In February 2021, the City priced $350 million of Pension Obligation Bonds (POBs) with the proceeds from the issuance used to pay off the City’s Unfunded Accrued Liability (UAL) for employee pension benefits with California Public Employees' Retirement System (CalPERS). The all-in (inclusive of financing costs) interest rates set on the 24-year POBs were 2.54%, the lowest rate set on any pension bond in recent years.

In addition to converting the 7% UAL debt with CalPERS to 2.54% debt on the POB, the City utilized the restructuring to achieve several objectives including: (1) developing a more manageable repayment schedule for this large pension liability that will enhance budget predictability and enhance City’s ability to maintain service levels; (2) prioritizing projected savings towards adequately funding various City reserves, including setting aside a portion into a new Section 115 Trust and Bond Call Fund to mitigate future impacts from pension and OPEB cost increases. Ideally, this strategy will enable the City to potentially pay off (redeem) the POBs early.

Over $175 million of interest rate savings is projected on the refinancing and over $14 million annually on average for the next 15 years. While those savings assume CalPERS earns 7% returns in the future, the City is conservatively planning for below average performance by CalPERS and has put into place strategies, through the POB, and new Pension Funding Policy, to mitigate that risk to ensure the City’s long term fiscal sustainability 

The following Q&A provides more information. You also may download the Chula Vista Q and A - Pension Obligation Bonds document. 

Why is the City issuing a POB?

The City of Chula Vista was paying 7% interest on over $350 million dollars owed to CalPERS for unfunded pension liability (detailed definition below).  Given the City’s extremely strong credit rating (AA), and historically low current market interest rates, the City was able to borrow at interest rates between 3.25% and 3.50% - significantly lower than the 7% CalPERS charges.  Furthermore, the City will use the POB to create a new repayment shape for the debt that is more predictable and conducive to the City’s continued fiscal health. There are significant savings projected (over $10M per year on average for next 15 years) which can be used to bolster the City’s reserve levels and reduce the risk that the City will need to cut staff, services or critical capital projects that will benefit the community.

This chart shows the restructuring strategy with the green line representing the new debt payments, and the bars representing the current repayment schedule with CalPERS that will be eliminated.

What is a Pension Obligation Bond (POB)?
A POB is a taxable bond that the City issues to investors.  The proceeds that the City raises are then sent to CalPERS to extinguish all or a part of the City’s current unfunded accrued liability (UAL). 

What is a UAL?
A UAL is the shortfall between what the City has in assets vs. what it will need in assets to fully pay out the benefits that it has promised to retirees.  This number was $356 million for the City of Chula Vista.  The UAL is essentially the City’s debt to CalPERS.  CalPERS charged the City a 7% interest rate on this debt and enforced a mandatory repayment schedule.  This payment schedule is not flat like a mortgage, but rapidly escalating over the next 10 to 15 years before declining to $0 in 2046.

Projected Savings is Not Guaranteed and is Based on CalPERS Future Returns (Reinvestment Risk)
Correct. The rule of thumb is that if CalPERS earns more than the rate paid on the bonds (3.25% to 3.50% estimated right now), the City will be better off.  If CalPERS earns under the bond rate, the City would be worse off. While past performance does not guarantee future results, CalPERS’ historical 30-year returns are 8.0%, 5.5% for the last 20 years on average, 8.5% for last 10 years and 6.3% for the last 5 years.  

What Has the City Done to Address Reinvestment Risk?
The City has taken this risk into careful consideration, both quantifying this risk through stress-testing analysis completed by a 3rd party actuary and working in consultation with its financial advisor.  The stress testing analysis included looking at the impact to the City if CalPERS does not meet its 7.0% annual investment return target.  Specifically, the actuary calculated savings if CalPERS only makes 6% per year, as well as a more dire scenario where there is another 2008-like recession right after the City issues the POB.  Under both, the City is projected to still be significantly better off than if it had not issued the POB.  Over $45 million of savings (present value) is still projected even if there was another 2008-like recession.

Furthermore, the City has structured the new payments in a way that creates enhanced resiliency for the City to absorb new UAL that might be added on in the future from potential below average investment performance. 

Lastly, the savings will get set aside in various reserves to address future economic uncertainty, emergencies, and address future pension and OPEB liability increases (per policy noted below).  This money could be invested back into the market if there was a downturn.

What is the City’s Plan for the Projected Savings?
The City has adopted a comprehensive reserve and pension funding policy. This policy provides the framework behind how the City will set aside surplus funds and savings from the POB each year.  This policy will prioritize the City’s basic operating reserves first, then its two emergency/economic contingency reserves, and then start to fund its pension and OPEB reserves, as well as a POB Bond redemption reserve.  These reserves will allow the City to accumulate funds to address future potential pension liability increases as well as pay down the POB debt early to save on interest costs.

Are taxpayers on the hook?
The CalPERS debt of $356M is a liability that the City must pay. The POB replaces that existing liability with a lower cost liability to reduce the burden on the City and taxpayers.

The City should address this issue through pension reform, not Bonds.
The current liability cannot be undone through pension reform and the City must make its payments as prescribed by CalPERS; the City is addressing this large liability through the POB issuance

While the City cannot address the current UAL through pension reform, the City has undertaken reforms that are available, including requiring employees to pay their fair share.  Additionally, new PEPRA state laws have reduced benefits for new employees (and Employer costs).

The UAL could come back.
This is correct, but the UAL may come back whether the City issues a bond or not.  The new repayment shape created provides more capacity/resilience for City to pay for any potential “shocks” while also maintaining services to City residents.

POBs are “kicking the can down the road”
No. The City’s proposed strategy does not include an extension of maturity.

Rating Agencies will view these negatively.
No. The City carries a “AA” Stable rating from Standard & Poor’s Global Ratings, which is above average for California cities.  S&P recognizes the significant benefits of the restructuring and importantly, the prudence and thoughtfulness behind the recent pension funding policy that was adopted.

Pension Bonds exchange a “soft” liability for “hard” bonded debt
The City’s liability to CalPERS is already debt on its balance sheet: it is legally enforceable and has a mandatory payment schedule.  Rating agencies treat unfunded pension liabilities as debt in calculating liability and fixed expense ratios.

GASB requires it shown in CAFR.

It is expensive debt - CalPERS charges 7% interest on the UAL.

Pension Bonds have sometimes contributed to or enabled unsound policy decisions.
City’s proposed POBs DO NOT finance current year obligations nor provide any sort of benefit.

Why 100% of the UAL and one deal?
A larger transaction provides more potential savings. City has considered staggered/multiple issuances, however, the City has determined that the opportunity to lock in historically low interest rates right now is the preferred approach.

How many other Agencies have issued pension bonds or are considering them?
More than 30 agencies have used bonds to restructure their UAL over the past two years, totaling about $3 billion in UAL refinanced.  Based on conversations with the City’s advisor and other market participants, it is estimated that at least 20 other cities (totaling >$5 billion in UAL) are currently moving forward with or evaluating this strategy.

Addressing GFOA Concerns

 Recent Pension Bonds (CalPERS UAL Restructurings)