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INFORMAL REPORT TO CITY COUNCIL MEMBERS No. 7427
�..,�„� November 14, 1989
`of F0 To the Mayor and Members of the City Council
Subject: TAX-EXEMPT COMMERCIAL PAPER
For some time staff has attempted to keep the City Council apprised of the
increased capital improvement financing needs of the City's water and wastewater
system projected for the next several years. The present projection is for a
five year capital requirement of over $250 million. It is the opinion of the
staff and the City's financial advisors that for financing requirements of this
size the City's best interest might be served by establishing a tax-exempt
commercial paper program. Prior to the submission of a recommendation for such a
program, staff believes that a general discussion of the subject would be of
benefit to the Council.
Commercial paper is one of the oldest financial instruments used in corporate
financing; however, the tax-exempt commercial paper market has primarily been
developed in the United States only within the past ten years. Tax-exempt
commercial paper is a short-term unsecured promissory note backed, for liquidity
purposes, by a line of credit with one or more banks. Maturities range from 1 to
270 days, with an average maturity of 30 to 45 days. It is normally issued in
bearer form and is priced on either a discount-from-par basis or on an
interest-to-follow basis. Buyers of tax-exempt commerical paper include a
diversity of investors: insurance companies, non-financial business firms, bank
trust departments, investment companies and money market funds, among others.
Tax-exempt commerical paper can be issued and/or "rolled-over" on a frequent
basis, depending on capital needs and market conditions.
Tax-exempt commercial paper is used to provide seasonal working capital or to
finance construction projects on an interim basis. It can also be used as a
permanent part of an issuer's debt structure to finance small projects which
might otherwise be funded with current revenues or with bond funds. In Texas,
tax-exempt commercial paper can only be used to finance "project costs"
associated with the construction or improvement of a public utility.
The primary advantages of commercial paper financing are:
1) interest costs are low because funds are borrowed short-term,
rather than long-term. In the municipal market, short-term rates
are traditionally lower, although the spread between short and
long-term rates has narrowed in recent months;
2) issuance costs are low because the only ongoing costs involved
are dealer fees, liquidity fees, and paying agent fees. The
dealer and liquidity fees would approximate 1/8% to 1/4% and 1/4%
to 1/2% per year, respectively. These fees would be added to the
interest rate charges. The paying agent fee would be paid annually
and vary depending upon the agent and size of program. Initial
bond counsel and financial advisory fees are within normal ranges;
3) financial flexibility is greater because money can be borrowed in
relatively small amounts and on specific maturities;
ISSUED BY THE CITY MANAGER FORT WORTH, TEXAS--
INFORMAL REPORT TO CITY COUNCIL MEMBERS No 7427
6'OT10,4
AM.* To the Mayor and Members of the City Council November 14, 1989
Subject: TAX-EXEMPT COMMERCIAL PAPER
4) projects with short lives can be financed with borrowed funds at
short-term rates;
5) the water and sewer system's debt service coverage ratio improves
because tax-exempt commercial paper is issued to subordinate revenue
bonds;
6) the system's debt/equity ratio improves to the extent that tax-
exempt commercial paper is treated as a current liability; and
7) arbitrage rebate problems are avoided to the extent that proceeds
are expended in six months or invested in tax-exempt money market
funds.
There are two potential disadvantages to tax-exempt commercial paper which
should be mentioned. First, because tax-exempt commercial paper rates are
short-term, the program could be more expensive than a revenue bond program if
short-term rates rise to equal or exceed long-term rates for a sustained
period. Secondly, because tax-exempt commercial paper is "rolled-over" on an
0ORL almost daily basis, it is somewhat time-consuming from an administrative
standpoint--requiring on the order of one hour or so per day of staff time.
If the City were to implement a commercial paper program, it could expect to
achieve savings in overall debt service through the payment of interest rates
initially lower than long-term interest rates and the deferment of principal
repayment. The City would also use the program to time necessary borrowings
by contract award dates rather than revenue bond sales dates, reducing any
"negative arbitrage" that might be associated with the carry of long-term
bonds.
In order to provide financing for Water Department construction schedules
staff anticipates coming to Council with a specific tax-exempt commercial
paper program recommendation within the next 45 days. If, in the interim, the
City Council should have questions about such a program the staff will be
pleased to provide any additional information.
6,^Aavid Ivory
City Manager
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-ISSUED BY THE CITY MANAGER FORT WORTH, TEXAS