TO: HONORABLE MAYOR FROM: Rick Bruneau
AND CITY COUNCIL AND Kerrie Romanow
CITY OF SAN JOSE Matt Loesch
FINANCING AUTHORITY BOARD
SUBJECT: ISSUANCE OF CITY OF SAN JOSE DATE: May 30, 2023
FINANCING AUTHORITY
COMMERCIAL PAPER NOTES
Approved Date
6/8/23
RECOMMENDATION
(1) Conduct a public hearing in accordance with Section 6586.5 of the California Government Code, to hear and consider information concerning the approval by the City of San José of a lease financing by the City of San José Financing Authority and the City for certain public capital improvements of the City, consisting of the construction of a new Administration and Operations Building, and the acquisition, construction, and installation of related capital improvements, for the City of San José Environmental Services Department Water Resources Division, to be located at 3025 Tuers Road in the City of San José, through the issuance of lease revenue commercial paper notes by the City of San José Financing Authority, and the significant public benefit of such financing by the City of San José Financing Authority in accordance with the criteria specified in Section 6586 of the California Government Code.
(2) Adopt a resolution of the City of San José Financing Authority to approve and authorize the issuance of lease revenue commercial paper notes in the amount not to exceed $40,000,000 to (i) finance, on an interim basis, the construction of the Administration and Operations Building, and the acquisition, construction, and installation of related capital improvements, for the City of San José Environmental Services Department Water Resources Division, (ii) reduce the amount of City of San José Financing Authority lease revenue commercial paper notes authorized to be issued to finance the purchase of power and other operating costs of San José Clean Energy to an amount not to exceed $75,000,000 and further amending City of San José Financing Authority Resolution No. SJFA 152 in connection therewith, and authorizing other related actions; and
(3) Adopt a resolution of the City of San José to approve and authorize the issuance of City of San José Financing Authority lease revenue commercial paper notes in the amount not to exceed $40,000,000 to finance, on an interim basis, the construction of the Administration and Operations Building, and the acquisition, construction, and installation of related capital COUNCIL AGENDA: 6/20/23
FILE: 23-940
ITEM: SJFA2
HONORABLE MAYOR AND CITY COUNCIL
May 30, 2023
Subject: Issuance of City of San José Financing Authority Commercial Paper Notes
improvements, for the City of San José Environmental Services Department Water Resources Division, reduce the amount of City of San José Financing Authority lease revenue commercial paper notes authorized to be issued to finance the purchase of power and other operating costs of San José Clean Energy to an amount not to exceed $75,000,000 and further amending Resolution No. 80125 in connection therewith, and authorizing other related actions.
SUMMARY AND OUTCOME
Approval of these recommendations will allow the issuance of commercial paper notes (CP Notes) to finance the construction of the Administration and Operations Building for the Water Resources Division of the Environmental Services Department, and reduce the amount of CP Notes to finance the purchase of power and other operating costs of San José Clean Energy.
BACKGROUND
The San José Municipal Water System (Muni Water) main offices and maintenance facility are located at 3025 Tuers Road in San José, next to the Los Lagos golf course, near the intersection of East Capitol Expressway and Highway 101, and is operated by the City of San José (City) Environmental Services Department. The existing facility consists of three buildings comprising of a converted vehicle storage warehouse, a temporary mobile office trailer, and an administration building. All three buildings, built in the 1960s, require replacement and significant upgrades to meet current demands and life and safety standards. Rehabilitation or renovation of the existing buildings will not address costly maintenance and operational issues or other facility shortcomings of insufficient parking and other necessary day-to-day facilities requirements. In 2022, a preliminary study analyzed conditions and recommended three different options:
1) purchasing and renovating an existing building elsewhere; 2) purchasing land and constructing a new building; or 3) demoli tion of the existing site and building new buildings on the existing site.
Option 3 was selected because it was the lowest cost for this project.
Staff recommends short-term financing through the City’s existing commercial paper program.
The City will issue tax exempt CP Notes for this project in the amount not to exceed $40 million and reimburse the CP Notes with long term lease revenue bonds in the future.
