As part of the remodel of the Sunnyvale Town Center, the developer, American Mall Properties (AMP), requested, and the City Council approved, Mello-Roos bond financing for the construction of the two parking garages required as part of the remodel project.

Construction of the new parking garages at the Sunnyvale Town Center is almost ready to begin and, by the terms of the Reciprocal Easement Agreement, must begin by April 1 or be delayed until 2001. Rising interest rates and construction costs, combined with the results of a new appraisal of the mall that reduces the value due to the obligation to pay the Mello-Roos special tax, require the issuance of Mello-Roos bonds in an amount that requires special action by the City Council.

State law requires that, if the value of the property paying the special tax used for debt service is less than three times the amount of bonds issued, the City Council, by a vote of four-fifths of its members, must determine that there are public policy reasons to proceed. There is insufficient value to meet the 3:1 test. Staff therefore recommends that the financing proceed on the basis of a 2.5:1 ratio. Even at that ratio, there is a $3.7 million shortfall.

Therefore, staff further recommends that the City reallocate some of its investment in the Town Center to purchase $2.5 million of a separate series of Mello-Roos bonds to meet most of that shortfall. The $2.5 million will come from the City’s net proceeds from the land swap with AMP and from moneys held in the debt service reserve fund for the Town Center parking facility COPs.

The Mello-Roos bonds that the City will buy will bear interest and will be fully repaid or redeemed no later than 2012. They will be secured by a lien on the Town Center, though such lien will provide protection for owners of the publicly-offered bonds first. The public policy reasons to proceed on this basis are that the successful remodeling of the mall will provide additional community benefits and tax revenues, the risks of the lower value to debt ratio will be fully disclosed to investors and the City has taken and will take additional steps to ensure that the owner of the mall will be able to pay debt service on both the City-owned and publicly owned bonds.

$2.5 million in City funds, already invested in the mall, would be reallocated to assist with the project. These funds come from the land swap proceeds and from moneys held in the debt service reserve fund for the Town Center parking facility COPs. This investment would be secured through City ownership of Mello-Roos bonds and a written agreement with AMP incorporating safeguards described in the Discussion Section of this report and in the attached Summary of Terms (Attachment B).

Public contact has been accomplished through publication and posting of the Council agenda. Additionally, Reports to Council are available in the Library and on the City’s web page.

Staff recommends the City Council proceed with the issuance of Town Center debt for the public policy reasons specified above and reallocate the City’s investment in the parking project by:

1. Adopting the resolution set forth in Attachment A: Rescinding Resolution No. 164-99 and Authorizing the Issuance and Sale of Special Tax Bonds, and Approving and Authorizing Related Documents and Actions (Community Facilities District No. 1). In doing so, Council is making a finding that the funding of construction of the two garages with Mello-Roos bonds accomplishes a public policy purpose that justifies their issuance even though the value of the property responsible for the special tax is less than three times the par amount of the bonds.
2. Agreeing to provide approximately $2.5 million of funding in the form of a re-investment of the $1,495,000 from the land swap and the funds released from the COP debt service reserve fund. The City's investment would be secured as an owner of Mello-Roos bonds with security features subordinate to those of the notes and bonds to be issued to the public.
3. Authorizing staff to negotiate a written agreement with AMP incorporating the safeguards described above and in the attached Summary of Terms (Attachment B). Staff will proceed with the sale of the Mello-Roos notes only upon satisfaction that the requirements of the Summary of Terms have been satisfied.

The debt service on Mello-Roos bonds is paid from the proceeds of special taxes imposed on the owners of property in the Mello-Roos district (known as the Community Facilities District, or CFD.) All of the property in CFD No. 1 is owned by Sunnyvale LLC, the associated company of American Mall Properties (AMP) established to purchase, develop and operate the Sunnyvale Town Center. Owners of Mello-Roos bonds expect that the owners on whose property the special tax is imposed will pay their taxes. If they don't, bondholders can get their bonds repaid from the proceeds of a foreclosure of the property. Thus, the ultimate security for the bonds is value that can be realized at a foreclosure sale.

To help ensure that the remedy of foreclosure will produce enough proceeds to repay the bonds, the municipal bond industry has developed a rule of thumb that generally requires the value of the property securing a Mello-Roos bond issue to be at least three times the amount of bonds it secures. This concept is similar to a bank requiring that a homeowner have at least 20% equity in their home if they take out a mortgage. In the case of the Mello-Roos bonds, however, this 3:1 value to debt ratio imposes an equity requirement of 67%.

State law incorporates this industry practice by requiring the issuer of Mello-Roos bonds to take special steps if the value of the property subject to the tax is not three times the par amount of the bonds. Specifically, the City Council must, by a vote of four-fifths of its members, find that there are public policy reasons to proceeds with the sale of the bonds in the absence of a 3:1 ratio of value to debt.

