TO: HONORABLE MAYOR
AND CITY COUNCIL AND CITY
OF SAN JOSE FINANCING
AUTHORITY BOARD
FROM: Maria Öberg
Jeffrey Provenzano
SUBJECT: See Below DATE: April 14, 2025
Approved
Date:
4/22/25
COUNCIL DISTRICT: Citywide
SUBJECT: Issuance of City of San José Financing Authority Commercial Paper for the Advanced Metering Infrastructure System
RECOMMENDATION
(a) 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 Advance Metering Infrastructure project (AMI Project), a system-wide upgrade of approximately 27,000 water meters to a cellular based advanced metering infrastructure system within the City of San José Municipal Water System, 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.
(b) 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 $23,000,000 to finance the purchase and installation of the AMI Project for the City of San José Environmental Services Department Water Resources Division.
(c) 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 $23,000,000 to finance the purchase and installation of the AMI Project for the City of San José Environmental Services Department Water Resources Division.
COUNCIL AGENDA: 5/6/25
FILE: 25-476
ITEM: SJFA 2
HONORABLE MAYOR AND CITY COUNCIL AND CITY OF SAN JOSE FINANCING AUTHORITY BOARD
April 14, 2025
Subject: Issuance of City of San José Financing Authority Commercial Paper Notes
SUMMARY AND OUTCOME
Approval of these recommendations will allow the City of San José Financing Authority (CSJFA) to issue commercial paper notes (CP Notes) to finance the purchase and installation of the AMI Project for the City of San José Environmental Services Department Water Resources Division.
BACKGROUND
City of San José Financing Authority
The Authority is a joint exercise powers authority created pursuant to Section 6500 et seq. of the California Government Code and a joint exercises of powers agreement, dated December 8, 1992, by and between the City and the former Redevelopment Agency of the City of San José (the Former Agency), for the purpose, among others, of having the Authority issue its instruments of debt to finance the acquisition, construction and improvement of certain public capital improvements. The Former Agency was dissolved as of February 1, 2012 and the City has become the successor agency to the Former Agency pursuant to Part 1.85 of Division 24 of the California Health and Safety Code. The joint exercise of powers agreement establishing the Authority remains in effect.
The City Council is the governing board of the Authority. The City Manager is the Executive Director, the City Clerk is the Secretary, and the Director of Finance is the Treasurer.
San José Municipal Water System
The San José Municipal Water System (SJMWS) provides drinking water to portions of the City of San José (City) across four major service areas: North San José/Alviso, Evergreen, Edenvale, and Coyote Valley. SJMWS is one of three retail water suppliers in the City, providing potable and recycled water service to 27,000 metered connections with a service population of approximately 143,000 residents, which is roughly 12% of the City. As a critical utility within Silicon Valley, SJMWS is committed to delivering reliable, efficient, and sustainable water services to meet current and future demands.
Water supply challenges, including climate variability, droughts, and population growth contribute to stress on water resource availability. Most of SJMWS’ water supply comes from imported water purchased from two wholesale agencies. Additionally, new regulatory framework “Making Conservation a California Way of Life” includes standards-based budgets for efficient use of water in each sector, including indoor and outdoor residential, commercial, and industrial uses, as well as distribution system water loss.
HONORABLE MAYOR AND CITY COUNCIL AND CITY OF SAN JOSE FINANCING AUTHORITY BOARD
April 14, 2025
Subject: Issuance of City of San José Financing Authority Commercial Paper Notes
The AMI Project, supported by engineering studies and findings by the City Auditor’s Office, will implement a system-wide upgrade of approximately 27,000 water meters to a cellular based AMI system within the City of San José Municipal Water System.
Completion of the project will have multiple benefits, including providing customer resources to increase affordability, improve customer service, track and reduce water usage, and identify leaks within home plumbing; increasing the efficient use of water supply sources by allowing real-time tracking and identification of use trends, leaks, and other contributing factors; and better enabling the water utility to meet stringent water use reduction levels issued by the State of California.
The total project cost is estimated to be $24 million. Staff recommends short-term financing through the City’s existing commercial paper program to reduce immediate significant cost impacts on SJMWS ratepayers. The City will issue tax exempt CP Notes for this project which will be amortized over a 10-year period.
Commercial Paper Program
The Commercial Paper Program (CP Program) utilizes a lease revenue financing structure. Under this program, the CSJFA 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 CSJFA 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 five 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 be paid upon maturity of the CP Notes.
