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STAFF REPORT ��„�, ..{b �,c�,��..��
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REQUEST: AUTHORIZE STAFF TO NEGOTIATE WITH WELLS
FARGO BANK REGARDING THE BANK'S PROPOSAL TO
ASSIST THE CITY WITH STRUCTURING A VARIABLE
RATE BOND ISSUE TO PROVIDE FINANCING FOR THE
CITY'S ENERGY INDEPENDENCE PROGRAM
SUBMITTED BY: PAUL S. GIBSON, FINANCE DIRECTOR
DATE: NOVEMBER 20, 2008
CONTENTS: (1) LETTER PROPOSAL FROM WELLS FARGO
INSTITUTIONAL SECURITIES, LLC
(2) GRAPH OF HISTORICAL ONE-MONTH LIBOR
PREPARED BY DEL RIO ADVISORS LLC
Recommendation:
By Minute motion, that the City Council authorize staff to negotiate
with Wells Fargo Bank regarding the bank's proposal to assist the
City with structuring a variable rate bond issue to provide financing
for the City's Energy Independence Program.
Background:
The City of Palm Desert has undertaken a groundbreaking program to finance
energy efficiency improvements by sponsoring legislation that amended Chapter
29, Entitled "Contractual Assessments" Sections 5898.10 through 5898.32, of the
Streets and Highways Code by authorizing the establishment of a "contractual
assessment program" to finance public improvements otherwise authorized
under the 1911 Act. Under Chapter 29, the improvements are limited to
developed property (cannot be used for property undergoing development). The
assessments levied pursuant to Chapter 29 are only with the free and willing
consent of the owner of each lot or parcel on which an assessment is levied.
AB 811 (Chapter 159, Statutes of 2008, effective July 21, 2008) amended
Chapter 29 by expanding the improvement work which may be financed to
include:
"installation of distributed generation renewable energy sources and
energy efficiency improvements that are permanently fixed to real
property," and authorizes a participating property owner to:
"purchase directly the related equipment and materials" and to "contract
directly for the installation" of the improvements
Any loans under the energy program are made to private entities. The private
nature of these loans prevents the City from financing these loans tax-exempt.
An assessment lien is placed on the property and the annual installments of
principal and interest are placed, in conjunction with the ad valorem taxes, on a
property owner's tax bill.
Current Situation
The City's Financial Advisor has spent a great deal of time and effort in exploring
other potential lending sources including commercial banks, private lenders and
bond financing. The current turmoil in the financial markets has made many
lenders pull back from lending. The current real estate market has made it very
difficult to lend based only on the assessment liens, established under Chapter
29, secured by the real property. In addition, the current taxable interest rates
are considerably higher than the 7.00% loan rate being offered by the program.
Alternative Financing Structure
The Financial Advisor approached several larger commercial banks including
Bank of America, Union Bank of California and Wells Fargo Bank about the
possibility of lowering the bond financing costs by using the General Fund of the
City as the backstop credit to finance these loans. However, even with the
excellent credit of the General Fund, the fixed-rate taxable market for this more
secure debt would still be higher than the 7% loan rate from the energy loans.
Wells Fargo Bank came back, via its subsidiary Wells Fargo Institutional
Securities, LLC, with an offer to provide a letter or credit that would add an
additional backstop to the bond program and allow the City to issue variable rate
demand bonds for which the interest rate would be reset at periodic intervals
(usually on a weekly basis, but may also be daily, monthly or some other
intervals). The term of the bonds would be for 20 years, the expected issue size
would be approximately $10.9 million and the bonds would provide $10 million in
loan proceeds. The City can use the proceeds in different ways: (i) payback the
General Fund the original $2.5 million loan and use the balance of $7.5 million to
originate new loans or (ii) use the $10 million to be combined with moneys from
the other programs bringing the total available to $17.5 million.
Under the Wells Fargo's proposal, Wells Fargo, through its affiliated entities,
would potentially act in multiple roles in the financing: trustee, underwriter,
remarketing agent, letter of credit provider and interest rate hedge provider. In
addition to the trustee fee and underwriter's discount that are normally
associated with a fixed rate bond deal, the City would also pay Wells Fargo
upfront and ongoing fees to maintain the fetter of credit and an ongoing fee for
the periodic remarketing of the bonds. The letter of credit would likely have a
term of a few years. At its expiration, the City would have to negotiate for an
extension of the letter of credit or purchase a substitute liquidity facility. In
addition, should the City chooses to purchase some interest rate protection as
outlined in the proposal letter, there would also be an additional upfront fee for
that protection.
The Financial Advisor has made some preliminary estimates regarding the
expected cash flow for the proposed bonds over time. Even though the General
Fund will provide the credit for the marketing of the bonds, it is expected that,
internally, the City will use repayment from the energy loans (payable by the
property owners at a rate of 7.00% per year), as the primary source of repayment
for the bonds.
