CITY CLERKS & MUNICIPAL FINANCE OFFICERS ASSOCIATION OF KANSAS MUNICIPAL CLERKS CERTIFICATION INSTITUTE YEAR 2 NOVEMBER 14, 2017 DOUBLETREE BY HILTON HOTEL WICHITA AIRPORT WICHITA, KANSAS MUNICIPAL BOND BASICS presented by GARTH HERRMANN, DOMINIC ECK, AND JACOB EDIGER INTRODUCTION As federal and state regulations become more complex and the financial resources needed to fund governmental operation become scarcer, municipal officers in the state of Kansas (the State or Kansas ) face significant challenges. In order to balance the budget, the finance officer will need to utilize many funding sources. One such source is the ability to finance capital improvement projects. Used prudently, this financial management tool can allow a municipality to construct needed infrastructure improvements, while at the same time funding needed administrative, cultural and social programs from current revenues. This presentation is intended as a summary of significant financing tools available to municipal finance officers. It is not intended to be exhaustive. Specific questions concerning the financing options discussed herein or other methods may be addressed to any member of the firm. I. WHY FINANCE? GOVERNMENTAL PURPOSE OBLIGATIONS A. Cash Basis Law (K.S.A. 10-1101 et seq.). Unless otherwise provided, it is unlawful for the governing body of any Kansas municipality to create any indebtedness in excess of the amount of funds actually on hand in the treasury of such municipality at the time for such purpose. Municipalities that fall within the parameters of the Cash Basis Law include cities, counties, school districts, community colleges, and other similar political subdivisions and taxing districts.
B. Exceeding Limitations of the Cash Basis Law. K.S.A. 10-1116 provides that the limitations on indebtedness under the provisions of the Cash Basis Law may be exceeded in certain instances, including when: (a) payment has been authorized by referendum in a municipality, (b) provision has been made for payment by the issuance of bonds or temporary notes as provided by law and (c) a lease or lease-purchase agreement has been authorized that complies with K.S.A. 10-1116b. Additionally, an amount equal to 100% of the accrued revenue of the current fiscal year, plus balances carried forward, cash reserves and grants, is prescribed as the limit of indebtedness for certain funds, including enterprise funds established to account for self-supporting activities which render services on a user charge basis to the general public. Once a municipality has appropriately identified and established an exemption from the Cash Basis Law, the municipality may proceed to execute contracts for the construction of the proposed improvements without violating the Cash Basis Law. C. Basic Financing Steps 1. Governing Body proposes capital project 2. Staff contacts Bond Counsel/Financial Advisor to discuss transaction, develop calendar of events 3. Governing Body acts to authorize project and financing 4. Financing team prepares necessary documentation and markets securities to prospective purchasers 5. Sale of securities completed; interest rate locked in 6. Governing Body approves sale of securities to specific purchaser 7. Documentation finalized; transaction approved by Attorney General, if necessary 8. Closing and delivery of funds to Issuer Plan Ahead: entire process can take 1-6+ months depending on complexity of project and financing II. GENERAL OBLIGATION BONDS, TEMPORARY NOTES AND GOVERNMENTAL PURPOSE REVENUE BONDS A. General Obligation Bonds. General obligation bonds are the most secure debt instrument which may be issued by Kansas municipalities. Usually, such bonds will provide the lowest interest rate available at that time in the financial markets for similar length of maturing obligations. General obligation bonds may be issued to finance a variety of public improvements, including public buildings, streets, sewers and water system improvements. All general obligation bonds are secured by the full faith and credit of the issuing municipality, and such municipality must levy unlimited taxes on all taxable tangible property in the municipality to repay the principal of and interest on the bonds. Even though a municipality issues general obligation bonds, it may anticipate that revenues generated from a particular source (e.g. utility system) will provide the necessary funds for payment of the principal and interest on the bonds. If revenues are insufficient, however, the municipality must make the payments from other funds of the municipality, including from ad valorem taxes, if necessary. Kansas law provides that general obligation bonds, other than special assessment bonds, must mature within 32 years of issue. Special assessment bonds must mature within 22 years of issue. Unless associated with a refunding issue, general obligation bonds in excess of $2,000,000 must be sold at competitive public sale. A Notice of Intent to Seek Private Placement must be published in the Kansas Register and local newspaper for general obligation bonds in the principal amount of $2,000,000 or less that are not sold at competitive 2
public sale. Special rules exist with respect to bonds sold to the United States of America or any agency or bureau thereof (e.g. USDA/RD). These special rules permit such bonds to be sold at negotiated sale and have a final maturity not in excess of 40 years. The authorization for the issuance of general obligation bonds is both Constitutional and statutory. In general, the type of project to be constructed will determine the authority and method by which bonds are authorized. Certain statutes require a referendum, while others allow the governing body to commence a project on its own initiative. Special assessment projects are typically initiated by petition of affected property owners, but may be initiated by the governing body, with affected property owners having a right to protest the commencement of the project, or may be initiated without a petition and without a right of protest for special assessment sewage projects. Under certain circumstances, property not initially assessed but benefitted may be responsible for future benefit fees. A summary of authorization requirements for certain government infrastructure improvements is set