The City’s fiscal policies assist in ensuring its long-term fiscal stability. These policies are intended to provide direction so that the City’s finances are managed in a manner that will continue to provide for the delivery of quality services; maintain an enhanced service delivery; ensure a balanced budget; and establish reserves necessary to meet known and unknown future obligations.
Fiscal policies are included in the City’s budget, and are an essential component of long-term forecasts and contingency plans. We believe they will help provide critical analysis and sound review for budget development decisions.
Fiscal Policy Statements
- The City will maintain sound financial practices in accordance with all Federal, State and local laws and direct its financial resources towards meeting the City’s long-term goals.
- The City will maintain and further develop programs to assure its long-term ability to pay the costs necessary to provide the level and quality of service required by its citizens.
- The City of Santa Monica annually adopts a budget for the upcoming fiscal year. Through this budget, City Council establishes public policy by setting funding levels for departments and exercises control over City spending. The budget further serves as a financial planning tool to ensure that the inflow of resources (revenues) is adequate to meet both anticipated and unanticipated needs (expenditures).
The Biennial Budget
The City will follow a Biennial budget process, emphasizing long-range planning and effective program management. A biennial budget process allows staff to plan ahead, to take advantage of the efficiencies when not recreating the budget document each year to focus on strategic projects and capital budgeting, and has the added benefit of decreasing requested budget increases from one year to the next.
- The Biennial Budget will comply with the Charter of the City of Santa Monica, specifically Article XV—Fiscal Administration, which provides the framework for the preparation and adoption of an annual budget for each fiscal year. This includes:
- Fiscal Year definition — July 1 through June 30.
- Proposed budget preparation by the City Manager, in consultation with each department head.
- Proposed budget submission to City Council at least 35 days prior to the beginning of each fiscal year.- Budget adoption by City Council on or before June 30 following a public hearing where stakeholders are given an opportunity to comment on the proposed budget.
- Before the beginning of the second year of the two-year cycle, the Council will consider and approve the exception-based budget for the second year.
- The mid-year budget review analyzes the budget status at the mid-point of the year and provides an opportunity to adjust revenue projections and make expenditure appropriation changes.
- The year-end budget review makes budget transfers and additional appropriations, as necessary, to ensure that expenditures are within budget authority.
- Budget modifications may occur as necessary at any City Council meeting through staff report proposals that receive five affirmative votes from the members of the Council.
Operating Budget Policies
- The City will adopt a balanced budget annually by June 30.
- The City will make all current, ongoing expenditures with current, ongoing revenues, avoiding procedures that balance current budgets by postponing needed expenditures or accruing future revenues.
- The City will estimate revenues using an objective and analytical process; in the case of assumption uncertainty, conservative projections will be used.
- The City will maintain a level of expenditures that support essential services and promote quality-of-life to its citizens.
- The City will forecast its General Fund and other major fund expenditures and revenues for a five-year period and will update the forecast semi-annually. The forecast will be taken into consideration when preparing budget recommendations.
- The City will endeavor to maintain a diversified and stable revenue system to minimize the impact of short-term fluctuations in any one revenue source.
- The City will avoid targeting revenues for specific purposes whenever possible, allowing maximum flexibility in funding decisions on an annual basis.
- One-time revenues will be used for one-time expenditures only.
- The City will investigate potential new revenue sources, particularly those that will not add to the tax burden of residents and local businesses.
- The City will implement expenditure control budgeting. At the end of each fiscal year, the City will reappropriate one-third of each General Fund Department’s non-salary operating budget savings to each department, to be used as the Department Head decides to fulfill the mission of the department. The remaining two-thirds of the non-salary savings will be incorporated into the General Fund fund balance.
- Provided there are sufficient funds, the annual budget will include a minimum set-aside of $1 million in the General Fund, and commensurate set-aside amounts in all other funds, to be used towards payments to CalPERS. These payments will be in addition to the Annual Required Contribution and will serve to reduce the City’s unfunded retirement liability. If any additional funds are available, staff will also annually assess the set-aside of any additional funds for CalPERS payments against other unfunded needs, and present the City Council with a recommendation. This policy will remain in effect until such time as there is no remaining unfunded retirement liability.
- The City will prefund other post employment benefit obligations (OPEB) each year, setting aside the equivalent of the actuarially-determined annual required contribution (ARC) in an irrevocable trust.
