Loading...
HomeMy WebLinkAbout2022-06-14; Council Policy No. 94 - Debt Management Policy Policy No. 94 Date Issued June 14, 2022 Resolution No. 2022-142 Subject: Debt Management Policy Purpose The purpose of the Debt Management Policy (“Policy”) is to establish guidelines and parameters for the effective governance, management and administration of the city’s current and future debt. This policy is intended to comply with California Government Code Section 8855(i), and any successor statute, and shall govern all debt which is contemplated or incurred by the city and city entities that adopt the policy. Background California Government Code Section 8855(i) requires that the issuer of any proposed debt issue of the state or local government shall, no later than 30 days prior to the sale of any debt issue, submit a report of the proposed issuance to the California Debt and Investment Advisory Commission by any method approved by the commission. The report of the proposed debt issuance shall include a certification by the issuer that it has adopted local debt policies concerning the use of debt and that the contemplated debt issuance is consistent with those local debt policies. A local debt policy must include all of the following: 1. The purposes for which the debt proceeds may be used; 2. The types of debt that may be issued; 3. The relationship of the debt to, and integration with, the issuer’s capital improvement program or budget, if applicable; 4. Policy goals related to the issuer’s planning goals and objectives; and 5. The internal control procedures that the issuer has implemented, or will implement, to ensure that the proceeds of the proposed debt issuance will be directed to the intended use. Additionally, the city recognizes that a fiscally prudent policy is necessary to: 1. Maintain the city’s sound financial position; 2. Ensure the city has the flexibility to respond to changes in future service priorities, revenue levels, and operating expenses; 3. Protect the city’s creditworthiness; 4. Ensure that all debt is structured to protect both current and future taxpayers, ratepayers and constituents of the city; and City Council Policy Statement June 14, 2022 Page 2 5. Ensure that the city’s debt is consistent with the city’s planning goals, objectives, capital improvement program, and/or budget. Statement of policy SECTION 1: SCOPE AND AUTHORITY This Policy governs the issuance, management and post issuance compliance of all debt funded through the capital markets, including the selection and management of related financial and advisory services and products, and the investment of bond proceeds. This Policy also governs the use and issuance of debt used for financing the purchase of major and/or multiple pieces of equipment. The city will utilize debt obligations only after giving due consideration to all available funding sources, including but not limited to available cash reserves in the city’s General Fund, General Capital Construction Fund, Infrastructure Replacement Fund, Water Replacement Funds, Sewer Replacement Fund and other funds, as appropriate, other strategic savings programs, available current revenues, potential future revenue sources, existing and potential grants, and all other financial sources legally available to be used for such purposes. When and if deemed an appropriate alternative, the city may issue debt for the purposes stated in this Policy. This Policy will be reviewed and updated periodically, as required. Any changes to the policy are subject to approval by the City Council at a noticed and public meeting. While adherence to this Policy is required in applicable circumstances, the city recognizes that changes in the capital markets, city programs and other unforeseen circumstances may from time to time produce situations that are not covered by the Policy and require modifications or exceptions to achieve policy goals. In these situations, management flexibility is appropriate, provided specific authorization from the City Council is obtained. Overall policy direction of this Policy will be provided by the City Council. Responsibility for implementation of the Policy, and day-to-day responsibility for structuring, implementing, and prudently and properly managing any and all debt incurred by the city will lie with the Finance Director. The following policy provides the methods, procedures, policies and practices which, when exercised, ensure the sound fiscal management of the city’s debt program. SECTION 2: PURPOSES FOR WHICH DEBT MAY BE ISSUED Long-term debt may be issued to finance the construction, acquisition, and rehabilitation of capital improvements and facilities, equipment and land to be owned and operated by the city. Long-term debt financing may be deemed appropriate when the following conditions exist: 1. The project to be financed is necessary to provide basic services; and City Council Policy Statement June 14, 2022 Page 3 2. The project to be financed will provide benefit to constituents over multiple years; and 3. Total debt does not constitute an unreasonable burden to the issuer and its taxpayers and ratepayers; or 4. Debt is issued to refinance outstanding debt to produce debt service savings or to realize the benefits of a debt restructuring. The city may use long-term financing subject to the following conditions: 1. The project to be financed must be approved by the City Council; 2. The city determines the issuance of the debt will comply with the applicable state and federal law; 3. Debt services should not affect the city’s ability to meet future operating, capital and reserve requirements; 4. The maximum term of each debt financing should be no longer than the expected useful life of the asset or improvement financed; 5. Debt should be used only to finance improvements that cannot be paid for with current reserves or revenues, unless the purpose of the debt is to spread improvement costs to ensure future users become responsible for portions of