forth on Schedule I attached hereto. B. Short-Term Financing/Temporary Notes. Short-term financing may be issued to provide construction financing prior to the issuance of long-term debt and may be repaid by such longterm debt or from a dedicated source of revenue. Temporary notes or bond anticipation notes, often referred to as BANS, are issued to finance the construction of capital improvement projects of the municipality prior to the issuance of long-term debt. In order to issue temporary notes, the issuer must first authorize the long-term bonds. Other examples of short-term obligations are notes issued to provide funding in advance of receipt of federal or State grant funds. Such notes are secured by the receipt of such grant funds and may or may not be general obligations of the issuer. Kansas municipalities have great flexibility in issuing notes. Notes may be sold at public or negotiated sale. The municipality may issue notes that are repaid from ad valorem tax levies or other revenue sources without the necessity of issuing long-term debt. The term of such notes may not exceed four years. This enactment allows a municipality to pay for a specified capital improvement over a short period without the costs associated in issuing long-term debt. C. Governmental Purpose Revenue Bonds. As opposed to general obligation bonds, revenue bonds are payable from specific revenue sources and not from ad valorem taxing authority. Revenue bonds therefore usually have a higher interest rate than similar term general obligation bonds of the same issuer. Usually, revenue bonds have no specific tax backing, and, while payment can be made from tax revenues or any other source the municipality deems advisable, revenue bonds are secured solely by a dedicated source of revenue. Primary examples are bonds issued for and secured by municipal electric, water, sewer and natural gas utilities. Other examples of revenue bonds are sales tax revenue bonds, public building commission revenue bonds and bonds issued by colleges and universities which are secured by dormitory or student union fees. Revenue bonds may be secured by a gross or net revenues pledge. A gross revenues pledge is one that pledges for payment of debt service the revenues of a system before payment of operation and maintenance expenses. A net revenues pledge is one that pledges for payment of debt service the revenues remaining after deduction for payment of operation and maintenance expenses. Revenue bonds which pledge as security the same source of revenues, equally and ratably, as other outstanding bonds of the issuer are known as parity bonds. Debt service payments on parity bonds are made equally, on a parity and the same priority of lien with the debt service on the other outstanding 3
bonds. Revenue bonds which pledge as security the same source of revenues as other outstanding bonds of the issuer, but which have a subordinate lien on the revenues pledged and on which the debt service payments will be made after payment has been made on the prior lien bonds are known as subordinate lien or junior lien bonds. Revenue bonds may have maturities of up to forty years, are permitted to be sold at public or negotiated sale and may have provision for citizen protest prior to authorization and issuance. Brief descriptions of various types of revenue bonds follow. 1. Utility Revenue Bonds. Kansas law (K.S.A. 10-1201 et seq.) authorizes any municipality to issue revenue bonds to finance the costs of constructing or making improvements to a revenue producing utility. In the event the municipality does not currently operate such utility, a referendum is required to issue the bonds. However, if such utility is currently in operation, the governing body may declare its intent to issue the revenue bonds by resolution. Thereafter, a notice of such intent is published one time and citizens are provided the opportunity to protest (20% of qualified electors within 15 days). If no sufficient protest is filed, the municipality may issue the bonds. Utility revenue bonds issued under the above statute are generally secured by the net revenues of the utility (gross revenues after deducting operation and maintenance expenses). Market conditions usually dictate that the municipality establish a bond reserve account equal to ten percent of the issue size and maintain or raise utility rates in order to achieve net revenues of not less than 125 to 140 percent of the current year's debt service requirements. 2. Public Building Commission Revenue Bonds. Kansas law (K.S.A. 12-1757 et seq.) authorizes both cities and counties to create public building commissions ( PBC ). A PBC may be created by appropriate ordinance or resolution and may consist of between three and nine members, as appointed by the creating municipality. A PBC may finance buildings or facilities maintained and operated for a county courthouse, county or city offices and related parking facilities and lease the same to the cities, counties or other enumerated governmental agencies. However, city and county obligations to make lease payments to a PBC are subject to the Tax Lid (as discussed below in Section II.J. Budget and Property Tax Lid) unless the obligation existed prior to July 1, 2016. The PBC has no power to levy taxes and PBC revenue bonds are not general obligations or debt of any public body within the meaning of any statutory or constitutional debt limitation. PBC revenue bonds are payable solely from the rents and revenues to be derived from the operation, management or use of the buildings or other facilities operated and maintained by the PBC. PBC bonds are excluded from the bonded indebtedness of the applicable municipality. Cities and counties may, however, provide for PBC financing of other public facilities through home rule charter action as described below. PBC leases may be for a term of up to 50 years and will be valid notwithstanding the Cash Basis Law and budget law (K.S.A. 79-2925 et seq.). Thus, lease payments to a PBC are not subject to annual appropriation like payments under a normal lease or lease-purchase agreement, as described in Section III herein, and may include operation and maintenance expenses. A PBC must fix rental rates in the lease sufficient to provide for repayment of debt issued by the PBC to finance the leased premises. Prior to the issuance of revenue bonds to finance the aforementioned buildings or facilities, a PBC must adopt a resolution declaring it necessary to finance such project. The resolution must be published once a week for two consecutive weeks in the official newspaper of the applicable municipality. A referendum is required if a protest petition is filed by not less than 4
