Santa Paula Council: The Albatross Decision

By Sheryl Hamlin

Referring to the wastewater plant, Council Member Crosswhite used the expression “albatross”, a metaphor for a burden one must bear because of a previous decision. She had used this description during a previous meeting and it is beginning to feel more accurate.

The September 9 Special City Council Meeting focused on refinancing the wastewater bonds. Anyone who has refinanced a loan knows that the shorter the time period, the less total interest one will pay, while the reverse is true. The consultant provided three scenarios: 1) refinance coterminus with the existing bonds, 2) extend the term five years and 3) extend the term ten years. Below is a summary of the options:

Source: NHA Presentation

Option 1 has the highest savings with the least interest paid ($41,429,000), while option 3 has the lowest savings and the highest interest paid ($65,259,000) over the life of the bonds. Option 2 is in the middle at $52,907,000. The total interest savings for each option as shown are $20,374,000 for Option 1, $8,582,000 for Option 2 and (-$3,860,000) for Option 3, a loss.

With a superior gross savings of $20 million, Option 1 provides a leaner balance sheet in the future with a shorter term of the new bonds with a date of 2050 versus 2055 (Option 2) and 2060 (Option 3).

Unanswered Questions

For each option, there was no calculation showing the Total Interest Paid per ratepayer over time. The latest rate study assumed a 2% buildout rate for East Area 1. There should have been a chronological chart showing a forecast number of ratepayers in each period and the cost per ratepayer, as the number of ratepayers increases.

The total amount of outstanding bonds to be refinanced is $74 million, but the new financing is $82 million. One consultant said this $8 million was a “premium”, which makes no sense because the new bonds are taxable with a lower interest rate, as compared to the new issue which is non-taxable with a higher interest rate. The other consultant said the excess was due to “negative arbitrage”, which was glossed over by the consultants. A negative arbitrage exists when a city is trying to refinance bonds which are not yet due, so monies must be placed in escrow to service the existing bonds throughout their term. How much of the new funds will the city lose to this escrow? How was this incorporated into the three scenarios? There were no charts explaining this part of the transaction flow. As a reminder, the City of Santa Paula borrowed $55 million in water bonds in 2010 but used half of the $55 million to defease the 2003 water bonds, so effectively lost half of the $55 million, which is why the full transaction must be detailed for the council.

The other issue was the cost of the $15 million Reverse Osmosis Project (RO), which can actually be more if a different option is chosen. The financing costs for $15 million at today’s rates are about $800,000 annually. Therefore if Option 1 is chosen, the annual average savings will not cover this annual financing of the $15 million, but the gross savings of over $20 million will cover the costs of a $15 million RO project. An analysis should be made as to how the $20 million savings over time can contribute to the capital and maintenance of the RO project.

Council Discussion

Cost savings for the plant such as new membranes, which will use less power, and variable frequency drivers for the blowers were discussed without quantifying the savings. Nor has there been a plan for commercialization of the RO permeate.

Council Member Sobel preferred Option 3, the most expensive option in the long term, while Mayor Araiza, Vice Mayor Juarez and Council Member Garman preferred Option 1 because in the long term this option costs the city less. Council Member Crosswhite said she understood the math, but felt that if the annual costs were considered the impact to the cash flow of the wastewater fund and its ratepayers would be less stressful in the other options, so suggested the middle option as a compromise.

The council voted for Option 2 and the consultants will rush to have the city’s bond rating updated. The council will revisit the item on September 16, 2020.

To watch the meeting, click here.

To read about the author, click sherylhamlin dot com

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