This value test is meant to assure the realization of enough foreclosure proceeds to pay off the bonds. In other words, its purpose is to establish a standard for security in the event the property owners do not pay their special taxes and the bonds go into default. It is not a measure of the likelihood property owners will pay their taxes and avoid the need to foreclose in the first place. Such measures are not incorporated into the law, nor are there industry standards. The reason may be that different types of projects -- retail, industrial, residential, etc. -- each require unique analytical tools to evaluate the likelihood that property owners will pay their taxes.

The financing plan for the two garages involves the issuance of Mello-Roos notes that will mature in about two and a half years. At that time, the garages and the mall improvements will have been completed and the notes will be refinanced with long-term Mello-Roos bonds. The note issuance was planned, in part, knowing that at the time the garage financing was needed, the mall would not have sufficient value to meet the 3:1 test in the law since the private mall improvements would still be unbuilt. Therefore, the plan was to issue the notes and, at the time the notes were issued, to commission an appraisal demonstrating the likelihood that the value test could be met by the time the long-term bonds were issued in 2002.

The City, as the issuer of the Mello-Roos bonds, has no obligation to pay debt service to investors in the event that special tax collections are insufficient to pay debt service. Even if the City chooses to issue bonds with less than a 3:1 ratio, and the bonds go into default, the City has no obligation to pay debt service. This value requirement in state law is designed to protect investors against purchasing excessively risky bonds. The City’s obligation if issuing bonds with less than a 3:1 ratio is to make a finding that there are public policy reasons to do so and to ensure that the risks inherent in the bond issue are properly disclosed to investors through dissemination of a thorough and accurate Official Statement. Agreeing to issue the bonds at a ratio of less than 3:1 does not obligate the City to stand behind the bonds financially, just as the City does not stand behind bonds with a ratio of more than 3:1.

In late January, it became clear that a full financing of the garage construction, including interest payments during construction, would not be likely to meet the requirement that value be at least three times debt when the long-term bonds are to be issued. Three developments since the City Council approved the Mello-Roos financing in June were responsible for this:

With these new developments, the value of the mall would only be about twice the par amount of the bonds that need to be issued. In other words, the ratio of value to debt would be about 2:1 rather than the 3:1 currently required.

Staff believes the ratio of value to debt must be higher than 2:1 to proceed with the Mello-Roos bond issue, though there are reasons to conclude it need not be 3:1. As a result, staff informed AMP that a minimum ratio of 2.5:1 would be required. To meet that standard, the amount of the project to be financed from the bonds would have to be reduced by $3.0 million.

Staff recommends that $2.5 million of the shortfall be made up by reallocating City funds already invested in the mall to assist with construction. These funds would be re-invested in the project in the form of the purchase by the City of subordinate Mello-Roos bonds. The funds would come from two sources:

In addition to the City’s $2.5 million, the remaining shortfall of approximately $1.1 million will be made up from one or more of the following sources:

• A redesign to save $1.2 million -- AMP is working with Penney’s and Macy’s to see if they would approve a redesign to eliminate the underground floor in the garage to be built on the Macy’s lot and add an additional floor on top of the garage to be built on the Penney’s lot. AMP is seeking their approval without the need to execute a formal amendment to the Reciprocal Easement Agreement. If AMP is successful in these discussions, staff will return to Council for an amendment to the previously approved use permit. Council should be aware, however, that by endorsing the proposed financing plan they may be giving conceptual approval of the garage redesign. Should the redesign be necessary, staff will, of course, return to Council for final review and approval of the architectural revisions.

• Additional equity from AMP

To fully fund construction and other costs during the construction period, there will be three separate financings completed within the next year. The need for more than one financing arises because the total amount of debt authorized for CFD No. 1 is currently only $25 million, but a total of approximately $30 million of debt is needed. As a result, the plan of financing anticipates the following:

• If the City Council approves the recommendations in this report, staff, the City’s consultants and AMP will negotiate an agreement incorporating the terms endorsed by the City Council in approving these recommendations. Anticipating this to occur within three weeks, the City will sell $25 million of notes at that time and close the note issue by the end of March. This will fully fund construction and related expenditures for the first garage and partially fund the second garage. Construction of the first garage will begin no later than April 1.

• Shortly thereafter, staff will request the City Council to establish a new Community Facilities District (CFD No. 2) which will be used to issue the separate series of bonds that the City will buy. Bond counsel believes that creating a separate CFD is the simplest way to accommodate a City investment. The new CFD should be in place in May or June. At that time, the City would issue and purchase its investment of $2.5 million of bonds.