five percent of the electors of the applicable municipality within thirty days after the last publication. A city or county also may exempt certain PBC bond issues from the notice, protest and referendum requirements through home rule charter action. A charter ordinance or resolution is an ordinance or resolution that exempts a city or county from the whole or any part of any enactment of the Kansas legislature and may provide substitute and additional provisions on the same subject. A charter ordinance requires passage by a two-thirds vote of the governing body of a city. A charter resolution requires passage by a unanimous vote of a three-member county governing body and a two-thirds vote of a five or seven-member county governing body. Every charter ordinance or resolution must be published once each week for two consecutive weeks in the official city or county newspaper. No charter ordinance or resolution shall take effect until sixty days after its final publication. If, within sixty days of its final publication, a petition, signed by a number of city electors equal to not less than ten percent of the number of electors who voted at the last preceding regular city election, or by a number of electors equal to not less than 2% of the number of county electors who voted at the last preceding November general election or 100 county electors, whichever is greater, shall be filed in the office of the city clerk or county election officer, as applicable, demanding that such ordinance or resolution be submitted to a vote of the electors, such ordinance or resolution shall not take effect until submitted to a referendum and approved by a majority of the electors voting thereon. The governing body of a city or county may also directly submit any charter ordinance or resolution to a referendum without petition and such charter ordinance or resolution shall then become effective when approved by a majority of the electors voting thereon. Pursuant to charter home rule authority, PBCs have acquired and constructed State prisons, law enforcement centers, swimming pools, recreational facilities, school auditoriums, hospitals, senior care centers and community college educational facilities. 3. Sales Tax Revenue Bonds. K.S.A. 12-187 et seq. authorizes any city or county which receives the proceeds of a local option sales tax to issue revenue bonds to construct noncommercial municipal facilities that could be financed with general obligation bonds. The local sales tax must be approved at a referendum. If the proposition of issuing bonds is not contained in the sales tax election, a notice and protest period with right of referendum is required prior to the issuance of the bonds. Because sales tax revenue bonds are not general obligations of the issuer, the bonds do not count toward the bonded debt limitations of the issuer and may be sold at public or negotiated sale. Under certain situations, however, these sales tax revenue bonds may also constitute general obligations of the issuing municipality and, in those instances, the bonds are subject to the public sale law and count toward the bonded debt limitation of the issuer unless the project financed qualifies for one of the exceptions under the bonded debt limitation statues (see K.S.A. 10-309 discussed below). D. Statutory Limitations on Bonded Indebtedness 1. Limit on Bonded Indebtedness (K.S.A. 10-308). Except as otherwise provided in the statutes, the authorized and outstanding bonded indebtedness of any city shall not exceed 30% of the assessed valuation of all taxable tangible property in the city as certified to the county clerk on the preceding August 25. 2. General Exceptions (K.S.A. 10-309). Notwithstanding the provisions of K.S.A. 10-308 and amendments thereto, the following shall not be included in computing the 5
total bonded indebtedness of the city for the purposes of determining the limitations on bonded indebtedness: (a) bonds issued by any city for the purpose of acquiring, enlarging, extending or improving any storm or sanitary sewer system; or (b) bonds issued by any city for the purpose of acquiring, enlarging, extending or improving any municipal utility; or (c) bonds issued by any city to pay the cost of improvements to intersections of streets and alleys or that portion of any street immediately in front of city or school district property. 3. Revenue Bonds Excluded from Computation (K.S.A. 10-311). All revenue bonds issued by a city shall not be included in computing the total bonded indebtedness of such city for the purpose of determining the limitations on bonded indebtedness of such city. Revenue bonds mean bonds issued by any city to be paid from the revenue derived from the operation of a publicly owned utility, instrumentality or facility of a revenue producing character, or which are not general obligations of the issuing city. 4. Lease Obligations Excluded from Computation. Lease agreements are not bonded indebtedness and therefore are excluded from the bonded debt limitation computation of municipalities. 