the cost; and 6. The city shall not use long-term debt for current operations. Short-term debt may be issued to provide financing for the city’s operational cash flows to maintain a steady and even cash flow balance. The city may use short-term financing subject to the following conditions: 1. Short-term debt may be issued to provide financing for short-lived capital projects; and 2. Short-term debt, such as bond anticipation notes, grant anticipation notes, commercial paper or a line of credit, may be used to provide interim financing in connection with the implementation of a capital program or to smooth out the city’s cash flow requirements. SECTION 3: TYPES OF DEBT The city may issue all such types of debt as are permitted by the state constitution, applicable state statutes, and the city’s ordinances, and may include, but are not limited to: 1. Internal borrowing1 2. Bank or agency loans 1 The city may borrow internally from other funds with surplus cash in lieu of issuing debt. Purposes warranting the use of this type of borrowing could include, without limitation, addressing cash flow issues; offsetting timing differentials between expenditures and reimbursements (typically associated with grant funding, impact fees, etc.); funding a future project prior to securing project financing; and for other needs as deemed appropriate by the City Council. City Council Policy Statement June 14, 2022 Page 4 3. General obligation bonds 4. Capital appreciation bonds 5. Revenue bonds 6. Special assessment/community facilities district/bridge and thoroughfare district debt2 7. Tax and revenue anticipation notes 8. Line of credit 9. Refunding obligations SECTION 4: RELATIONSHIP OF DEBT TO CAPITAL IMPROVEMENT PROGRAM AND BUDGET The city's multi-year Capital Improvement Program (CIP) sets priorities for projects and funding while this Policy provides policy direction and limitations for proposed financings undertaken to implement the CIP. Debt issuance for capital projects should be incorporated into the CIP to be recommended for City Council approval. New debt issuances, and refinancing of existing debt, should be analyzed for compatibility with the city’s established long-term plans for replacing aging physical infrastructure. The city strives to maintain a level funding plan that will minimize the peaks and valleys in General Fund support levels and allows the funding of projects over time. The city shall strive to fund the upkeep and maintenance of its infrastructure and facilities due to normal wear and tear through the expenditure of available operating revenues. The city shall seek to avoid the use of debt to fund infrastructure and facilities improvements that are the result of normal wear and tear. The city shall seek to issue debt in a timely manner to avoid having to make unplanned expenditures for capital improvements or equipment from its General Fund. SECTION 5: POLICY GOALS RELATED TO PLANNING GOALS AND OBJECTIVES The city is committed to long-term financial planning, maintaining appropriate reserve levels, and employing prudent practices in governance, management and budget administration. The city intends to issue debt for the purposes stated in this Policy and, in doing so, to implement policy decisions incorporated in the city’s long-term capital plans and its annual operating budget. It is a policy goal of the city to protect taxpayers, ratepayers (when applicable) and constituents by utilizing conservative financing methods and techniques to obtain the highest practical credit ratings (when applicable) and the lowest practical borrowing costs. 2 Special assessment districts, community facilities districts, and bridge and thoroughfare districts also subject to Council Policy Statement 33 (2002) which sets policy for financing such districts. City Council Policy Statement June 14, 2022 Page 5 SECTION 6: GENERAL DEBT GUIDELINES 6.1 METHOD OF ISSUANCE AND SALE OF BONDS The city will strive to sell its bonds competitively but may pursue negotiated sales when conditions warrant. 6.2: STRUCTURE AND TERM The city will establish all terms and conditions relating to the issuance of debt, and will control, manage, and invest all debt proceeds. The following restrictions will be followed unless otherwise authorized by the City Council: 1. Term of Debt - Debt will be structured for the shortest period practicable, consistent with a fair allocation of costs to current and future users. The standard term of long- term debt borrowing will typically be 5-30 years. Consistent with its philosophy of keeping its capital facilities and infrastructure systems in good condition and maximizing a capital asset's useful life, the city will make every effort to set aside sufficient current revenues to finance ongoing maintenance needs and to provide reserves for periodic replacement and renewal. Generally, debt will not be issued for periods exceeding the useful life or average useful lives of projects, or equipment, to be financed. 2. Debt Repayment Structure - In structuring a debt issuance, the city will manage the amortization of the debt and, to the extent possible, track the anticipated debt service payments to its projected cash flow. In addition, the city will seek to structure debt with aggregate level annual debt service payments over the life of the debt. Structures with unlevel debt service will be considered when one or more of the following exist: A. Natural disaster or extraordinary unanticipated external factors make payments on the debt in the early years prohibitive; B. Such a structure is beneficial to the city' s aggregate overall debt payment schedule; C. Such a structure will allow debt service to more closely match project revenues. 3. Bond Maturity Options - For each bond issuance, the city will select serial bonds or term bonds, or both. On the occasion where circumstances warrant, capital appreciation bonds (CABs) may be used. The decision to use term, serial or CABs is typically driven by market conditions. 