City of Allentown Addressing the City’s Major Fiscal Challenge

1. City of AllentownAddressing the City’s Major Fiscal Challenge April 17, 2013

2. Executive Summary • A significant ongoing fiscal imbalance has resulted in the need to find a long-term solution to the City’s fiscal challenges • To close the fiscal gap in recent years, the City has nearly depleted all available Fund Balance while also making substantial expenditure and revenue adjustments including: • Implemented new taxes • Restructured Fire and Police contracts • Debt Restructurings • Various revenue sharing agreements • Cut other major expenditures • Even after significant restructurings of the police and fire contracts, projected pension costs (because of the legacy costs) are anticipated to result in significantly greater fiscal pressures on the City’s General Fund (2012 current estimate of unfunded liability is $158 million (based on an 8% return assumption) • Return assumptions are being reconsidered and are likely to drop which will increase unfunded liability • The Minimum Municipal Obligation (“MMO”) is projected to increase by approximately $13.3mm -$18mm in the near term • In 2006, the pension costs were $7mm (9.70% of Budget). In 2015, the pension cost is projected to be approx. 30%-33% of Budget.

3. Executive Summary (continued) • Illustration of projected MMO budget impact…requiring significant ongoing new revenue source and/or a significant ongoing expenditure reduction.

4. Viable Options Explored to Address the City’s Financial Challenges • Revenue Enhancement Options to pay the MMO • Option 1 – Increase the millage rate • * Allentown has the highest millage rate in the area • Option 2 – Increase the earned income tax • Options to Reduce Unfunded Liability (i.e decrease MMO expense) • Option 3 – Issue a second Pension Obligation Bond • * City would issue Taxable debt secured by its tax pledge • Option 4 – Sell the Water and Sewer systems to a new Allentown Authority • * New Authority would issue Taxable debt secured by water and sewer revenues • * May require a City guarantee • Option 5 – Enter into a concession/lease agreement (Public - Public Partnership) of the Water and Sewer systems with LCA • * LCA was the highest bid secured through the bidding process

5. Option 1 – Raise the Millage Rate (figures do not include School District mills) • One long-term solution to the City’s fiscal challenges is to raise the real estate tax (i.e. millage rate) to cover increasing obligations. (Countywide reassessment effective 2013, however for continuity, 2012 millage and assessment are assumed) • Millage Impact: • Assumptions to cover increase in MMO only, no significant reduction in the unfunded liability: • 2012 MMO: $13,200,000 • Estimated MMO in near term: $26,500,000-$31,200,000 • Revenue from surplus fund(see page 14 - $33mm): $2,000,000-$3,000,000 • Budget impact from increased MMO and additional revenue: $15,300,000-$21,000,000 • Conclusion: • The millage rate would need to increase by approximately 9.5 to 13.1 mills to cover the projected MMO increase in the near term. The millage rate would go from 17.53 mills to approximately 27-30.6 mills. • The millage rate increase above would only cover the estimated MMO increase. Additional millage rate increases may be needed (approx 2-3mills) for other City expenditure needs and increases. • *Assumes 2012 value of mill of $1,600,000 and 2012 millage rate of 17.53, however, this option may negatively impact the collection rate.

6. Lehigh County – Municipality Millage Rates - 2012

7. Option 2 – Raise the Earned Income Tax (figures do not include the School District’s EIT rate) • The City could decide to increase the Act 511 earned income tax to generate additional revenue to cover increasing obligations • EIT Rate Impact: • Assumptions to cover increase in MMO only, no significant reduction in the unfunded liability: • 2012 MMO: $13,200,000 • Estimated MMO in the near term: $26,500,000-$31,200,000 • Revenue from surplus fund(see page 14-$33mm): $2,000,000-$3,000,000 • Budget impact from increased MMO and additional revenue: $15,300,000-$21,000,000 • Current City EIT rate: 0.85% • Current City EIT revenue: $12,500,000 • Conclusion: • The City’s earned income tax rate would need to increase by 122%-168% to cover the projected MMO increase in the near term. The EIT rate would go from 0.85% to approximately 2.28%. • The EIT rate increase above would only cover the estimated MMO increase. Additional rate increases may be needed for other City expenditure needs and increases.

