Introduction - Florida Water Environment Association - FWEA
COMPARISON OF REVENUE BONDS AND FDEP ADMINISTERED DRINKING WATER AND CLEAN WATER STATE REVOLVING FUND LOANSJennifer Ivey (ARCADIS-US), Lynn Spivey (ARCADIS-US), Sharon Simington, (ARCADIS-US)IntroductionARCADIS is currently working with a central Florida County municipality (County) that is planning to expand their regional wastewater reclamation facility (WRF) and corresponding service area infrastructure. The estimated cost of that project is approximately $45 million. To date, the County has secured $50 million in an FDEP State Revolving Fund loan. This comparison uses the information from the Clean Water State Revolving Fund Loan Agreement.Municipal governments have a variety of options to secure debt funding for utility capital improvement projects. This paper summarizes and compares key aspects of three common alternative forms of debt financing available to the County, and uses the County’s FDEP loan as the example for option 3.The options evaluated include:General obligation bonds, secured by the “full faith and credit” of the County;Revenue bonds, secured by the pledged revenues of the Utility; andFlorida Department of Environmental Protection (FDEP) administered drinking water and clean water revolving fund loans.In choosing options for debt financing, communities often balance the life cycle cost savings with the time and cost of internal and external personnel and resources to secure funding, administer activities during construction and comply with on-going reporting requirements. This paper focuses on the following key aspects of each of the debt options including:Debt issuance process;Requirements during construction;Continuing reporting requirements through life of the debt obligation; andTotal costs and life cycle interest costs.Interest rates, issuance costs and other transactional costs can vary based on the market conditions, creditworthiness and other unique circumstances for each community. The comparisons completed within this paper are intended to illustrate major differences between these forms of utility debt financing using estimates and general “rules of thumb.” General Obligation BondsGeneral obligation (GO) bonds are one of two types of municipal bonds (the other type is revenue bonds). GO bonds are backed by the full faith and credit of the issuing municipality, which means that the municipality commits its full resources to paying bondholders, including general taxation and the ability toraise more funds through credit1. Because the issuing municipality may need to increase ad valorem taxes to repay the debt, GO bonds typically must be approved by the voters who would pay the taxes that support the bonds. GO bonds are often used by governmental entities to fund projects that will not provide a direct source of revenue or projects that are initiated by general fund departments. As an enterprise fund of the County, the Utility has a direct source of revenue from which to pay its debt obligations. Therefore, revenue bonds are a better debt financing option for this project because the funding source and funded project are contained within the enterprise fund and no interfund transfers are needed, and GO bonds were not considered further.Revenue BondsTax-exempt revenue bonds are a common debt funding source for municipal utilities. The process involves selling bonds to institutional and individual purchasers and is outlined in the following major steps:Governmental entity determines which projects will be financed by the ernmental entity assembles a team that typically includes financial advisors, bond counsel and disclosure counsel to assist in planning and manage the overall transaction. Underwriters are selected to assist the governmental entity in gaining access to the market and selling bonds at a guaranteed minimum price. Disclosure counsel and/or bond counsel prepares an official statement to assist in marketing the bonds. The official statement includes extensive information about the community, management team, utility, project, revenue and other outstanding debt obligations. Governmental entity typically requests a bond rating from at least one of three rating agencies to improve the marketability and reduce the overall interest cost of the bonds.Engineering feasibility consultant may be retained to certify the project cost estimate and review utility system condition and operations.Financial feasibility consultant may also be retained to certify that project system revenues are available to fund ongoing operations and meet conditions of current and future debt obligations. Bond resolution is adopted, committing the entity to the repayment