5. Calculating Valuation for Debt Limitation Purposes. Assessed valuation means the value of all taxable tangible property as certified to the county clerk on the preceding August 25. K.S.A. 10-310 provides that the county clerk shall add (1) the taxable value of each motor vehicle, as shown on the application for registration for the previous year or as otherwise established in the manner prescribed by K.S.A. 79-5105, and amendments thereto, and (2) the taxable value of motor vehicles established in the manner prescribed by K.S.A. 79-1022, and amendments thereto, to the equalized assessed tangible valuation on the tax roll of each taxing subdivision in which such motor vehicle has acquired tax situs. The resulting total shall constitute the equalized assessed tangible valuation of the taxing subdivision for the computation of limitations upon bonded indebtedness and for all other purposes except the levying of taxes and the computation of limitations thereon. E. Interest Rate Limits. K.S.A. 10-1009 provides that the maximum stated rate of interest on any municipal bond in Kansas shall not exceed the daily yield for the ten-year treasury bonds published by The Bond Buyer, in New York, New York, on the Monday next preceding the day on which the bonds are sold, plus (1) 3%, if the interest on the bonds is excluded from gross income for federal income tax purposes or (2) 4%, if the interest on the bonds is included in gross income for federal income tax purposes. F. Electronic Bidding. K.S.A. 10-106, which relates to the public sale of general obligation bonds, also permits the receipt of bids by electronic means, including electronic auction bids. This statute permits bids to be received via telefax or through an internet provider. There are several national companies which provide platforms for receipt of electronic bids and/or electronic auction bids. Some charge the issuer of the bonds a transaction fee, others do not. Certain platforms require a membership for entities submitting bids. In addition, these platforms have a service that disseminates via the internet the notice of bond sale and preliminary official statement to potential bidders. G. Good Faith Deposit. K.S.A. 10-106 requires a good faith deposit in the amount of 2% of the total par value of the bonds being sold at public sale to be furnished at or prior to the time of the public sale. Good faith deposits may be in the form of cash, including cash deposited into an account of the municipality or its agent by electronic fund transfer, a certified or cashier s check or surety bond. 6
H. Bond Ratings. Nationally recognized companies with headquarters in New York provide expert analysis on municipal obligations. The most recognized of such companies are Moody's Investors Service, S&P Global Ratings, a division of S&P Global Inc., and Fitch Ratings. These companies attach financial ratings to various debt obligations after analyzing their credit-worthiness. The ratings enhance a municipality's ability to reach the national credit markets by providing a uniform national credit analysis. The ratings vary from issuer to issuer and the type of obligation, with the most secure being AAA. I. Bond Insurance. At the beginning of 2007, several bond insurance companies provided, in exchange for a premium, policies which insured the prompt payment of municipal debt obligations. In most cases, the issuance of those policies automatically provided the issue with a AAA credit rating, which allowed issuers to achieve lower interest costs than otherwise would be attainable without the insurance. Since 2007, all of the bond insurers have been downgraded by the ratings companies, and most companies are no longer insuring municipal bonds. Currently, Assured Guaranty Municipal Corp., Assured Guaranty Corp., Ltd., and Build America Mutual Assurance Company are the primary active bond insurers. J. Budget and Property Tax Lid. A city or county may levy taxes in accordance with the requirements of its adopted budget. Property tax levies are based on the adopted budget of the city or county and the assessed valuations provided by the County appraiser. The Kansas Legislature passed legislation in 2015 and 2016 that, among other things, imposes an additional limit on the aggregate amount of property taxes that may be imposed by cities and counties, without a majority vote of qualified electors of the city or county (the Tax Lid ). The Tax Lid became effective on January 1, 2017, and provides that, subject to certain exceptions, no city or county may approve an appropriation or budget which provides for funding by property tax revenues in an amount exceeding that of the immediately prior year, as adjusted to reflect the average changes in the consumer price index for the preceding five calendar years and provided that such average shall not be less than zero, unless approved by a majority vote of electors. The Tax Lid does not require an election in the following situations: (1) Increased property tax revenues that, in the current year, are produced and attributable to the taxation of: (A) The construction of any new structures or improvements or the remodeling or renovation of any existing structures or improvements on real property, which shall not include any ordinary maintenance or repair of any existing structures or improvements on the property; (B) increased personal property valuation; (C) real property located within added jurisdictional territory; (D) real property which has changed in use; (E) expiration of any abatement of property from property tax; or (F) expiration of a tax increment financing district, rural housing incentive district, neighborhood revitalization area or any other similar property tax rebate or redirection program. (2) Increased property tax revenues that will be spent on: (A) Bond, temporary notes, no fund warrants, state infrastructure loans and interest payments not exceeding the amount of ad valorem property taxes levied in support of such payments, and payments made to a public building commission and lease payments but only to the extent such payments were obligations that existed prior to July 1, 2016; (B) payment of special assessments not exceeding the amount of ad valorem property taxes levied in support of such payments; 7