8. Option 3 – Issue Pension Obligation Bond • The City would issue a Taxable Pension Obligation Bond Issue (“POB”). • The proceeds from the POB would be used to pay issuance costs and reduce/eliminate the unfunded liability. • Debt Service related to paying the POB would represent a new fixed expenditure in the City’s General Fund and would need to be funded through additional millage rate increases. • The primary goal of any POB is to achieve an investment rate of return of the pension fund greater than the cost of debt service on the POB and greater than the actuarial assumed rate of return. As a result, POBs generally work best for entities with a strong credit rating (i.e. lower cost of capital): • Estimated cost of the debt service: 6.00% - 6.75% • Currently assumed actuarial rate of return: 8.00% (may be reduced) • Historical Pension fund returns: Since 2000 – annualized net rate is less than 4.0%

9. Option 3 – Issue Pension Obligation Bond (continued)(figures do not include School District mills) • Millage Impact: • Assumes a Taxable POB to eliminate the unfunded liability: • 2012 MMO: $13,200,000 • Estimated MMO with no unfunded liability: $4,000,000 • Estimated POB Debt Service: $18,000,000 – $21,000,000 • Combined MMO and POB Debt Service: $22,000,000 – $25,000,000 • Budget impact from MMO and POB Debt Service: $8,800,000 – $11,800,000 • Conclusion: • The millage rate would need to increase by approximately 5.5 – 7.4 mills to cover the projected increased costs in the near term. The millage rate would go from 17.53 mills to approximately 23 - 25 mills. • To maintain no unfunded liability in the Pension plan, the Pension fund would need to return at least the actuarial assumed rate of return (currently at 8.00%). • General Obligation pledge on the Bonds by the City would place downward pressure on the City’s credit rating. • *Assumes 2012 value of mill of $1,600,000 and 2012 millage rate of 17.53, however, this option may negatively impact the collection rate.

10. Option 3 – Issue Pension Obligation Bond (continued)

11. Option 4 – Sell Water and Sewer Systems to a New Allentown Authority • A new Allentown Authority would be created by the City. • Allentown City would sell the Water and Sewer systems to newly created Authority. • The newly created Allentown Authority would issue Taxable Revenue Bonds (secured by water and sewer revenues) and use the proceeds to purchase the Water and Sewer systems from the City. • Allentown City would use the proceeds from the sale of the systems to reduce/eliminate the unfunded pension liability and pay off existing water and sewer debt, reducing the annual MMO cost of funding the pension plan. • Debt Service coverage ratio of 1.25x would likely be required. • Debt Service Reserve Fund, issuance costs and Operating Reserves would need to be funded. • The newly created Authority would need to raise water and sewer rates to cover debt service cost increases associated with issuing Taxable bonds required to purchase the system. • Water and Sewer Budget Impact: • Assumptions to cover increase in MMO only, no immediate reduction in the unfunded liability: • 2012 Total Water and Sewer Revenues (City): $32,900,000 • 2015 Total Water and Sewer Revenues Required for Balanced Budget • (after Taxable Bond Issue) (New Authority): $49,700,000 • Budget impact: $16,800,000

12. Option 4 – Sell Water and Sewer Systems to a New Allentown Authority (continued) • Conclusion: • Water and Sewer metered rates would need to increase by approximately 73% over the next two years to cover the projected increased costs in the near term. The average water and sewer bill would increase from $487 to $842 by 2015. • After 2015, water and sewer rates would annually grow at approximately CPI. • The newly created Authority would need to issue a Taxable Revenue Bond to finance the purchase of the Water and Sewer systems. • Water and sewer rates would need to be increased to cover debt service costs. • SB 375 and other state law significantly reduces the legal ability of the Authority to transfer monies to the City’s General Fund