Generally, the interest rates on taxable municipal variable rate bonds have
tracked one-month LIBOR (London Interbank Offering Rate). The interest rate
on some similar bonds was 3.75% during the week of October 27t", 2.51% for
the week of November 3�d and 1.90% for the week of November 10t". Attached to
this report is a graph and analysis prepared by the Financial Advisor showing
historical one-month LIBOR over the last fifteen years. Even with the ongoing
fees, the Financial Advisor estimates there is an annual spread between the
incoming revenue from the energy loans and the outgoing payments and fees on
the bonds. Any spread, if realized, can be used for any lawful purposes including
ongoing administration costs of the program.
The Financial Advisor has calculated that, assuming an average 3.75% interest
rate on the bonds, the City could realize a spread of over $1.5 million over the life
of the bonds. Using a more conservative assumption of 4.253% (the historical
average one-month LIBOR over the last fifteen years), the spread would be
almost $800,000 over the life of the bonds. One additional feature of the
proposed variable rate demand bonds is that the City can optionally call the
bonds at anytime without premium and can also repay a portion of them when a
property owners pays off their assessment lien.
One must note is that there is no guarantee that the rate on the variable rate
bonds (inclusive of all fees) will always be below the 7.00% loan rate. Variable
rate bonds are subject to market volatility. At the on-set of the dramatic credit
market down-turn in September and October of this year, the interest rate on
many variable rate municipal bond issues spiked. Remarketing agents, in some
cases, could not find investors to buy the bonds and were forced to "put" the
bonds to the credit bank. Most recently, the interest rates on the variable rate
municipal bonds with good underlying credits and good bank partners have
begun to remarket at more historical interest rate levels.
In order to use the City's General Fund as the credit for marketing purposes, the
proposed bonds will be structured as lease revenue bonds. Under the California
Constitution, a City is generally not allowed to issue bonds (or incur other forms
of debt) secured by a pledge of the General Fund without voter approval. An
often-used method to avoid violating this constitutional debt limitation and still
utilize the General Fund as the credit for a bond issue is the lease revenue
structure, which has been approved by California courts in a line of cases.
In the proposed financing, the Palm Desert Financing Authority would issue the
bonds. Concurrently, the Authority and the City would enter into a lease and a
sublease. Under the lease, the Authority would lease certain properties from the
City for a nominal amount of rent ($1.00). Under the sublease, the City would
sublease the same properties back from the Authority and pay semi-annual rent
in sufficient amounts to allow the Authority to use this "rental income" to pay debt
service on the bonds.
In order to avoid a violation of the constitutional debt limitation, the sublease
must meet the certain criteria established by the court cases, including:
(1) The rent payable by the City each year must be contingent on the City having
beneficial use of the leased property for that year. Therefore, under no
circumstances can future rent be accelerated. Moreover, if the leased property is
destroyed or substantially damaged, the rent will have to be abated during the
time that the property cannot be occupied.
(2) The rent payable by the City cannot exceed the "fair rental value" of the
leased property.
To provide protection for bondholders in light of the first criterion, the bond
documents will require the City to maintain certain types of insurance with
respect to the leased properties, such as fire and extended coverage insurance
and rental interruption insurance.
With respect to the second criterion, it is often difficult to establish "fair rental
value" for a public-owned property. It has been generally accepted that a
municipality is not paying rent that exceeds "fair rental value" if the aggregate
principal amount of the bonds is not more than the value of the leased property,
and the interest rate on the bonds does not exceed reasonable market rates.
California law limits the interest rate on the bonds at 12 percent per annum.
The task then is to identify City-owned assets which may be used for the lease-
sublease. The aggregate value of such assets must be at least equal to the
principal amount of the proposed bonds. Staff has explored using the following
leased assets (current insured value shown):
Parkview Office Building (two floors) $4,815,400
Parkview Office Building (one floor) $2,894,145
Fire Station 33 $1,821,342
Fire Station 71 $1,541,133
Total Value= $11,072,020
Wells Fargo has reviewed and provided preliminary approval of the list. The
assets can be released from the list as principal is repaid and other assets can
be substituted under the bond documents.
The lease revenue bond structure is a very common and accepted way for public
agencies to finance projects, and can be used in our case to provide financing for
the energy efficiency program. The Riverside County Palm Desert Financing
Authority closed today a series of lease revenue bonds to finance various County
facilities, including the new Palm Desert Sheriff Station.
Conclusion
Staff is not recommending the acceptance of Wells Fargo's proposal at this
stage. However, the proposal provides the City an opportunity to explore a
financing structure which may provide funding for the City's AB 811 Program.
Staff requests authorization to proceed with the negotiation. If the negotiation
progresses to the point where Staff will be in a position to recommend the
acceptance of the Wells Fargo proposal, then Staff will bring back proposed bond
documents for the City Council's consideration.
