CONCLUSION
The Buffalo Pound Water Treatment Plant (the Plant) has aging electrical infrastructure that is reaching the end of its life phase. Therefore, at the June 26, 2017 City Council meeting (CR17-64), Council approved BPWTC to accelerate the Electrical Upgrade Capital Project (EUCP) and approved BPWTC to examine and pursue financing options.
Accelerating the EUCP now will require BPWTC to incur approximately $50 million of expenditures over years 2017 to 2019. Since BPWTC does not have this amount of cash on hand, financing is required for the principal amount of up to $45 million by November 2017. As the joint owner of the BPWTC with the City of Moose Jaw, the City of Regina would show debt on its financial statements at its 74% proportionate ownership share or the principal sum of $33.3 million, plus interest and other costs if the borrowing is approved.
Pursuant to section 5.2 (f) of the Unanimous Member’s Agreement (UMA) between the City of Regina and Moose Jaw (the Cities) and BPWTC, as well as section 153 of The Cities Act, City Council is required to approve borrowing requests of BPWTC as the debt incurred by BPWTC is consolidated (included in) the City of Regina’s debt and the City would be ultimately responsible for repayment. The Cities are also being asked to guarantee the loan. For this reason, in addition to authorizing the borrowing itself, a borrowing/guarantee bylaw will be required to be passed by Council. This report authorizes BPWTC to borrow up to $45 million as outlined in the BPWTC’s request as attached in Appendix B.
If BPWTC borrows this debt, the impact on the City of Regina’s financial position is reasonable. It is also important to note that BPWTC indicates moving forward with the recommendations in this report will not cause an increase to the water rates that the Cities pay to BPWTC, other than water rate increases previously contemplated.
In addition to dealing with the loan for BPWTC, this report also includes some governance housekeeping matters for Council approval such as BPWTC’s corporate bylaws and the appointment of a new auditor.
BACKGROUND
BPWTC is a municipal corporation or what is called a “controlled corporation” under The Cities Act with the Cities as its sole voting members. BPWTC is required by the Unanimous Membership Agreement (UMA), to obtain the approval of both Cities for the borrowing of funds to proceed with the EUCP. Clauses 5.2 (f) and (z) and section 5.3 of the UMA state:
5.2 Matters for City Approval. The Corporation shall not take any of the following actions without the prior approval of each of the Cities:
(f) the borrowing of money or the issuing any debt obligation or amending, varying or altering the terms of any existing debt obligation;
(z) any transaction or series of related transactions that are outside of the normal course of business of the Corporation and involve an expenditure of an amount exceeding $1,000,000, plus the Escalation Factor, unless such transaction or series of related transaction have been approved in the annual budget for such fiscal year.
5.3 Decisions of City. Where approval of the Cities is required pursuant to section 5.2 of this Agreement, the chairperson of the Board of Directors shall make a written request to each of the Regina Council and Moose Jaw Council which includes all information necessary for the Cities to make an informed decision. All requests pursuant to this section 5.3 shall include all supporting information and shall be provided to the City Manager, or delegate of each of the Cities, who shall bring the matter forward to Regina Council and Moose Jaw Council, respectively, for consideration.
In accordance with sections 5.2 and 5.3 of the UMA, the BPWTC Board of Directors have submitted the attached request in Appendix B which requests approval and guarantee for the borrowing to proceed with the EUCP.
The reason for the EUCP is the Plant has aging electrical infrastructure that is reaching the end of its life phase. Recent electrical failures have raised the issues and potential impacts of the Cities’ dependency on the Plant.
Addressing this issue now will require BPWTC to incur approximately $50 million of expenditures over years 2017 to 2019. Since BPWTC does not have this amount of cash on hand, financing is required for the principal sum of up to $45 million in November 2017.
In order to best facilitate the borrowing, the City of Regina, along with the City of Moose Jaw, is being asked to provide a guarantee of the debt to BMO. The provision of a formal guarantee is not unusual in this type of situation and would permit BPWTC to complete the borrowing without providing security in the assets. This is desirable from the perspective of both the City of Regina and BPWTC and is consistent with the fact that notwithstanding a formal guarantee, the debt incurred would count against the City of Regina’s debt limit and the City would be ultimately responsible for repayment if default occurred. The guarantee would be for the City of Regina’s 74% proportionate share of BPWTC, or the principal sum of $33.3 million, plus any interest and other costs, if the principal sum of $45 million is borrowed.