13. Option 5 – Enter into Concession/Lease Agreement with LCA • In exchange for the 50-year Concession/Lease Agreement, LCA would provide the City a substantial upfront payment of $220,000,000 and annual payments of $500,000 escalated by CPI (starting in 2016). • No rate increases prior to January 1, 2016 and $10million of system improvements launched immediately • Allentown City would use the upfront payment from the Concession/Lease Agreement to reduce/eliminate the unfunded pension liability and payoff existing water and sewer debt, reducing the annual MMO cost of funding the pension plan. • LCA will be required to comply with the Concession/Lease Agreement and Operating Standards established by the City’s staff and consultants. • LCA will be responsible for implementing capital improvements needed over the next 50-years. (requires City approval) • LCA would be able to finance the upfront payment through the issuance of Tax-Exempt debt. • Conclusion: • City could receive a substantial upfront payment to reduce the unfunded pension liability, substantially reducing the annual MMO cost. • Future water and sewer rate increases must comply with provisions established in the Concession/Lease Agreement. • LCA will be responsible for operating and maintaining the Water and Sewer systems based on the requirements established in the Concession/Lease Agreement and Operating Standards. • Further analysis on this option provided in the next few pages.

14. Option 5 – Enter into Concession/Lease Agreement with LCA (cont.) • Upfront Consideration paid from LCA to the City: $ 220,000,000 • Annual City Payment starting in 2016: $ 500,000 per year adjusted for inflation • (Example: In 30th year, Annual City Payment = approx. $950,000) • If for some reason the LCA charter is not extended, LCA can transfer to another operator approved by City or return the system to the City for $0 • Base Schedule of Permitted Annual Rate Adjustment (other rate adjustments may be realized): • 2013 – 2015 = 0% • 2016 – 2032 = up to CPI + 2.50% • 2033 and each year thereafter = up to CPI + 2.00%* • *(approximately 0.50% of the 2.0% is to advance fund a capital projects fund to be used towards late term projects) • Historical LCA rates have averaged below CPI • LCA shall be responsible for all capital improvements with respect to the System, required to be completed in accordance with the Agreement. • City will receive project reports and designs from LCA • LCA may impose an additional charge to recover the capital costs of Major Capital Improvements (CCR Charge). If LCA seeks to impose a CCR Charge it shall submit a report to the City for its review and Approval. • Note: CPI has averaged approximately 2.50% over the past 20 years.

15. Estimated Summary of Sources and Uses of Funds • For comparison purposes of the Debt Financed Options, the following assumptions were made based on the actual high bid from Lehigh County Authority • Estimated Sources: • Upfront payment from LCA* $ 220,000,000 • Existing Accounts Receivables and Reserves (Est.) $ 5,000,000 • Total Estimated Sources $ 225,000,000 • Estimated Uses: • Unfunded Liability Deposit $ 158,000,000 • Amount Required to pay Water & Sewer Debt $ 30,500,000 • Estimated Closing and reimbursable costs $ 3,500,000 • Additional Funds Available to the City ** $ 33,000,000 • Total Estimated Uses $ 225,000,000 • * LCA will be structuring their tax-exempt financing to provide the upfront payment with a separate indenture including its own credit rating and financing terms, not tied to any current LCA system assets or revenues (i.e. LCA’s existing system will not be used as collateral for the lease bond issue). • ** Use of Additional Funds Available to the City has not been determined by Council or the Administration. Options include rainy day fund, endowment for the other City projects or programs. Use for operating expenses of City not recommended.

16. Overview of Debt Financed Alternatives to Reduce Pension Unfunded Liability • The City issues a Taxable Pension Bond Issue • Arbitrage play between rate of return in Pension plan vs. cost of capital on Pension Bonds • A newly created Allentown Authority would issue Taxable Revenue Bonds • Debt service on Water and Sewer system would increase substantially above current levels • Lehigh County Authority through the Concession/Lease would issue Tax-exempt Revenue Bonds • LCA would issue Tax-exempt Revenue Bonds to fund an upfront payment to the City to lease the Water and Sewer systems for 50 years • LCA is subject to the terms and conditions in the Concession Agreement • Analysis: • There is currently a wide variance between the Taxable rates that the City and new City Authority would borrow at vs. LCA’s borrowing at Tax-Exempt rates. • As an example, the annual debt service difference between Taxable rates vs. Tax-Exempt rates for a 30-year, $250 million bond issue is $5,500,000 - $6,000,000. • This critical component (debt) of a long term solution becomes one of the key drivers in determining the most beneficial impact to the City and the taxpayers and ratepayers.

