February 15, 2005

SUBJECT: Consideration of Resolution to Become a Member of California Statewide Communities Development Authority (CSCDA) and Resolution to Approve Documents with Respect to the Sale of Sunnyvale's Vehicle License Fee Receivable from the State of California

Staff is bringing to the Council's attention the California Statewide Communities Development Authority (CSCDA) Vehicle License Fee Gap Receivables Financing Program (the "Program"). This Program would allow the City to receive the $2,271,988 owed to us from the State from Motor Vehicle License Fees deferred in FY 2003/2004. These funds are scheduled to be repaid by the State in FY 2006/2007, and have been included in the City's General Fund Long Term Financial Plan. Under the Program, the repayment could be received in March 2005 because of Notes issued by CSCDA. The repayment would be approximately $76,063 to $84,926 less under the Program because of costs associated with the Notes financing.

The primary reason for the City to participate in this Program would be to minimize the risk that the State would not repay the money in 2006 or would defer the repayment until a later date. The State-local budget agreement provides for the repayment by August 15, 2006 of the approximately $1.2 billion VLF Gap Repayment. The repayment of these funds, however, was not included in Proposition 1A and is therefore not constitutionally protected. The repayment must be included in the Governor's State Budget for FY 2006/2007. The only penalty to the State for not repaying the Gap funds is that they cannot "borrow" from local governments again until the monies are repaid. For this reason, the Gap funds are considered less secure than the ongoing Property Taxes that are replacing VLF beginning in FY 2006/2007.

After analysis, staff is not recommending that the City participate in the VLF Gap Repayment Program at this time because the risk of nonrepayment does not appear to warrant the cost (or discount) associated with the Program. The sale of the first round of CSCDA Notes is scheduled for March 2, 2005 and if Council wishes to participate the decision must be made prior to February 18 2005. However staff is including the two resolutions which are necessary in case Council does wish to participate in the Program.

It should be noted that the possibility exists of a second round of Notes being issued in July 2005, depending upon number of participants and market conditions. Council may wish to monitor developments in the State Budget and consider participation in July after we have a better understanding of the State Budget impact. Participation will cost more at that time because the funds will be received later and will only earn 12 months of interest instead of 17.

Vehicle License Fees (VLF) have been historically assessed in the amount of 2% of a vehicle’s depreciated market value for the privilege of operating a vehicle on California’s public highways. Beginning in 1999, the VLF paid by vehicle owners was offset (or reduced) to the effective rate of 0.65%. In connection with the offset of the VLF, the Legislature authorized appropriations from the State General Fund to "backfill" the offset so that local governments, which receive all of the vehicle license fee revenues, would not experience any loss of revenues. The legislation that established the VLF offset program also provided that if there were insufficient State General Fund moneys to fully "backfill" the VLF offset, the percentage of offset would be reduced proportionately (i.e. the License Fee payable to drivers would be increased) to assure that local governments would not be disadvantaged.

In June of 2003, the State Director of Finance ordered the suspension of VLF offsets due to a determination that insufficient State General Fund moneys would be available for this purpose, and, beginning in October 2003, the VLF paid by vehicle owners was restored to the 2% level. However, the increase in rate was rescinded by Governor Schwarzenegger on November 17, 2003 and State offset payments to local governments resumed. Local governments received the "backfill" payments totaling $3.80 billion in FY 2002/2003. "Backfill" payments totaling $2.65 billion were paid to local governments in FY 2003/2004. However, approximately $1.2 billion was not received by local governments during the time period between suspension of the VLF offsets and the implementation of higher fees and is still owed them by the State (the "VLF Gap Repayments"). Sunnyvale’s share of the VLF Gap Repayment is $2,271,988.

Fiscal Sub Element Goal 7.1B states "Maintain sound financial practices which meet all applicable standards and direct the City’s financial resources toward meeting the City’s long term goals."

As part of the 2004 State Budget Act negotiations, an agreement was made between the State and local government officials (the "State-local agreement") under which the VLF rate would be permanently reduced from 2% to 0.65%. In order to protect local governments, the reduction in VLF revenue to cities and counties from this rate change was replaced by an increase in the amount of Property Tax they receive. Under the State-local agreement, for FY 2004/2005 and FY 2005/2006 only, the replacement Property Taxes that cities and counties receive has been reduced by $700 million. Commencing in FY 2006/2007, local governments will receive their full share of replacement Property Taxes and those replacement Property Taxes will now enjoy constitutional protection against transfers by the State due to the approval of Proposition 1A at the November 2004 election.

