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Pitchbook US template

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Title: Pitchbook US template


1
J A N U A R Y   2 0 0 6
O P E B   F U N D I N G      O P E B 
 T R U S T S      O P E B   B O N D S
S T R I C T L Y   P R I V A T E   A N D 
 C O N F I D E N T I A L
2
This presentation was prepared exclusively for
the benefit and internal use of the JPMorgan
client to whom it is directly addressed and
delivered. This presentation is for discussion
purposes only and is incomplete without reference
to, and should be viewed solely in conjunction
with, the oral briefing provided by JPMorgan.
Neither this presentation nor any of its contents
may be used for any other purpose without the
prior written consent of JPMorgan. The
information in this presentation may be based
upon any management forecasts provided to us and
reflects prevailing conditions and our views as
of this date, all of which are accordingly
subject to change. In preparing this
presentation, we have relied upon and assumed,
without independent verification, the accuracy
and completeness of all information available
from public sources or which was provided to us
by or on behalf of the State or which was
otherwise reviewed by us. In addition, our
analyses are not and do not purport to be
appraisals of the assets, stock, or business of
the State or any other entity. JPMorgan makes no
representations as to the actual value which may
be received in connection with a transaction nor
the legal, tax or accounting effects of
consummating a transaction. Notwithstanding the
foregoing (but subject to any applicable federal
or state securities laws), JPMorgan and the State
may disclose to any and all persons, without
limitation, the tax treatment and tax structure
of any transaction contemplated hereby and all
materials (including opinions or other tax
analyses) relating thereto, so long as such
disclosure is not made prior to the earlier of
(x) public announcement of discussions relating
to the transaction or of the transaction itself
and (y) the execution of an agreement to enter
into the transaction. JPMorgans policies
prohibit employees from offering, directly or
indirectly, a favorable research rating or
specific price target, or offering to change a
rating or price target, to a subject company as
consideration or inducement for the receipt of
business or for compensation. JPMorgan also
prohibits its research analysts from being
compensated for involvement in investment banking
transactions except to the extent that such
participation is intended to benefit
investors. JPMorgan is a marketing name for
investment banking businesses of J.P. Morgan
Chase Co. and its subsidiaries worldwide.
Securities, syndicated loan arranging, financial
advisory and other investment banking activities
are performed by J.P. Morgan Securities Inc. and
its banking affiliates. JPMorgan deal team
members may be employees of any of the foregoing
entities.
O P E B   F U N D I N G      O P E B 
 T R U S T S      O P E B   B O N D S
3
Funding plan options
OVERFUNDED PLAN BENEFIT High level of security
for benefit payments. (105 funded) DRAWBACKS Pr
essure to provide new benefits leads to
funding holidays, followed by gen fund budget
pressure when surplus has been drawn
down. FULLY FUNDED PLAN BENEFIT High level of
security for benefits payments (80-100
funded) DRAWBACKS Could cement liabilities if
not required by contract. Reduces flexibility
to change benefits in the future. Difficult for
most public entities to fund quickly. PARTIALLY
FUNDED BENEFITS Good security for benefit
payments in medium term. Indicates fiscal
responsibility to rating (20-60 funded) rating
agencies, bondholders, etc. Insulates general
fund from fluctuations in medical
costs. DRAWBACKS May result in annual
contributions that are higher than
pay-as-you-go costs in the short run. PAY AS YOU
GO BENEFITS Lower short run contributions in
many cases no need to create or join OPEB
trust. (0 funded) DRAWBACKS Could affect
credit ratings, balance sheet. Strongly rising
costs over time. Long term cost accruals
higher than funded plans.
O P E B   F U N D I N G      O P E B 
 T R U S T S      O P E B   B O N D S
1
4
What is the impact of NOT funding OPEB
liabilities at all?
  • Accounting Unfunded plans generate greater
    liabilities than funded plans
  • Public entity will be required to calculate the
    present value of OPEB liabilities at a lower
    interest rate, e.g., 3.5 - 4.5 instead of 6.5
    - 8.0
  • In many cases, over time the large unfunded OPEB
    accruals can consume all net assets, or even
    become larger than all assets of all kinds
    (investments, capital assets, receivables, etc.)

O P E B   F U N D I N G      O P E B 
 T R U S T S      O P E B   B O N D S
2
5
What is the impact of NOT funding OPEB
liabilities at all? (continued)
  • Cash flow differential
  • Funding some portion of the liability results in
    investment earnings which reduce future
    expenditures. There are good reasons why
    completely unfunded pension plans are rare.
  • Unexpected increases in medical costs directly
    affect the current years budget.
  • Labor relations
  • Completely unfunded plans leave labor and
    retirees worried about the security of their
    benefits.
  • Ratings
  • Rating agencies have already identified
    management of OPEB liabilities as a significant
    issue which may affect credit ratings going
    forward.

