3. Policy on Debt and Financing |
Committee Recommendation
That Council adopt the Policy on Debt and Financing
attached as Annex A.
Recommandation du comité
Que le Conseil adopte la Politique sur les dettes et le financement
ci-jointe en Annexe A.
Documentation
1. Chief Corporate Services Officer's report
dated 12 March 2007 (ACS2007-CRS-FIN-0007).
2. Extract of Draft Minute, 3 April 2007.
Report
to/Rapport au :
Corporate Services and Economic Development Committee
Comité des services organisationnels
et du développement économique
and Council / et au Conseil
12 March 2007 / le 12 mars 2007
Submitted by/Soumis par : Greg Geddes,
Chief Corporate Services Officer/Chef des Services généraux
Contact
Person/Personne ressource : Marian Simulik, Director, Financial Services and
City Treasurer/Directrice des services financiers et trésorière municipale
Financial Services/Services financiers
(613) 580-2424 x 14159, Marian.Simulik@ottawa.ca
SUBJECT: |
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OBJET : |
REPORT RECOMMENDATION
That Corporate Services and Economic Development Committee recommend Council adopt the Policy on Debt and Financing attached as Annex A.
RECOMMANDATION DU RAPPORT
Que le Comité des services
organisationnels et du développement économique recommande au Conseil d’adopter
la Politique sur les dettes et le financement ci-jointe en Annexe A.
BACKGROUND
The
Policy on Debt and Financing ("Policy") provides the policy framework
to administer both short-term and long-term financing for the City. The
proposed Policy sets out objectives for the debt program, standards of care in
administering debt, provides a list of authorized financing instruments and
provides guidelines to use in selecting the appropriate financing mechanism and
various risk management tools.
As
at 31 December 2006, the long-term debt outstanding for the City was $666.6
million (net debt of $508.7 million net of sinking funds). The City's outstanding debt includes
instalment debentures, sinking fund debentures and amortizing debentures.
Although the City has primarily issued debentures in the Canadian public
financial markets it has also entered into loan agreements and guaranteed bank
loans amounting to $60.3 million including interest rate exchange or swap
agreements, in connection with three Public Private Partnerships.
The
Municipal Act and its related Regulations govern all short and long-term
financing activities of Ontario municipalities. The Province enacted Regulation
604/06 which provides a framework to consider capital leases and permits the use
of bond forward agreements to mitigate the risks resulting from changing
interest rates when issuing debentures.
The proposed Policy permits the City to enter into Bond Forward
Agreements and provides a Lease Financing policy as required by this Regulation.
Ontario
Regulation 604/06 requires municipalities to adopt a statement of policies and goals which includes a discussion of
the risks in using lease financing agreements and which may provide for a category of lease financing agreements
which would not result in a material impact on the municipality. This Regulation requires, before entering
into a lease financing agreement, the Treasurer to prepare a report assessing
the costs and risks associated with the proposed lease, provide a comparison
with other methods of financing, indicate the effective cost of the lease, and
provide a summary of any contingent payments and the assumptions applicable to
any variations in the payment schedules.
The proposed Policy addresses these requirements and also identifies
other criteria to be considered including the overall economic benefit expected
from undertaking the project.
The
regulation also requires Council to receive a report at least once a year
providing a summary of the total lease financing arrangements undertaken and
the proportion this represents of the total long-term debt of the City.
Bond
Forward Agreements
Ontario
Regulation 604/06 also permits municipalities to enter into bond forward
agreements to reduce the risk of changing interest rates before a debenture is
issued. A bond forward agreement is a contract with an approved financial
institution that allows the municipality to effectively fix the interest rate
on a debenture issue in advance of the issue date. Bond Forward agreements have been used by Federal Government
Crown Corporations, Provincial Governments, corporations, universities and
municipalities outside of Ontario, for many years.
The
City normally obtains long-term financing by issuing debentures in the Canadian
public financial markets which is generally regarded as the most cost effective
alternative to obtain fixed rate long-term financing. However the interest rate is not fixed until the actual time the
debentures are launched or issued in the market. It is only at that time that investors actually commit to
purchase the City’s debentures for a
specific term and with a specific fixed rate of interest. Thus the City is exposed to changes in
interest rates up until the time the issue is launched. By using bond forward
agreements, a municipality now has the ability to lock in yields on the
underlying Government of Canada or Province of Ontario bonds at any period in
time for all or part of its borrowing requirements thus eliminating or reducing
the risk of unfavourable movements in interest rates. The Provincial regulation currently limits the period for which a
bond forward can fix an interest rate to 60 days. While the debentures will be issued at the interest rates
prevailing at the time of issue, payments resulting from the bond forward
agreements will be received from or made to the financial institution which
will effectively fix the cost of the rate on the debentures.
The
proposed policy provides guidelines on the use of bond forward agreements. It is proposed that the amount of any bond
forward contract not exceed seventy-five per cent of the applicable debenture
issue. Also in accordance with the
regulation, bond forward agreements may only be entered into with eligible
schedule I, II and III banks.
The
proposed Policy as set out in Annex A complies with the requirements of
Regulation 604/06.
CONSULTATION
The proposed Policy is an administrative matter and the public consultation process is not applicable.
FINANCIAL IMPLICATIONS
The proposed Policy on Debt and Financing will allow the City to consider and enter into Lease Financing arrangements as an alternative financing mechanism. The Policy also permits bond forward agreements in accordance with the Provincial Regulation which provides a mechanism to manage interest rate risk on its debt issues. At the present time the Province has limited the use of bond forward agreements to 60 days.
