HomeMy WebLinkAboutSS3 - Pension Progress, Debt Service, Bond Ratings - Handout 1Received After Agenda Printed
September, 23, 2014
In Focus: Debt for Facilities Item No. SS3 �� >
City of Newport Beach
By Dave Kiff, City Manager, and Dan Matusiewicz, Finance Director _ n
September 23, 2014 `p0. "��
Background — Why do cities issue debt?
Some people fundamentally oppose debt of any kind — even a home mortgage. Others enter into too much
debt, sacrificing the future for present reward. Others see debt as a way to apportion cost — albeit with
interest — for a long -term asset. Something that will be used by a generation or more can be paid for over
that same duration. To a local government, reasonable amounts of debt can be a way to construct a project
with a 40 -80 year lifespan and ensure that one generation does not have to fund it all. Typically, there are
three reasons why cities issue debt:
1- Help Distribute Costs and Benefits Appropriately
If a long -term asset is purchased using only cash, the cost is borne entirely by the current generation of facility
users — even as the facility itself might serve 3 -4 generations. While this does not always result in increased
taxes, it can result in lost opportunities — a park, special landscaping, or a community center might not be built
when all available cash is used to fund the single long -term asset. This can also result in lower levels of
services for the current generation while the opposite will occur for future generations. Buildings often serve
the community for 40 -80 years. Debt can help distribute the payments for the asset over its useful life so that
the cost and community benefits are more closely matched over time.
2 - Favorable Market Conditions
High interest rates increase the total carrying cost of debt, so cities also consider debt issuance (rather than
paying cash) when interest rates are lower. During the recent sustained low- interest rate environment, cities
have been able to borrow money at historically low rates. The construction market is another aspect of
market condition to consider. If construction costs are low but likely to increase, cities might use debt to build
facilities for a lower total cost. In Newport Beach's example for the Civic Center project, the City used debt to
fund part of the Civic Center project when both interest rates and construction costs (labor and materials)
were low.
3 - Cash Flow
Most cities receive their revenue on a seasonal basis. Property taxes, typically the largest source of revenue,
are collected in November - January and again in May -July. Sales Taxes can vary, too. While the City of Newport
Beach does not issue debt instruments to finance ooeratine activities or manaee these cash flows, it has
issued debt for construction projects.
These projects have been included in our award - winning Facilities Financing Plan, which combines cash
reserves (including one -time funds from development projects), limited debt, and a general fund contribution
to match the necessary cash flows associated with major construction activities. Striking the right balance
between cash reserves and debt issuance is a matter of having solid financial projections and professional
judgment. Going with all -cash funding for major construction projects can quickly cause a significant strain on
cash flow especially when cash in -flows are "out -of- season;' a recession hits, or unanticipated needs arise.
Newport Beach Debt Issuances
The City's founders and subsequent leaders understood that debt financing could improve the quality of life
for citizens where projects' use crossed multiple generations. Below are examples of some community
facilities that City leaders constructed with debt proceeds:
Year of Issuance Purpose Amount
Debt
1905 School house $5,000
1909 First water delivery system $40,000
1923 Balboa Island sewer system $145,000
1927 -28 Newport Harbor jetties $700,000
1987 Balboa Yacht Basin $3,300,000
1988 Cannery Village parking lot $5,000,000
1992 Central Library $7,500,000
1998 Water storage and transmission facilities $14,225,000
Current Debt
Here is a summary of the City's current debt obligations and a description of other financing mechanisms that
the City has used.
Civic Center Certificates of Participation
In November of 2010, the City issued $126.6 million in Certificates of Participation (COPS) to finance the
construction of the City's new Civic Center including City Hall, Civic Center Park, Parking Structure, and Library
expansion and to refinance a portion of the previous Central Library COPS.