- The biennial budget will establish measurable goals and objectives and allow reasonable time to accomplish those objectives.
- The City will work proactively with the League of California Cities and local communities to monitor and impact legislation that may impact the City financially.
Capital Improvement Program (CIP) Budget Policies
- The City will biennially plan for capital improvements for a five-year period. The CIP budget will incorporate Council priorities, community objectives, and projects that will improve operational efficiency. The CIP Biennial Budget will be presented to Council in the second year of the Operating Biennial Budget.
- Future operating costs associated with new capital improvements will be projected and included in the Operating Budget forecasts.
- An inventory of the City’s physical assets, their condition, and remaining useful life will be maintained.
- The City will maintain all assets at a sufficient level to protect the City’s capital investment and to minimize future maintenance and replacement costs.
The City Council is required to adopt an annual budget for all City departments and funds with the exception of the Rent Control Fund. The City Council also serves as the governing body for the Santa Monica Redevelopment Successor Agency, the Housing Authority, the Parking Authority, and the Public Financing Authority, which adopt budgets for the Redevelopment Successor Agency, the Housing Authority, the Parking Authority Funds, and Public Financing Authority Funds.
Adoption of the budget requires a majority Council vote (4 of 7 Council members).
The City Council approves any revisions that increase the total budgeted expenditures or revenues of any department and fund, and any changes to staffing levels, including budgeted permanent and as-needed full-time equivalent positions. The City Manager is authorized by the City Council to allocate the budget to more detailed levels of control for administrative purposes. This includes changes between major object or program categories (i.e., Salaries & Wages, Supplies & Expenses including Capital Outlay, or Capital Improvements) within a department. Budget changes to capital improvement program accounts that change or increase project scope must be approved by Council.
Changes to the budget due to emergency work, additional project costs exceeding the budget authority, or receipt of a grant, take place throughout the year through semi-monthly Council meetings. Citywide comprehensive budget review takes place twice a year.
To change the budget after it is adopted requires a supermajority Council vote (5 of 7 Council members).
Essential to the development of Santa Monica’s annual budget is feedback from individuals and organizations regarding issues or programs that they believe need to be addressed with additional resources. Input from the community is received through various channels, including City Council meetings, the City website, the Government Outreach system, through the various forums presented by City boards, commissions and community groups. Additional opportunity for public comments occurs in June with the formal public hearing on the proposed budget.
Basis of Budgeting
Basis of budgeting for the City’s budget is consistent with the Comprehensive Annual Financial Report (CAFR) with a few exceptions, primarily in non-cash adjustments.
Governmental funds, including general, special revenue, and capital project funds, are budgeted on a modified accrual basis with a focus on near-term inflows and outflows of financial resources. Revenues are recognized when they are measurable and available, while expenditures are recognized as soon as liabilities are incurred, except for debt service, capital lease obligations, inventories, and prepaid items. Year-end encumbrances are included in the fiscal year’s expenditures (actual, budgetary basis), as they represent financial resources committed for goods or services to be delivered in the near future (usually within one or two months). However, many multi-year capital projects are budgeted on a full cost basis. Year-end remaining capital budgets for active projects are continued to the next fiscal year until the completion of the project.
Proprietary funds, including enterprise and internal service funds, are budgeted on an accrual basis similar to private-sector businesses, with a focus on total economic resources. Revenues are recognized when they are earned, while expenses are recognized when the liability is incurred. Year-end encumbrances are excluded from the fiscal year’s expenses, for the transactions have not yet occurred. However, non-cash items, such as investment adjustments to market value, depreciation, amortization and bad debt expense are not budgeted. Just as with the governmental funds, multi-year capital projects are often budgeted on a full cost basis and the year-end active project budgets are continued to the next year until the completion of the project.
The Council will annually adopt a resolution establishing the City's appropriations limit (the Gann Limit) calculated in accordance with Article XIII-B of the Constitution of the State of California, Section 7900 et seq. of the State of California Government Code, and any other voter approved amendments or state legislation that affect the City's appropriations limit. Under the Gann Limit, a maximum amount is established for tax-funded government services. That amount is to be adjusted each year depending on state population, changes in non-residential assessed value, and the transfer of financial responsibility for various governmental activities from one level of government to another. Any significant amount of state tax revenue received above that Gann Limit is to lead to future tax rebates or tax cuts.