4. Interest Rate Structure - The city' s practice has been to issue fixed rate debt. Such debt provides certainty, at the time of debt issuance, as to the level of principal and interest owed annually. Moreover, it allows the city to have even debt service payments over time. City Council Policy Statement June 14, 2022 Page 6 Specific conditions may arise where the city would consider the use of variable interest rate debt. Variable debt has interest rates that reset on a periodic basis (e.g., daily, weekly, monthly). Conditions which would cause consideration of variable rate debt are: A. An adverse fixed-rate municipal market B. Uncertainty over the level of annual revenues to cover debt service C. The potential for rapid repayment of debt D. The need or desire to optimize the city' s asset/liability balance Variable interest rate debt, however, exposes the city to interest rate risk over the term of the financing. While credit rating agencies are supportive of variable rate debt, the magnitude of any unhedged variable rate debt could raise concerns. Rating agencies suggest the aggregate amount of such debt be capped at a level not exceeding 20-25 percent of debt outstanding. It is possible to issue a combination of both fixed and variable rate debt. The city could use this tool, as well as others, such as front or back ending debt to manage its debt portfolio. These structures should be used in a manner which best supports the city's long-term financial condition. There are other types of debt that are a variation of fixed and variable debt. These can involve swaps of fixed for variable debt (or vice versa) depending on the interest rate environment and the city's general financial position. These instruments can become most complex and sensitive to shifts in the interest rate and economic environment. They require careful analysis and monitoring. 5. Credit Enhancement - Credit enhancement may be used to improve or establish a credit rating on a city debt obligation. Types of credit enhancement include letters of credit, bond insurance and surety policies. The financing team will recommend the use of a credit enhancement if it reduces the overall cost of the proposed financing or if the use of such credit enhancement furthers the city's overall financial objectives. 6. Debt Service Reserve Fund - Debt service reserve funds are held by the trustee to make principal and interest payments to bondholders in the event that pledged revenues are insufficient to do so. The city will fund debt service reserve funds when it is in the city's overall best financial interest. Under federal tax law, the size of the reserve fund is generally limited to the lesser of 1) 10% of par amount of bonds, 2) 125% of average annual debt service and 3) 100% of maximum annual debt service. City Council Policy Statement June 14, 2022 Page 7 In lieu of holding a cash funded reserve, the city may substitute a surety bond or other credit instrument in its place. The decision to fund a reserve fund with cash rather than to use a credit facility is dependent upon the cost of the credit instrument and the investment opportunities. Additionally, the city may decide not to utilize a reserve fund if there would be no adverse impact to the city's credit rating or interest rates. 7. Capitalized Interest – Generally, the nature of the city's revenue stream is such that funds are continuously available, and the use of capitalized interest should not normally be necessary. However, certain types of financings may require the use of capitalized interest from the issuance date until the city has constructive use/benefit of the financed project. Unless otherwise required, the city will avoid the use of capitalized interest to avoid unnecessarily increasing the bond size. Interest will not be funded (capitalized) beyond three years or a shorter period if further restricted by statute. 8. Lien Levels - Senior and junior liens for each revenue source will be utilized in a manner that will maximize the most critical constraint, typically either cost or capacity, thus allowing for the most beneficial use of the revenue source securing the debt. 9. Call Provisions - A call option or optional redemption provision gives the city the right to prepay or retire debt prior to its stated maturity date. This option may permit the city to achieve interest savings in the future through the refunding of the debt. Often the city will pay a higher interest rate as compensation to the buyer for the risk of having the debt called in the future. In addition, if the debt is called, the holder may be entitled to a premium payment ("call premium"). Because the cost of call options can vary depending on market conditions, an evaluation of factors will be conducted in connection with each issuance. In general, the city' s securities will include a call feature that is no later than ten years from the date of delivery of the debt. The city will generally avoid the sale of non- callable debt. The use of a call option will be evaluated and recommended on a case-by- case basis. 10. Original Issue Discount - An original issue discount will be permitted only if the city determines that such discount results in a lower true interest cost on the debt and that the use of an original issue discount will not adversely affect the project identified by the legal documents related to the debt. 11. Debt Limits - California Government Code Section 43605 states a city shall not incur bonded indebtedness payable from the proceeds of property tax which exceeds 15 percent of the assessed value of all real and personal property of the city. This provision, however, was enacted when assessed valuation was based upon 25 percent of market value. Effective with the 1981-82 fiscal year, each parcel is now assessed at 100 percent City Council Policy Statement June 14, 2022 Page 8 of market value (as of the most recent change in ownership for that parcel). To reflect the intent of the debt limit stipulation in Section 43605, the 15 percent limitation has been adjusted to one-fourth of that level, or 3.75 percent, of the assessed value of all real and personal property of the city. The cumulative annual debt service of all bond issues supported by the General Fund is restricted to no more than 8 percent of annual operating expenses for the General Fund unless an exception is approved by the City Council. Bond issues supported by Enterprise Funds should maintain a minimum ratio of net operating income to annual debt service that the Finance Director concludes is beneficial to the city. Typically, the higher the ratio the better the rating and the lower the interest rate paid by the city. For all other city funds annual debt service shall not exceed 15 percent of annual operating expenses unless an exception is approved by the City Council. 