The State-local agreement also provides for the repayment by August 15, 2006 of the approximately $1.2 billion VLF Gap Repayment. The repayment of these funds, however, was not included in Proposition 1A and is therefore not constitutionally protected. The only penalty to the State for not repaying the Gap funds is that they cannot "borrow" from local governments again until the monies are repaid. For this reason, the Gap funds are considered less secure than the ongoing Property Taxes that are replacing VLF beginning in FY 2006/2007. Repayment will require that the Governor include these funds in his recommended FY 2006/2007 Budget and that the Legislature concur.

CSCDA is a joint powers authority sponsored by the League of California Cities and the California State Association of Counties (CSAC). The member agencies of CSCDA include approximately 230 cities and 54 counties throughout California. In order to participate in this financing program, each city or county is required to be a member. The City is not yet a member but if Council wishes to participate in the Program they must adopt a resolution to execute an agreement to allow the City to become a member.

Authorized under SB 1096, the VLF Program was instituted by CSCDA in 2004 to enable cities and counties to sell their respective VLF Receivables to CSCDA for an upfront fixed purchase price. Underwriters and Bond Counsel for the Program were chosen through a competitive selection process managed by CSCDA. The League and CSAC each had a representative on the selection committee. The financing team is as follows:

Co-senior managers: Citigroup and E.J. De La Rosa & Co.

Bond counsel: Orrick Herrington & Sutcliffe

Disclosure counsel: Sidley Austin Brown & Wood

The VLF Notes will be issued in two series: one taxable and the other tax-exempt. The proceeds of the taxable series may be used by a government for any legal purpose, including operations. The tax-exempt proceeds may only be used for capital projects and have to be spent by the time the Notes mature (roughly 17 months). Further, the issuance costs for taxable Notes are higher than for tax-exempt Notes, and the net proceeds are therefore only about $30,000 greater with the tax-exempt Notes. Because of the greater flexibility and relatively low difference in net proceeds, it is recommended that if the City chooses to participate it do so in the taxable series of VLF Notes. CSCDA expects to sell the Notes on March 2 and close on March 16, 2005.

The Notes will be insured by XL Capital Assurance and FSA, thereby giving them AAA ratings. The security behind the Notes is the State's obligation to repay the VLF Gap loans in 2006. As a result, the Official Statement for the Notes will make no mention of the individual cities and counties that are selling their receivables, and the local governments will not be responsible should the State not make the repayments.

In the taxable series, the receivables will be sold by the local jurisdictions to CSCDA at a purchase price that is estimated to be approximately 91% to 93% of the VLF Gap Repayment amount. The actual purchase price of the VLF Receivables will depend on the total amount of VLF Receivables that cities and counties sell to CSCDA and on bond market conditions at the time the VLF Notes are priced. If the City of Sunnyvale were to sell its VLF Receivable under the VLF Program, CSCDA would pledge Sunnyvale’s VLF Receivable to secure the repayment of a corresponding portion of the VLF Notes. The decision to sell the VLF Receivable is irrevocable. As mentioned earlier, Noteholders would not have any recourse to Sunnyvale if the State does not make the VLF Gap Repayment.

As of February 7, 2005 approximately 155 cities and counties throughout California have applied to participate in the VLF Receivable Program.

Upon delivery of the VLF Notes, CSCDA would make available to Sunnyvale its fixed purchase price. This payment would equal Sunnyvale’s VLF Receivable amount less capitalized interest costs (to pay interest on the VLF Notes until maturity), credit enhancement fees and bond issuance costs. As mentioned above, Sunnyvale’s VLF Receivable is $2,271,988.

The table following shows the net sale proceeds that Sunnyvale would receive based on a series of assumptions. Current taxable debt rates are 3.75%. The table also shows a "worst-case" scenario, should interest rates increase by 100 basis points (1%) between now and when the Notes are issued in early March. In order to calculate the net effect to the City, the benefit of receiving cash related to the City’s VLF Gap Receivable in March 2005, rather than August 2006 is also considered. Staff used the current rate of interest paid on a seventeen-month federal agency security, which yields 3.35%. That investment would earn $98,724 to offset the cost or "discount" on the proceeds. Therefore, the net discount or cost to the City of this transaction at 3.75% is estimated to be $76,063. At the worst-case scenario of 4.75% it is assumed that the interest earnings on the proceeds would be correspondingly higher as well, and the net discount would be $84,926. If the sale proceeds are more and/or the investment interest rate increases, the benefit to the City would also increase and the amount of the discount would decrease.

Staff believes that, while interest rates will potentially increase between now and the time of sale of the VLF Notes, it is unlikely the increase will be a full 100 basis points. However, in order to minimize the risk of being excluded from the VLF Gap Receivables Financing Program at the time of sale, staff is recommending that the City select a minimum threshold amount of $2,062,012 if we participate. If the interest rate on the VLF Notes at the time of sale is less than 4.75%, the amount the City would receive as sale proceeds would be more than $2,062,012. However, the purchase price to be paid by CSCDA cannot be determined with certainty until the total number of participants in the VLF Program is known and bond market conditions are taken into account at the time the VLF Notes are priced.