and conditions of issuance, closing of the bond, and completion of bond sale. A trustee is retained to manage funds during construction and complete various administrative and continuing reporting requirements of the bond agreement between the community and bond holders.Once the bonds are sold and issued, there are restrictions of the use of the bond proceeds during construction and additional steps followed by the community as outlined in the bond agreement until the funds are spent. An example of these restrictions is limiting the use of the bond proceeds to only the projects specified in the official statement.Notes: Source: typical restriction of revenue bonds is that bond proceeds are required to be fully expended within two years of disbursement to eliminate any potential arbitrage rebate requirements2. If the bond proceeds are still invested and not spent after two years, the governmental entity risks earning positive arbitrage in excess of the tax-exempt cost-of-funds or “rebate yield limit” that must be rebated to the federal government.FDEP Revolving Fund LoansFDEP administers drinking water and clean water (wastewater and stormwater) revolving fund loans for eligible governmental entities at below market interest rates. In addition to lower financing costs, FDEP loans do not carry the risk of arbitrage that comes with the issuance of bonds. The process to obtain funds is outlined on the department’s website3 and includes the following major steps:Governmental entity submits a request for inclusion of eligible projects.For construction loans, engineering planning, design, permitting and site information are submitted. For pre-construction loans, the request for inclusion is all that is required.FDEP places project on priority ernmental entity submits a loan application, completes a capital financing plan and provides project, community and utility financial information.FDEP awards funds based on available funding and priority determination of eligible projects.A loan agreement is completed that outlines multiple conditions and covenants of the loan, repayment of loaned funds and recurring reporting requirements.During the construction phase of the loan, the authorized community representative submits disbursement requests to FDEP for reimbursement until the projects are completed.FDEP completes a final review after the project is completed, finalizes the loan amount, loan service fee, capitalized interest during construction, and debt service payments for the term of the loan.Process ComparisonRevenue bonds and FDEP loans were further evaluated as potential funding sources for the County WRF Expansion project. The two alternative forms of debt financing share many common elements as well as differences. For example, both options require:Capital project engineering design and cost estimates, Historical and projected system and financial information,Capacity of system revenues to meet requirements of current and new debt obligations while maintaining the current system.Notes:2 “Arbitrage may occur when an issuer raises money through the sale of a bond issue and invests the proceeds in instruments with a yield above the bond issue’s cost-of-funds.” Source: 2Summary Comparison of Revenue Bond and FDEP Loan Elements4,5ElementRevenue BondFDEPLoan ApplicationNot required. Financial, project and community information included in Official StatementRequiredOfficial StatementIncludes summary of community, system, management team, financial information, project information and covenants and conditions of bond issueNot requiredCapital Financing PlanNot required; however, similar information is typically included in an Official StatementSummarizes total project cost, loan terms, projected utility revenues available to repay debt obligations and meet additional loan conditionsHistorical Financial InformationRequiredRequiredFeasibility ConsultantsMay provide engineering and/or financial feasibility to provide assurance to bond purchasers and reduce the interest rateMay assist in preparation of technical and financial planning documents and applicationReimbursement Requests During ConstructionNot required as bond funds are held in separate accounts to fund eligible project expendituresRequired based on project expenditures and reimbursed by FDEPDavis-Bacon WagesNot typically requiredRequiredOn-going Reporting and ComplianceProvide financial and community information to trustee as well as significant eventsRequired to submit annual audited financial information and compliance with loan conditionsNotes:4 County, Water and Sewer Revenue Bonds Series 2004 Official Statement, Dated February 27, 2004 ($41,045,000).5 County, Clean Water State