COPS are government securities used to finance capital costs related to construction or acquisition and may
not be used to finance ongoing operating costs. Unlike General Obligation (GO) bonds (which typically
become a property tax levy), COPS are repaid from the existing revenues. COPS are used very selectively to
implement high dollar projects essential to delivering public services and are retailed to investors who like the
good credit quality of Newport Beach. In return, the investors or certificate holders "participate" in lease
revenues that repay the investor's principal and interest at a stated rate. As noted, the $126.6 million included
$3.9 million to refinance the previously- issued Central Library COPS. The refunding was undertaken to reduce
total debt service payments over a nine -year period by $1,084,556 and resulted in present value savings of
$429,500. In total, the Civic Center, Park, Parking Structure, and Library addition cost approximately $141
million of which $123 million was financed and the $18 million was funded in cash. The current principal
outstanding on the Civic Center COPS is $116.5M.
Newport Coast Special Assessment District Relief
The Newport Coast area's infrastructure improvements were financed primarily by special assessments.
Before this area was officially annexed into the City limits, the City entered into a pre- annexation agreement
with the Newport Coast Committee in the year 2000. At this time the City agreed to reduce a small portion of
the cost of these special assessments. As a part of the pre- annexation agreement, the Irvine Ranch Water
District (IRWD) transferred $25 million to the City in exchange for the right to continue to provide water utility
service to this area. With this $25 million from IRWD, the City dedicated $7 million toward the construction of
the Newport Coast Community Center which opened in 2007. The remaining $18 million went to reducing
the special assessment levies by $1.2 million a year for 15 years. As of June 30, 2014, $3,600,000 was
outstanding. Interest earned on the proceeds held by the City accrues to the City.
Community Development Block Grant (CDBG) Loan
The CDBG program is a federal revenue source that is restricted to programs and projects that benefit low and
moderate income areas. In August of 2002, the City was granted a $2.4 million loan that is secured and will be
repaid solely from future block grant allocations to partially finance the Balboa Village improvements.
Commonly known as a "Section 108 Loan," this loan will be repaid over 20 years in $215,000 annual
installments. As of June 30, 2014, the outstanding balance of this loan was $1,462,000.
A financial summary of the aforementioned debt issuances are summarized in the table below.
How do we know that the City can meet its debt obligations? There are a number of key indicators that
suggest the City will remain financially secure and has the financial means to issue more debt if deemed
appropriate.
Key Factors and Associated Ratings Used to Assess the City's Credit Quality
A credit rating agency (also called a ratings service) is a company that
assigns credit ratings. These analyses rate a debtor's likelihood of
default and its ability to pay back debt by making timely interest
payments. Credit rating is a highly concentrated industry, with the
two largest rating agencies — Moody's Investors Service and Standard
& Poor's (S &P)— controlling 80% of the global market share, and the
"Big Three" credit rating agencies — Moody's, S &P, and Fitch Ratings —
controlling approximately 95% of the ratings business. On August 1,
2014, the credit rating agency Fitch Ratings reaffirmed the City of
Newport Beach's "AAA" implied credit rating citing the City's
"superior financial management" and its "low debt and carrying
costs."
The following assessments of key risk factors were assigned to the
City of Newport Beach by Fitch during a recent reaffirmation of the
City's "AAA" credit rating (see the adjacent table for other credit
ratings).
Economy —Above Average
7 Moody's Aaa Highest Quality
S &P AAA Highest quality
Fitch AAA Highest Quality
In determining credit risk, investors rely heavily on the
credit rating issued by the rating agencies Fitch,
Moody's, and Standard & Poor's. When assigning a
rating for general obligation bands, these agencies
assess a government entity's economic /financial
condition, debtstructure, demography, and
management practices.
'The implied "AAA" ratings ignifies an extremely strong
capacityto meetfinancial commitments -it is the
highest rating.
The ultimate basis for repaying debt is the strength and resilience of the local economy. The size, diversity,
and strength of a local government's tax base and economy drive its ability to generate financial resources.
