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Item 12 - Provide Water Infrastructure Improvement Prog. Update and Adopt a Reso Auth. Reimb. of Certain Water CIP ExpendituresJune 1, 2021, Item #12DATE: TO: FROM: CONTACT: SUBJECT: Summary: AG EN DA REPORT City of Poway June 1, 2021 Honorable Mayor and Members of the City Council Aaron Beanan, Director of Finance~ Aaron Beanan, Director of Finance 858-668-4411 or abeanan@poway.org Shadi Sarni, Principal Civil Engineer 858-668-4717 or ssami@poway.org CITY COUNCIL Provide Water Infrastructure Improvement Program Update and Adopt a Resolution Authorizing Reimbursement of Certain Water Capital Improvement Expenditures from the Proceeds of Future Indebtedness This report will provide an update on the Water Infrastructure Improvement Program ("Water Program"), current planning and design level cost estimates, and the benefits of adopting a resolution authorizing reimbursement of certain water capital improvement expenditures from the proceeds of future indebtedness ("Reimbursement Resolution") for these projects. Recommended Action: It is recommended that the City Council adopt a resolution authorizing reimbursement of certain water capital improvement expenditures from the proceeds of future indebtedness. Discussion: As previously discussed at the City Council Meetings on March 18, 2020, June 16, 2020, October 20, 2020, November 17, 2020, and March 16, 2021, to improve the reliability, redundancy and resiliency of Poway's water system, the City is embarking on a significant capital improvement program (Water Program). The Water Program is comprised of the Clearwell Bypass, the Clearwell Replacement, and the San Diego County Water Authority (SDCWA) Treated Water Connection projects. In addition, these projects meet the objectives of the Settlement and Release Agreement between the City of Poway and the State Division of Drinking Water (DDW). The Clearwell Bypass Project is an enabling project for the Clearwell Replacement Project. It includes construction of a bypass system that consists of two temporary 1 .4-million-gallon storage tanks, pipelines, a pump station and a pressure reducing station. Once the bypass system is operational, the Clearwell can be taken offline for replacement. The Clearwell Replacement Project's scope consists of replacing the existing 10 million-gallon Clearwell with two new storage tanks built to industry standards. The SDCWA Treated Water Connection project 1 of7 June 1, 2021, Item #12provides the City of Poway with its first treated water connection, allowing for additional resiliency and flexibility in the water operations system. Project cost estimates are inherently filled with uncertainty. However, the uncertainty decreases as a project moves further into the project life cycle. For example, planning level cost estimates have a higher degree of uncertainty increasing risk the actual project expenditures will deviate from the cost estimate. Design level cost estimates, on the other hand, have a higher degree of certainty decreasing risk the actual project expenditures will deviate from the cost estimate. The Water Program is currently in various stages of the project life cycle. The Clearwell Bypass Project is currently being designed. The design level project cost estimate for this project is approximately $10 million. The Clearwell Replacement and the San Diego County Water Authority projects are currently being planned. The planning level project cost estimate for the Clearwell Replacement Project is approximately $32 million and for the SDCWA Treated Water Connection project is approximately $27 million. This information is summarized in the table below along with the estimated construction date. Project Construction Date Cost Estimate Level Cost Estimate Clearwell Bypass September 2021 Design Level $10,200,000 Clearwell Replacement March 2023 Planning Level 32,200,000 SDCWA Treated Water Connection May 2024 Planning Level 27,100,000 Total $69,500,000 Additionally, staff held a town hall meeting on May 10, 2021 to provide an overview of the upcoming projects and why these projects are critical to ensure a safe and reliable water supply. Over thirty people attended the town hall format that included a question and answer session with staff. Project Financing As discussed in the November 17, 2020 staff report, there are several approaches to financing these projects. For example, they can be financed using a pay-go approach (using cash on hand and yearly rate increases to provide the necessary cash flow) or debt. As staff had indicated in that staff report, comparing cash on hand to the estimated cost of the projects helps determine which funding option may be most appropriate. When cash on hand exceeds the estimated cost of the proposed project, there is a strong argument for pay-go financing. When the estimated cost of the proposed capital projects exceed cash on hand, there is a strong argument for debt financing. Current cost estimates for the Water Program are $69.5 million, which exceed the current cash on hand, or the approximately $11 million on hand in the Water Operations Fund as of June 30, 2020. Another factor to consider when specifically looking at capital projects financed by water rate payers is how pay-go financing impacts the annual