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, National Association (U.S. Bank) and additionally secured by a pledge of lease payments received by the CSJFA from the City pursuant to a sublease of certain real property
2 owned by the City. The current
LOC is scheduled to expire on June 20, 2025. The Finance Department is negotiating a new LOC with TD Bank, N.A. (TD Bank) and expects to have that agreement executed before the expiration of the U.S. Bank LOC.
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 CP process.
1 Rate estimates as of March 4, 2025.
2 Pledged properties include Animal Care Center, Fire Stations #1 and #3, Police Communication Center, South San José Police Substation, and Tech Museum.
HONORABLE MAYOR AND CITY COUNCIL AND CITY OF SAN JOSE FINANCING AUTHORITY BOARD
April 14, 2025
Subject: Issuance of City of San José Financing Authority Commercial Paper Notes
ANALYSIS
Project Description
The project will implement system improvements by installing AMI technology. Doing so will help SJWMS meet water conservation targets, improve customer service, and improve efficiency in operations and maintenance of the water distribution system. The project involves all 27,000 SJMWS customers and includes procurement of metering equipment (including meter bodies, registers, communication endpoints, replacement meter box lids, and other miscellaneous materials), configuration of associated hosted software components, and installation services for complete replacement of existing metering infrastructure. The project is expected to take 2-3 years to complete.
Debt Management Policy and San José Municipal Code Requirements Related to Lease Financings
The plan to issue CP Notes to finance the costs of the AMI Project is subject to the City’s Debt Management Policy, City Council Policy 1-15 and San José Municipal Code Chapter 4.34 related to lease financings.
Per Section III (B) of the Debt Management Policy, the City Council may authorize the use of short-term financing vehicle with maturity longer than seven years consistent with the useful life of the financed project if use of a short-term financing vehicle would be a beneficial component of the applicable debt portfolio. The AMI Project is not eligible for long-term financing and expects a useful life of approximately 15 to 20 years upon completion. Staff recommends an amortization schedule of 10 years.
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 in which project revenues are identified as the repayment source. The Water Utility Capital Fund will be the source of payment for the proposed CP notes. A feasibility study is not required because the AMI Project is not identified as a repayment source as it will not generate significant project revenues.
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).
HONORABLE MAYOR AND CITY COUNCIL AND CITY OF SAN JOSE FINANCING AUTHORITY BOARD
April 14, 2025
Subject: Issuance of City of San José Financing Authority Commercial Paper Notes
Source of Repayment/Funding
The CP Notes issued for the AMI Project, including interest and all associated fees, are expected to be paid by transfers from the Water Utility Capital Fund, which is funded by Municipal Water System customer user charges and applied to capital improvements of the Municipal Water System The principal amount will be repaid over 10 years after the AMI Project is completed. The projected amortization period starts in 2027-2028 and ends in 2036-2037. In the event Municipal Water funds are insufficient, repayment could be made from any legally available funds of the City.
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 AMI Project will result in significant public benefits accruing from such financing. The public hearing will allow the City Council and CSJFA Board to hear and consider information concerning the approval of the financing by the CSJFA and the City for the issuance of CP Notes for the AMI Project. No later than five days before the public hearing to be held by the City Council on May 6, 2025, 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;
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 AMI Project will result in significant reductions in user charges levied for the customers of SJMWS, supported by the ability to track and reduce water usage, and identify leaks within home plumbing. Installation of the AMI Project will also create employment benefits for the local economy. Additionally, SJMWS will more efficiently deliver services to residential and commercial customers by allowing real-time tracking and identification of use trends, leaks, and other factors.
HONORABLE MAYOR AND CITY COUNCIL AND CITY OF SAN JOSE FINANCING AUTHORITY BOARD
April 14, 2025
Subject: Issuance of City of San José Financing Authority Commercial Paper Notes
Utilization of the CP Program
The CP Program has a total capacity of $175 million. The amount of CP Notes currently authorized is $125.7 million.
The table below illustrates CP Notes outstanding, remaining authorization and proposed authorization actions by project. With the proposed authorization of $23 million for the AMI Project, utilization of the CP Program will total $148.7 million, with $26.3 million remaining in unutilized capacity.
CSJFA CP Program as of March 6, 2025
($175 million Capacity)
Risks Associated with the CP Program
The CP Program is subject to the following risks:
• LOC Renewal Risk – If the LOC expires and the City is not able to execute a replacement LOC in time, the CP Notes outstanding will need to be repaid in full.
The General Fund is ultimately responsible for the repayment of outstanding CP Notes. LOC fees are also subject to change at future renewal dates based on market conditions.