Concurrently, the recommendation of approval of the Initial Study/Mitigated Negative Declaration for the San José Municipal Water New Offices Project (SCH #2022120213) and authorizing the Director of Public Works to (a) decide any timely bid protest(s) and make the City’s final determination as to the lowest responsive bidder that is responsible as needed to award the contract, (b) award and execute a construction contract to the lowest bidder in an amount not to exceed $38,214,500, and (c) approve a contingency of up to 15 percent of the amount of the
HONORABLE MAYOR AND CITY COUNCIL
May 30, 2023
Subject: Issuance of City of San José Financing Authority Commercial Paper Notes
construction contract for the project will be heard on June 20, 2023 at City Council. City Council and the City of San José Financing Authority (Authority or CSJFA) Board are being asked to approve the issuance of CP Notes to ensure sufficient funds are available to award the contract.
Commercial Paper Program
The Commercial Paper Program (CP Program) utilizes a lease revenue financing structure. Under this program, the Authority can issue CP Notes at prevailing interest rates for periods up to 270 days. Although the maturity of each CP Note may not exceed 270 days, the Authority may have CP Notes outstanding longer for a project by issuing new CP Notes to pay maturing CP Notes (and interest) instead of repaying the principal and interest owed on the maturing CP Notes. In the current market, all-in costs (interest and fees) for CP Notes are estimated to be under six percent for taxable and under four percent for tax-exempt issuances. 1 This project will be funded with tax-
exempt CP Notes and the interest payable on the CP Notes will continue to be capitalized until the CP Notes are refunded on a long-term basis with lease revenue bonds.
The payment of principal and interest on the CP Notes is supported by a direct-pay letter of credit (LOC) provided by U.S. Bank and additionally secured by a pledge of lease payments received by the Authority from the City pursuant to a sublease of certain real property 2 owned by the City. The
LOC is scheduled to expire on March 24, 2025. See Attachment A for a description of the structure of the CSJFA CP Program along with a summary of the CP Program amendments since inception in 2004. See Attachment B for the technical aspects of the commercial paper process.
On June 22, 2021
3, the City Council authorized the issuance of CP Notes in an amount not to exceed $95 million to provide funding for energy costs for San José Clean Energy. The City subsequently issued $60 million under that $95 million authorization; the San José Clean Energy Department has repaid $40 million of that $60 million, leaving a balance of $20 million outstanding.
ANALYSIS
Project Description
The project includes the demolition of all three existing buildings, the parking lot, and the communication tower and construction of two new buildings consisting of a two-story office building, an adjacent storage building, a new communication pad and tower, and a new parking lot (Project). The two-story office building area will be 22,280 square feet and the storage building
1 As of the commercial paper roll date on April 18, 2023. 2 Properties include Animal Care Center, Fire Stations #1 and #3, Police Communication Center, South San José Police Substation, and Tech Museum.
3 City Council June 22, 2021, Issuance of City of San Jose Financing Authority Commercial Paper Notes for San Jose Clean Energy Operations and Related Budget Action
https://sanjose.legistar.com/LegislationDetail.aspx?ID=4980087&GUID=62F1A065-8718-4987-BF48- 8D127C0803E5&Options=ID|Text|&Search=san+jose+clean+energy
HONORABLE MAYOR AND CITY COUNCIL
May 30, 2023
Subject: Issuance of City of San José Financing Authority Commercial Paper Notes
area will be 6,000 square feet. Site work includes construction of 99 required parking spaces, Americans with Disabilities Act stalls, electric vehicle and electric vehicle capable stalls, and clean air vehicle stalls for staff and the public. There will also be an emergency generator. Site amenities are expected to include conference and training rooms; a customer service and payment area; a water quality laboratory; a map room for utility plans and documents; a warehouse for equipment, materials, and parts; a welding shop for metalwork and fabrication needs; adequate parking for staff, City vehicles, and visitors; and site security systems and fencing.
Debt Management Policy and San José Municipal Code Requirements Related to Lease Financings
The plan to issue CP Notes to finance the construction costs of the Project is subject to the City Debt Management Policy, City Council Policy 1-15 and San José Municipal Code Chapter 4.34 related to lease financings. Under Section III (D) of the Debt Management Policy, the Finance Department is required to conduct its due diligence for the proposed lease financing and identify a source of repayment. The Debt Management Policy requires a feasibility study be performed prior to the issuance of lease financing; however, such requirement is not applicable to the issuance of the CP Notes when project revenues are not identified as repayment sources. In this case, Project revenues are not the sources of repayment of the CP Notes, therefore a feasibility study is not required prior to the issuance of this financing.