water rates. Water rates could be increased over the next three to five years to finance the program. However, based on the estimated cost of the Water Program the annual increases to rate payers would be so large that it would be financially unfeasible for many rate payers. This would create an undue burden on rate payers and impact the sustainability of the water enterprise. Based on the potential cost of the Water Program and the impact to rate payers under a pay-go approach, debt financing is a reasonable solution. Debt financing provides the cash upfront to construct the projects while spreading the repayments out over a longer time horizon. This helps 2 of7 June 1, 2021, Item #12create intergenerational equity by aligning the Water Program costs to the people who benefit from the projects. When debt is issued, current rate payers would not be responsible for fully funding projects today that will have a useful life beyond 30 years. Reimbursement Resolution The Water Program is a multi-year program with cash flow needs that are projected to span four to five years. Issuing debt now for the full estimated cost of $69.SM would be inappropriate for several reasons. The timing and cost estimates for the later phases of the program (e.g. Clearwell Replacement) will likely change as discussed above. This could result in under or over issuing debt. It also increases the near-term burden on ratepayers earlier than the project timing would require. Further, investors would be unlikely to support a debt issuance for a project that is still years from being constructed. Most importantly, it would fail to meet certain requirements allowing the debt issuance to be tax exempt. Given the number of projects and time horizon for construction it is appropriate to align debt financing with the cash flow needs of the program for a couple reasons. Having the flexibility to issue debt when cash flow dictates (typically around when construction is anticipated to begin) and when the debt sale can be optimized to market conditions helps ensure ratepayer impacts are minimized (e.g. they are not paying for debt earlier than necessary). Issuing tax-exempt bonds instead of taxable bonds also provide a benefit to rate payers because they are issued at a lower interest rate than taxable bonds. All else being equal, this provides a lower cost of debt which translates to a lower impact to rate payers. The Internal Revenue Service ("IRS") requires that bond proceeds from a debt issuance can only be used to pay for capital improvement expenditures expended not more than 60 days prior to the issuance of bonds in order for the bonds to qualify as tax exempt. While this requirement was put in place to limit the potential for abuse, it also limits the flexibility in timing a debt issuance and could drive up costs for rate payers. Through Code of Federal Regulations (CFR) Title 26 Section 1.150-2 et seq. the IRS has provided agencies issuing tax exempt debt a tool to help maintain the benefits associated being able to time a debt issuance. To maintain the bonds tax-exempt status and allow capital improvement expenditures to occur outside of the 60-day window, the IRS allows an agency to pass a Reimbursement Resolution prior to that 60-day window. To help minimize the potential for abuse while still allowing agencies flexibility in their debt issuances, the Reimbursement Resolution requires certain items to demonstrate good faith. For example, two requirements supporting this are that the resolution must contain a general description of the projects as well as the maximum principal amount of debt expected to be issued for such purposes. Timing of bond sales would be optimized to provide flexibility to issue based on cash flow needs and market conditions helping lower costs to rate payers. Preserving the tax-exempt status of the debt issuance also save rate payers money. As such, staff recommends Council adopt a Reimbursement Resolution to afford the City flexibility to time debt issuances and preserve the debts' tax-exempt status under IRS regulations. IMPORTANT This recommendation does not obligate the Council to issue debt and does not authorize the issuance of debt. By law, Council must approve the issuance of debt. Staff will return to Council for their consideration of any debt issuances related to the Water Program. 3 of7 June 1, 2021, Item #12Environmental Review: This action is not subject to review under the California Environmental Quality Act (CEQA). Fiscal Impact: There is no direct fiscal impact associated with adopting the Reimbursement Resolution. It provides the City with the legal mechanism to ensure capital expenditures related to the Water Program can be recuperated in the event the City chooses to issue debt to finance these projects. Staff will return to Council soon with a recommended approach to finance the Water Program. Public Notification: None. Attachments: A. Resolution ofThe City Council ofThe City of Poway Regarding Its Intention to Issue Tax-Exempt Obligations for Its Water System Reviewed/ Approved By: We,nd Kaserman Assistant City Manager 4of7 Reviewed By: Alan Fenstermacher City Attorney Approved By: City Manager June 1, 2021, Item #12RESOLUTION NO. 21-A RESOLUTION OF THE CITY COUNCIL OF THE CITY OF POWAY CALIFORNIA REGARDING ITS