The taxable properties within a tax base generate the property tax levy. The retail sales activity dictates sales
tax receipts. The income earners living or working in the jurisdiction shape income tax receipts. The size,
composition, and value of the tax base, the magnitude of its economic activity, and the income levels of its
residents are therefore all crucial indicators of the entity's capacity to generate revenues. Fitch indicated
about Newport Beach that "economic characteristics have remained strong, demonstrated by low
unemployment, very high wealth levels, stable housing market, and a resilient overall tax base."
Debt Service Estimates
2014 -15
2015
Year of
Original
Balance
Total
Principal
Final
Issuance
613012015
Payments
Interest
Paid to Date
Payment
Pre - Annexation Agreement
18,000,000
2,400,000
1,200,000
-
15,600,000
2017
2010 Civic Center COP
126,660,000
116,515,000
10,584,217
7,644,217
10,145,000
2041
Section 106 Loan
2,400,000
1,339,000
205,315
82,315
1,061,000
2024
Total Debt Service
147,060,000
120,254,000
11,989,532
7,726,532
26,806,000
2010 Civic Center COP BAB Subsidy
(2,352,662)
(2,352,662)
2041
Total Debt Service Wi BAB Subsidy
147,060,000
120,254,000
9,636,870
5,373,870
26.806.000
How do we know that the City can meet its debt obligations? There are a number of key indicators that
suggest the City will remain financially secure and has the financial means to issue more debt if deemed
appropriate.
Key Factors and Associated Ratings Used to Assess the City's Credit Quality
A credit rating agency (also called a ratings service) is a company that
assigns credit ratings. These analyses rate a debtor's likelihood of
default and its ability to pay back debt by making timely interest
payments. Credit rating is a highly concentrated industry, with the
two largest rating agencies — Moody's Investors Service and Standard
& Poor's (S &P)— controlling 80% of the global market share, and the
"Big Three" credit rating agencies — Moody's, S &P, and Fitch Ratings —
controlling approximately 95% of the ratings business. On August 1,
2014, the credit rating agency Fitch Ratings reaffirmed the City of
Newport Beach's "AAA" implied credit rating citing the City's
"superior financial management" and its "low debt and carrying
costs."
The following assessments of key risk factors were assigned to the
City of Newport Beach by Fitch during a recent reaffirmation of the
City's "AAA" credit rating (see the adjacent table for other credit
ratings).
Economy —Above Average
7 Moody's Aaa Highest Quality
S &P AAA Highest quality
Fitch AAA Highest Quality
In determining credit risk, investors rely heavily on the
credit rating issued by the rating agencies Fitch,
Moody's, and Standard & Poor's. When assigning a
rating for general obligation bands, these agencies
assess a government entity's economic /financial
condition, debtstructure, demography, and
management practices.
'The implied "AAA" ratings ignifies an extremely strong
capacityto meetfinancial commitments -it is the
highest rating.
The ultimate basis for repaying debt is the strength and resilience of the local economy. The size, diversity,
and strength of a local government's tax base and economy drive its ability to generate financial resources.
The taxable properties within a tax base generate the property tax levy. The retail sales activity dictates sales
tax receipts. The income earners living or working in the jurisdiction shape income tax receipts. The size,
composition, and value of the tax base, the magnitude of its economic activity, and the income levels of its
residents are therefore all crucial indicators of the entity's capacity to generate revenues. Fitch indicated
about Newport Beach that "economic characteristics have remained strong, demonstrated by low
unemployment, very high wealth levels, stable housing market, and a resilient overall tax base."
Financial Performance and Reserves — Strong
A local government's fiscal position determines its cushion against the unexpected, its ability to meet existing
financial obligations, and its flexibility to adjust to new obligations. Financial structure reflects how well a
local government's ability to extract predictable revenues adequate for its operational needs are matched to
its economic base. According to Fitch's analysis, "Management has successfully implemented expenditure
savings, including major labor concessions and the use of contracted services." The City has also implemented
a new debt policy, effective in 2013. The policy addresses specific purposes, forms, and levels of debt, as well
as the procedure the City will take in the event of future borrowing.