Revolving Fund Loan Agreement, Dated February 7, 2012 ($10,377,000).Typical Costs Associated with Each Financing OptionThere are many costs associated with debt financing capital projects. The interest or financing costs are typically the highest, but the other costs can also be significant. Most of these costs are one-time costs related to the debt issuance process and are incurred when the debt is issued. However, there are also costs that are incurred throughout the life of the debt. These issuance and life cycle costs are discussed further in the following sections.Issuance CostsThere are issuance costs associated with both debt funding alternatives, which are often financed with the principal amount of the debt. The typical issuance costs are summarized below and estimated in Table 3.Capitalized InterestRevenue BondsRevenue bonds do not typically include capitalized interest because repayment of the loan is not delayed until construction is complete. Semiannual payments, including principal and interest, begin approximately 6 months after loan proceeds are received by the governmental entity. Loan proceeds are not disbursed when needed, as with the FDEP loans, but are disbursed in one lump sum.FDEP LoanCapitalized interest is the finance charges that accrue on the FDEP loan during construction of the project. The charges begin accruing at the loan interest rate on outstanding loan proceeds from the time of the first disbursement until six months before the first semiannual loan payment is due. As additional disbursements are made, the interest continues to accrue on the total disbursement amount. Once the project is complete, the capitalized interest is financed with the loan principal.Loan Service FeeRevenue BondsA Loan Service Fee is not charged for revenue bonds.FDEP LoanThe Loan Service Fee is an origination fee paid on FDEP loans. For this FDEP loan, the Loan Service Fee is 2 percent of the loan principal amount, not including capitalized interest. Capitalized interest accrues on the Loan Service Fee at the interest rate established in the final amendment, calculated based on timing and amount of loan disbursements. Debt Service ReserveRevenue BondsPrior to the credit crisis in 2008, bond issuers often purchased insurance to improve the credit rating of the bonds and obtain a lower interest rate on the bonds. However, the insurance companies that provided this insurance no longer have the credit rating required to provide this. Now many loans require a debt service reserve, typically equal to 10 percent of the borrowed amount or 100 percent or more of the average annual debt service payment, as “insurance” for repayment. Although the debt service reserve is not paid out, these funds are restricted for the life of the debt. If the governmental entity does not have the necessary cash available to set aside in a debt service reserve fund, this amount can be financed with the principal loan amount.In some cases, the bond contract allows the issuer to purchase a surety bond to guarantee repayment of revenue bonds instead of funding a debt service reserve. The price of a surety bond typically ranges from 0.30 to 0.50 percent of the loan principal amount.FDEP LoanFDEP loans do not require the establishment and funding of a debt service reserve or purchase of a surety bond.Financial AdvisorRevenue BondsGovernmental entities often retain a financial advisor to advise them regarding the issuance of debt. Financial advisors review all documentation from the underwriter, underwriter’s counsel and bond counsel. They also manage the bond issuance process. Financial advisors are typically paid a flat fee to assist with the issuance of revenue bonds, which could be as high as $50,000 to $100,000.FDEP LoanARCADIS is providing support services to the Utility related to the FDEP loan process, similar to those services that a financial advisor provides when issuing revenue bonds. For the FDEP construction loan, ARCADIS would provide compliance services during the construction phase and project close out. For the County WRF expansion and associated service area projects, the ARCADIS fee is currently estimated at $725,000.00. This cost is shown in Tables 2 and 3, and would be a one-time cost that covers the entire construction phase, even if the incurred FDEP loan debt / project cost exceeds $50 million.TakedownRevenue BondsThe takedown is the selling concession for a bond paid to the underwriting syndicate, expressed in dollars per thousand dollars of bonds. Takedown is included in the issuance costs for revenue bonds and is estimated to be $4.00 to $4.25 per $1,000 of bonds for a 30-year term. If the term of the bonds is less than 30 years, the