INTENTION TO ISSUE TAX-EXEMPT OBLIGATIONS FOR ITS WATER SYSTEM WHEREAS, the City of Poway (the "City") proposes to undertake the financing of the acquisition and construction of certain improvements, betterments, renovations and expansions of facilities within its water system (as described in Exhibit A, collectively, the "Project"); WHEREAS, the City intends to finance the acquisition, construction and installation of the Project or portions of the Project with the proceeds of the sale of obligations the interest upon which is excluded from gross income for federal income tax purposes (the "Obligations"); and WHEREAS, the City desires to pay certain costs with respect to the Project prior to the issuance of the Obligations from available moneys of the City and to reimburse itself for such costs from a portion of the proceeds of the sale of the Obligations. NOW, THEREFORE, BE IT RESOLVED by the City Council of the City of Poway as follows: SECTION 1: The City Council of the City of Poway (the "City Council") hereby specifically finds and declares that each of the statements, findings and determinations of the City that are set forth in the above recitals are true and correct. SECTION 2: The City reasonably expects, and hereby states its intention, to reimburse itself for Project costs incurred prior to the issuance of the Obligations with proceeds of the Obligations. Exhibit A describes either the general character, type, purpose, and function of the Project or the fund or account from which Project costs are to be paid and the general functional purpose of the fund or account. SECTION 3: The reasonably expected maximum principal amount of the Obligations that is anticipated to be used for such reimbursement is $69,500,000. SECTION 4: Except as described in Section 8 below, this resolution is being adopted not later than 60 days after the payment of the original expenditures (the "Expenditures Date or Dates"). SECTION 5: Except as described in Section 8 below, the expected date of issue of the Obligations will be within 18 months of the later of: (a) the Expenditure Date or Dates; or (b) the date that the Project is placed in service; provided that the reimbursement may not be made more than three years after the Expenditure Date or Dates. SECTION 6: Proceeds of the Obligations to be used to reimburse the City for Project costs are not expected to be used, within one year of reimbursement, directly or indirectly to pay debt service with respect to any obligation ( other than to pay current debt service coming due within the next succeeding one year period on any tax-exempt obligation of the City (other than the Obligations)) or to be held as a reasonably required reserve or replacement fund 5 of7 ATTACHMENT A June 1, 2021, Item #12with respect to an obligation of the City or any entity related in any manner to the City, or to reimburse any expenditure that was originally paid with the proceeds of any obligation, or to replace funds that are or will be used in such manner. SECTION 7: This resolution is consistent with the budgetary and financial circumstances of the City as of the date hereof. No moneys from sources other than the Obligations are, or are reasonably expected to be, reserved, allocated on a long-term basis or otherwise set aside by the City (or any related party) pursuant to their budget or financial policies with respect to the Project costs. To the best of our knowledge, this City Council is not aware of the previous adoption of official intents by the City that have been made as a matter of course for the purpose of reimbursing expenditures and for which tax exempt obligations have not been issued. SECTION 8: The limitations described in Sections 4 and 5 above do not apply to: (a) costs of issuance of the Obligations; (b) an amount not in excess of the lesser of $100,000 or five percent (5%) of the proceeds of the Obligations; or ( c) any preliminary expenditures, such as architectural, engineering, surveying, soil testing, and similar costs other than land acquisition, site preparation, and similar costs incident to commencement of construction, not in excess of twenty percent (20%) of the aggregate issue price of the Obligations that finances the Project for which the preliminary expenditures were incurred. SECTION 9: This resolution is adopted as official action of the City in order to comply with Treasury Regulation § 1.150-2 and any other regulations of the Internal Revenue Service relating to the qualification for reimbursement of City expenditures incurred prior to the date of issue of the Obligations, is part of the City's official proceedings, and will be available for inspection by the general public at the main administrative office of the City. SECTION 10: This resolution shall take effect immediately. PASSED, ADOPTED AND APPROVED at a Regular Meeting of the City Council of the City of Poway, California on the 1st day of June, 2021 by the following vote, to wit: AYES: NOES: ABSENT: DISQUALIFIED: Steve Vaus, Mayor ATTEST: Vaida Pavolas, CMC, City Clerk 6 of7 June 1, 2021, Item #12EXHIBIT A DESCRIPTION OF PROJECT • Clearwell Bypass Project • Clearwell Replacement Project • San Diego County Water Authority Treated Water Connection Project • Pipelines that provide redundancy and operational flexibility 7 of7