SUPPORTING DOCUMENTATION
Annex A - Policy on Debt and Financing
DISPOSITION
Following consideration at Corporate Services and Economic Development Committee, this report and Policy will be sent to Council for its consideration.
ANNEX A
A policy governing the use and administration of capital financing and debt.
All financial
obligations including related agreements and capital financing leases that are
entered into by the City, as well as
those employees responsible for the control, administration or management of
capital financing and debt issuance activities.
This policy establishes
objectives, standards of care, authorized financing instruments, reporting
requirements and responsibilities for the prudent financing of the City’s
operating and infrastructure needs.
Amortizing Debentures: Debentures for which the amount of the periodic
(annual, semi-annual, monthly) payment of principal and interest is
approximately the same throughout the life of the debenture issue.
Banker’s Acceptance: A short-term credit obligation created by a
non-financial firm such as a Corporation which is endorsed by a bank as to payment effectively making
the obligation that of the bank.
Bond Forward Agreement: A financial contract with an eligible Schedule I, II
or III bank used to hedge future interest rates by short selling a particular
Government of Canada or Province of Ontario bond and repurchase the same bond
at a predetermined future settlement date.
A settlement payment may be required by either the issuer or the bank if
there is a difference between the price at which the government debt
instruments are sold and the price at which they are bought back on the
settlement date.
Bought Deal:
A financing transaction, such as a debenture issue, in which an individual
underwriter or underwriting group purchases the entire amount in order to
resell to investors.
Capital Financing:
A generic term for the financing of capital assets using debt, financing
leases, swaps and other financing mechanisms.
Construction Financing:
A form of debt financing in which the issuer does not pay any principal and/or
interest for periods of normally up to 5 years during the construction or
rehabilitation of the facility.
Cross-Border Lease:
A lease in which the lessor and lessee are located in different countries, and
where the holder of legal title to the asset can claim tax benefits in its home
country, while the tax laws of the asset user treat it as owner for tax
purposes in its own country.
Debenture:
A formal written obligation to repay specific sums on certain dates. In the
case of a municipality debentures are typically unsecured.
Debt and Financial Obligation Limit: A calculation provided annually to a municipality by
the Ministry of Municipal Affairs and Housing that determines the maximum
amount of new annual debt servicing costs that a municipality can undertake or
guarantee without seeking the approval of the Ontario Municipal Board in accordance with Ontario Regulation
403/02.
Debt: Any obligation
for the payment of money. For Ontario municipalities, debt would normally
consist of Debentures as well as either notes or loans from financial institutions but could also include loans
from reserves, Sinking Fund or the Endowment Fund. Debentures issued to
Infrastructure Ontario are also considered as debt.
Financial Guarantee: An agreement whereby the City will take responsibility
for the payment of debt in the event that the primary borrower fails to
perform.
Foreign Currency Debentures: Debentures that are denominated or payable in a foreign currency. In
Ontario a municipality is permitted to issue debentures denominated in United
States dollars, Pound Sterling, Japanese Yen, Euros, Australian dollars, and
Swiss Francs.
Foreign Currency Exchange Agreements: An agreement
entered into with a financial institution to fix the rate of exchange for
future payments made in a foreign currency.
Hedging: A strategy used
to offset or mitigate currency and/or interest rate risk.
Infrastructure Ontario (formerly Ontario Strategic Infrastructure
Financing Authority (OSIFA)): An entity
established by the Province of Ontario to provide Ontario municipalities,
universities and hospitals access to alternative financing service for
longer-term fixed rate loans for the building and renewal of public
infrastructure.
Instalment (Serial) Debentures: Debentures of which a portion of the principal
matures each year throughout the life of the debenture issue.
Interest Rate Exchange Agreements:
An agreement entered
into with a financial institution to fix the future rate of interest paid on a
variable rate debenture or short-term or long-term bank loans.
Lease Financing Agreements: A lease
allowing for the provision of Municipal Capital Facilities, including those
capital facilities designated by
Council as Municipal Capital Facilities under Section 110 of the Municipal Act,
that:
·
transfers substantially all the benefits and risks incident to ownership
of the property to the lessee;
·
is entered into for the purpose of obtaining long-term financing of a
capital undertaking; and
·
may or will require payment by the City beyond the current term of
Council.
Long-Term Bank Loan:
Long-term debt provided by a bank or a syndicate (group) of banks.
Long-Term Debt:
Any debt for which the repayment of any portion of the principal is due beyond
one year.
Municipal Capital Facilities: Includes land, as defined in the Assessment Act, works, equipment, machinery and related systems and
infrastructures.
Non-Material Leases:
A class of financing leases in which the annual payment for individual leases
will be less than $500,000,
the term of the lease does not exceed ten years and as a class does not
exceed one percent (1%) of the City’s net tax levy.
Project Financing:
Financing in which principal and interest payments are structured so as to more
closely match the revenues or cost savings of a specific project.
Refinancing: As applied to debentures, describes the process of
issuing a new debenture to fund a lump sum amount maturing in one or more
outstanding debentures to extend the maturity date but not exceeding the term
authorized by Council.
Retirement Fund Debentures: Debentures for which money is accumulated on a regular basis,
commencing several years after the issuance of the debentures, in a separate
custodial account that is used to redeem the debentures.
Short-Term Debt:
Any debt for which the repayment of all the principal is due within one year.
Sinking Fund Debentures: Debentures for which money is accumulated on a regular basis in a
separate account that when combined
with interest earned is used to retire the debentures on maturity.