O P E B   F U N D I N G      O P E B 
 T R U S T S      O P E B   B O N D S
3
6
What is an OPEB Bond?
  • A bond whose proceeds are used to partially or
    fully fund payments for Other Post-Employment
    Benefits
  • Most likely used to fund a shortfall which
    already exists, rather than to finance current
    year costs over many years
  • It might have a single direct issuer, use a
    conduit issuer, or even be issued by a joint
    powers authority

O P E B   F U N D I N G      O P E B 
 T R U S T S      O P E B   B O N D S
4
7
States where pension bonds have been issued
O P E B   F U N D I N G      O P E B 
 T R U S T S      O P E B   B O N D S
Yellow 1 Billion in State GreenOther States
With POBs
5
8
OPEB bonds overview Some similarities to
pension bonds
  • OPEB bonds are similar to Pension Obligation
    Bonds in many ways
  • Bonds are issued by a public entity, with net
    proceeds going to an OPEB trust, pension fund, or
    retirement association
  • Proceeds are used to reduce or eliminate an
    unfunded liability
  • It is hoped/expected that long-term investment
    returns on proceeds will be greater than cost of
    borrowing
  • Bond interest is very likely taxable
  • The bonds would typically be long term, 15 years
  • Synthetic fixed interest bonds, capital
    appreciation bonds, current interest bonds, and
    variable rate bonds are possible
  • In California, validation proceedings might be
    used to verify authority for issuance (other
    methods might also be used, e.g., statutory
    authorization)

O P E B   F U N D I N G      O P E B 
 T R U S T S      O P E B   B O N D S
6
9
OPEB bonds overview Some potential differences
from pension bonds
  • Potential differences include
  • Many public entities do not yet have an OPEB
    trust or retirement system which is willing and
    able to manage investments
  • OPEB bond proceeds may be going to new OPEB
    trusts or JPAs investment strategies/policies
    will need to be defined in advance
  • Most OPEB bond issuers will have funding ratios
    near zero percent before issuance
  • Authority for OPEB bond issuance may come from
    different sections of the code than pension bonds
  • The GASB accounting incentives for moving away
    from a completely unfunded OPEB plan are stronger
    than for pensions
  • In some cases, the estimates of future OPEB
    liabilities may not be as precise as estimates of
    pension liabilities
  • In some cases, the commitment to make OPEB
    payments is very clear (e.g., written into state
    law or city charter) in other cases the
    commitment is not so clear

O P E B   F U N D I N G      O P E B 
 T R U S T S      O P E B   B O N D S
7
10
Potential advantages of OPEB bonds
  • Can increase funding levels for OPEB liabilities
    in a very short time, resulting in lower booked
    liabilities and annual accruals than
    pay-as-you-go or level amortization
  • Lower expected out of pocket cash flow and net
    present value cost than amortizing the unfunded
    liability in 30 level payments
  • Flexible debt service structures, potentially
    including interest-only or capital appreciation
    bonds
  • A lower chance of disruption to benefits to
    current and future retirees
  • Long-term taxable interest rates in early 2006
    are lower than historic averages

O P E B   F U N D I N G      O P E B 
 T R U S T S      O P E B   B O N D S
8
11
Potential disadvantages of OPEB bonds
  • OPEB bonds can only benefit those employers who
    have, or obtain, authority to issue such bonds
  • There must be a retirement system, OPEB trust, or
    other entity in place to receive and invest the
    bond proceeds
  • All other things being equal, lower-rated issuers
    will have higher borrowing costs, and may want to
    look at alternatives to bonds which have lower
    credit charges/credit spreads. JPMorgan has
    developed certain products as alternatives to
    OPEB bonds.
  • There is a chance that long term investment
    returns could be lower than borrowing costs for
    OPEB bonds
  • Overfunding

O P E B   F U N D I N G      O P E B 
 T R U S T S      O P E B   B O N D S
9
12
Should an OPEB bond be sized to fund the entire
shortfall?
  • Probably not, for several reasons
  • Debt service is higher on larger bond amounts
  • If investment returns are especially good, OPEB
    could quickly become overfunded
  • Short-term overfunding of pension funds in the
    late 1990s led to long-term changes in benefits
  • Funding holidays caused budget fluctuations
  • Estimates of liabilities from the first actuarial
    study may be more uncertain than subsequent
    studies
  • Public entities are allowed to amortize the
    funding shortfall over a period of up to 30 years
  • Funding a significant portion of the shortfall
  • Provides more assets to earn investment returns
    on than level amortization
  • Has a lower booked OPEB liability, and lower
    annual accruals than being completely unfunded