The supporting documentation used in calculating the City's appropriations limit and projected appropriations subject to the limit will be available for public and Council review at least 10 days before Council consideration of a resolution to adopt an appropriations limit. The Council will generally consider this resolution in connection with final approval of the budget.
The City will maintain at the end of each fiscal year a General Fund Operating Contingency at a level that is equal to at least 15% of the following year’s General Fund annual operating and capital expenditure budget and subsidies to other funds covered by ongoing revenues as originally adopted by Council. Council approval will be required before expending funds from the Operating Contingency.
In addition to the General Fund Contingency, the City’s goal is to maintain an Economic Uncertainty balance operating with the level to be established as needed.
The City will maintain a balance in the General Fund for earned vacation benefits of General Fund employees. Compensated absences for all General Fund employees are recorded in the respective funds.
The City will maintain a capital contingency fund balance to be determined as part of the annual budget adoption. The capital contingency balance is to be made available by Council appropriation to meet unanticipated, unscheduled, and/or unprogrammed capital and maintenance needs of City infrastructure and facilities. This balance is intended to be used for major capital repair where facility failure, unexpected hazards, or destruction of City property has occurred and where repair or replacement is not planned within the established capital, operations, or other replacement funds.
Equipment Replacement Funds
The City will maintain a Fleet Replacement Fund to provide for the timely replacement of vehicles and related equipment. The City will maintain a minimum fund balance in the Fleet Replacement Fund of at least 15% of the original purchase cost of the items accounted for in this fund. The annual contribution to this fund will generally be based on the annual use allowance, which is determined based on the estimated life of the vehicle or equipment and its original purchase cost. Interest earnings and sales of surplus equipment as well as any related damage and insurance recoveries will be credited to the Fleet Replacement Fund.
The City will maintain a Computer Equipment Replacement Fund to provide for the timely replacement of information hardware technology. The annual contribution to this fund will generally be based on the annual use allowance, which is determined based on the estimated life of the equipment and its original purchase cost. The City will maintain a minimum fund balance in the Computer Equipment Replacement Program of at least 25% of the original purchase costs of the items accounted for in this fund.
Water, Wastewater, and Resource Recovery and Recycling Funds
The City will maintain reserves for the purposes of offsetting unanticipated fluctuations in Water Fund or Wastewater Fund revenues to provide financial stability, including the stability of revenues and the rates and charges related to each Enterprise. The reserves are based on the following:
- An operating reserve equivalent to 50% of the MWD purchases (3 year running average) budget, with a minimum level of $3 million.
- A capital reserve of 50% of annual capital program expenditure, with a minimum level of $3 million.
- A rate stabilization reserve of $1 million.
- An operating reserve equivalent to 50% of the Hyperion treatment expenses (3 year running average) budget, with a minimum level of $3 million.
- A capital reserve of 50% of annual capital program expenditures except Hyperion Capital Payment, with a minimum of $3 million.
- A rate stabilization reserve of $1 million.
Resource Recovery and Recycling Fund
- An operating reserve equivalent to 5% of total annual expenditures.
Fund Balance Classifications
The City’s fund balance is made of the following components, or classifications:
- Non-spendable fund balance typically includes inventories, prepaid items and other items, that by definition cannot be appropriated.
- The restricted fund balance category includes amounts that can be used only for the specific purposes stipulated by constitution, external resource providers, or through enabling legislations.
- The committed fund balance classification includes amounts that can be used only for the specific purposes determined by a formal action of the City Council. The City Council has authority to establish, modify, or rescind a fund balance commitment.
- Amounts in the assigned fund balance classification are intended to be used by the City for specific purposes but do not meet the criteria to be classified as restricted or committed. The City Manager or designee has the authority to establish, modify or rescind a fund balance assignment.
- Unassigned fund balance is the residual classification for the City’s funds and includes all spendable amounts not contained in the other classifications.
The City considers restricted or unrestricted amounts to have been spent when an expenditure is incurred for purposes for which both restricted and unrestricted fund balance is available.
The City’s committed, assigned, or unassigned amounts are considered to have been spent when an expenditure is incurred for purposes for which amounts in any of those unrestricted fund balance classification could be used.
Interfund Transfers and Loans
To achieve important public policy goals, the City has established various special revenue, capital project, debt service and enterprise funds to account for revenues whose use should be restricted to certain activities. Accordingly, each fund exists as a separate financing entity from other funds, with its own revenue sources, expenditures and fund equity.