(C) court judgments or settlements of legal actions against the city or county and legal costs directly related to such judgments or settlements; (D) expenditures of city or county funds that are specifically mandated by federal or state law with such mandates becoming effective on or after July 1, 2015, and loss of funds from federal sources after January 1, 2017, where the city or county is contractually obligated to provide a service; (E) expenses relating to a federal, state or local disaster or federal, state or local emergency, including, but not limited to, a financial emergency, declared by a federal or state official. The board of county commissioners may request the governor to declare such disaster or emergency; or (F) increased costs above the consumer price index for law enforcement, fire protection or emergency medical services. (3) Any increased property tax revenues generated for law enforcement, fire protection or emergency medical services shall be expended exclusively for these purposes but shall not be used for the construction or remodeling of buildings. (4) The property tax revenues levied by the city or county have declined: (A) In one or more of the next preceding three calendar years and the increase in the amount of funding for the budget or appropriation from revenue produced from property taxes does not exceed the average amount of funding from such revenue of the next preceding three calendar years, adjusted to reflect changes in the consumer price index for all urban consumers as published by the United States department of labor for the preceding calendar year; or (B) the increase in the amount of ad valorem tax to be levied is less than the change in the consumer price index plus the loss of assessed property valuation that has occurred as the result of legislative action, judicial action or a ruling by the board of tax appeals. The Tax Lid also provides that [w]henever a city or county is required by law to levy taxes for the financing of the budget of any political or governmental subdivision of this state that is not authorized by law to levy taxes on its own behalf, and the governing body of such city or county is not authorized or empowered to modify or reduce the amount of taxes levied therefore, the tax levies of the political or governmental subdivision shall not be included in or considered in computing the aggregate limitation upon the property tax levies of the city or county. Because of ambiguities in the Tax Lid, it is unclear how the various exceptions will be interpreted and how the provisions will be implemented. However, as described above, the Tax Lid provides a specific exception for [b]ond, temporary notes, no fund warrants, state infrastructure loans, and interest payments not exceeding the amount of ad valorem property taxes levied in support of such payments as well as certain lease payments. Therefore, a city or county is permitted under the Tax Lid to levy unlimited ad valorem taxes as necessary to pay principal of and interest on general obligation bonds and general obligation temporary notes. The Tax Lid does not include a specific exception to the property tax lid for lease payments (including lease payments to a public building commission), unless such leases were obligations that existed prior to July 1, 2016. III. LEASE AND LEASE-PURCHASE AGREEMENTS A. General. Cities are empowered by their home rule authority (Article 12, Section 5 of the Kansas Constitution and K.S.A. 12-101 et seq.) to enter into lease, lease purchase or installment purchase obligations (jointly defined herein as Lease Agreements ) to finance projects. Therefore, a home rule ordinance needs to be adopted and published to authorize a city Lease Agreement. 8
B. Exceeding Limitations of the Cash Basis Law. K.S.A. 10-1116b provides, in substance, that the Cash Basis Law shall not prohibit a municipality from entering into (1) an agreement to pay for electric interconnection or transmission facilities or services, (2) a lease agreement, or (3) a lease purchase or installment purchase agreement; if any such agreements specifically state that the municipality is obligated only to pay periodic payments or monthly installments under the agreement as may lawfully be made from (a) funds budgeted and appropriated for that purpose during such municipality's current budget year or (b) funds made available from any lawfully operated revenue producing source. However, city and county obligations to make lease payments are subject to the Tax Lid (as discussed above in Section II.J. Budget and Property Tax Lid) unless the obligation existed prior to July 1, 2016. C. Procedural Requirements. K.S.A. 10-1116c provides additional procedural requirements with respect to the foregoing entities entering into Lease Agreements. Sections (a) and (d) of that statute provide that any Lease Agreement for a term in excess of the current fiscal year shall be (1) approved by a majority vote of all members of the governing body (e.g. similar to requirements for adoption of an ordinance) and (2) must specify (a) the amount or capital cost required to purchase the item if paid for by cash, (b) the annual average effective interest cost and (c) the amount included in the payments for service, maintenance, insurance or other charges exclusive of the capital cost and interest cost. D. Notice Requirements. K.S.A. 10-1116c(b) provides that if a municipality other than a county, school district or community college (e.g. a city) proposes to enter into a Lease Agreement involving (1) the acquisition of land or buildings, (2) is for a term of three or more years and (3) payments in any year in excess of 3% of the total budget of that municipality for the current year, excluding debt service, a notice specifying the purpose and total payments under the Lease Agreement must be published once each week for two consecutive weeks in a newspaper of general circulation within such municipality. If a petition in opposition of the Lease Agreement is filed by 5% of the qualified electors of the municipality within 30 days of the last publication, the Lease Agreement shall not take effect until approved at a referendum held in the manner provided in K.S.A. 10-120. Any such election shall be called and held in the manner provided by K.S.A. 10-120, and amendments thereto, or in accordance with the provisions of the mail ballot election act. E. Miscellaneous. Lease Agreements are not bonded indebtedness and therefore are excluded from the bonded debt limitation computation of municipalities. Transcripts authorizing Lease Agreements need not be submitted to the Attorney General for review and are not required to be registered with the State Treasurer. However, taxes levied to make payments under a Lease Agreement may be subject to (1) the required ordinance or resolution to exceed prior general fund levies or (2) an election pursuant to the Tax Lid. Lease Agreements and certificates of participation thereunder may be sold at negotiated or public sale. F. Practical Considerations 1. General. When it is anticipated that an interest in a Lease Agreement will be sold to more than one investor, it is necessary to document that transaction in a manner that will allow the sale of portions of the municipality's obligation under the Lease Agreement. The two most common structures used to accomplish that objective are (1) certificates of participation ( COP s ) evidencing a proportionate interest in the right to receive rentals under the Lease Agreement, and (2) lease revenue bonds payable solely from rentals received by the issuer of the bonds or Lessor under the Lease Agreement. 9