Syndicated Bank Loans: A loan between the City and a bank listed in Schedule
I, II or III of the Bank Act (Canada),
a loan corporation registered under the Loan
and Trust Corporations Act or a credit union to which the Credit Unions and Liaison Popalaires Act,
1994 applies where the financing to the loan is obtained through a
financing agreement in which each of the institutions that is a party of the
term agreement agrees to contribute a portion of the loan.
Tile Drainage Debentures: Debentures issued to the Province of Ontario to finance the
construction of a tile drainage system for agricultural land in accordance with
the Tile Drainage Act R.S.O. 1990.
Underwriter(s):
An individual or group of investment bankers appointed as principals or on an
agency basis, for the purpose of purchasing and reselling new debentures issued
by the City.
Variable Interest Rate Debentures: Debentures that provide for one or more variations
in the rate of interest payable on the principal during the term of the
debenture.
DESCRIPTION:
A) Capital Financing And Debt
Issuance
Council may, where it is
deemed to be in the best interest of its taxpayers, approve the issuance of
debt for its own purposes, or those of its municipal business corporations if
any.
Through its Long Range
Financial Plan as it is updated and amended from time to time, Council has
adopted a number of guiding principles related to debt financing for capital
projects as follows:
·
Maintain current
tax-supported debt servicing costs at existing levels by allowing new tax supported debt each year (excluding
Police Services) in an amount which approximately corresponds to the principal
amount of debt maturing. Thus
tax-supported debt is referred to as revolving debt as it replaces maturing
debt with new debt.
·
Debt funding for
lifecycle projects should be reduced and employed on projects related to
capacity expansion or growth, projects financed by development charges, future
new non-traditional infrastructure projects and projects tied to third-party
matching funding. It is recognized that the goal of eliminating debt financing
for lifecycle projects would be phased in.
·
When required,
debt funding is considered an appropriate way to finance longer-life capital
projects since future taxpayers who will benefit from the project will pay for
it through future debt charges.
These guiding
principles will be met through the
objectives outlined below.
B) Primary Objectives Of The Capital Financing And Debt Program
The primary objectives
for the City’s capital financing and debt program, in priority order, shall be:
·
Adhere to
statutory requirements;
·
Ensure long term
financial flexibility and sustainability;
·
Limit financial
risk exposure;
·
Minimize
long-term cost of financing;
By successfully fulfilling all of these objectives the City will
endeavor to maintain attractive credit ratings by Standard and Poor’s Rating
Services and Moody’s Investors Service Inc. or such other rating agencies as
may be approved from time to time.
1) Adhere to Statutory
Requirements
Capital
financing may only be undertaken if and when it is in compliance with the
relevant sections of the Municipal Act,
the Local Improvement Act, or the Tile Drainage Act, and their related
regulations. Requirements include but are not limited to the following:
a)
The term of
temporary or short-term debt for operating purposes will not exceed the current
fiscal year;
b)
The term of the
capital financing will not exceed the lesser of 40 years or the useful life of
the underlying asset;
c)
Long-term debt
will only be issued for capital projects;
d)
The total annual
financing charges after a proposed debt issue will not exceed the Debt and
Financial Obligation Limit for the City, unless otherwise approved by the
Ontario Municipal Board;
e)
Prior to entering
into a lease financing agreement, an analysis will be prepared that assesses
the costs and benefits as well as the financial and other risks associated with
the proposed lease with other methods of financing;
f)
Prior to passing
a debenture by-law which provides that instalments of principal or interest, or
both, are not payable during the period of construction of an undertaking,
Council will have considered all financial and other risks related to the
proposed construction financing; and
g)
Long-term debt
will be a full faith and credit
obligation of the City
2) Ensure Long-Term Financial Flexibility
The
capital financing program will be managed in a manner consistent with other
long-term planning, financial and management objectives.
Prior
to the issuance of any new capital financing, consideration will be given to
its impact on future ratepayers in order to achieve an appropriate balance
between capital financing and other forms of funding.
3) Limit Financial Risk Exposure
The
capital financing program will be managed in a manner to limit, where
practicable, financial risk exposure.
As a result, it will be the City’s normal practice to issue debt that is
only denominated in Canadian dollars with an interest rate that will be fixed
over its term.
Notwithstanding,
if a situation arises where there is a material financial advantage and/or it
is deemed prudent for the City to issue debt that is subject to fluctuations,
in foreign currency and/or interest rates, a hedging strategy will be
considered to either reduce or eliminate the risk.
This
strategy would include the following:
a)
For debentures
that are not denominated in Canadian currency, the rate of exchange will be fixed
for the term of the obligation (both principal and interest payments) on or
before the date of issuance.
b)
For variable
interest rate debentures with a term exceeding one year, the interest rate will
be fixed within six months of the issuance date.
However,
long-term bank loans for which the interest rate may vary may not be fixed if
prevailing market conditions are such that in the opinion of the City Treasurer
it is in the City’s best interests to allow the rate to float where such debt,
in addition to any other outstanding variable rate loans or debentures, do not
exceed fifteen percent (15%) of the total outstanding debt of the City as
authorized by O.Reg 276/02 s(2).
Finally,
it is recognized that financing leases have different financial and other risks
than traditional debt that must be considered, and where practicable mitigated
prior to its use, including; contingent payment obligations for items such as;
lease termination provisions; equipment loss; equipment replacement options;
guarantees and indemnities. These risks will be identified prior to entering
into any material financing lease.
(Refer
to Section E of this Policy – Financing Risk Identification and
Mitigation Strategies.)