Any transfers between funds for operating purposes are clearly set forth in the Biennial Budget. From time to time, interfund borrowing may be appropriate; however, this is subject to the following criteria in ensuring that the fiduciary purpose for that fund is met: The Council must approve temporary interfund loans, while the Director of Finance and the City Manager are authorized to negotiate and approve terms and conditions of those loans.
Indirect Cost Allocation for General Fund Services
Proprietary and special revenue fund programs, which are financed by service user fees or grant funding, are assessed administrative costs to reflect the true costs of doing business through the City’s indirect cost allocation plan. This plan provides a reimbursement to the General Fund for central services costs such as custodial services, personnel services, financial services, facilities maintenance, legal services, and administrative time, which is directly applicable to enterprise and special revenue fund operations. Data used in determining cost allocation is gathered from the last audited annual financials. Cost allocation plan updates will occur, at a minimum, every five years. During years between updates, a factor reflecting a blended expenditure increase will be added to the existing amount.
User Fee Cost Recovery Goals
City policy is to charge for the full costs of services provided by City Staff when such services benefit individual users rather than members of the community as a whole. The City has calculated the cost of providing various recreational services and opportunities to individuals and has discounted those costs to ensure that individuals will be able to utilize these services and opportunities. Fees will be reviewed and updated on an ongoing basis to ensure that they keep pace with cost of living and service delivery changes. A comprehensive analysis of City costs and fees should be made at least every five years. In the interim, fees will be increased annually by a factor based on the annual increase in total compensation costs, unless otherwise stated for specific fees. Fees may also be adjusted during this interim period based on supplemental analysis whenever there have been significant changes in the method, level or cost of service delivery. When setting user fees and cost recovery levels, the following economic and policy considerations may be considered:
Enterprise Fund Rates
Water, Wastewater, Resource Recovery & Recycling
The City will set rates at levels that fully cover the total direct and indirect costs, including operations and maintenance, capital outlay, and debt service of the Water, Wastewater, and Resource Recovery and Recycling programs.
The City will set rates at levels that are needed to cover the costs to operate and maintain parking operations and structures, taking into account market conditions and City policies to encourage use of alternate transportation methods.
Big Blue Bus
Based on targets set under the Transportation Development Act, the City will strive to cover at least twenty percent of transit operating costs with fare revenues.
The City will prepare annual financial statements as follows:
- In accordance with Charter requirements, the City will contract for an annual audit by a qualified independent certified public accountant. The City will strive for an unqualified auditors’ opinion.
- A Comprehensive Annual Financial Report will be prepared and audited by a qualified independent public accounting firm.
- The City will issue audited financial statements within 180 days after fiscal year end.
- The City’s accounting and financial reporting systems will be maintained in conformance with generally accepted accounting principles and standards of the Government Accounting Standards Board, and reports will strive to meet the requirements of the GFOA’s Award for Excellence in Financing Reporting program.
The City will prepare and issue timely interim reports on the City’s fiscal status to the Council and staff. This includes:
- Online access to the City’s financial management system by City staff
- Monthly online reports for City staff use
- Midyear and year end reviews to Council and staff
An investment policy will be submitted annually to the City Council for review and adoption.
The City will invest public funds in a manner that will provide a market rate of return after ensuring optimum safety and meeting the daily cash flow demands of the City.
The City of Santa Monica (City) maintains conservative financial policies to assure strong financial health both in the short- and long-term. The City issues debt primarily to finance large capital investments such as construction of public infrastructure or property acquisitions.
Maintaining the City’s bond rating is an important objective of the City’s financial policies. To this end, the City is constantly working to improve its financial policies, budgets, forecasts, and financial health.
Purpose of Policy
This policy sets forth the criteria for issuance and repayment of debt. The primary objective of the Debt Policy is to establish criteria that will protect the City’s financial integrity while providing a funding mechanism to meet the City’s capital needs. The underlying approach of the City is to borrow only for capital improvements that cannot be funded on a pay-as-you-go basis. The City will not issue long-term debt to finance current operations.
All debt issued will be in compliance with this policy, the debt limit noted in Article VI of the City Charter and with all other relevant state and federal regulations.
A biennial review of the Debt Policy will be performed and any changes to the Debt Policy will be brought forward for City Council consideration and approval. Further, in the event there are any recommended deviations or exceptions from the Debt Policy when a certain bond issue is structured, those exceptions will be discussed in the staff reports when the bond issue is presented for City Council’s consideration.