Cities are authorized pursuant to section 153 of The Cities Act to guarantee the repayment of a loan where the loan is made between a lender and a city’s controlled corporation. As mentioned above, BPWTC is the Cities’ controlled corporation under The Cities Act as it is a corporation in which a group of cities hold securities to which are attached more than 50% of the votes that may be cast to elect a majority of the directors of the corporation. A bylaw authorizing the borrowing/guarantee is required to be passed by both City Councils prior to BPWTC entering into this external financing arrangement and prior to the Cities guaranteeing this loan. Pursuant to section 153 of The Cities Act, the bylaw must contain details of the following:
· The amount of money to be borrowed under the loan to be guaranteed and in general terms the purpose for which the money is borrowed;
· The rate of interest under the loan or how the rate of interest is calculated, the term and the terms of repayment of the loan; and
· The source or sources of money to be used to pay the principal and interest owing under the loan if the city is required to repay the loan under the guarantee.
This report delegates authority to the Chief Financial Officer to negotiate, approve, and enter into all necessary agreements with BPWTC, BMO and the City of Moose Jaw on behalf of the City of Regina and generally do all things and execute all documents and other papers in the name of the City of Regina in order to carry out the borrowing and guarantee for BPWTC to a maximum of $45 million with BMO. The City Manager has formally appointed the new Executive Director, Financial & Corporate Services as the City’s Chief Financial Officer.
DISCUSSION
BPTWC’s Proposed Debt Structure
The borrowing contemplated by BPWTC includes credit facilities totalling up to the principal sum of $45 million. BPWTC approached two financial institutions with respect to the borrowing. The process to request proposals from the two lending institutions followed by BPWTC is consistent with the process used in the past by the City of Regina.
BMO offered the most attractive borrowing with the best interest rates. The amount, repayment sources, interest rate and term for each aspect of the loan is summarized below:
· Non-Revolving Term Loan: up to the principal sum of $45 million: In terms of interest rates, BPWTC has the option of choosing the Canadian Prime Rate less 0.50% or the Banker’s Acceptance Rate (BA) plus 0.75% credit spread. BPWTC has indicated that they will be choosing the BA rate because it is typically lower. As at October 17, 2017 the BA based rate was 2.08% (1.33% BA rate plus 0.75% credit spread) and the prime-based rate is 2.7% (3.2% prime rate less 0.50%) but these rates change on a daily basis. This loan will be repaid from BPWTC’s revenue that it receives from water rates charged to each of the respective Cities. Payments on both the principal and interest will be made monthly and will be calculated based on a 25 year repayment schedule however the loan is for a 10 year term. This means that there will be a balloon payment required at the end of the 10 year loan term unless the loan is renewed. Subject to the later approval of both City Councils and later guarantee bylaws, BPWTC’s intention is to renew this loan at the 10 year period so that it would not be making the balloon payment but would instead repay the loan over a further 10-15 year term.
· Interest Rate Swap: BPWTC intends to enter into an interest rate swap agreement for a 25 year term that would cover the interest rates for the $45 million non-revolving term loan. The reason the swap agreement is 25 years and the loan agreement is only 10 years is that BPWTC intends to renew the loan after the 10 year period. In this case, BPWTC is receiving a variable interest rate under the loan agreement with BMO but it can swap this interest rate with a fixed rate by entering into a swap agreement. The reason for entering into a swap agreement is to manage variableness of the BA rate and thus achieve a fixed rate over the 25 year repayment term. This provides cost certainty and protects against potential interest rate increases. The formula is the 25 year swap rate plus 0.75% credit spread. As at October 17, 2017 the 25 year swap rate is 2.75%, resulting in a total rate of 3.5% (2.75% plus 0.75% credit spread). The result is BPWTC will pay a fixed rate of 3.5% over the 25 year term subject to the risks noted below. This rate is also subject to change until the final legal documents are signed. The credit spread under the interest swap agreement is reviewed by BMO at the 10 and 20 year intervals and is adjusted based on the Cities’ creditworthiness.
If the Cities were required under the guarantee to repay the principal and interest owing under the loan as well as any early termination or unwind fees for terminating the swap agreement, the City of Regina would make the payments from any one or more of the following sources: municipal property taxes, the general fund reserve or the utility fund reserve.