UNDER BOTH THE DEBT MANAGEMENT POLICY AND SAN JOSE MUNICIPAL CODE SECTION 4.34.200, APPROVAL OF THE ISSUANCE OF THESE CP NOTES REQUIRES A TWO-THIRDS VOTE BY THE CITY COUNCIL (EIGHT VOTES).
Source of Repayment/Funding
The CP Notes issued and capitalized interest owed for the identified purposes are expected to be repaid through the issuance of lease revenue bonds in the future. It is important to note fees associated with the CP Notes will be paid by the Water Utility Capital Fund.
Authorization to Issue Commercial Paper Notes
To authorize the issuance of CP Notes, the City Council will hold a duly noticed public hearing in accordance with Section 6586.5 of the California Government Code, and will consider whether the financing of the Project will result in significant public benefits accruing from such financing. The public hearing will allow the City Council and Authority Board to hear and consider information concerning the approval of the financing by the Authority and the City for the issuance of CP Notes for the Project. No later than five days before the public hearing to be held by the City Council on June 20, 2023, a notice advertising the hearing will be published in the San José Post- Record. Per Section 6586 of the California Government Code, "significant public benefits" means any of the following benefits to the citizens of the local agency:
(a) Demonstrable savings in effective interest rate, bond preparation, bond underwriting, or bond issuance costs;
HONORABLE MAYOR AND CITY COUNCIL
May 30, 2023
Subject: Issuance of City of San José Financing Authority Commercial Paper Notes
(b) Significant reductions in effective user charges levied by a local agency; (c) Employment benefits from undertaking the project in a timely fashion; or (d) More efficient delivery of local agency services to residential and commercial development.
The issuance of CP Notes to finance the proposed Project will result in significant public benefits accruing from such financing within the meaning of said Section 6586, consisting of, among other things, reduced financing cost. Such reduced financing cost are due to the Authority’s ability to issue additional CP Notes under its existing program whereas the City would be required to create a new financing program to issue certificates of participation or incur other debt that typically require lead times in excess of the time when funds are needed by the City to commence the Project. No amendments to the documents that established the CP Program are necessary.
Utilization of the CP Program
The CP Program has a total capacity of $175 million. Of that $175 million, $107.815 is currently authorized which includes an outstanding balance of approximately $26.4 million. San José Clean Energy holds $20 million of this outstanding amount, with Parks, Recreation, and Neighborhood Services holding the remaining outstanding $6.4 million.
Staff recommends the City Council authorize the issuance of $40 million of CP Notes to fund the new Muni Water Administration and Operations Building, and related capital improvements.
Concurrently, staff recommends the reduction of the San José Clean Energy CP Notes authorization, by $20 million, from the current $95 million to $75 million, which will result in CP carrying fee savings for San José Clean Energy and free up CP capacity for other City use.
The table below illustrates CP Notes outstanding, remaining authorization, and proposed authorization actions by project. With the proposed changes to commercial paper authorization, utilization of the CP Program will total $127.8 million, with $47.2 million remaining in unutilized capacity.
HONORABLE MAYOR AND CITY COUNCIL
May 30, 2023
Subject: Issuance of City of San José Financing Authority Commercial Paper Notes
Authority4 CP Program as of May 26, 2023
($175 million Capacity)
* $500,000 projected to be issued in June 2023.
** One time authorization of $10 million. CP Notes issued are amortized over seven years. Approximately $700,000 will be paid on the outstanding principal of $6,415,000 in June 2023.
Risks Associated with the CP Program
The CP Program is subject to the following risks:
• LOC Renewal Risk - Should U.S. Bank decide not to renew the LOC upon expiration in March 2025 and no replacement banks are identified, the CP Notes outstanding will need to be repaid in full. The General Fund is ultimately responsible for the repayment of outstanding notes. LOC fees are subject to change at future renewal dates based on market conditions.
• Interest Rate Risk - The interest rates on the CP Notes currently are much higher than a year ago, and may increase depending on general interest rate trends, factors affecting the
4 The Authority was created by a Joint Exercise of Powers Agreement between the City and the Authority. The Authority was created for the purpose of facilitating the financing of public improvements and facilities within the City and is authorized to issue bonds and CP N otes for this purpose. The Authority is governed by an 11 -member Governing Board, which consists of the members of the City Council and the Mayor. 5 February 13, 2018, Issuance of City of San José Financing Authority Commercial Paper Notes for the Flood Recovery Construction Projects of City Improvements
https://sanjose.legistar.com/LegislationDetail.aspx?ID=3321204&GUID=ABD27748-FA4F-44BF-BF9E- 9C6274C49FBD&Options=&Search=
