The URL can be used to link to this page

Home My WebLink About06.b. Receve update on borrowing decision discussed at March 2022 Financial Planning Workshop Page 1 of 5 Item 6.b. CENTRAL SAN July 26, 2022 TO: FINANCE COMMITTEE FROM: PHI LIP LEI BER, DI RECTOR OF FINANCEAND ADMINISTRATION KEVIN MIZUNO, FINANCE MANAGER REVIEWED BY: ROGER S. BAILEY, GENERAL MANAGER SUBJECT: RECEIVE UPDATE ON BORROWING DECISION DISCUSSED AT MARCH 2022 FINANCIAL PLANNING WORKSHOP At the March 24, 2022 Financial Planning workshop, staff presented on the issue of borrowing to fund the Capital Program. The key question was whether to borrow this year, or later in 2024 and 2026-27, when funds are needed for the Ultraviolet (UV) Disinfection and Solids Handling Facility Improvements (Solids Handling) projects, respectively. Based on the current outlook for these projects, borrowing needs are expected to be about$60 million in 2024, and $130 million in 2026-27. As was discussed at the March workshop, future borrowing needs would likely be most cost effectively met by applying for State Revolving Fund (SRF) loans, to receive an interest rate set at 50% of the State's most recent general obligation bond borrowing rate at the time of loan approval. Borrowing sooner (such as during 2022)would involve a direct debt issuance by Central San. Also discussed at the workshop, was the question of whether the borrowing rate in 2022 would be lower than the future SRF rate, or whether given the competitive process for SRF funds, Central San would be awarded such funds. This memorandum provides an update on developments since the March 24 discussion. Funding needs As noted above, the two projects for which additional funding is needed is UV Disinfection around 2024, and Solids Handling Phase I I about two-three years later. • Considerations related to the UV Disinfection project may have shifted in a couple ways that make SRF financing less viable. • Timing: Timing of the project is under discussion. While presently scheduled for 2024, if it were started sooner(late 2023 under discussion)that would be before availability of SRF loan proceeds, given the extended application and approval timeline. • Equipment: About$4 million of equipment needed for the UV Project is likely to be sourced from manufacturers located outside the United States, so for at least that portion of the project, SRF proceeds, which have a "Buy-America/Build America" requirement, cannot be used. • The scope and timing of the Solids Handling Project remains tentative. Phase 1 A can be funded from the already secured $173 million SRF funding. This is a 30-year loan at an interest rate of only July 26, 2022 Regular FINANCE Committee Meeting Agenda Packet- Page 109 of 117 Page 2 of 5 0.9%. The scope and timing of Phase 2, and whether this involves digestion or more work on the existing incineration process, will be clarified later in 2022 as a comprehensive study of alternatives is completed. Interest Rates Over the course of 2022, there has been a significant increase in interest rates, related to federal actions to tame inflation, as shown in the table below. These rate increases were higher than what was anticipated in the forward interest rate curves that were considered in the "borrow now or later" analysis conducted in March. June 27, April Avg. March Avg. Feb Avg. Jan Avg. 2022 10 Year MMD 2.9% 2.48% 1.92% 1.57% 1.24% Rates 30 Year MMD 3.35% 2.83% 2.31% 1.96% 1.69% Rates Along with this, there has been increasing concern about the federal ability to mitigate inflation while avoiding the risk of a recession (i.e., its ability to navigate a "soft landing"). Given these concerns, the market expects interest rates to peak, and then decline, during 2023. As noted by Piper Sandler's economist: "With recession talk continuing to increase, the terminal Fed funds rate dropped by 30 by last week and is nowjust above 3.5%. The market expects the Fed to begin cutting rates as soon as the second quarter of 2023, with the Fed funds rate dropping by 100 by between April 2023 and July 2024" and "With Americans facing higher borrowing costs and 1 y inflation expectations hitting record highs , consumer spending should weaken in the second half of 2022, increasing the odds of an economic downturn." Chart1 Substantial rate cuts are already beincl priced in -s 11D1D by rut - ............