Advantages and Risks of Debt Structure
Advantages:
· Allows BPWTC to achieve a fixed rate, which today is 3.5% over the 25 year term. The alternative is to not enter into a swap and be subject to interest rate changes.
Risks:
· As mentioned above, the loan expires after 10 years. If it is not renewed there is a risk that BPWTC would have to repay both the outstanding loan amount and settle up the potential breakage cost/benefit on the interest rate swap. The potential breakage cost/benefit is dependent upon prevailing interest rates and fluctuates from a loss to a gain dependent upon market interest rates. For example, if BPWTC were to terminate the swap in year 10 and rates decreased by 1%, BPWTC would incur a loss of about $3 million. BPWTC does not have the intention to terminate the swap agreement and intends to carry it to full term. BMO has also stated that they intend to renew the loan at the 10 and 20 year milestones. Given the low approximately 3.5% fixed rate, the potential risks in entering into an interest rate swap were considered reasonable.
· At the 10 and 20 year milestones, BMO will review the 0.75% credit spread for any adjustment. However, this spread is not based on market rates. Rather it is based on the Cities’ creditworthiness, which is not typically variable. The swap rate is not variable and remains fixed for the 25 year term. Therefore, the risk is low that a large interest rate increase would occur at the 10 and 20 year milestones.
· Under the guarantee, if BPWTC defaulted on the loan, the Cities would be required to repay their proportionate shares of the loan as well as any potential early termination costs or unwind fees due to the interest rate swap agreement being terminated based on their respective ownership shares in BPWTC, which are 74% for Regina and 26% for Moose Jaw.
City’s Debt Limit and Current Debts Outstanding for the City and BPWTC
The City of Regina has been conservative with respect to its borrowing and regularly monitors debt to ensure it maintains a sound financial position and that credit quality (rating) is protected. The current credit rating of AA+ received by Standard and Poor’s is a very strong rating. Remaining in good standing enables the City to have access to capital markets and favourable interest rates for the debt it assumes.
The City’s current debt limit is $450 million with $294 million outstanding as of
December 31, 2016. The outstanding debt for the City is projected to reach approximately
$300 million by December 31, 2017 (including outstanding guarantees). BPWTC currently has no debt. If the proposed debt of $45 million by BPWTC is taken into consideration, it will increase the City’s projected debt to $333 million (including outstanding guarantees) based on the City being responsible for its proportionate share (74%) of the principal value of the debt or $33.3 million. The increase will leave approximately $120 million in debt available to the City and it reduces the availability of debt financing to support other high priorities that may arise and could potentially impact the City’s credit rating if not repaid when due. To mitigate the risk of the additional debt on the current credit rating, the City will continue to work within the parameters established in the Debt Management Policy. This Policy specifies that the City of Regina maintain a debt service ratio of 5%, which is the percentage of the City’s revenue used for annual debt interest and principal payments. It also specifies that the percentage of the City’s debt to revenues should remain within 60%. Both of these debt ratios for the City are projected to remain within the specified targets for at least the next five years.
Assessment of BPWTC Current and Projected Financial Condition
As money borrowed by BPWTC ultimately represents a debt obligation of the City of Regina and reduces the available debt to the City, it is important to evaluate BPWTC’s current and projected financial condition to determine its ability to repay borrowed funds. In addition, it is necessary to evaluate the potential risks the City may face with respect to debt issued by BPWTC.
In order to determine BPWTC’s overall ability to meet its debt obligation, consideration was given to BPWTC’s audited financial statements for 2015 and 2016, along with unaudited cash flow information provided by BPWTC. Administration reviewed BPWTC’s projected cash flows for reasonability and have concluded that Buffalo Pound can manage an annual debt payment of approximately $2.7 million. The borrowing of the principal sum of $45 million would have an annual debt payment of less than $2.7 million. Therefore Administration concludes that BPWTC can meet this debt obligation. By lending to BPWTC, the BMO has also concluded that BPWTC can meet its debt obligations.