• Based on the appraisal, as much as $26.7 million of notes can be issued and still comply with the 2.5:1 value test. Notes of this amount will require, for their redemption, issuance of a larger amount of bonds. This increase in size is necessary to finance issuance costs and a debt service reserve fund. The current debt limit in CFD No. 1, however, limits issuance at this time to only $25 million of debt. Staff will therefore request the City Council to increase the debt authorization of CFD No. 1. After this occurs, staff will request the City Council to authorize the issuance of additional Mello-Roos notes. These notes, in the amount of approximately $2.5 million, will be issued some time in the second half of 2000 prior to the commencement of construction of the second garage. These notes will be sold to the public, just as the original $25 million note issue will be.

These three steps will provide funding for construction. When construction is completed, the financing plan anticipates the following steps to put long-term financing in place:

• The appraisal estimates that the mall will reach stabilized occupancy in August 2002. At that time, the value of the mall is estimated to be $71.6 million. The notes sold to the public will be structured to mature on August 1, 2002. On that date, they will be redeemed from the proceeds of long-term Mello-Roos bonds that will be issued and sold to the public. The estimated size of the bond issue – assuming the mall is, indeed, appraised at $71.6 million in 2002 – will be $28.7 million so that the 2.5:1 value test is met.

• If the mall appraises for more than $71.6 million in 2002, the City will issue more than $28.7 million of bonds. The increased amount will be used to redeem, to the extent possible, the CFD No. 2 bonds that the City owns. The value of the mall would have to be approximately $83 million in 2002 to permit the issuance of enough bonds, subject to the 2.5:1 value test, to fully redeem the City-owned bonds.

• If the appraisal does not permit the issuance of $83 million of bonds, the City would retain ownership of some or all of the City-owned bonds. Those bonds would be paid off from the collection of special taxes from AMP or, when the mall’s value subsequently increases, by a small issuance of additional bonds sold to the public after the August 2002 offering. It should be noted that this second issuance of bonds can be triggered unilaterally by the City following an appraisal showing that the value is sufficient for the additional debt. The bonds would pay interest and would be fully repaid over a period of ten years from the time that the mall is completed in 2002.

The City's investment would be in the form of the ownership of $2.5 million of Mello-Roos bonds. As currently anticipated by the City’s bond counsel, Jones Hall, the City would purchase bonds issued by a separate CFD (CFD No. 2) from the one that issues the bonds to the public (CFD No. 1 which has already been created). The City would have its investment returned in one of the two ways described above: a redemption of the City-owned bonds from the proceeds of the bonds sold to the public, or the payment of debt service from the collection of special taxes so that the City-owned bonds are fully repaid by 2012.

In the event debt service is not paid to the City, its investment would ultimately be secured by the value of the mall and the ability to realize sufficient proceeds from a foreclosure sale to repay the City. The mechanics of this remedy are that the party conducting the foreclosure sale must accept only bids that are sufficient to pay off all accumulated delinquent special tax payments, with the new owner acquiring the property with the obligation to pay the special tax in the future. However, to give the owners of the CFD No. 1 bonds the security indicated by a 2.5:1 value ratio, the City’s bonds are effectively subordinate to the CFD No. 1 bonds sold to the public. This is manifested in two ways:

• If the special tax levied to pay debt service on the City’s bonds is not paid, the City would not be able to trigger a foreclosure sale if debt service were being paid on the publicly-owned bonds.

• As described above, bids at a foreclosure sale must be sufficient to pay all delinquent taxes and transfer ownership of the property with the special tax obligation in the future remaining with the property. However, if no such bids are received, the party conducting the foreclosure sale will be directed to proceed with the sale in the event that it can repay all the CFD No. 1 delinquencies and transfer the property with the future CFD No. 1 tax obligation intact. If the sale is conducted on that basis, the City would not benefit from the foreclosure and the bonds it owns would default.

To increase the likelihood that the City would be paid, the City has informed AMP that operating revenues from the mall must be remitted to a bank which would withhold revenues sufficient to pay the special tax for both CFDs and then pass on to AMP the remainder

The City's position as an owner of subordinate Mello-Roos bonds puts it in a stronger position than the private lender on the mall remodel. In the event of a foreclosure, the private lender would receive proceeds only after the City is paid in full. It should be noted that the private lender will be making a loan for approximately $60 million which will be in third place behind the two Mello-Roos issues.

In order to proceed with the financing, staff is requesting the City Council to take three actions:

1. Reauthorize the issuance of the Mello-Roos bonds and, in doing so, make a finding that the funding of construction of the two garages with Mello-Roos bonds accomplishes a public policy purpose that justifies their issuance even though the value of the property responsible for the special tax is less than three times the par amount of the bonds.

2. Agree to provide approximately $2.5 million of funding in the form of a re-investment of the $1,495,000 from the land swap and the funds released from the COP debt service reserve fund. The City's investment would be secured as an owner of Mello-Roos bonds with security features subordinate to those of the notes and bonds to be issued to the public.
3. Authorize staff to negotiate a written agreement with AMP incorporating the safeguards described above and in the attached Summary of Terms (Attachment B). Staff will proceed with the sale of the Mello-Roos notes only upon satisfaction that the requirements of the Summary of Terms have been satisfied. Sale of the notes is anticipated during the week of March 20, so staff and AMP will have approximately three weeks to work out the details.