4) Minimize Long-Term Cost of Financing
The
timing, type and term of financing for each capital asset will be determined
with a view to minimize the City’s
overall long-term cost of financing.
Factors
to be considered will include: current
versus anticipated future interest rates; the availability of related reserve
fund monies; the pattern of anticipated revenues or costs savings attributable
to the project or purpose; the applicability of using bond forward agreements
to hedge interest costs; and, all costs related to the financing of the project
whether by debenture, construction financing or financing lease.
5) Match the Term of the Capital Financing to the
Useful Life of the Related Asset
The
City’s normal practice will be to issue debt for a term that does not exceed 20
years unless otherwise specifically approved by Council. In no case shall the
term of financing exceed the anticipated useful life of the underlying asset.
C) Standard
Of Care
All
officers and employees responsible for capital financing and debt activities
will follow the standard of care identified in this Policy.
1) Ethics and Conflicts of Interest
Officers
and employees involved in the capital financing process are expected to abide
by the City’s Code of Conduct.
2) Delegation of Authority
The
City Treasurer will have the overall responsibility for the capital financing
program of the City. As authorized by By-law 2006-112 the City Treasurer is
authorized to proceed to launch debenture issues provided that the annual debt
charges are within the debt servicing budget approved by Council in the annual
operating and capital budgets and the project debt authority has been
authorized by Council. The Manager Treasury will have responsibility for
directing/implementing the activities of the capital financing program as well
as the establishment of procedures consistent with this Policy. No person shall be permitted to engage in a
capital financing activity except as provided for under the terms of this
Policy. The City Treasurer will be responsible for all activities undertaken,
and shall establish a system of controls to regulate the activities of
subordinate officials and exercise control over that staff.
Notwithstanding,
the City Treasurer may approve non-material financing leases as previously
defined. In considering such leases, the City Treasurer should be satisfied
that there are real benefits including the overall economic benefits expected
from undertaking the project/capital asset itself, to entering into a lease
compared to purchasing the material/equipment on a cash basis or financing the
purchase through traditional debentures or bank loans. In assessing the overall
economic benefit of a lease financing transaction, the analysis will include,
if applicable, its alignment with Council priorities and strategic plans, its
community impact, any leveraging of partnership funding as well as its impact
on economic development and quality of life.
3) Requirement for
Outside Advice
The
City’s staff will be expected to have sufficient knowledge to prudently
evaluate standard financing transactions. However, should in their opinion the
appropriate level of knowledge not
exist for instances such as capital financing transactions that are unusually
complicated or non-standard, or as otherwise directed, outside financial and/or
legal advice will be obtained.
D) Suitable and Authorized Financing
Instruments
The form of financing that meets the objectives listed above will be
dependent in part upon its term and the type of asset to be financed.
1) Short-Term – Under
One (1) Year
Financing of operational needs for a period of less than one (1) year
pending the receipt of taxes and other revenues, or interim financing for
capital assets pending long-term capital financing may be from one or more of
the following sources:
a)
Bank line of
credit or loan agreement;
b)
Short-term
promissory notes issued to aforementioned institutions;
c)
Bankers'
Acceptances;
d)
Receiver General
Auction (municipalities are eligible to obtain short-term funding by bidding on
Government of Canada surplus cash balances through the Bank of Canada ); and
e)
Infrastructure
Ontario short-term advances pending issuance of long-term debentures.
2)
Long-Term – Greater than One (1) Year
Financing
of assets for a period of greater than one year may be from any of the
following sources:
a)
Debentures
(including those issued to Infrastructure Ontario), which may be in the
following form or a combination thereof:
·
Instalment
(including those with a refunding provision)
·
Sinking Fund
·
Amortizing
·
Variable Interest
Rate
·
Foreign Currency
·
Retirement Fund
b) Long-Term
Bank Loans (including Syndicated Bank Loans)
These may be used
if deemed cost effective or otherwise necessary. These loans may be either fixed or variable interest rate loans
as determined by the City Treasurer.
c)
Construction
Financing
May be used for a
period of normally up to five (5) years during construction or rehabilitation
of certain facilities from which a revenue stream or cost savings is expected
to be generated upon its completion.
d) Lease
Financing Agreements (Capital Financing Leases)
May be used when
it provides benefits, including the overall economic benefits expected from
undertaking the project/capital asset itself,
compared with other forms of financing.
Capital financing leases may include cross-border and rolling stock
leases.
e)
Tile Drainage
Debentures
These will be used to finance the construction of tile drainage systems
for agriculture and for those individual farmers who apply and are accepted for
financing.
3)
Credit Rating Requirements
The City may only issue foreign currency debentures,
variable rate debentures, or variable rate long-term bank loans if its
long-term debt obligations are rated by:
a)
Dominion Bond
Rating Service Limited as “AA (low)” or higher, or
b)
Fitch Ratings as
“AA-“ or higher, or
c)
Moody’s Investors
Service, Inc. as “Aa3” or higher, or
d)
Standard and
Poor’s as “AA-“ or higher.
E) Financing Risk Identification And
Mitigation Strategies
It
is explicitly recognized that there may be additional risks associated with
certain types of financing. It is expected that these risks will be identified
and considered prior to their use in relation to other forms of financing that
would be available. Also, the
mitigation strategies discussed below will be used to reduce the additional
risk when deemed practicable.
1) Construction Financing
Construction
financing may be used to “lock-in” the debt needed for a capital project
generally when the amount required is considered too large to finance from
internal cash flow or when it is considered appropriate to segregate all the financing
required for a particular project.