6 See Footnote #3 on page 3.
7 June 21, 2016, Issuance of City Of San José Financing Authority Commercial Paper Notes for Purchase of Energy Conservation Equipment, https://records.sanjoseca.gov/Resolutions/RES77836.PDF, https://records.sanjoseca.gov/Resolutions/RES130.PDF
Project
CP
Outstanding
Remaining CP
Authorization
CP Outstanding
& Authorized
Proposed
Authorization
CP Program
Utilization
A B C = A + B D E = C + D
Flood Improvement Recovery –
Parks, Recreation, and
Neighborhood Services5,*
$6,400,000 $6,400,000 $6,400,000
Energy Purchases – San José
Clean Energy6
20,000,000 75,000,000 $95,000,000 (20,000,000) 75,000,000 Energy Service Company
(ESCO) Conservation Project –
Public Works7,**
6,415,000 $6,415,000 6,415,000
Muni Water Building
Infrastructure – Environmental
Services Department
40,000,000 40,000,000
Totals $26,415,000 $81,400,000 $107,815,000 $20,000,000 $127,815,000
HONORABLE MAYOR AND CITY COUNCIL
May 30, 2023
Subject: Issuance of City of San José Financing Authority Commercial Paper Notes
supply and demand for short-term paper, and investor perceptions on the course of future interest rates or investor perceptions about the bank providing the LOC.
• Downgrade Risk – U.S. Bank’s credit ratings may be downgraded in the future due to changes in the market's perception of the financial health of the bank. To the extent a downgrade occurs, the CP Notes may become unmarketable. Additionally, if the City is downgraded by any of the credit rating agencies, the annual fees for the LOC backing the CP Notes may be increased based on a schedule agreed to by U.S. Bank, the Authority, and the City.
• Marketability Risk - If there is a lack of market demand for CP Notes, the Authority may not be able to roll the notes for additional terms.
The payment of principal and interest on the CP Notes are ultimately backed by lease payments to be made by the City to the Authority for certain real properties with a total insured replacement value of approximately $216.3 million as of June 2022. If any such leased properties in the future become unavailable for the City's continued beneficial use and occupancy, replacement real property owned by the City may need to be identified in order for the maximum principal amount of CP Notes not to be reduced. Replacement assets require approval by U.S. Bank and are subject to certain conditions set forth in the documents related to the CP Notes.
EVALUATION AND FOLLOW-UP
The Finance Department plans on issuing lease revenue refunding bonds in the near future to, in part, refund the CP Notes issued for this Project and potentially refund CSJFA Lease Revenue Bonds, Series 2013B. No additional evaluation or follow-up to the City Council or the Authority Board is anticipated
.
COST SUMMARY/IMPLICATIONS
On June 20, 2023, City Council will also consider approving the Initial Study/Mitigated Negative Declaration for the Project and authorizing the Director of Public Works to award a construction contract concurrently with this request to authorize the issuance of CP Notes to fund the Project.
Staff requests to issue an amount not to exceed $40 million in CP Notes to fund this Project. The interest owed on the CP Notes will be capitalized and added to the CP Notes outstanding balance until the CP Notes are refunded on a long-term basis with lease revenue bonds. Applicable commercial paper fees estimated to be $225,000 will be paid by the Muni Water Utility Capital Fund in Fiscal Year 2023-2024. The commercial paper issuance and fee payments have been incorporated into the 2023-2024 Proposed Capital Budget.
HONORABLE MAYOR AND CITY COUNCIL
May 30, 2023
Subject: Issuance of City of San José Financing Authority Commercial Paper Notes
COORDINATION
This memorandum has been coordinated with the City Attorney’s Office and the City Manager’s Budget Office.
PUBLIC OUTREACH
This memorandum will be posted on the City’s Council Agenda website for the June 20, 2023 City Council meeting.
COMMISSION RECOMMENDATION AND INPUT
No commission recommendation or input is associated with this action.
CEQA
Initial Study/Mitigated Negative Declaration, File No. ER22-114 (Muni Water New Offices Project). Not a Project, File No. PP17-003, Agreements/Contracts (new or amended) resulting in no physical changes to the environment.
PUBLIC SUBSIDY REPORTING
This item does not include a public subsidy as defined in section 53083 or 53083.1 of the California Government Code or the City’s Open Government Resolution.