2. Certificates of Participation. COP's are merely certificates that represent a proportionate interest of the owner of each Certificate in the right of the Lessor to receive rental payments made by the Lessee under the Lease Agreement. COP's are not obligations themselves, but merely evidence the obligations of the Lessee under the Lease Agreement. The Lessor may be the vendor, a leasing company, an investment banking firm, a single purpose corporation or a bank or trust company. It is not necessary that the Lessor be a nonprofit entity or have the ability to issue tax-exempt obligations. The Lessee and the Lessor enter into a Lease Agreement pursuant to which the Lessor leases the leased property (the Leased Property ) to the Lessee, and the Lessee agrees to pay rent at specified times to the Issuer or its assigns. The Lessor may assign its rights under the Lease Agreement and in the Leased Property to a trustee or an agent (the Trustee ) pursuant to an assignment agreement. The Lessor and the Trustee enter a trust indenture or an agency agreement pursuant to which the Trustee, as assignee of the Lessor, executes and delivers Certificates in the Lease Agreement to investors. Under an alternate structure, the Trustee is the Lessor and no assignment is required. In that structure, the Trustee makes a declaration of trust pursuant to which it executes and delivers Certificates in the Lease Agreement to investors. In either case, the Trustee has, either by assignment or directly, the interest of the Lessor under the Lease Agreement. 3. The Trustee. In general, the responsibilities and liabilities of the Trustee are no different in a COP or bond transaction than in any other municipal bond transaction in which there is a Trustee. As in any transaction, the trust document specifies the requirements for standard of care, insurance, the designation of various funds and accounts, the timing of deposits to and withdrawals from the funds and accounts and the Trustee's responsibilities upon default or nonappropriation. The Trustee may also have the responsibility to monitor insurance, to continue UCC filings and to disseminate continuing disclosure materials. In any COP or bond transaction involving real property, the Trustee will have a leasehold or fee interest in that real property, either by assignment or directly. The secured creditor exemption should protect the Trustee from liability under CERCLA, however most documentation requires that there be a Phase I Environmental Survey on the real property covered by the Lease Agreement. The Trustee is usually required to confirm that the items required for closing, such as title insurance, environmental surveys, insurance and required UCC filings, are in place and in the required form prior to closing. IV. STATE INFRASTRUCTURE LOANS A. KDHE Programs. There are currently two primary programs of the Kansas Department of Health and Environment ( KDHE ) that permit municipalities to enter into loan agreements with KDHE to finance wastewater treatment works projects and safe drinking water projects. In each case, the loan agreements are deemed to be bonds for purpose of the cash-basis law. The authorizing legislation permits the municipality to approve the loan agreements by action of the governing body; no election or protest period is required. The loans have below market interest rates due to a subsidy from federal funds. The loans may be secured by an ad valorem tax pledge or a pledge of a revenue producing source (e.g. water or sewer revenues). If a revenue source is pledged, KDHE may require that a bond insurance policy be obtained to further secure the loan. The loan may be for up to 20 years and is not subject to annual appropriation. Both KDHE programs permit a draw-down of loan proceeds, thus, interest accrues only on the actual borrowed amount, regardless of the stated principal amount. The loan agreement does not count against the statutory debt limit. 10
B. Kansas Transportation Revolving Fund. The Kansas Transportation Revolving Fund (the TRF ) is a Statewide revolving loan fund administered by the Kansas Department of Transportation ( KDOT ) for the purpose of providing financial assistance to local governmental units for transportation projects. All cities and counties and other political subdivisions of the State and certain private enterprises in partnership with a governmental unit are eligible to borrow from the TRF. The loans have below market interest rates due to a subsidy from KDOT funds. The loans may be secured by an ad valorem tax pledge or from designated revenues (e.g. sales tax). The loan may be for up to 20 years, are not subject to annual appropriation and permit a draw-down of loan proceeds, thus, interest accrues only on the actual borrowed amount, regardless of the stated principal amount. The loan agreement does not count against the statutory debt limit. V. BANK-QUALIFIED OBLIGATIONS A. General. The term bank-qualified is a term that has been adapted by finance professionals and capital market participants to describe certain types of governmental obligations that may achieve more favorable federal tax treatment when owned by certain types of financial institutions. In fact, this term does not appear in the Internal Revenue Code of 1986, as amended, or the related regulations issued by the U.S. Treasury Department (collectively, the Code ). The actual term is a qualified tax-exempt obligation, defined in Section 265(b)(3) of the Code as a bond which (a) is not a private activity bond (other than a qualified 501(c)(3) bond and certain types of refunding bonds) and (b) is issued by an issuer which reasonably anticipates to issue, together with subordinate entities, not more than $10 million of tax-exempt obligations (other than private activity bonds, as described in clause (a)) during the calendar year. Financial institutions referenced in this Code section include any person or entity that accepts deposits from the public in the ordinary course of its trade or business and is subject to federal or state supervision as a financial institution, or is a foreign banking organization (e.g. commercial banks, trust companies and savings and loan associations). The obligations referred to in this section include bonds, notes, lease agreements and related COP's and any other form in obligation issued by or on behalf of a state or local governmental entity, the interest on which is excluded from federal income taxation under the Code ( tax-exempt ). A financial institution which owns bonds that are qualified taxexempt obligations is allowed a deduction for that portion of such financial institution s interest expense that is allocable to tax-exempt interest. To put this in perspective, a bank pays interest to its depositors. When the bank prepares its federal income tax return, it is allowed to deduct from gross income its ordinary and necessary business expenses, including such items as rent, salaries, utilities and interest paid to depositors. By deducting these amounts, the bank's taxable income is reduced, so it pays less income tax. But suppose a bank holds some municipal bonds in its portfolio, and these make up 25% of all the bank's assets (land, buildings, equipment, investment securities and loans). Unless the bonds are qualified tax-exempt obligations, the bank must reduce its interest deduction by 25%, which will force it to pay more federal income tax. Because of this provision, many financial institutions are more willing to purchase municipal bonds that the bonds are bank qualified. B. Qualified Small Issuers. Only qualified small issuers are permitted to designate their tax-exempt obligations as qualified tax-exempt obligations under Section 265(b) of the Code. Section 265(b)(3)(C) defines a qualified small issuer to mean, with respect to obligations issued during any calendar year, any issuer if the reasonably anticipated amount of tax-exempt obligations (other than obligations described below) which will be issued by such issuer during such calendar year does not exceed $10,000,000. Generally, an obligation is not taken into account in determining status as qualified small issuer if such obligation is: 11
(1) A private activity bond (other than a qualified 501(c)(3) bond, as defined in section Code Section 145); or (2) an obligation issued to refund (other than to advance refund) any obligation to the extent the amount of the refunding obligation does not exceed the outstanding amount of the refunded obligation. In the case of an issue under which more than one governmental entity receives benefits, if: (a) all governmental entities receiving benefits from such issue irrevocably agree (before the date of issuance of the issue) on an allocation of the amount of such issue; and (b) such allocation bears a reasonable relationship to the respective benefits received by such entities; then only the amount of such issue so allocated to an entity will be taken into account with respect to such entity. A special rule for qualified 501(c)(3) bonds was included in the ARRA of 2009 to provide a separate $30,000,000 limit for each qualified 501(c)(3) entity. C. Limitations On Amount of Designation. In general, not more than $10,000,000 of obligations issued during any calendar year may be designated by the issuer as qualified tax-exempt obligations. Certain refundings of designated obligations may be deemed designated as qualified taxexempt obligations. In other words, even though an issuer cannot designate as bank-qualified more than $10,000,000 in bonds in any calendar year, bonds that meet the requirements set forth below are deemed to be designated and are bank qualified. This rule applies to bonds issued to refund a prior issue of qualified tax-exempt bonds if: (1) The size of the refunding issue does not exceed the outstanding amount of the refunded issue; (2) the refunding issue is a current refunding (i.e. the refunded bonds are discharged not more than 90 days after the refunding bonds are issued); (3) the average maturity date of the refunding issue is not later than the average maturity date of the refunded bonds; and (4) the refunding issue has a maturity date which is not later than the date which is 30 years after the date the original qualified tax-exempt obligation was issued. The restriction on average maturity does not apply if the average maturity of the original qualified tax-exempt obligation (and of the refunded issue) is 3 years or less. But no bond issue may be designated as a qualified tax-exempt obligation or treated as designated if: (a) any obligation issued as part of such issue is issued to refund another obligation; and (b) the aggregate face amount of such issue exceeds $10,000,000. D. Aggregation of Issuers. For purposes of determining the aggregate principal amount of obligations that an issuer may designate as qualified tax-exempt obligations, an issuer and all entities which issue obligations on behalf of such issuer (such as a public building commission) will be treated as one issuer. All obligations issued by a subordinate entity are treated as issued by such other entity. An entity formed to avoid the foregoing requirement (such as a public building commission, 63-20 12