O P E B   F U N D I N G      O P E B 
 T R U S T S      O P E B   B O N D S
10
13
Prefunding annual required contributions at ANY
level significantly reduces total contributions
by the Public Entity…
Annual Required Contributions (ARC) ( billions)
O P E B   F U N D I N G      O P E B 
 T R U S T S      O P E B   B O N D S
11
14
…and result in a cushion against medical
inflation and rising costs
Percentage funded
O P E B   F U N D I N G      O P E B 
 T R U S T S      O P E B   B O N D S
12
15
How have pension obligation bonds performed
historically?
  • Comprehensive data on pension bond performance
    had not previously been published, so JPMorgan
    conducted a study of the 76 pension bonds with
    more than 100 million in par value issued from
    1986 through 2004
  • JPMorgan compared borrowing costs to asset
    returns of CalPERS from date of issuance to
    2/28/05

O P E B   F U N D I N G      O P E B 
 T R U S T S      O P E B   B O N D S
13
16
Notes on pension bond performance
  • While most POBs were profitable to their issuers,
    the margins tended to be higher for more highly
    rated issuers
  • Issuing bonds in times of low interest rates
    improved results
  • Most unprofitable bonds were issued between
    1999-2001, and encountered a major investment
    downturn shortly after issuance
  • Future returns averaging in the 7 - 9 range
    would ultimately make most of those bonds
    profitable.
  • This is a caution about evaluating results after
    only 1-5 years on bonds with ultimate maturities
    of 15-30 years
  • Past performance does not guarantee future results

O P E B   F U N D I N G      O P E B 
 T R U S T S      O P E B   B O N D S
14
17
What about future investment returns?
  • Pension funds commonly publish assumed
    investment returns
  • For example, CalPERS currently assumes 7.75
    annual returns
  • In its 2005 Report on State Retirement Systems,
    Wilshire Group forecasts a long-term return on
    state pension assets equal to 7.5 per annum
  • January 24, 2006 yields for 20-year taxable bonds
    with different ratings were
  • AAA (insured) ____
  • AA ____
  • A ____
  • BBB ____

O P E B   F U N D I N G      O P E B 
 T R U S T S      O P E B   B O N D S
15
18
CalPERS historic annual returns, mean return
CalPERS Historic Annual Returns, Mean Return
  • Instructions
  • Enter annotation values in datasheet (Column Q)
    where needed. Activate the column in order for
    the markers to appear. Deactivate the column
    when finished if markers are not desired.
  • Position text and lines where needed on top of
    the chart (outside of MSGraph)
  • Text boxes w/ fill background (from JPMorgan
    colors)
  • 8pt. font size (increase/decrease as needed)
  • Left alignment
  • Use black lines (0.5pt)
  • No bold (only when necessary)

O P E B   F U N D I N G      O P E B 
 T R U S T S      O P E B   B O N D S
Source JPMorgan Securities, CALPERS Annual
Report, The Wilshire Group
16
19
Comparison of interest costs and expected
investment returns
Comparison of Interest Costs and Investment
Returns
  • Instructions
  • Enter annotation values in datasheet (Column Q)
    where needed. Activate the column in order for
    the markers to appear. Deactivate the column
    when finished if markers are not desired.
  • Position text and lines where needed on top of
    the chart (outside of MSGraph)
  • Text boxes w/ fill background (from JPMorgan
    colors)
  • 8pt. font size (increase/decrease as needed)
  • Left alignment
  • Use black lines (0.5pt)
  • No bold (only when necessary)

O P E B   F U N D I N G      O P E B 
 T R U S T S      O P E B   B O N D S
Source JPMorgan Securities, CALPERS Annual
Report, The Wilshire Group
17
20
Conclusion
  • If you intend to set aside any prefunding at all,
    regardless of the source of the prefunding, make
    sure you have an entity which is willing, able,
    and authorized to invest that money
  • Creating a new OPEB trust takes time, start early
    if you think you will need one
  • There are many good reasons not to immediately
    try to fund 100 of the estimated liabilities
  • Pension bonds have usually been profitable to
    their issuers, and OPEB bonds are expected to
    have similar characteristics, but past
    performance does not guarantee future results
  • Analysis of the effects of various alternatives
    usually includes both bankers and actuaries

O P E B   F U N D I N G      O P E B 
 T R U S T S      O P E B   B O N D S
18
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