Project
CP Notes
Outstanding
Remaining
Authorization
Outstanding &
Authorized
Proposed
Authorization
Program
Utilization
A B C = A + B D E = C + D
Flood Improvement
Recovery – Parks,
Recreation, Neighborhood
Services
$652,000 $5,031,000 $5,683,000 $5,683,000
Energy Purchases – San
José Clean Energy
$75,000,000 $75,000,000 $75,000,000
ESCO Conservation
Project – Public Works
$5,015,000 $5,015,000 $5,015,000
Muni Water Building
Infrastructure –
Environmental Services
Department
$40,000,000 $40,000,000 $40,000,000
Muni Water Advanced
Metering Infrastructure –
Environmental Services
Department
$23,000,000 $23,000,000
Totals $5,667,000 $120,031,000 $125,698,000 $23,000,000 $148,698,000
HONORABLE MAYOR AND CITY COUNCIL AND CITY OF SAN JOSE FINANCING AUTHORITY BOARD
April 14, 2025
Subject: Issuance of City of San José Financing Authority Commercial Paper Notes
• Interest Rate Risk - The interest rates on the CP Notes vary depending on general interest rate trends, factors affecting the 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 – Credit ratings of the bank providing the LOC may be downgraded 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 commitment fees for the LOC backing the CP Notes may be increased based on a schedule agreed to by the bank, the CSJFA, and the City.
• Marketability Risk - If there is a lack of market demand for CP Notes, the CSJFA may not be able to roll the CP 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 CSJFA for certain real properties with a total insured replacement value of approximately $221.6 million as of June 2024. 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 the LOC provider bank and are subject to certain conditions set forth in the documents related to the CP Notes.
Climate Smart Analysis
The actions recommended in this memorandum support the City’s Climate Smart goals by facilitating a reduction of water use consumption and increasing water use efficiency in homes and commercial buildings throughout the San José Municipal Water System service area. Completion of the AMI Project will realize multiple benefits, including alerting customers and the utility of water leaks or usage increases in compliance with State of California water efficiency regulations.
EVALUATION AND FOLLOW-UP
Staff from Environmental Services Department and Finance Department will be available to answer questions at the joint meeting of the City Council and the City of San José Financing Authority Board on May 6, 2025.
HONORABLE MAYOR AND CITY COUNCIL AND CITY OF SAN JOSE FINANCING AUTHORITY BOARD
April 14, 2025
Subject: Issuance of City of San José Financing Authority Commercial Paper Notes
COST SUMMARY/IMPLICATIONS
Additionally, on the May 6, 2025 agenda, staff seeks City Council approval to award the construction contract for the AMI Project concurrently with this request to authorize the issuance of commercial paper to fund a portion of the project. Staff requests to issue an amount not to exceed $23 million in CP Notes to fund the AMI Project. The interest and fees owed on the CP Notes are estimated to be $6.9 million. The total cost for the AMI project, including financing costs, is estimated to be $31 million. The Water Utility Capital Fund will pay for the principal and associated fees and interest over a twelve- year period.
Currently, there is $24.5 million budgeted in financing proceeds attributed to two different projects utilizing commercial paper – AMI project and the Water Resources Administration and Operations Facility. Actions to align the budget for the AMI projects beyond 2024-2025 will be included in the 2025-2027 Proposed Biennial Capital Budget which will be released in late April.
COORDINATION
This report was prepared by the Finance Department and Environmental Services Department in coordination 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 May 6, 2025 City Council meeting.
COMMISSION RECOMMENDATION AND INPUT
No commission recommendation or input is associated with this action.
CEQA
Categorically Exempt, File No. ER25-032, CEQA Guidelines Section 15301 - Existing Facilities.
HONORABLE MAYOR AND CITY COUNCIL AND CITY OF SAN JOSE FINANCING AUTHORITY BOARD
April 14, 2025
Subject: Issuance of City of San José Financing Authority Commercial Paper Notes
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/
MARIA ÖBERG JEFFREY PROVENZANO
Director of Finance Director of Environmental Services
For questions on the CP 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 AMI Project, please contact Jeffrey Provenzano, Director of Environmental Services Department at [email protected].
ATTACHMENTS
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 Notes
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 (CSJFA) various City-owned facilities pursuant to a Site Lease (as amended, the Site Lease). The CSJFA 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 CSJFA issues the CP Notes under the Marks-Roos Local Bond Pooling Act of 1985 pursuant to an Amended and Restated Trust Agreement between the CSJFA and Computershare Trust Company, National Association (as successor in interest to Wells Fargo Bank, National Association), as Trustee, as amended, restated, supplemented r otherwise modified from time to time (the Trust Agreement) and a Third Amended and Restated Issuing and Paying Agent Agreement between the CSJFA and Computershare Trust Company, 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 LOC from U.S.
