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HomeMy WebLinkAbout07.B.1) (Handout) Central San Use of Century Bonds Item 7.13.'1 (Handout) AdskiAll Central Contra CoSanitarysta District January 28, 2017 TO: HONORABLE BOARD OF DIRECTORS VIA: ROGER S. BAILEY, GENERAL MANAGER FROM: PHILIP R. LEIBER, DIRECTOR OF FINANCE & ADMINISTRATION THEA VASSALLO, FINANCE MANAGER SUBJECT: CENTRAL SAN USE OF CENTURY BONDS Introduction This memorandum addresses whether ultra-long term bonds, commonly known as century bonds, should be considered for use in financing a portion of Central San's upcoming infrastructure needs. In short, as the bonds are subject to fluctuating market demand, it is not advisable to assume the use of these bonds in Central San's financial plan, but their use could be considered closer to the time of issuance. Background and Use of Centu Bonds at DC Water The District of Columbia Water and Sewer Authority (DC Water) considered, and proceeded to issue in July 2014, $350 million of bonds with a 100-year term to finance a $2.8 billion tunnel with an anticipated useful life in excess of 100 years. Commentary about the offering noted that pension funds had a desire for very long term non-callable obligations. DC Water cited the following factors for issuing such long duration bonds: • Asset-Liability Matching: Century bonds permit DC Water to match its long-lived assets and liabilities on its balance sheet. ■ Intergenerational Equity and Fairness: century bonds spread the costs of the project more affordably and fairly to those who will benefit over the next 100 years. • Committed Long-Term, Low-Cost Capital: Century bonds allow DC Water to take advantage of historically low interest rates and to lock in funding costs for a very long-lived asset. Longer duration means lower principal repayment costs each year, but this can come at the cost of a higher interest rate. The DC Water century bonds (which were federally taxable) were offered at an interest rate of 4.814%. The bonds could not be issued on a tax-exempt basis as the duration of tax exempt bonds is limited to the lessor of 125% of the useful life of the asset being financed, or a maximum of 40 years. Interest rates will typically be higher for longer duration bonds assuming a normal yield curve, although this can change based on market conditions. CENTRAL SAN USE OF CENTURY BONDS January 26, 2017 Page 2 During parts of 2015, taxable century bond interest rates were estimated to be lower than 40- to 50-year tax-exempt rates; however, that was a very unusual circumstance driven by investors' strong desire for yield in an extremely low interest rate market. Accordingly, the market "window" for issuance of century bonds opens and closes over time based on market dynamics. It is noted that Central San's financial advisor, PFM, served as one of the co-f inancial advisors on the DC Water financing, on a century bond issuance for Wesleyan University in May 2015, and is currently evaluating the use of century bonds for another large issuer in California. PFM notes that of the 20 century bond financings that have been sold by traditional municipal issuers (versus corporate or sovereign entities) since 1996, all of them were for higher education or healthcare entities except the DC Water transaction, and 11 of them were $300 million or larger. It is also worthwhile to note that increasing the duration of bonds has a diminishing benefit on the level of debt service payments. For comparative purposes, and assuming the same interest rates, borrowing $1 million over the following periods results in the following annual debt service amounts, and total debt service over the life of the bonds. Moving from 30-year to 100-year bonds only reduces annual debt service from $55,051 to $50,383, while more than doubling the overall amount to be paid for debt service over the life of the bonds. Bond Annual Debt Service % of 10-Year Total Payments % of 10-Year Duration 10 129,595 100% 11295,045 100% 20 80,243 52% 11504,852 124% 30 55,051 50% 1,951,543 151% 50 541777 42% 21738,837 211% 100 50,383 39% 51038,314 389% Decision Criteria/Considerations • Market demand for ultra-long-term bonds from a smaller agency such as Central San. ■ Interest rates of ultra-long term vs. traditionally termed (30 year) debt. • Profile (expected life) of assets being financed. CENTRAL SAN USE OF CENTURY BONDS January 23, 2317 Page 3 Assessment at Central San According to PFM, the market for century bonds comes and goes over time and there is not enough certainty that it will exist at a given point in the future when Central San needs to fund projects. Further, even when there are active buyers for century bonds, because there has only been one utility that has issued using this structure and that entity is well known to investors (having $2.8 billion in outstanding indebtedness), it is difficult to predict whether century bond investors would be receptive to an offering by Central San. Such bonds also may make the most sense for a single large expenditure that had a very long life, such as the DC water tunnel. In central San's case, where replacement of long-lasting infrastructure is to be conducted in a phased manner over an extended period of time, this would be a less relevant factor. Accordingly, Central San staff and PFM believe it would be prudent to assume a more traditional (up to 30-year) financing term for planning purposes. Recommendation Central San should use traditional long-term bonds with a maturity not to exceed 30 years for planning purposes and development of the rate plan. Subsequently, market conditions should be considered closer to the time of issuance as well as the market's receptivity to longer-term bonds for an agency such as Central San.