Authority to issue debt is given by the City Council, exercising the powers reserved to the City under Section 6 of Article XI of the Constitution of the State of California and Section 400 of the City Charter of the City of Santa Monica. The Treasurer and designated staff, including the Assistant City Treasurer, assist in the duties of debt issuance, interest payments, principal repayments and other debt-related activities.
The Finance Director is responsible for assuring that the activities related to the issuance and payment of bonds or other obligations will not jeopardize the bond rating.
Purpose of Financing
The City borrows money primarily to fund long-term capital improvement projects and to refinance existing debt. The issuance of debt to fund operating deficits is not permitted.
While the preferred means of financing projects is the “pay-as- you-go” method of using current revenues to pay for capital projects because it avoids interest payments, the City would be able to undertake capital projects under this method only if sufficient cash accumulates. Prudent use of debt financing rather than pay-as- you-go funding of capital projects can distribute the cost of a project over its useful life, facilitate better allocation of resources and increase financial flexibility. Debt can also be used in conjunction with pay-as-you-go financing to pay only a portion of the project using debt if insufficient funds are available from non-debt sources.
The Treasurer, working with the Assistant Treasurer, will periodically evaluate the City’s existing debt and execute, upon approval of the City Council, refinancings when economically beneficial. A refinancing includes the issuance of bonds to refund existing bonds.
See “Bond Refunding” for refunding considerations.
Budgeting and Capital Planning
The City shall develop and maintain a Five-Year capital planning process that includes a Biennial Capital Improvement Program budget that is approved and adopted by the City Council as part of the budget process. The capital plan is informed by the City’s Five-Year forecasting process.
The decision to utilize debt to fund all or a portion of a capital project first requires an analysis by the Finance Department of how the debt will be repaid. The source of revenues to repay the debt must be identified and the impact of repayment of the debt on existing budget commitments must be assessed.
The Finance Department is responsible for coordinating and analyzing the debt requirements. This will include timing of debt, calculation of outstanding debt, debt limitation calculations and compliance, impact on future debt burdens, and current revenue requirements.
Generally, no debt will be issued for periods exceeding the useful life or average useful lives of projects to be financed.
Types of Debt
The following is a description of the types of long-term debt the City may issue:
General Obligation Bonds
General Obligation (GO) bonds are secured by a pledge of full faith and credit of an issuer and a promise to levy taxes in an unlimited amount as necessary to pay debt service. GO bonds usually achieve lower rates of interest than other financing instruments since they are considered to be a lower risk.
California State Constitution, Article 16 - Public Finance, Section 18, requires that the issuance of a GO bond by the City must be approved by a two-thirds majority of those voting on the bond proposition. Uses of bond proceeds are limited to the acquisition and improvement of real property.
Lease financings are long-term obligations that include Lease Revenue Bonds and Certificates of Participation. Lease Revenue Bonds (LRBs) are lease obligations secured by an installment sale or by a lease-back arrangement between the City and the City’s Public Financing Authority, a joint powers authority, where City revenues are pledged to pay the lease payments, which are, in turn, used to pay debt service on the LRBs. Alternatively, Certificates of Participation (COPs) are lease obligations secured by a financing lease between the lessee, which would be the City, and a lessor, which may be the City’s Public Financing Authority, that undertakes the construction of a project. These obligations do not constitute indebtedness under the state constitutional debt limitation and, therefore, are not subject to voter approval.
Payments to be made under valid leases are payable only in the year in which use and occupancy of the leased property is available, and lease payments may not be accelerated. Lease financing requires the fair market rental value of the leased property to be equal to or greater than the required debt service or lease payment schedule. The governmental lessee is obligated to place in its Annual Budget the rental payments that are due and payable during each fiscal year the lessee has use of the leased property.
Revenue bonds are obligations payable from revenues generated by an enterprise as defined in Section 54300 et seq of the California Government Code. City issuance of revenue bonds is specifically authorized by Chapter 2.36 of the City’s Municipal Code. Since the debt service is directly paid by the enterprise, such debt is considered self-liquidating and generally is not considered as part of the maximum debt capacity of the issuer.
The City’s utility Revenue Bonds are payable solely from the appropriate City Enterprise Fund and are not secured by any pledge of ad valorem taxes or general fund revenues of the City. In accordance with the agreed upon bond covenants, the revenues generated by these Enterprise Funds must be sufficient to maintain required coverage levels, or the customer rates of the enterprise have to be raised to maintain the coverages. The issuance of revenue bonds does not require voter approval.