------------------------- L Fed fund futures (96) 1-S 1 Jun-22 Nov-22 Apr-23 Sep-21 Feb-24 Jul-24 With high inflation, and low unemployment (3.6% nationally as of June), the economy presently appears strong on some measures. However the Fed's short-term interest rate hikes are causing a slowing, and contributing to increasing economic uncertainty. Recurring news stories have indicated an increased likelihood of recession on the horizon. The technical definition of a recession involves a period of two July 26, 2022 Regular FINANCE Committee Meeting Agenda Packet- Page 110 of 117 Page 3 of 5 consecutive quarters of gross domestic product (GDP) contraction. Growth was negative in Q1 of 2022, and indications (Federal Reserve Bank of Atlanta GDP trackers) are developing that Q2 growth will be negative as well. An Associated Press story on July 6 indicated: • "Federal Reserve officials were concerned at their meeting last month that consumers were increasingly anticipating higher inflation, and they signaled that much higher interest rates could be needed to restrain it." • But, "the signs of economic sluggishness have intensified fears that high prices and rising rates could send the economy into a recession late this year or next year." A story on MSN on July 7 indicated: "A closely watched recession indicator is flashing again after the Fed minutes reveal another big rate hike could be on the way". • The treasury yield curve deepened its inversion (where long-term rates drop below short-term rates). • An inverted yield curve is a notorious predictor of a recession. • As the Fed plans for another rate hike, investors are expecting some turbulence in the economy. Conclusion With respect to interest rates, early in 2022 would have been an optimal time to borrow. However, project plans were not sufficiently clear in order to issue at that time. Preparing for and executing a bond offering on the fastest viable path after discussion of the "Borrow now or later" with the Board in March would have targeted an issuance in about June 2022, but by this point, rates had already substantially risen. As of mid- June, tax-exempt (MMD) rates had risen to a level higher (2.91%)than the 10 year average since 2012 of 2.67%. Given this rise, as well as the higher probability of a recession in 2023 (which would likely trigger an interest rate decrease), it became the sense of staff that an issuance in 2022 was not looking particularly attractive. But conditions remain volatile, and longer-term rates began dropping by late June, to a level 0.3% below the mid-June peak. Attached for reference is a AAA MMD Rate History chart. In light of this, it remains prudent to continue to monitor bond market conditions in the next 18 months or so, for a potential offering to meet the funding needs of the UV Disinfection project. Accordingly, staff will do this, and provide updates as appropriate, and not later than at the financial workshop during FY 2022-23 to discuss the Sewer Service Charge rate outlook for FY 2023-24 and beyond. As to the funding needs for the Solids Handling project Phase 11, a tentative plan to rely on SRF financing rather than a Central San bond issuance is presently anticipated. Further clarity as to the scope and timing of Phase I I of the project is likely to be available towards the end of this calendar year, with the completion of a comprehensive study of project alternatives. An SRF loan remains an attractive form of financing for this work given that the period of time between now and when funds are needed (nearly four years) is compatible with the extended SRF application and approval period. Staff looks forward to hearing Board Member views on this topic. Strategic Plan Tie-In GOAL THREE: Fiscal Responsibility Strategy 1—Maintain financial stability and sustainability, Strategy 2—Ensure integrity and transparency in financial management GOAL SEVEN:Agility andAdaptability July 26, 2022 Regular FINANCE Committee Meeting Agenda Packet- Page 111 of 117 Page 4 of 5 Strategy 2—Plan ahead for scenarios of direct adverse impacts ATTACHMENTS: 1.AAA MMD Rate History Chart July 26, 2022 Regular FINANCE Committee Meeting Agenda Packet- Page 112 of 117 AAA MMD Rate History 3.54°16 2`b2,25�° ��5°{�3 '++o 3.2596 1�No 3.04°16c12° 9� � t3��af'13 ��4ro 01 ofv �- r��r�7iii `L$,°h4 2.26% 4 2302. t. f 3 6 7- 1.75% `N N tN'i N !V N tN, [N, N ryNry �Nryy c04 {N CL N [N� N N N cN� N CV N N tV N N CV NilV +iiIi1 palI11l1 pp1 P_1 fil pall CSV N N N N N SV N -AAA GO 5 Year -AAA GG 10 Year AAA GO 20 Year AAAA GO 30 Year July 26, 2022 Regular FINANCE Committee Meeting Agenda Packet- Page 113 of 117