12. Derivatives - Derivative products may have application to certain city borrowing programs. In certain circumstances these products can reduce borrowing costs and assist in managing interest rate risk. However, these products carry with them certain risks not faced in standard debt instruments. The use of derivative products shall be evaluated on a case-by-case basis to determine whether the potential benefits are sufficient to offset any potential costs. 13. Refunding - The city shall refinance debt to achieve savings as market opportunities arise. The Finance Director shall remain cognizant of fluctuations in interest rates for the purpose of identifying refunding opportunities and prepare a present value analysis identifying the economic effects of a refunding to determine the value of refunding. There are two types of refunding, current or advance. Refunding may be undertaken in order to: A. Take advantage of lower interest rates and achieve debt service costs savings; B. Eliminate restrictive or burdensome bond covenants; or C. Restructure debt to either lengthen the duration of debt or free up reserve funds. Generally, the city shall strive to achieve a minimum of 3 percent net present value savings for a current refunding and a minimum of 5 percent net present value savings for an advance refunding. In addition, the total net present value savings should be greater than the costs of doing the refunding. The city may consider undertaking a refunding for other than economic purposes upon a finding that such a restructuring is in the city's overall best financial interest. City Council Policy Statement June 14, 2022 Page 9 The city will generally refund debt within the term of the originally issued debt. However, the city may consider maturity extension, when necessary to achieve a desired outcome, provided that such extension is legally permissible. The city may also consider shortening the term of the originally issued debt to realize savings. The remaining useful life of the financed asset will be given due consideration in formulating these decisions. The city will utilize the least costly securities available in structuring refunding escrows. A certificate from a third-party agent, who is not a broker-dealer, is required stating that the securities were procured through an arms-length, competitive bid process (in the case of open market securities), that such securities were more cost effective than state and local government obligations, and that the price paid for the securities was reasonable within federal guidelines. Under no circumstances will an underwriter, agent or municipal advisor sell escrow securities to the city from its own account. The city will take all necessary steps to optimize escrows and to avoid negative arbitrage in its refunding. Any resulting positive arbitrage will be rebated as necessary according to federal guidelines. 6.3: THE FINANCING TEAM The city will form a financing team for each debt issuance that will consist of the city treasurer, finance director, and assistant finance director at a minimum. The team may also consist of any other required staff, underwriter, bond counsel, financial advisor, or other consultants deemed necessary by the city. 6.4: USE OF CONSULTANTS The city may use outside consultants to complete a debt issuance including, but not limited to, bond counsel, disclosure counsel, underwriter, municipal advisor, trustee, and/or arbitrage analyst. In the case of land secured financings, an assessment engineer or special tax consultant, as applicable, and an appraiser or market absorption consultant may be necessary. In the case of tax increment financings, a fiscal consultant may be a necessary consultant. Conflict of Interest Disclosure - All parties involved with city debt issuance will be required to provide full and complete disclosure, relative to internal and external agreements. The extent of disclosure may vary depending on the nature of the transaction. However, in general terms, no agreements will be permitted which could compromise one’s ability to provide independent advice that is solely in the city's interest or which could reasonably be perceived as a conflict of interest. City Council Policy Statement June 14, 2022 Page 10 SECTION 7: COMPLIANCE When issuing debt, in addition to complying with the terms of this Policy, the city shall comply with any other applicable policies regarding initial bond disclosure, continuing disclosure, post- issuance compliance, and investment of bond proceeds. The city will periodically review the requirements of and will remain in compliance with the following: 1. Any continuing disclosure requirements. 2. Any federal tax compliance requirements, including without limitation arbitrage and rebate compliance, related to any prior bond issues. 3. The city’s investment policies as they relate to the investment of bond proceeds. Whenever reasonably possible, proceeds of debt will be held by a third-party trustee and the city will submit written requisitions for such proceeds. The city will submit a requisition only after obtaining the approval of the Finance Director.