Construction financing is unique in that the debt may be accrued in
advance of the project’s completion and the interest accrues and no payments
are made during the building period.
The
following risks compared to other forms of financing will be considered prior
to the use of construction financing:
a)
The financial risks include the
following:
·
The possibility
that interest rates may fall from the time the rate for the construction loan
is established and completion of construction.
Should there be a high probability of this occurring, staff will
consider the use of variable interest rate rather than fixed rate financing as
a method to mitigate this risk; and
·
The possibility
that the final cost of construction could be materially less than initially
forecasted and financed. Staff will
consider whether or not to issue debt until a fixed rate contract has been
awarded or to issue debt that does not exceed 75% of the projected cost as a
method to mitigate this risk.
b) Other
risks include that the construction project may not be able to proceed or is
not completed for technical or other reasons.
The mitigation option to be considered in this case will be not to issue
long-term debt until all critical construction contracts have been awarded.
2)
Financing Lease Agreements
Leases
may be used to finance equipment, buildings, land or other assets.
The
following risks compared to other forms of financing will be considered prior
to the use of capital financing lease agreements.
a) The
financial risks include the following:
·
The ability for
lease payment amounts to vary if based on changes in an underlying benchmark
debt instrument (generally expressed as a particular Government of Canada
Bond). This risk usually applies only
to new assets being added to a leasing schedule and would be the same as new
debt being issued from time to time;
·
The ability for
lease payment to vary based on changes in the assumed residual values of the
asset being leased. Again, this risk usually
applies only to new assets being added to a leasing schedule and would not be
riskier than other forms of financing;
·
Uncertainty over
leasing costs if contract needs to be extended or renewed. The normal practice of the City will be to
negotiate these costs prior to the leasing agreement being executed.
b) Other
risks include the potential for the seizure and removal of leased equipment if
the leasing company goes into default of its obligations to creditors, and its
creditors have the legal right to seize assets of the leasing company. The practice of the City will be to assess
the financial strength of the normal leasing company prior to the leasing
agreement being executed and/or to adopt other measures and strategies to
protect as far as practicable, the leased equipment/facilities from seizure.
3) Variable Interest Rate Debenture and
Long-Term Bank Loans
Variable rate debentures and long-term bank loans may
be used when there is volatility in the financial market and/or there is an
expectation of significantly lower interest rates occurring within a few months
of their issue. In all cases, the interest rate will be fixed no later than 6
months after issue by means of an interest rate exchange (i.e. hedging)
agreement in order to mitigate the financial exposure.
The City may only enter into interest rate exchange
agreements as part of a variable rate debenture with an eligible institution
whose credit ratings are equivalent to those cited in Section D(3) above.
4) Foreign Currency Debentures
Foreign currency debentures may be used when the “all
in” cost of financing in a foreign market is cheaper or the market conditions
are such that domestic financing is not practicable. The risk associated with foreign currency debentures is that the
rate of exchange incurred for future interest and principal payments could
significantly increase over the term of the debt, raising its overall cost.
The City’s practice with respect to foreign currency
debentures will be to have the rate of exchange for all interest and principal
payments fixed prior to their issue by means of foreign currency exchange or
hedging agreement in order to mitigate the financial exposure. The City will
manage the counterparty risk primarily by only entering into a foreign currency
exchange agreement with an institution whose credit ratings are equivalent to
those cited in Section D(3) above.
Any foreign currency exchange agreement or agreements
for a debenture will, when read together, provide for the reduction of currency
risk with respect to the entire amount of principal and interest payable under
the debenture and shall require any amount payable to any person under the
agreement or agreements to be expressed as a Canadian currency amount.
The
currencies set out in Appendix 1 are prescribed foreign currencies eligible
under provincial regulation.
5) Bond Forward
Agreements
When issuing debentures the interest rate is not fixed
until the actual time the debentures are launched or issued in the market. It is only at that time that investors
commit to purchase City debentures for a specific term and interest rate. As a result, the City is exposed to changes
in interest rates up until the issue is launched. Bond forward agreements will
allow the City to fix the underlying interest rate on all or part of a planned
debt issue prior to the issue date thus reducing the risk of changes in
interest rates.
Bond forward agreements may only be used for the issue
or the refinancing of debentures denominated in Canadian currency for which
Council approval has already been given or authority to proceed with a
debenture issue has been delegated to the City Treasurer in accordance with
By-law 2006-112.
Furthermore, it will be the City’s normal practice to
limit bond forward agreements to apply to no more than seventy-five percent
(75%) of the principal amount of debentures to be issued. Bond forward agreements will have a
settlement date which within the length of time approved by Provincial
Regulation which currently is not longer than 60 days after the day on which
the agreement is executed.
It will be the City’s normal practice that
counterparty payments resulting from the use of these agreements, if material,
will be added to or deducted from the principal of the amount being financed.
Utilizing bond forward agreements exposes the City to
the following risks:
a)
Credit risk to
the counterparty (financial institution) in the event interest rates have risen
and the counterparty cannot fulfill the terms of the agreement. Although this is considered a remote risk,
credit exposure resulting from any or all outstanding bond forward agreements
executed with any financial institution will be added to any outstanding
investments held in the City’s investment portfolio and will be subject to the
same limitation guidelines set out in Appendix 1 of the Investment Policy.
b)
There will be an
opportunity cost if interest rates fall and the City has to pay the
counterparty to the bond forward agreement.