Impact of BPWTC’s Debt on the City’s Debt Position
Debt Service Ratio
The debt service ratio measures the percentage of revenue required to cover debt servicing cost, including interest and principal payments. A high debt servicing ratio is an indication of financial risk as a substantial amount of operating revenues will be required to service debt obligation. The debt service ratio is the prime ratio used by Standard & Poor’s (S&P), the City’s credit rating agency, when assessing the debt burden of a municipality. The City Debt Management Policy sets an affordability target rate of less than 5%. As presented in Figure 1, the debt service ratio for the City of Regina increases slightly when BPWTC’s debt is included, but is still within the benchmark as shown in the graph below.
Figure 1
Tax-and-Rate Supported Debt Ratio
The Tax-and-Rate Supported Debt Ratio is used to assess the amount of debt that is repaid with consolidated operating revenues that are not dedicated to a specific project or fund. This is a key relevant measure of the City’s debt affordability because typically debt service costs are funded out of the general operating budget and thus compete directly with other funding needs.
As a key indicator used by S&P, a ratio in the range of 30-60% is considered moderate in the overall debt assessment of a municipality. Through the City’s debt management policy, a target of 60% or less has been set and will be used for monitoring, reporting and future debt considerations. Once 60% is reached there is an increased risk S&P may consider reducing the City’s current credit rating. As shown in Figure 2, if BPTWC’s debt is borrowed this ratio will increase slightly from 36% without the borrowing to 40% in 2017 therefore it is still well below the benchmark of 60% as show in the graph below.
Figure 2
Corporate Governance Housekeeping Matters
In addition to dealing with the loan, this report is requesting Council approval of two governance items: approval of BPWTC’s bylaws and the appointment of a new auditor.
Organizational Resolutions and Bylaws
Under clause 5.2(n) of the Unanimous Membership Agreement (UMA) both the Cities of Regina and Moose Jaw are required to approve the amending, or repealing of any of BPWTC’s bylaws. The bylaws set out matters such as the business of the corporation, how agreements will be signed, banking arrangements, details as to membership, procedures for members’ meetings, details as to directors and officers, procedures for meetings of directors, and details as to notices. Once both Councils have approved the organizational resolutions and bylaws, a proxy must be designated to exercise this vote. The amended corporate resolutions and bylaw set out in Appendix A were prepared and reviewed by legal counsel of both cities and the BPWTC Board has approved these documents and is requesting that both Cities approve them as well.
Auditor Appointment
Pursuant to clause 5.2(i) of the UMA, BPWTC cannot appoint or make any changes to their auditor without prior approval of the Cities. BPWTC has traditionally used the same auditor as the City of Regina. The audit contract for the City of Regina is expired and the new audit contract has been awarded to MNP LLP for the period 2017-2021. Given this, BPWTC has requested that the Cities as voting members of BPWTC approve the appointment of MNP LLP as BPWTC’s auditor for this period. BPWTC’s request for this appointment is attached in Appendix C.
RECOMMENDATION IMPLICATIONS
Financial Implications
With BPWTC borrowing of the principal sum of up to $45 million, this will reduce the debt room under the debt limit for the City. However, the City will still have slightly more than $100 million of debt room based on the City’s 74 % proportionate share of the principal sum of the debt, which is $33.3 million, plus any interest and other costs. Figure 3 shows the City’s projected debt based on projects in the capital plan, including BPWTC borrowing.
Figure 3
Administration have assessed the risks of increasing the City’s debt and BPWTC’s ability to repay the debt and conclude that the City will remain within its internal policy limits and that there is a high likelihood that BPTWC will be able to repay this loan.
It is also important to note that BPWTC indicates that moving forward with the recommendations in this report will not cause an increase to the water rates that the Cities pay to BPTWC, other than rate increases previously contemplated.
Environmental Implications
None related to this report.
Policy and/or Strategic Implications
The provision of drinking water to the Cities is a high priority.
Other Implications
None related to this report.
Accessibility Implications
None related to this report.
COMMUNICATIONS
This work is necessary. Continued evaluation of risk has accelerated the project at no additional cost to Regina ratepayers. This is positive and proactive. Public Notice was provided in the Leader Post, the City’s public notice board and the City’s website on November 4, 2017.
DELEGATED AUTHORITY
The recommendations contained in this report require City Council approval.
Respectfully submitted, Respectfully submitted,
June Schultz, Director Barry Lacey, Executive Director
Finance Financial & Corporate Services
Report prepared by:
Curtis Smith, Manager, Policy