Debt Profile — Low
The debt burden is a measure of the financial leverage of a community. Ultimately, the more leveraged a tax
base is, the more difficult it is to service existing debt and to afford additional debt, and the greater the
likelihood that tax base or financial deterioration will result in difficulties funding fixed debt service
expenditures. According to Fitch's analysis, "The City s total debt burden is low and likely to remain so with
planned capital investment funded by general revenues and capital reserves. Carrying costs, including debt
service and retiree benefit contributions, remain affordable." Fitch generally considers net debt service that is
12% of General Fund revenues affordable and less than 6% low. By this standard, the City's debt service as a
percent of General Fund revenues is low at 4.7 %.
2015 Debt Service as a % of General Fund Revenues
■ Net Debt Service ■ GF Revenues
Debt Service as % of GF Revenues Trend
$200,000,000
$175,000,000
$150,000,000
$125,000,000
$100,000,000
$75,000,000
$50,000,000
$25,000,000
2010 2015 2016 2017 2018 2019
Budgeted Projected Projected Projected Projected
■ Net Debt Service ■ General Fund Revenues
Frequently Asked Questions
1. "What guides the City's decision to issue debt ?"
On May 13, 2013, the City Council adopted a formal debt policy that establishes criteria for the issuance of
debt obligations so that acceptable levels of indebtedness are maintained, limiting debt service costs to 8% of
General Fund Revenues. The policy also transmits the message to investors and rating agencies that the City is
committed to sound financial management. Finally, this policy provides consistency and continuity to public
policy development when elected officials work from guidelines that govern the planning and execution of
projects for which debt is used.
Council Policy F -6 (Debt) can be viewed at: www.newportbeachca.gov /policies
2. "Would it be wise or unwise to retire the Civic Center debt now in order to avoid the long -term
financing costs ?"
This is just our opinion, but we think it would be unwise. An early repayment of the COPS triggers a costly $44
million early redemption premium and loss of the Federal Build America Bond (BAB) subsidy. Over time, the
City can expect to earn a reasonable rate of return on its conservative investment portfolio. As a result, there
is a greater economic benefit to pay the balance over time than to pay the debt now. There are also critical
opportunity costs. Using existing cash reserves to pay off debt sacrifices a number of things — especially other
community- driven projects underway or planned that today can be cash - funded. As importantly, depleting
our cash means we could be at risk should our community experience a natural disaster or similar event.
Major Cash - Funded Capital Projects
Oasis Senior Center $15,504,000
Marina Park $39,500,000
Sunset Ridge Park $8,500,000
Lifeguard Headquarters $2,459,000
3. "Why do some say that the Civic Center financing will cost $232 million when the total amount financed
was $126.6 million ?"
They are summing all future principal and interest payments including those that will be made more than 20
years from now. In doing so, they are ignoring the time value of money. We are often surprised when people
say this — most knowledgeable investors take net present value into consideration all the time.
In simpler terms, let's say you won $1 million. Would you rather receive the money today or 30 years from
now? Intuitively we know that a payment received today is worth more than a payment received 30 years
from now. Why? If you have the cash today, you can invest it to help retain and grow its value. If you got the
cash in 30 years, you lost the opportunity to earn interest your winnings and inflation would cut its value
significantly. It's just incorrect to value future dollars the same way as you value today's dollars.
By "discounting' the future payment by your assumed rate of earnings, you can approximate what the future
payment is worth to you today (hint: it's significantly less). If you were to apply this discounting methodology
to adjust the value of the future debt service payments on the Civic Center financing ($232 million), you
would land right back at a number approximating the $126.6 million we started with. This financial principle is
known as the "Time or Present Value of Money' and, as we noted, rarely anyone pretends it doesn't exist.
Thanks for reading this "In Focus" If you have any questions about the City's debt policy, the current levels of
debt, or the manner in which the City funds its operations and capital needs, please do not hesitate to ask us.
Dave Kiff
City Manager
Dkiff@newportbeachca.gov
949 - 644 -3001
Dan Matusiewicz
Finance Director
danm@newportbeachca.gov
949- 644 -3123