This is recognized, however the primary use of a bond forward agreement
is to “lock-in” the anticipated borrowing rate associated with the future
debenture issue and reduce or eliminate the risk of higher interest rates. The City’s practice of hedging less than
100% of the planned debenture issue would result in some of the savings still
being achieved.
By not utilizing a bond forward agreement, the City
will be exposed to movements in interest rates that will be either beneficial
or detrimental and will have less certainty about the cost of borrowing on a
prospective debenture.
Before
entering into a bond forward agreement, treasury staff and the City
Treasurer will analyze and provide:
a)
The fixed costs
and estimated costs to the City resulting from the use of such agreements.
b)
A detailed
estimate of the expected results of using such agreements.
Bond forward agreement may only be entered into with a bank listed in Schedule I, II or III to the Bank Act (Canada) and only if the bank's long-term debt obligations on the day the agreement is entered are rated by:
a) Fitch Ratings as “A+” or higher; or
b) Moody’s Investors Service Inc. as “A1” or higher; or
c) Standard and Poor’s as “A+” or higher.
d) Dominion Bond Rating Service as “A(high)” or higher.
F) Methods Of Marketing/Selling Debenture
Issues
Debenture
securities may be sold by the following means:
a) Underwriting Syndicate
The use of an underwriting syndicate will be the normal method by which
debentures will be sold by the City; or
b) Bought
Deal/Private Placement
This may be appropriate for only "one off" or unusual financing structures
when significant savings would be expected or when market conditions are
volatile or otherwise difficult.
G) Financial
Guarantees And Letters Of Credit
Financial
guarantees and/or letters of credit provided by the City will be considered as debt and will be
governed by this Policy.
H) Sinking/Retirement Fund Debentures
A
Sinking Fund will be established
whenever sinking and/or retirement fund debentures are issued during a calendar
year.
As
a guideline when setting the internal capitalization rate for new
sinking/retirement fund debt at the time of its issue, the rate shall not
normally exceed the 5-year Government
of Canada bond rate at time of issue.
I) Reporting Requirements
In
addition to any information requested by Council or that the City Treasurer
considers appropriate, the following reports will be provided:
1)
Annually, the
City Treasurer shall submit to Council a report or reports that:
a)
Requests
authority for temporary borrowing up to a stipulated amount to meet day-to-day
expenditures, pending receipt of tax levies, user fees and revenues anticipated
during the year;
b)
States the amount
of levies, if any, that must be raised for sinking fund purposes in that year;
2)
As required, the
City Treasurer shall submit to Council, the following:
a)
A report, before
entering into a financing lease which is other than a non-material lease with a
recommendation assessing the costs and financial and other risks associated
with the proposed financing lease as of the date the report is made. This
report shall include:
·
A comparison
between the fixed and estimated costs and the risks associated with the
proposed lease and those associated with other methods of financing;
·
A statement
summarizing, as may be applicable, the effective rate or rates of financing for
the lease, the ability for lease payment amounts to vary, and the methods or
calculations, including possible financing rate changes, that may be used to
establish that variance under the lease;
·
A statement
summarizing any contingent payment obligations under the lease that in his or
her opinion would result in a material impact for the municipality, including
lease termination provisions, equipment loss, equipment replacement options and
guarantees and indemnities;
·
A summary of the
assumptions applicable to any possible variations in the lease payment and
contingent payment obligations; and an assessment of the overall economic
benefits expected from undertaking the project and /or acquiring the
equipment/materials. In assessing the overall economic benefit of
a lease financing transaction, the analysis will include, if applicable, its
alignment with Council priorities and strategic plans, its community impact,
any leveraging of partnership funding as well as its impact on economic
development and quality of life.
b) Lists of
any outstanding financing leases including the following details:
·
Estimates of the
proportion of financing leases to the City’s total long-term debt and provides
a description of any change in that proportion since the previous year's
report; and
·
A statement that
in his or her opinion all financing leases were made in accordance with the
lease policy and goals as outlined in this Policy or as otherwise adopted by
Council.
c)
A statement
before passing a by-law providing for construction financing, which shall
consider:
·
The fixed and
estimated costs to the City;
·
Whether the costs
of the proposed financing for the construction of the undertaking are lower
than other methods of financing available;
·
A detailed
estimate with respect to the terms of the City’s expectations of revenue
generation from the undertaking, once constructed;
·
The risks to the
City if the undertaking is not constructed or completed within the period of
construction as estimated by Council; and
·
The financial and
other risks for the City.
d)
A report
detailing at least once in a fiscal year, any bond forward agreements in a
fiscal year which the City has entered into.
The
report must contain the following information and documents:
·
A statement
comparing the expected and actual results of using bond forward agreements
during the period of the report; and
·
A statement
indicating whether, in his or her opinion, all of the bond forward agreements
entered during the period of the report are consistent with the bond forward
policies and goals in this Policy or as otherwise adopted by Council.
e)
A report
detailing at least once in a fiscal year, any subsisting variable interest rate
bank loan agreements and any subsisting interest rate exchange agreements
applicable to them.
f)
Lists any outstanding
construction financing debentures including the following details:
·
A description of
the estimated proportion of the total debentures of the municipality issued to
the total long-term debt of the municipality and a description of the change,
if any, in that estimated proportion since the previous year's report;
·
A statement as to
whether, in his or her opinion, all debentures issued were made in accordance
with this construction financing policy and goals outlined in this Policy or as
otherwise adopted by Council;
·
A record of the
date of the repayment of each instalment of principal, interest or both
principal and interest made during the period of construction of the
undertaking for which the debentures were issued;
·
A statement of
the outstanding instalments of principal, interest or both principal and
interest repayable during the currency of the debentures issued that will be
due and payable in each year; and
g)
Details of all
outstanding hedging instruments related to foreign exchange, interest and swap
agreements, describing type, amount and purpose; and
h)
A report
detailing, at least once in a fiscal year, any outstanding variable interest
rate debentures or foreign currency debenture and any subsisting interest rate
or foreign currency exchange agreements applicable to them.