There are two reasons to recommend these actions. The first is that the payment of the special tax is likely and is not an onerous burden on AMP. The second is that the remodeling of the mall and the construction of additional parking will provide significant benefits to the community.

There are two reasons to believe that the special tax will be paid and that the credit quality of the bond financing at a ratio of 2.5:1 offers investors and the City reasonable security.

Town Center is at the core of the City's downtown retail district. In recent years, it has been underperforming relative to what the City expects City residents can support. This is confirmed by the appraisal which concludes that the mall’s share of retail sales in its market area is only about one-third of its share of leasable square feet of retail space.

After trying to sell the mall for two years at a price of $32 million, TrizecHahn, the mall's former owner, sold it to AMP in July, 1998 for $23.1 million. AMP is now ready to commence construction on an expansion of the mall that will add 252,000 square feet of retail space, representing a 35% increase in space. The expansion will replace the movie theater now at the mall with a new 20 screen theater to be operated by AMC. It will also bring the Gap, Old Navy and Barnes & Noble to the mall. The upgrading of the mall should generate significant additional sales tax and property tax revenue for the City and the Redevelopment Agency. It will also create the potential for the addition of national chain retail and national chain restaurant participation in the new entertainment boulevard.

The mall improvements also create the opportunity to create additional parking that can serve both the mall and the surrounding areas. This increase is being fully paid for by the new owner of the mall, yet its benefits accrue to the broader community.

If the Council does not approve these recommendations, the mall improvements and the construction of additional parking may not occur. Under the amended Reciprocal Easement Agreement, construction on the first parking garage must commence by April 1, or it must be delayed until 2001. If it is delayed, AMP will not be able to deliver the space it has leased to the Gap, Old Navy, Barnes & Noble and AMC, so those leases might be canceled. It is unclear whether or when a new plan that would not require the approvals requested of the City Council could be developed.

If the mall improvements are delayed or abandoned, the City would not realize the expected benefits of additional sales tax and property tax revenue. Furthermore, the mall could continue its past trend of declines in business. At the same time, the City would still be required to pay debt service on the COPs that are outstanding on the existing parking garage at the mall. The City is reimbursed from tax increment for those debt service payments, as well as for past payments for which there was insufficient tax increment to make reimbursement payments. If the mall's value declines, rather than increases as a result of the remodel, the availability of tax increment with which to reimburse the City's general fund for COP payments could be jeopardized.

$2.5 million in City funds, already invested in the mall, would be reallocated to assist with the project. These funds come from the land swap proceeds and from moneys held in the debt service reserve fund for the Town Center parking facility COPs. This investment would be secured through City ownership of Mello-Roos bonds and a written agreement with AMP incorporating safeguards described in the Discussion Section of this report and in the attached Summary of Terms (Attachment B).

For the reasons stated above, it is staff's conclusion that lowering the value to debt ratio on the Mello-Roos bonds is prudent for both the City and public investors. Further, the community benefits of proceeding with the mall and the parking facility make doing so appropriate public policy. Therefore, staff requests the City Council to approve proceeding with the project in the manner described.

Public contact has been accomplished through publication and posting of the Council agenda. Additionally, Reports to Council are available in the Library and on the City’s web page.

Staff recommends the City Council proceed with the issuance of Town Center debt for the public policy reasons specified above and reallocate the City’s investment in the parking project by:

1. Adopting the resolution set forth in Attachment A: Rescinding Resolution No. 164-99 and Authorizing the Issuance and Sale of Special Tax Bonds, and Approving and Authorizing Related Documents and Actions (Community Facilities District No. 1). In doing so, Council is making a finding that the funding of construction of the two garages with Mello-Roos bonds accomplishes a public policy purpose that justifies their issuance even though the value of the property responsible for the special tax is less than three times the par amount of the bonds.
2. Agreeing to provide approximately $2.5 million of funding in the form of a re-investment of the $1,495,000 from the land swap and the funds released from the COP debt service reserve fund. The City's investment would be secured as an owner of Mello-Roos bonds with security features subordinate to those of the notes and bonds to be issued to the public.
3. Authorizing staff to negotiate a written agreement with AMP incorporating the safeguards described above and in the attached Summary of Terms (Attachment B). Staff will proceed with the sale of the Mello-Roos notes only upon satisfaction that the requirements of the Summary of Terms have been satisfied.

Prepared by:

Grace Kim
Management Analyst

Reviewed by:

Mary J. Bradley
Director of Finance

Approved by:

Robert S. LaSala
City Manager