Bank, pursuant to a Letter of Credit and Reimbursement Agreement among U.S. Bank, the City, and the CSJFA (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 CSJFA Board actions summarized below.
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.
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 CSJFA 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.
May 22, 2007
October 21, 2008
Authorized the issuance of CSJFA CP Notes in an amount not to exceed $8.25 million to pay for capital improvements at the City’s HP Pavilion (Arena).
Authorized the issuance of CP Notes to refund bonds and other obligations of the City or the CSJFA pursuant to Government Code Sections 53570 et seq and 53580 et seq.
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 27, 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 CSJFA’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 CSJFA’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.
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.
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 CSJFA'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 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.
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 CSJFA’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 CSJFA’s Lease Revenue Commercial Paper Notes to increase the not-to exceed aggregate principal amount thereof from $125 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
June 20, 2023
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).
Authorized the issuance of CP Notes in an amount not to exceed $40 million for the purpose of financing the construction of the Administration and Operations Building and the acquisition, construction, and installation of related capital projects for the Water Resources Division.
Deauthorized $20 million CP Notes allocated to San José Clean Energy to lower the authorized amount from $95 million to $75 million CP Notes outstanding at any time.
February 14, 2025 Extended Letter of Credit with U.S. Bank from March 25, 2025 to June 20, 2025.
ATTACHMENT B
Technical Aspects of Commercial Paper Notes
The Mechanics of Commercial Paper Notes
Commercial Paper (CP) Notes are a form of debt that is sold with a maturity of between 1 and 270 days. The maturity of CP Notes is determined by the CP dealer and the issuer at the time it is sold. CP Notes bear interest at a fixed rate for the 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 CP Notes are described below under “Payment of Principal and Interest on Commercial Paper Notes” section.
Municipal CP programs typically require the issuer to obtain credit support through one or more letters of credit provided by a commercial bank. Upon each CP 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 CP 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 CP 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 CP Notes may be sold through a CP dealer either to a new investor or to the investor who held the maturing note. The process of rolling over new CP Notes is not considered to be the issuance of additional debt if the amount of CP Notes outstanding is not increased as a result of the “roll over.” Through the “roll over” mechanism, CP Notes can be kept outstanding indefinitely, as individual commercial paper notes continually mature and new CP Notes are issued.
CP Notes are considered a form of variable-rate debt. Even though the interest rate on each CP Note is fixed at the time such CP Note is issued, the rate on each CP Note will be based on market conditions at the time. The rates on new CP Notes will thus vary from one issuance or roll to another. The actual cost of the program to the issuer will be the average rate on all its outstanding CP Notes over time. Most issuers project such average rates on a quarterly or annual basis. Overall, CP rates tend to be among the lowest available in the tax-exempt and taxable markets for municipal debt.
The buyers of CP Notes are considered short-term investors because their investments in CP Notes mature in 270 days or less. One of the attractive features of CP Notes is the ability of the investor to match the CP Note maturity to the specific timing needs of their cashflow (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 CP Notes include major corporations and money market funds. CP Notes are attractive to money market funds because it complies with
the maturity limitations imposed on such funds, and the flexibility in setting the maturity of CP Notes 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 CP Notes as it rolls over, and thus may own an issue for an extended period.
Payment of Principal and Interest on Commercial Paper Notes
A CP Note 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 a CP Note will be repaid. The issuer can repay a CP Note on any date on which it is scheduled to mature by providing the funds to repay such CP Note to the paying agent. The paying agent uses such funds to pay the holder of the CP Note.
At the same time, the issuer instructs its CP dealer not to attempt to sell new CP Notes to roll over the paper that is maturing. Hence, when such steps are taken, the amount of CP Notes outstanding at the end of the day is reduced.
The individual CP Notes are likely to have different maturities, so an issuer repaying a CP program would do so in a series of steps as the individual CP Notes mature.
However, since each CP 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 CP dealer to issue the paper with short maturities as it rolls over, so that the issuer could retire the CP Note quickly when it begins the repayment process.
As noted above under “The Mechanics of Commercial Paper Notes,” interest or discount is payable on each CP 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 CP Note to the amount of new paper being sold. If this approach is used, the principal amount of the CP Note outstanding over time will increase as additional interest is capitalized (subject to the maximum authorized amount of CP 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 Notes. At that point, the issuer must provide to the paying agent the interest due at the time each CP 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 CP Note. Since the interest at that point is being paid by the issuer, and not by increasing the amount of the CP Note being rolled over, the principal amount of the CP Notes 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).