According to CSCDA, the benefits of participating in the VLF program include:

• Immediate cash relief

• Levelized cash flow over the next two years

However, since Sunnyvale budgets on a long-term (20-year) basis, many of these short-term benefits do not apply to us. It is staff's opinion that the most compelling reason for participating in this Program is to ensure that the City is actually repaid its VLF Gap funds. Since the repayment is not constitutionally guaranteed, but is dependent upon appropriation in the State Budget for FY 2006/2007, this Program transfers the risk of not being repaid to the Noteholders. The cost of this risk transfer is $76,063 to $84,926 depending upon market conditions. Staff's analysis is that the risk of not being repaid is not worth the discount that would be required. However, we are suggesting that Council carefully weigh the risks associated with delayed payment and make a determination about participation.

There are two resolutions that the City Council would need to adopt in order to give the City the necessary authority to participate in the State’s Vehicle License Fee Gap Receivables Financing Program. The first resolution approves, authorizes and directs the execution of an amended and restated Joint Exercise of Powers Agreement that will allow the City to become a member of CSCDA. Every participant in the Financing Program must be a member of CSCDA.

The second resolution would accomplish the following:

(1) authorize the sale of Sunnyvale’s VLF Receivable to CSCDA for a minimum sale price at least equal to $2,062,012;

(2) approve the form, and direct the execution and delivery of the Purchase and Sale Agreement with CSCDA and related documents;

(3) authorize and direct any Authorized Officer to send, or to cause to be sent, an irrevocable written instruction required by statute to the State Controller notifying the State of the sale of the VLF Receivable and instructing the disbursement of the VLF Receivable to the VLF Bond Trustee;

(4) approve the use of the VLF Receivable proceeds for operations;

(5) appoint certain officers and officials as Authorized Officers for purposes of signing documents; and

(6) authorize miscellaneous related actions and makes certain ratifications, findings and determinations required by law.

The two resolutions are included for Council's consideration and approval if the decision is made to participate in the Program.

The amount of VLF Gap that the City is entitled to receive is $2,271,988. The minimum sale price that the City should be willing to accept is $2,062,012; the difference is $209,976, which represents the maximum discount the City would realize from participating in the Program. However, the City would have the money 17 months earlier than currently scheduled and would be able to invest that money. It is estimated that the investment would earn $98,724 to $125,050. The net discount or cost to the City is therefore estimated to be between $76,063 and $84,926.

Conclusion

Staff recommends that the City not participate in the CSCDA Vehicle License Fee Gap Receivables Financing Program at this time. Participating in this program would allow the City to guarantee receipt of our VLF Gap funds and would allow us to receive them in March 2005, which is approximately 17 months ahead of schedule. However, the repayment would be made at a discount or net cost of 3.3% to 3.7% after taking into consideration interest earnings on the proceeds. Staff does not believe that the risk of repayment is worth the discount required. However, after Council considers the risk it may decide that it is prudent to participate. Therefore, two resolutions to allow the City to participate in the CSCDA Vehicle License Fee Gap Receivables Financing Program have been included for approval if desired.

PUBLIC CONTACT

Public comment was made through posting of the Council agenda on the City’s official notice bulletin board, posting of the agenda and report on the City’s web page, and the availability of the report in the Library and the City Clerk’s Office.

1. Approve the City's participation in the CSCDA Vehicle License Fee Gap Receivables Financing Program and adopt the two necessary documents. These documents include a resolution to execute an amended and restated Joint Exercise of Powers Agreement to allow the City to become a member of CSCDA and a resolution approving the form of and authorizing the execution and delivery of a Purchase and Sale Agreement and related documents with respect to the sale of Sunnyvale's Vehicle License Fee Receivable and authorizing certain other actions in connection with the City’s participation in the Program.

Staff recommends that Council approve Alternative #2.

Prepared by:

Therese B. Balbo
Finance Manager

Reviewed by:

Mary J. Bradley
Director of Finance

Approved by:

Amy Chan
City Manager

1. Resolution approving, authorizing, and directing execution of an amended and restated Joint Exercise of Powers Agreement relating to the California Statewide Communities Development Authority (.pdf format)
2. Resolution approving the form of and authorizing the execution and delivery of a purchase and sale agreement and related documents with respect to the sale of the seller’s vehicle license fee receivable from the State; and directing and authorizing certain other actions in connection therewith (.pdf format)