RESPONSIBILITIES
Officers
and staff of the City complying with this Policy shall have the necessary
authority to carry out the responsibilities and duties identified therein the
Policy.
In
addition, the following specific responsibilities are identified:
1) City
Treasurer and/or Manager, Treasury:
·
Reviews and
recommends the type and term of financing for capital projects and operating
requirements;
·
Updates the financial debt and obligation limit for
the City as prescribed by the Municipal Act;
·
In consultation
with the lead underwriters, approves the timing and structure of debt issues;
·
Coordinates with
the City Solicitor the preparation of debt issue by-laws for Council;
·
May execute and
sign documents on behalf of the City and perform all other related acts with
respect to the issuance of debt securities;
·
Liaises and
assists rating agencies in the evaluation of the credit worthiness of the
City's debt securities;
·
Reviews and
recommends to Council the financial and business aspects of any material lease
agreements and transactions; and
·
Ensures all
reporting requirements identified within this Policy are met.
2) Chair of Council
The
Mayor may execute and sign documents on behalf of the City with respect to the
issuance of debt securities.
3) City Clerk
The City Clerk may certify and sign documents on
behalf of the City with respect to the issuance of debt securities.
REFERENCE:
Municipal Act, 2001, S.O. 2001, c. 25 Sections 405(1), 407(1), 408(3,4),
409(2)
Local Improvement Act, R.S.O. 1990, c.L.26, Section 53(2)
Tile Drainage Act, R.S.O. 1990, c.T.8, Section 2(1)
Ontario Regulation 266/02 - Financing Leases for Municipal Capital
Facilities
Ontario Regulation 278/02 - Construction Financing
Ontario Regulation 276/02 – Bank Loans
Ontario Regulation 604/06 – Debt Related Financial Instruments and
Financial Agreements
By-law 2006-112
CONTACT:
Manager of Treasury, Corporate Services, Financial
Services Branch, Treasury Services
Division
APPENDIX 1
Prescribed Foreign Exchange Currencies
1.
Dollars of
Australia.
2.
Yen of Japan.
3.
Francs of
Switzerland.
4.
Sterling money of
the United Kingdom.
5.
Dollars of the
United States of America.
6.
The euro currency
adopted by member states of the European Union.
O. Reg. 247/01, Sched.
Policy on Debt and Financing
politique sur les dettes et le financement
ACS2007-CRS-FIN-0007 CITY WIDE / À L'ÉCHELLE DE LA VILLE
Ms. M. Simulik, Director of Financial Services and City Treasurer, spoke to a PowerPoint slide presentation, which served to provide the Committee with a brief overview of the staff report. A copy of her presentation is held on file with the City Clerk.
Responding to questions from Councillor El-Chantiry, Ms. Simulik explained that sinking funds were a type of debt instrument. She advised that the City had not issued these in recent years because of declining interest rates. She indicated the financial community was more interested in sinking funds when interest rates were on the rise. She recalled that when the City issued its sinking funds, Council approved a by-law that stated the City would need to earn 4% or 5% in order to pay them off; the City would make an annual contribution of principle, but in addition to that, it needed to earn a certain amount every year. She reported the City was earning that and more. Every year, staff comes forward to Committee to talk about the sinking funds and what has been set aside to pay off the balloon payments at the end. She noted that, in cases where there are excess funds due to earning more than the pre-set percentage, the City discontinues the levy to account for the fact the investment has been better than anticipated. She also reminded Committee that staff regularly bring forward reports at the end of the life of a sinking fund, when it is paid off and there was some surplus left in the account, so that the funds can be used for other capital purposes. With respect to comparisons, she submitted that rather than comparing Ottawa with other municipalities in this regard, Council should compare the performance against the benchmark established when the sinking fund was issued, and she reported that in all cases, they were doing what they said they would; 5% or more.
In response to a further question from Councillor El-Chantiry, Mr. G. Mahoney, Manager of Treasury Services, explained that a bond forward agreement is an agreement between the City and a financial institution that allows for a cash settlement, depending upon the interest rate between the time that you enter into the bond forward agreement and the time that it expires. If interest rates increase, the City receives a lump sum of money from that agreement. If the reverse happens, then the City has to pay under the bond forward agreement. He indicated the purpose of the agreement is really to fix the interest rate on your debt prior to actually issuing the debt.
Councillor El-Chantiry referenced the low interest rates and the increasing costs of doing some construction projects and lifecycle maintenance and he wondered at what point it would be wiser to debenture for some of the projects rather than defer them. Ms. Simulik suggested that was a question of balance; the state of repair of the infrastructure and how much debt the City wanted to have on its books. She acknowledged the Councillor’s points. However, she cautioned against issuing more debt because, in the minds of the public, debt is not a good thing. She submitted that Council would have to debate the issue and make a decision as to its objectives with respect to the debt levels. She indicated staff was fairly comfortable, even with $626 still unissued, that the current debt level would not impact the City’s credit rating. She advised that because of a Council-approved policy, staff had not been putting forward the concept of increasing the debt load to meet rehabilitation of renewal needs. However, she acknowledged that it may be time to review that policy.