/s/ /s/ /s/
RICK BRUNEAU
KERRIE ROMANOW MATT LOESCH
Director of Finance Director of Environmental Acting Director of Services Department Public Works
For questions on the commercial paper financial transaction, please contact Qianyu Sun, Deputy Director of Finance, Debt and Treasury, at (408) 535-7832. For questions on the programmatic use of the new Muni Water Administration and Operations facilities, please contact Napp Fukuda, Assistant Director of Environmental Services Department, at (408) 793-5353. For questions on the construction aspects of the project, please contact Matt Loesch, Acting Director of Public Works, at (408) 975-7381.
Attachment A – Structure of the City of San José Financing Authority Commercial Paper Program and Summary of Program Amendments since Inception in 2004 Attachment B – Technical Aspects of Commercial Paper
Attachment A
Structure of City of San José Financing Authority Commercial Paper Program and Summary of Program Amendments since Inception in 2004
The City leases to the City of San José Financing Authority (Authority or CSJFA) various City- owned facilities pursuant to a Site Lease (as amended, the “Site Lease”). The Authority subleased these same facilities back to the City pursuant to a Sublease (as amended, the “Sublease”) in exchange for the rental payments which support repayment of the commercial paper (CP) Notes. The facilities subject to the Site Lease and Sublease are the Animal Care Center, Fire Station No. 1, Fire Station No. 3, the Police Communication Center, the South San José Police Substation, and the Tech Museum.
The Authority issues the CP Notes under the Marks-Roos Local Bond Pooling Act of 1985 pursuant to an Amended and Restated Trust Agreement between the Authority and Wells Fargo Bank, National Association (as amended and supplemented, the “Trust Agreement”) and a Second Amended and Restated Issuing and Paying Agent Agreement between the Authority and Wells Fargo Bank, National Association. Barclays Capital, Inc. serves as the dealer for the CP Notes pursuant to an Amended and Restated Commercial Paper Dealer Agreement. The CP Notes are currently secured by a direct-pay letter of credit (LOC) from U.S. Bank, pursuant to a Letter of Credit and Reimbursement Agreement among U.S. Bank, the City, and the Authority (as amended, the “Letter of Credit Agreement”). Under its LOC, U.S. Bank is responsible for payments on all draws made on the applicable LOC. The LOC is issued in the principal amount of $175 million plus interest calculated at the maximum rate of 12% for a period of 270 days.
The CP Program was established in January 2004 and has been amended, expanded, and contracted through City Council and Authority Board actions summarized below.
October 21, 2008 Authorized the issuance of CP Notes to refund bonds and other obligations of the City or the Authority pursuant to Government Code Sections 53570 et seq and 53580 et seq.
Date City Council/City of San José Financing Authority Board Actions January 13, 2004 Authorized the issuance of tax-exempt CP Notes in an amount not to exceed $98 million to finance public improvements of the City including the offsite parking garage for the new City Hall and non-construction costs for technology, furniture, equipment, and relocation services for the new City Hall.
November 9, 2004 Authorized the issuance of tax-exempt CP Notes to provide additional funding for the “Integrated Utility Billing, Customer Service and Performance Management System” (the “CUSP Project”).
June 21, 2005 Authorized the issuance of taxable CP Notes, under the same $98 million not to exceed limitation as the tax-exempt notes. This subsequent authorization permits the Authority to issue taxable CP Notes to pay for expenses otherwise authorized under the CP Program, but ineligible to be paid from tax-exempt CP proceeds.
November 15, 2005 Authorized expanding the capacity of the CP Program from $98 million to $116 million and authorizing the issuance of CP Notes to pay a portion of the costs of the Phase II improvements at the City’s Central Service Yard and a portion of the demolition and clean-up costs at the City’s Main Service Yard.
Date City Council/City of San José Financing Authority Board Actions December 8, 2009 Authorized staff to amend and renew the Letter of Credit and Reimbursement Agreement supporting the CP Notes to extend the term to January 27, 2013.
April 20, 2010 Authorized the issuance of CP Notes to fund a loan to the low- and moderate- income housing fund and to fund short-term cash flow needs of the City.
March 15, 2011 Authorized the execution and delivery of a Third Amendment to the Site Lease, a Third Amendment to the Sublease, and other related actions pertaining to the Authority’s Lease Revenue Commercial Paper Program to provide for the substitution of certain components of the property under the Site Lease and the Sublease.