Submitted by: Reviewed by:
�
Paul S. Gibson, Finance Director Carlos L. O ga, City Manager
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Wells Fargo Institutional Securities, LLC ' . �
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Margo Kairoff
Senior Vice President
MAC#E2818-178-17"'Floor
T07 Wilshire Boulevard
Los Angeles,CA 90017
Direct:273�14-3327
Fax: 213-614-2720
e-mail margo.kairoff@wellsfargo.com
November 3, 2008
Kenneth L. Dieker, Principal
Del Rio Advisors, LLC
1325 Country Club Drive
Modesto, CA 95356
Re: Proposal to City of Palm Desert
AB811 Program
Dear Ken:
On behalf of Wells Fargo Public Finance ("Public Finance"), following up on our October 2008
presentation of qualifications we are now pleased to offer our proposal to provide the following
services to the City of Palm Desert for the proposed taxable bond issue:
■ investment banking;
■ bond underwriting and remarketing services;
■ interest rate protection;
■ trust services, and
■ Wells Fargo Bank Direct Pay Letter of Credit* supporting an $11MM taxable Variable
Rate Demand Bond offering.
In addition to bringing the financial strength of Wells Fargo & Co., the only bank in America
rated triple-A by both Standard & Poor's and Moody's and thereby providing a triple-A rating to
the City's bond issue, Wells Fargo offers stability during these tumultuous times.
After discussing the proposed operation of the City's AB811 program we believe a taxable
variable rate demand obligation (VRDO) structure supported by a bank direct pay letter of credit
provides the best option, offering the flexibility required for these private activity bonds which
are not eligible for tax exempt funding. Homeowners may prepay their loans when selling or
refinancing their homes and unlike the call protection or pre-pay prohibition mandated by
traditional fixed rate bond issues, a VRDO will accommodate the City's need for flexibility if
early prepayments occur.
*Subject to satisfactory review of City's financial statements and credit approval by Wells Fargo Bank.
Wells Fargo Public Finance(WFPF)bankers are registered representatives of Wells Fargo Brokerage Services, LLC, or Wells
Fargo Institutional Securities, LLC,brokerage affiliates of Wells Fargo&Company and members of the FINRA and SIPC.
Investments: •NOT FDIC insured• May lose value •No bank guarantee
Public Finance
Page 2
We propose to meet the 20 year loan term requested by the City by underwriting a 20+year bond
issue so the City has ample time to originate the $lOAMM for new loans and still offer a 20-year
loan amortization to homeowners. We also propose to utilize a 7-day repricing mode, thus
accessing longer term loan amortization of the loans while achieving lower interest rates by
pricing the interest rate at the short end of the yield curve.
We underwrite and remarket taxable VRDOs at levels of market acceptance,just as we do in our
tax exempt VRDO portfolio. Our repricing historically has been close to 1-month LIBOR and
for the current week Thursday 10/30/08 - Wednesday 11/5/08 our taxable VRDO rate is 3.75%.
The City's total debt burden for this week would be 3.75% plus the cost of the LOC plus .125%
for the remarketing agent.
Wells Fargo is prepared to offer the City interest rate upside protection by providing an interest
rate swap, collar or cap which will create a maximum interest rate ceiling on the VRDO floating
rate. We will work with the City, analyze cash flow projections and then customize the interest
rate hedging vehicle best able to minimize your interest rate exposure. For a general indication
of the cost of such instruments, please refer to the accompanying preliminary pricing for the
hedge options we discussed last month. These hedging instruments can be secured after the bond
issue closes so we have the opportunity to put a cap or swap in place at any time. I would like to
suggest that we continue our dialogue and stay in touch so we can provide additional details and
more current information as the project financing evolves.
We anticipate that, prior to the City Council meeting of November 20t"; we will present a more
formal proposal with up to date pricing for the various products including the direct pay letter of
credit. I will plan to attend the City Council meeting on November 20`" and in advance of that
meeting will be happy to meet with you and Staffpersons to answer any questions and comply
with City mandated requirements.
Thank you again for providing us with this opportunity to offer our services and in particular for
the opportunity to participate in helping to move Califomians toward "greener" lifestyles. We
look forward to working with you and the City as this process continues to develop.
Sincerely,
�t__.c....�
� G�
Margo Kairoff
Senior Vice President
Cc: Lynn Love, Wells Fargo Government Banking Division
Wells Fergo Public Finance(WFPF)bankers are registered representatives of Wells Fargo Brokerage Services,LLC or Wells Fargo Institutional Secunties,LLC,brokerage
affiliates of Wells Fargo&Company and members of the NASD and SIPC.
Investments:`NOT FDIC Insured 'Mav lose value "No bank auarantee �