takedown may decrease.FDEP LoanFDEP loans do not require takedown.Underwriter’s CounselRevenue BondsThe cost of the underwriter’s counsel is part of the required issuance costs for revenue bonds. The underwriter hires these municipal bond attorneys to review the bond resolution, official statement and all documents related to the underwriting of the bonds. FDEP LoanThis cost is not incurred for FDEP loans.Bond CounselRevenue BondsThe bond counsel is an independent attorney who provides an objective legal opinion on the validity and tax exemption of the revenue bonds and the authorization of the issuer to issue the revenue bonds. The cost of bond counsel is included in the required issuance costs for revenue bonds.FDEP LoanBond counsel is not necessary for FDEP loans.Disclosure CounselRevenue BondsDisclosure counsel is retained by the governmental entity issuing revenue bonds to advise the issuer regarding disclosure obligations. The disclosure counsel prepares the official statement and continuing disclosure agreement. FDEP LoanDisclosure counsel is not required for FDEP loans.Florida Attorney General ReviewLoan documents are required to be reviewed by the State Attorney General to ensure consistency with the State Constitution. The governmental entity typically pays a fee to the Attorney General’s office for this review and legal opinion. The cost of this review is incurred for both FDEP loans and revenue bonds.Credit RatingsRevenue BondsIn order to issue revenue bonds, it is necessary to solicit credit ratings from at least one of the three rating agencies (Moody’s, Fitch Ratings, or Standard & Poor’s). Ratings determine the interest rate that an issuer must pay on its debt. Revenue bonds may only require one rating, but two ratings are preferred. The fee to obtain a credit rating ranges from 0.035 to 0.05 percent of the debt principal amount.FDEP LoanFor Florida, the FDEP performs their own financial review based on information provided in the loan application and the audited financial statements of the individual municipalities. No official credit rating is required from any of the rating agencies. Table 3Summary Comparison of Revenue Bond and FDEP Loan Issuance Costs6DescriptionRevenue BondFDEPCapitalized InterestNone$ 1,296,700Loan Service FeeNone1,005,100Surety Bond or Debt Service Reserve$ 153,000 – $ 256,000NoneFinancial Advisor/Compliance50,000 – 100,000725,000Takedown204,000 – 217,000NoneUnderwriter’s Counsel30,000 – 40,000NoneBond Counsel7,000 – 10,000NoneDisclosure Counsel75,000 – 100,000NoneAttorney General Review/Annual Audit*10,000 – 15,00010,000 – 15,000Rating Agency Fees28,000 – 40,000NoneTOTAL$557,000 - $778,000$3,036,800 - $3,041,800*Annual Audit is a onetime independent audit required within 12 months of signing the final loan amendment. Life Cycle CostsIn addition to the costs incurred when the debt is issued, there are ongoing costs throughout the life of the debt. These costs are summarized below.Interest or Financing ChargesRevenue BondsThe interest or financing rate is applied to the unpaid principal of the debt and paid as part of the semiannual debt payments. Issuers of revenue bonds typically pay the market interest rate, which is estimated to be in the range of 3.6 to 4.0 percent, for the purpose of this analysis. It is also possible to issue revenue bonds with a variable interest rate, where the interest rate is set based on a market index or predetermined formula and typically reset daily or weekly, although they are sometimes reset less frequently. This option greatly reduces the initial interest rate, although there are risks associated with variable rate bonds, such as interest rate increases and “put” rights. A “put” right is the right of a bond buyer or investor to require the bond issuer or its remarketing agent to repurchase the bond at its full face value prior to the maturity date. Notes:6 County, Clean Water State Revolving Fund Loan Agreement ($50 million).These risks make it difficult to budget annual expenses related to variable rate revenue bonds. Currently, the indices that are used to set variable interest rates are very low, but many of them average 3.0 to 4.0 percent. FDEP LoanFDEP loans are made at a subsidized or below market interest rate. For clean water loans, the amount of the subsidy is based on an “Affordability Index” that measures the relative wealth of the community, with a maximum of 80 percent of the market interest rate assessed. The market interest rate is set quarterly by FDEP based on average of the Thomson Publishing Corporation’s 20-Bond General Obligation Bond Index (Index). Currently, the FDEP loan interest rate offered to the County for the last installment of $10.255 million is 1.63 percent, after a reduction for Davis-Bacon wages, which would generate a blended interest rate of 1.92 percent (weighted average) for the total loan amount of $50.255 million since the original, second and third installments were at higher interest rates.Reporting / Compliance CostsRevenue BondsRevenue bonds often carry ongoing reporting requirements; however, the information that must be reported is typically included in general financial reports prepared by the governmental entity and does not require preparation of a separate report for the specific bond issue.FDEP LoanGovernmental entities also incur additional direct costs to manage and comply with the FDEP loan requirements. These activities may include preparing disbursement requests and managing reporting and compliance during construction. Post-construction activities may include Davis-Bacon interviews and spot checks, certification of revenues, Loan Debt Service Account balance and required insurance, maintenance of accounting records, and management of annual audits, as required.Rate Covenant and Debt Service CoverageMany debt alternatives require the borrower to certify that rates and charges for their services will be set at an amount sufficient to provide revenue equal to or in excess of the sum of the annual operation and maintenance (O&M) expense and annual debt service payment. The multiplier used to determine the amount of net revenue required is called the coverage. Coverage of 1.25 requires net revenue to exceed the average annual or maximum annual debt service payment by at least 25 percent, where net revenue is the total revenue less the O&M expense and annual debt service payments of all outstanding senior obligations. Although the coverage amount is never paid out as an expense, the governmental entity’s revenue requirements must include coverage. As a result, issuing additional debt often requires a revenue increase equal to at least the proposed additional debt service payment times the required coverage. Table 3 includes a comparison of the revenue increase that each debt alternative would require.Revenue BondsRevenue bonds often include a rate covenant with a coverage requirement. Coverage requirements are typically in the range of 1.20 to 1.25 times the annual or maximum annual debt service payment; however, some covenants require coverage as high as 1.50. FDEP LoanThe FDEP rate coverage requirement is 1.15 times the sum of the semiannual loan payments due in each fiscal year. Table 4Summary Comparison of Revenue Bonds and FDEP LoanDescriptionRevenue Bond(Best Case)Revenue Bond (Worst Case)FDEPLoan Proceeds$ 50,255,000$ 50,255,000$ 50,255,000Other Financed Costs7$ 557,000$ 778,000$ 2,301,800Total Loan Amount$ 50,812,000$ 51,033,000$ 52,556,800Interest Rate3.60%4.00%1.92%Loan Term (yrs)303020Annual Debt Service Payment$ 2,797,438$ 2,951,243$ 3,180,484Total Interest Paid$ 33,111,144$ 37,504,303$ 10,977,010Other Cash-funded Issuance Costs8$ 0$ 0$ 740,000Annual Rate Coverage$ 560,000$ 1,480,000$ 477,073ADDITIONAL ANNUAL RATE BURDEN9$ 3,357,438$ 4,431,253$ 3,657,557TOTAL LIFE CYCLE COST$ 83,923,144$ 88,537,303$ 63,533,810This comparison shows that at the current revenue bond best case, the savings using the FDEP loan process would be $20,389,334.00, and at a worse case bond rate, the FDEP loan process would save the County $25,003,493.00.Notes:7 From Table 2. For FDEP loan, only capitalized interest and Loan Service Fee are assumed to be financed.8 From Table 2. For FDEP loan, these costs include debt service reserve, financial advisor fees, Attorney General review fees and rating agency fees.9 Additional annual rate burden is the revenue increase needed to support the debt issuance. This is the sum of the annual debt service payment and the annual rate coverage.In working with the County to procure the FDEP SRF loans, the following concerns were addressed when evaluating the FDEP loans vs. bonding the projects:Concern 1 – Use of Different Payback Periods for Purposes of Bond and Loan ComparisonThe debt term for the revenue bond finance option was listed as 30 years, as opposed to the FDEP loan debt term of 20 years. The difference in payback periods is a reflection of real-world conditions. More specifically, it is not feasible to obtain a revenue bond with a debt payback term of 20 years, which was also confirmed by the County finance staff. However, even if available, a best case 20-year bond would still be approximately $5 million higher than a comparable (20 year) loan payback period. Concern 2 – FDEP Loan Requirements will Result in Higher Project CostsThe County staff has been told by at least one contractor that the increased