corporation or other joint or on behalf of entity) and all entities benefiting thereby shall be treated as one issuer. In the case of an obligation which is issued as part of a direct or indirect composite issue, such obligation shall not be treated as a qualified tax-exempt obligation unless: (a) the requirements of Section 265 are met with respect to such composite issue (determined by treating such composite issue as a single issue); and (b) the requirements of Section 265 are met with respect to each separate lot of obligations which are part of the issue (determined by treating each such separate lot as a separate issue). VI. SECURITIES LAWS A. General. Rule 15c2-12 of the Securities Exchange Commission generally requires that before an underwriter may participate in a primary offering of municipal securities in excess of $1,000,000, the underwriter must first obtain and review an official statement that the issuer of the securities deems final, except for the omission of certain information. Additionally, that rule requires that the issuer of such securities undertake to provide certain financial information and operating data on a continuing basis. Certain limited exceptions from continuing disclosure are available to issuers offering securities in authorized denominations of $100,000 or more and if the securities (i) are sold to not more than 35 sophisticated investors, or (ii) have a maturity of nine months or less, or (iii) have certain tender options to the holder. B. Electronic Municipal Market Access. On July 1, 2009, the Electronic Municipal Market Access (EMMA) system established by the Municipal Securities Rulemaking Board (MSRB) became the exclusive repository for filing continuing disclosure reports and material event notices required by SEC Rule 15c2-12. Amendments to Rule 15c2-12 made EMMA the sole nationally recognized municipal securities information repository (NRMSIR) designated by the Securities and Exchange Commission to receive these filings. Existing Continuing Disclosure Agreements and Continuing Disclosure Undertakings do not have to be amended to eliminate references to the NRMSIRs or to add references to MSRB or EMMA. EMMA is a web-based system designed to file and access information relating to municipal securities (www.emma.msrb.org). The goals of EMMA are to enhance public access to information relating to municipal securities, permit trading of information and access to official statements by the general public at no cost via EMMA and make interest rate and auction results for municipal auction rate securities, daily market statistics and educational materials about municipal bonds available to the general public. here are no costs associated with EMMA filings, and EMMA will make all documents submitted available to the public within one hour after submission. 1. Types of Disclosures. EMMA provides three different categories of continuing disclosure: (1) required disclosures provided by municipal issuers and other parties known as obligated persons or obligors under contractual agreements entered into under Rule 15c2-12 of the Securities and Exchange Commission (SEC); (2) voluntary disclosures provided by issuers and obligated persons without any legal obligation to do so; and (3) advance refunding documents provided by underwriters when an old issue of bonds is being refinanced with a new issue of bonds. 2. Format of Disclosures. All documents must be filed electronically with EMMA in a PDF word-searchable format. In creating an EMMA submission account, an issuer/borrower may designate one or more agents that will be authorized to make filings on its behalf. A 13
designated agent can be the dissemination agent under a continuing disclosure agreement, an employee of the issuer/borrower or any other person authorized by the issuer/borrower to make filings on its behalf. C. Municipal Advisor Rule. Section 975 of the Dodd Frank Act amended the Securities Exchange Act of 1934 to require Municipal Advisors to register with the SEC. A Municipal Advisor is a person that provides advice to or on behalf of a municipal entity or obligated person with respect to municipal financial products or the issuance of municipal securities, including advice with respect to the structure, timing, terms, and other similar matters concerning such financial products or issues; or undertakes a solicitation of a municipal entity or obligated person. Providing advice is generally construed as recommending a call to action with respect to a particular endeavor. Providing information of a factual nature or providing general information that is widely disseminated for use by the public does not constitute providing advice. There are context-specific exemptions applicable to underwriters, public officials and employees, and other professionals. Any person operating under an exemption must take care not to operate outside of the intended scope of the exemption (e.g. City Attorney offering non-legal financial advice). D. MCDC Initiative 1. Participation. On March 10, 2014 the SEC announced its Municipalities Continuing Disclosure Initiative (the MCDC Initiative ). The MCDC Initiative allowed issuers and underwriters of municipal securities to self-report any materially inaccurate statements or omissions about prior continuing disclosure in the offering documents (the Official Statements ) for such municipal securities over the past five years. Whether a statement or omission is materially inaccurate depends on the underlying facts and circumstances. The SEC has not provided any guidance with respect to evaluating materiality for the purposes of the MCDC Initiative. The reporting deadline for underwriters was September 10, 2014. The reporting deadline for issuers was originally also September 10, 2014, but was subsequently pushed back to December 1, 2014. The SEC will not assess monetary penalties against participating municipal issuers. The MCDC Initiative did not extend to individuals. For municipal issuers, participation in the MCDC Initiative involved agreeing to standard settlement terms, including the following: the issuer will establish policies and procedures and training regarding continuing disclosure obligations of the issuer; the issuer will correct any past continuing disclosure delinquent filings and will comply with those continuing disclosure undertakings in the future; the issuer will cooperate with the SEC in any subsequent investigation by the Enforcement Division, including the roles of individuals and other parties involved; the issuer will disclose the cease-and-desist order in a clear and conspicuous fashion in each municipal bond offering document for the next five years; and the issuer will provide the SEC with a compliance certification with respect to the above matters on the first anniversary of the settlement. 2. Results to Date. To date, the SEC has announced MCDC settlement agreements against 72 underwriters with amounts ranging from $20,000 up to the maximum $500,000; none of the releases indicate the specific issuers of municipal securities that caused such underwriters to be sanctioned by the SEC. Additionally, the SEC announced actions taken against 71 issuers 14