June 19, 2012 Authorized the issuance of CP Notes in an amount not to exceed $10.0 million to provide funding for additional projects for the Convention Center Expansion and Renovation project.
December 4, 2012 Authorized staff to amend and restate the Letter of Credit and Reimbursement Agreement supporting the CP Notes to extend the term to March 15, 2013.
February 12, 2013 Authorized staff to negotiate two new Letter of Credit and Reimbursement Agreements supporting the CP Notes; and authorized the execution and delivery of a Fourth Amendment to the Site Lease, a Fourth Amendment to the Sublease, and other related actions pertaining to the Authority’s Lease Revenue Commercial Paper Program to provide for the substitution of certain components of the property under the Site Lease and the Sublease. The facilities currently subject to the Site Lease and Sublease are: the Animal Care Center, Fire Station No. 1, Fire Station No. 3, the Police Communications Center, and the South San José Police Substation.
June 17, 2014 Authorized the Fifth Amendment to the Site Lease, a Fifth Amendment to the Sublease, and other related actions to provide for the addition of a component of property (the Tech Museum) under the Site Lease and the Sublease in connection with the City of San José Financing Authority's Lease Revenue Commercial Paper Program to provide additional security.
September 15, 2015 Authorized the issuance of CP Notes in an amount not to exceed $3.5 million to provide funding for the Municipal Water System’s Water Meter Replacement project.
June 21, 2016 Authorized the issuance of CP Notes in an amount not to exceed $10.0 million to provide funding for Energy Conservation Company (ESCO) projects.
January 31, 2017 Authorized the issuance of CP Notes in an amount not to exceed $15.0 million to provide funding for the Convention Center Exhibit Hall project.
August 29, 2017 Authorized the issuance of CP Notes in an amount not to exceed $10.0 million to provide funding for startup costs relating to San José Clean Energy.
Date City Council/City of San José Financing Authority Board Actions February 13, 2018 Authorized the issuance of CP Notes in an amount not to exceed $21.0 million to provide funding for the flood recovery and construction for parks and community facilities.
August 14, 2018 Authorized the issuance of CP Notes in an amount not to exceed $47.0 million to provide funding for the purchase of Convention Center - South Hall site and amendments of the two Letter of Credits and Reimbursement Agreements.
August 14, 2018 Authorized the negotiation, execution, and delivery of amendments to two Letter of Credit and Reimbursement Agreements and authorizing other related actions in connection with the City of San José Financing Authority’s Lease Revenue Commercial Paper Notes to increase the not-to-exceed aggregate principal amount thereof from $85 million to $125 million and to extend the stated expiration dates and commitments available under such Letter of Credit and Reimbursement Agreements.
January 12, 2021 Authorized the issuance of CP Notes in an amount not to exceed $23.4 million to provide bridge funding for the Fire Training Center and Emergency Operations Relocation project.
June 22, 2021 Authorized the issuance of CP Notes in an amount not to exceed $95.0 million to provide funding for energy costs for the San José Clean Energy department and deauthorized $7.8 million for the Parks Floods Recovery projects to dedicate that amount to the San José Clean Energy CP authorization amount.
August 31, 2021 Authorized the negotiation, execution, and delivery of amendments to a Letter of Credit and Reimbursement Agreement and authorizing other related actions in connection with the City of San José Financing Authority’s Lease Revenue Commercial Paper Notes to increase the not-to exceed aggregate principal amount thereof from $125 million to $175 million and to extend the stated expiration date and commitment available under such Letter of Credit and Reimbursement Agreement to March 2025.
October 5, 2021 Deauthorized the issuance of CP Notes for $23.4 million for the Fire Training Center and Emergency Operations Relocation project upon the issuance of CSJFA Lease Revenue Bonds, Series 2021A (Fire Department Training Center and Central Service Yard projects).
Attachment B
Technical Aspects of Commercial Paper
The Mechanics of Commercial Paper
Commercial paper is debt that is sold with a maturity of between 1 and 270 days. The maturity of an individual commercial paper note is determined by the commercial paper dealer and the issuer at the time it is sold. Each commercial paper note bears interest at a fixed rate for the 1-270 day period it is outstanding; or is sold at a discount, and such interest or discount is payable when the note matures. The procedures for the payment of interest on the commercial paper are described below under “Payment of Principal and Interest on Commercial Paper”.
