoned. To keep a lid on his depredations, Pomierski arranged to buy the silence of the handful of city employees who recognized what he was up to and the larger circle of city employees who had suspicions by increasing their salaries and benefits. Doing so without making it obvious that a cabal of city employees, including members of the police department, were in on the graft entailed increasing the salary and benefits for virtually all of the city’s employees, including fattening their pensions. As a consequence, as of June 30, 2012, the City of Upland’s unfunded pension liability, calculated on an actuarial basis, had reached $88,994,066. It steadily grew thereafter, reaching $99,976,917 as of June 30, 2018, and then climbing ever more steeply thereafter, hitting $112,039,675 as of June 30, 2019 and $120,920,721 as of June 30, 2020.
With the California Public Employees Retirement System’s investment performance still failing to reach the 7.5 percent goal, as in the case of achieving 4.7 percent in fiscal year 2019-20, not only is Upland’s unfunded pension liability escalating, but the amount of money being diverted from the city’s general fund to simply stay current on its pension obligations is increasing as well. This year, fiscal 2020-21, $9.1 million of the city’s $43.6 million general fund is being devoted to making payments to the California Public Employees Retirement System. Next year, 2021-22, that payment is anticipated to jump to $9.6 million.
Taking stock of the consideration that in recent years the cities of Ontario, La Verne, Baldwin Park and Carson have availed themselves of the long-term financing strategy of issuing pension obligation bonds to reduce the amount of money being paid annually to the California Public Employees Retirement System, city officials have conferred with Suzanne Harrell of the firm Harrell & Company, a municipal financial advisor, with regard to potentially issuing pension obligation bonds of its own. According to Harrell, Upland should be able to reduce its annual pension costs and in time reduce its unfunded pension liability through a strategy by which the proceeds from the issuance and sale of the pension obligation bonds will then be invested in higher yielding securities that will bring in a rate of return greater than the interest to be paid on the bonds.
That strategy involves a gamble that the stocks and other securities that Upland will invest the proceeds of the pension obligation bonds in will perform well and provide the investment returns hoped for.
On Thursday, September 10, the Upland City Council is slated to hold a workshop at which the potential of the city issuing pension obligation bonds is to be discussed. The staff member to preview that option is Assistant City Manager Stephen Parker. Much of what he is to present is based upon the contents of a 26-page report put together by Harrell & Company. It is not known outside of City Hall whether Suzanne Harrell will participate in the workshop. Her report states that the California League of Cities has identified pension obligation bonds as “an approach to address unfunded pension liabilities.” Harrell’s report further states that the “city may issue pension obligation bonds at lower interest rates to pay off the unfunded actuarial liability.” This can be done, she said, by “refinanc[ing] 7% payments at a lower fixed rate of 3.3%, including the cost of issuance” and the “savings realized can add to reserves and/or be used for other city priorities.”
Harrell sought to blunt criticism of the use of pension obligation bonds by entities such as the Howard Jarvis Taxpayers Association and the Government Finance Officers Association. Those naysayers maintain that pension obligation bonds are credit negative. Harrell countered that pension obligation debts can actually be credit positive by means of a higher debt funding ratio. The critics say that pension obligation bonds extend the maturity of the financing mechanism and thereby commit the city to a longer debt service period. That is not necessarily so, according to Harrell, who maintains that the maturity of the bonds can be matched to the existing maturity, life or sunset dates of the city’s other debts or investments. Another disadvantage of pension obligation bonds is that they do not provide an opportunity for early prepayment, their detractors claim. According to Harrell, the bonds can be refinanced after ten years. Pension obligation bonds impact the city’s debt capacity, those advising against their use say. That does not matter, Harrell says, since the unfunded actuarial liability is already a debt. Pension obligation bonds entail a complex structure, those who find fault with them suggest. Harrell insists that a traditional structure can be used in formulating pension bond issuances. Pension obligation bonds are an investment vehicle subject to the vicissitudes of the market, entailing considerable risk, the doomsters warn. Harrell characterizes the bonds not as an investment but rather as a debt management tool.
In touting the pension obligation bonds, Harrell said they had the advantage of not requiring voter approval and their issuance could be subject to a judicial validation proceeding. There is existing law pertaining to debt refunding allowing pension obligation bonds to be, she said, “treated as refinancing an existing obligation.”
Challenges by the Howard Jarvis Taxpayers Association to the validation process used for the issuance of the bonds by other cities, she said, are “unlikely to prevail.”
Harrell said her “recommendation is to adopt a pension liability funding policy to address further unfunded actuarial liabilities.”
It is not clear whether Harrell stands to gain anything beyond what she is being paid for her basic advice as an advisor if the city elects to issue the bonds, such as being party to an arrangement by which she obtains a commission on the issuance.
The precise value of the bonds proposed for issuance is not specified in Harrell’s report.
Conservative financial advisors are less than enthusiastic about pension obligation bonds, pointing out that they are intended to fund the unfunded public pension debt by creating further debt. This has been likened to paying off the money owed on one credit card with another credit card.
The Government Finance Officers Association is an association of officials employed by government entities. In a warning to governmental entities, the association stated, “The Government Finance Officers Association recommends that state and local governments do not issue pension obligation bonds for the following reasons: The invested pension obligation bonds’ proceeds might fail to earn more than the interest rate owed over the term of the bonds, leading to increased overall liabilities for the government. Pension obligation bonds are complex instruments that carry considerable risk. Pension obligation bonds structures may incorporate the use of guaranteed investment contracts, swaps, or derivatives, which must be intensively scrutinized as these embedded products can introduce counterparty risk, credit risk and interest rate risk. Issuing taxable debt to fund the pension liability increases the jurisdiction’s bonded debt burden and potentially uses up debt capacity that could be used for other purposes  In addition, taxable debt is typically issued without call options or with ‘make-whole’ calls, which can make it more difficult and costly to refund or restructure than traditional tax-exempt debt. Pension obligation bonds are frequently structured in a manner that defers the principal payments or extends repayment over a period longer than the actuarial amortization period, thereby increasing the sponsor’s overall costs. Rating agencies may not view the proposed issuance of pension obligation bonds as credit positive, particularly if the issuance is not part of a more comprehensive plan to address pension funding shortfalls.”
-Mark Gutglueck