requirements to comply with FDEP-administered loans would result in a “10% increase in project costs.” These statements are based on the loan requirements to comply with the Davis-Bacon Act, which is a federal law that established the requirement for paying current wages on public works projects. It is worth noting that the only additional requirement imposed on any contractor competing for the County WRF project by utilizing the FDEP loan is compliance with the Davis-Bacon Act. There are no additional requirements associated with FDEP financing, such as “Buy American” or other certification requirements, including payroll certification, that differ from those associated with bond financing options. The contractor’s responsibilities to comply with Davis Bacon requirements are detailed below:Posters – Posted On-Site (assistance in obtaining the posters is offered)Review of the Wage Determination Davis-Bacon (Labor Standards) A good portion of these requirements are required for the project regardless of whether the contractor is required to comply with the Davis-Bacon Act or not. Davis-Bacon compliance also seeks to protect the County, and ensure that a legal and qualified work force will be employed for the County WRF expansion project at fair current wages. The Davis-Bacon requirement only impacts the potential labor cost associated with the project. Therefore, the potential increase in project construction cost is only impacted by the potential increase in the overall project labor cost. That is, the cost of equipment and materials is not impacted by the loan or Davis-Bacon requirements. The labor costs on utility projects typically range from 10-30% based on the complexity of the project. This estimated average labor cost is based on guidelines contained in the RS Means construction cost estimating reference series and conversations with local contractors. For the County WRF expansion project, which has an overall construction cost estimate of $40 million, the total labor cost would be approximately $12 million based on a conservative labor cost percentage of 30%. Assuming that the 10% increase in project cost quoted by the contractor is accurate, the increase in the project labor cost, as well as the overall project cost, would be approximately $1.2 million. This is equivalent to a 3% increase in the overall project cost. Even in the conservative approach of using a 10% increase on the total amount of the construction cost to cover Davis Bacon related costs, the construction cost increase would be approximately $4 million. The FDEP loan option would still show a significant cost saving over revenue bonds. Table 4 below is revised with the added estimated increased construction cost that a contractor may include to comply with FDEP loans. It is worth noting that the $40,000,000 is an estimate. that utilizes RS Means and other cost estimating guidelines, which routinely include at least 30% labor for construction and installation of equipment. Therefore, though there is a potential increase in project cost associated with FDEP financing, the reality is that the engineer’s estimate likely is conservative enough to account for minor fluctuations in labor rates associated with Davis-Bacon. Further, this highlights another advantage of FDEP financing. The project bids come in at less than the estimate, not only is the impact of Davis-Bacon less, but the FDEP financing option allows the County to reconcile the final amount of the loan to the exact construction cost (if desired) resulting in further savings to the County. However, in the case of bond financing, the County will be forced to repay the full $40 million dollars.Table 4 RevisedSummary Comparison of Revenue Bonds and FDEP LoanDescriptionRevenue Bond(Best Case)Revenue Bond (Worst Case)FDEPLoan Proceeds$ 50,255,000$ 50,255,000$ 51,762,650Other Financed Costs$ 557,000$ 778,000$ 2,358,578Total Loan Amount$ 50,812,000$ 51,033,000$ 54,121,228Interest Rate3.60%4.00%1.92%Loan Term (yrs)303020Annual Debt Service Payment$ 2,797,438$ 2,951,243$ 3,270,181Total Interest Paid$ 33,111,144$ 37,504,303$ 11,284,387Other Cash-funded Issuance Costs$ 0$ 0$ 740,000Annual Rate Coverage$ 560,000$ 1,480,000$ 490,527ADDITIONAL ANNUAL RATE BURDEN$ 3,357,438$ 4,431,253$ 3,760,708TOTAL LIFE CYCLE COST$ 83,923,144$ 88,537,303$ 65,405,615*$1.5M Estimated Construction Cost increase was included in the overall financed FDEP loanThis comparison shows that at the current revenue bond best case, the savings using the FDEP loan process would be $18,517,529.00, and at a worse case bond rate, the FDEP loan process would save the County $23,131,688.00. ................
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