17. Summary of City Controls Under Proposed Concession/Lease The City retains title to System assets and will get the System back at the end of the term in good condition at no cost along with the improvements and updates that have been made to the System and equipment City continues to own, maintain, and preserve the Retained Water Supply The City maintains responsibility for the requirements of the EPA Administrative Order The City has oversight and sanction authority over operating performance of LCA City retains right to modify the Operating Standards in the future The City has control of surplus water and any associated sale of water to new municipal or bulk sale customers The City will work very closely with LCA for necessary capital improvements – approval rights over improvements and finance plan The City will receive LCA financials and other disclosure information The City has removal and approval rights of the operator The City set the initial schedule of rates and drafted the document such that future rate increases correlate closely to the historical rate increases of the System

18. Overview of Concession/Lease Process • To ensure the City followed a process of high integrity, transparency and thoughtfulness, the following process was utilized over the last year to year and a half: • Perform due diligence and financial studies on the assets while analyzing other alternatives • Initial Request for Qualifications to determine operational and financial ability • Various public meetings conducted around the City with substantial public input • Selection of Pre-qualified bidders • City drafted Operating Standards requirements overseen by Council representative • City drafted Concession and Lease Agreement with requirements for highest conforming bidder • City Council authorization to move forward with the Concession/Lease process • One on one meetings with pre-qualified bidders to review concession agreement terms and operating standards, combined with tour of and ongoing access to City water and sewer system assets • Negotiated terms of final Concession and Lease Agreements with pre-qualified bidding teams • Released Request for Bids (“RFB”) with final terms and conditions • BAFO, Best and Final Offer process due to second highest bid within 10% of highest • Selection of winning bidder based on highest present value bid • Up to 90 days to close

19. Conclusion • Various alternatives have been analyzed by the team to address the current fiscal challenges • Some options are not legally or financially viable • The City has previously issued POBs which have an unsuccessful record to date • Many of the alternatives result in a substantial amount of new debt and ongoing annual debt service • The magnitude of tax increases needs to be evaluated with impacts on economic development • There will be future fiscal challenges on City’s horizon • OPEB liability/healthcare for retirees – Currently over $50mm liability • Uncertainty in treatment of calculating MMOs for pensions • May use lower return rate which will increase unfunded liability • Future legislation and enforcement of current laws may impose budgetary restrictions on how/if the City’s General Fund can use Water and Sewer revenues to assist in balancing its budget • Expiring police grants • Capital needs • City has received responses to the Concession/Lease agreement through a competitive bidding process • LCA has submitted a very competitive bid which will allow the City to significantly reduce/eliminate the unfunded pension liability • Operating Standards will ensure systems are operated and maintained at high standards • Council and the Administration will put forward charter amendment(s) and policies to significantly mitigate or eliminate the ability to repeat prior actions that put the City in this situation • Council and Administration will work together to review alternatives and cost benefit analysis on ultimate use of money (debt retirement, unfunded liability, trusts). • Lease with LCA will allow the assets to remain in public hands.

20. Disclosure • The foregoing presentation must be read together with the oral presentation that accompanied it. The presentation is a discussion of a potential options and is subject to the following limitations: • Projections and Estimates – All statements as to what will or may happen under certain circumstances are based on assumptions, some but not all of which are noted in the presentation. Assumptions may or may not be proven correct as actual events occur, and results will depend upon events outside of your or our control. Changes in assumptions may have a material impact on results. Estimates and projections represent our judgment as of this date and are subject to change without notice. There can be no assurance that estimated returns and results will not be materially different in the context of an actual transaction over time. Past performance does not necessarily reflect and is not a guarantee of future results. • General Disclaimer – Public Financial Management, Inc. disclaims all liability relating to the information contained in this presentation. Opinions expressed in the presentation are current opinions only and are subject to change without notice. • Actuarial Assumptions – Actuarial calculations as provided by the City’s Actuary are based on current calculation methodologies and are subject to change in the future. Future methodology changes to actuarial calculations may materially impact the numbers contained herein.