As a result of the exchange between Councillor El-Chantiry and Ms. Simulik, Mayor O’Brien asked that staff come forward with information on this issue for discussion during the Long Range Financial Plan process: the benefits of debenturing for rehabilitation projects versus deferring them and the risks and changes that would be required to address this issue. He also asked that the document include a recap as to whether or not the City should be considering Euro-bonds.
Responding to questions from Councillor Wilkinson, Mr. Mahoney explained that the direct PPP debt referenced on slide 4 of the presentation referred to debt from an existing public, private partnership. He indicated that transaction was one where the City was actually the borrower. He indicated that debt associated with lease payments on structures the City would own in the future would show up in financial statements. Ms. Simulik added that the City would disclose capital lease obligations in the financial statements, in the note on debt.
Responding to further questions from Councillor Wilkinson with respect to an annual report on all the financial lease agreements, Ms. Simulik explained this was a new requirement stemming from the adoption of the present policy. Once approved by Council, the policy would require that she report annually to Committee on the City’s lease obligations. She acknowledged that staff had not considered when these reports would begin. However, she confirmed that she could provide a report in 2007 with respect to 2006.
With respect to the revolving debt authority, Ms. Simulik explained that it was it was $150M to $175M because the City did not actually issue the debt until the project was complete. She noted that capital asset projects typically took 3 to 4 years to complete. Therefore there was a lag that would always roll forward; $50M times 3 years worth of debt authority. She confirmed that the City was paying off approximately $50M each year but that it was also adding approximately $50M each year. She indicated she would not recommend reducing it.
Responding to a series of questions from Councillor Desroches, Ms. Simulik indicated this policy was before Committee and Council at this time because, by regulation, the City had to have a policy, and because the City was about to enter into a lease financing agreement on the Orléans Arts Centre. With respect to the Auditor General’s involvement, she suspected he would use this policy to assess the Department’s compliance with it in future years. She confirmed that the policy only applied to capital projects because these were the only initiatives for which the City could issue debt. With respect to development charges, she noted that any debt issuance would have to comply with the Development Charge policy approved by Council last year; only additional project costs above what had been identified at the outset could be debt financed.
Councillor Deans felt the key number in the debt discussion was the impact on the annual operating budget; the cost to service the debt. She believed Council needed to determine the appropriate level and that the level needed to reflect the City’s growth and its growing service needs. She recalled that the former City of Ottawa had decided to set that number at zero whereas the former Region had a debt servicing envelope of about $80M. She noted that multiple municipalities had been merged into 1 and that the City was growing at the fastest rate in its history. She referenced the ever-growing demands for services and infrastructure and she posed questions with respect to the debt servicing envelope: did it reflect Council’s comfort level and would the City’s credit rating be affected by increased debt if the debt servicing envelope was not increased. Ms. Simulik indicated Council had adopted a policy for the debt servicing to remain constant. As a result, staff had kept it between $88M and $92M. She noted that dropping interest rates had helped in that, as debt incurred at 8% or 9% was dropping off, it was being replaced with debt incorrect at 4% or 5%. Therefore, the City had been able to service more debt with the same envelope. Although she did not know how long that would continue, she acknowledged that this may be an opportunity to go out and issue significant amounts of debt with the minimum amount of impact on taxation.
Mayor O’Brien wondered whether staff had done a sensitivity analysis on the City’s credit rating in terms of percentage interest rates and expansion of debt, should Council choose to increase debt. Ms. Simulik indicated that could form part of the discussion paper to be brought forward to Committee in terms of putting more debt on to fund renewal rehabilitation and at what point it could affect the City’s credit rating.
Councillor Deans felt that, in order to make recommendations to Council on future direction, this Committee needed to have a greater understanding of the City’s current state of affairs and whether or not this was a good time to issue more debt. She also suggested looking at some best practices in other municipalities; their ratio of debt and debt servicing envelope to their population and their credit rating. Ms. Simulik indicated this could also be included in the discussion paper to be brought forward. However, she advised that the City of Toronto had adopted a policy whereby their debt servicing remained constant as a percentage of their taxation. As their taxation grew, their debt servicing envelope grew. In comparison, Ottawa’s debt servicing, as a percentage of taxation, had declined since amalgamation.
Responding to questions from Councillor Bloess, Mr. Mahoney advised that the City was currently rated AAA by one rating agency and AA+ by another. He indicated staff had not heard any suggestions that these agencies were concerned about the City’s position and wanted to change the rating. He noted that staff typically met with the rating agencies in the spring and early summer so those meetings were coming up. However, he did not foresee any risks to the rating. Ms. Simulik reminded Committee that last year, there had been some discussions around risks to the City’s rating relative to light rail transit but that those risks had disappeared.
Councillor Brooks maintained there was good debt and bad debt. He was concerned that the low interest rates would result in a huge temptation to go out and borrow money. He maintained the need for setting priorities and spending wisely. With respect to the City of Toronto’s policy insofar as its debt servicing envelope being a percentage of taxation, he believed that was a recipe for disaster in the long run. He referenced the Long Range Financial Plan (LRFP) and a revolving debt of $400M and he wondered how that amount had been determined. Ms. Simulik explained the number was actually $40M times 10 years because the City had a 10-year plan. She further explained that the $40M was an average arrived at by staff looking at what debt was expiring and what servicing went with that in any given year.
That
Corporate Services and Economic Development Committee recommend Council adopt
the Policy on Debt and Financing attached as Annex A.
CARRIED