Municipal commercial paper programs typically require the issuer to obtain credit support through one of more letters of credit provided by a commercial bank. Upon each note maturity, the paying agent is authorized and required to draw on the supporting letter of credit in the amount of principal and interest due on that date. The issuer may then “roll over” the commercial paper notes by issuing renewal notes and using the proceeds of the renewal notes to reimburse the draw on the letter of credit. To the extent that the commercial paper dealer is unable to find an investor for the renewal notes, the draw on the letter of credit remains unreimbursed and the issuer is responsible for repaying the bank or banks that provided the letter of credit. The terms and conditions governing the letter(s) of credit and the reimbursement process are memorialized in a reimbursement agreement entered into between the issuer and the bank or bank(s) that provided the letter of credit.
The renewal notes may be sold through a commercial paper dealer either to a new investor or to the investor who held the maturing note. The process of rolling over commercial new paper is not considered to be the issuance of additional debt if the amount of commercial paper outstanding is not increased as a result of the “roll over.” Through the “roll over” mechanism, commercial paper can be kept outstanding indefinitely, as individual commercial paper notes continually mature and new commercial paper notes are issued.
Commercial paper is considered a form of variable-rate debt. Even though the interest rate on each commercial paper note is fixed at the time such note is issued, the rate on each commercial paper note will be based on market conditions at the time. The rates on new commercial paper notes will thus vary from one week or month to another. The actual cost of the program to the issuer will be the average rate on all its outstanding commercial paper notes over time. Most issuers project such average rates on a quarterly or annual basis. Overall, commercial paper rates tend to be among the lowest available in the tax-exempt and taxable markets for municipal debt.
The buyers of commercial paper are considered short-term investors because their investments in commercial paper mature in 270 days or less. One of the attractive features commercial paper offers to an investor is that the maturities can be matched to the specific timing needs of an investor (such as 27 days, or 112 days). This helps an investor invest amounts for a very precise period until such funds are needed for a specific known payment obligation in the future. Buyers of commercial paper include major corporations and money market funds. Commercial paper is attractive to money market funds because it complies with the maturity limitations imposed on such funds, and the flexibility in setting the maturity of commercial paper may help the fund achieve or maintain the average maturity it is seeking. Money market funds are likely to continue
to buy a given issue of commercial paper as it rolls over, and thus may own an issue for an extended period.
Payment of Principal and Interest on Commercial Paper
Commercial paper is not sold with a fixed principal repayment schedule. Instead, the issuer maintains almost complete flexibility with respect to the timing and amounts in which the principal amount of commercial paper will be repaid. The issuer can repay commercial paper on any date on which a commercial paper note is scheduled to mature by providing the funds to repay such note to the paying agent for the issue. The paying agent uses such funds to pay the holder of the commercial paper. At the same time, the issuer instructs its commercial paper dealer not to attempt to sell new commercial paper to roll over the paper that is maturing. Hence, when such steps are taken, the amount of commercial paper outstanding at the end of the day is reduced.
The individual commercial paper notes are likely to have different maturities, so an issuer repaying a commercial paper program would do so in a series of steps as the individual notes mature. However, since each note would have a maximum maturity of 270 days, an entire program could be repaid at the option of the issuer in not more than 270 days from the time the issuer decided to commence such a repayment. It is likely that an issuer planning to repay an amount in the near future would instruct its commercial paper dealer to issue the paper with short maturities as it rolls over, so that the issuer could retire the commercial paper quickly when it begins the repayment process.
As noted above under “The Mechanics of Commercial Paper,” interest or discount is payable on each commercial paper note as it matures. During the construction period for a project, the interest payable can be “capitalized” by adding the amount of interest due on the maturing commercial paper to the amount of new paper being sold. If this approach is used, the principal amount of paper outstanding over time will increase as additional interest is capitalized (subject to the maximum authorized amount of notes permitted to be outstanding at any one time under the program).
Interest on tax-exempt debt generally cannot be capitalized following completion of the projects financed with commercial paper. At that point, the issuer must provide to the paying agent the interest due at the time each note matures. The paying agent then pays such interest to the investor together with the proceeds received from rolling over the principal amount of the commercial paper. Since the interest at that point is being paid by the issuer, and not by increasing the amount of paper being rolled over, the principal amount of commercial paper outstanding will stay constant after the projects are completed. That principal amount outstanding could either be reduced in the future if the issuer decides to repay some, or all, of the program, or increased if the issuer decides to undertake additional projects (which may require an increase in the authorized amount of the program).