Under certain circumstances, it may be advantageous to obtain financing through a direct bank loan. Bank loans can be in the form of fixed rate or variable rate loans with defined maturities or lines of credit that have variable interest rates and flexible payment provisions. One potential advantage of bank loans is that the process for execution is generally simpler and can be less expensive to issue than a public bond issue. Additionally, a bank loan can often be structured in a manner that more closely conforms to specific project or repayment considerations than a bond issue. However, since bank loans are issued in an environment less transparent than a public debt issue, it is more difficult to assess how the proposed loan rates, fees, and terms compare to the market. The City Treasurer will consult with the City’s Financial Advisor to determine the when a bank loan is the appropriate financing measure.
Assessment District Financing
The Municipal Improvement Act of 1913 provides for a local agency to form an Assessment District to finance certain infrastructure, including roadways, water and sewer facilities, storm drains, and other improvements often required in connection with new development. An Assessment District must include all properties that will benefit directly from the improvements to be constructed, and formation of the district requires an election in which at least 50% of property owners vote in favor of the district. If an Assessment District is formed, the City may levy assessments that can be utilized to directly finance the public improvements, or may be pledged to support debt service on bonds, which may be issued under the Improvement Bond Act of 1915. The assessments that are levied upon each parcel must be based upon the direct and special benefit received by the property.
Limitations of Indebtedness
The City’s indebtedness is limited by Article VI of the City Charter, which states that the bonded indebtedness of the City may not exceed the sum of ten (10%) percent of the total assessed valuation of property within the City, exclusive of any indebtedness that has been or may hereafter be incurred for the purpose of acquiring or establishing a system of waterworks for the supplying of water, or for the purpose of constructing sewers or drains in the City, for which purposes a further indebtedness may be incurred by the issuance of bonds, subject only to the provisions of the State Constitution and of this Charter. The City will include all lease obligations when calculating its compliance under this debt limit even though they may not constitute bonded indebtedness.
General Obligation Debt
The decision on whether or not to assume new general obligation debt shall be based on costs and benefits, current conditions of the municipal bond market, and the City’s ability to afford new debt and service it as determined by an objective analytical approach. This process shall compare generally accepted measures of affordability to the current values for the City. These measures shall include:
- Debt per capita: the outstanding principal as a percentage of population.
- Debt as a percent of assessed valuation: outstanding principal as a percentage of assessed valuation.
General Fund-Supported Debt
The most important affordability ratio used in analyzing the City’s debt position with respect to General Fund supported debt (e.g., lease obligations) is the Annual General Fund debt service/lease payment (e.g., payment on lease revenue bonds) as a percentage of available revenue or expenditures. This ratio, which pertains to only general fund backed debt, is often referred to as “lease burden.” This analysis excludes enterprise revenue bonds and other obligations supported by dedicated revenue pledges. Additionally, this analysis may exclude other General Fund liabilities such as loan obligations or the City’s annually required contribution to the pension system or retiree health care costs. Liabilities of the City’s related agencies are also excluded from the debt affordability ratios.
Credit rating agency guidelines recommend a lease burden ratio of no more than 12%; the City shall strive to maintain its lease burden ratio below 10%. Affordability analysis as determined by this measure will be undertaken before new General-Fund supported debt is issued.
In addition to the City’s direct debt burden, debt levels of underlying and overlapping entities such as counties, school districts, and special districts add to a City’s overall debt burden. The City’s proportional share of the debt of other local governmental units, which either overlap it or underlie it is called the overlapping debt. Overlapping debt is generally apportioned based upon relative assessed value. While the City does not control debt issuance by other entities, it recognizes that its taxpayers share the overall debt burden. The City shall include a statement of overlapping debt in its initial and continuing disclosure.
In determining the affordability of proposed revenue bonds, the City will perform an analysis comparing projected annual net revenues (after payment of operating and maintenance expense) to estimated annual debt service. Generally, legal covenants requiring a minimum coverage ratio are set forth in the bond documents, and are based on the level of security provided to the bondholders. The City’s revenue bonds require a legal coverage ratio of at least 120% for senior bonds and a coverage ratio of at least 100% for senior and subordinate debt combined. Credit rating agencies point to a target coverage ratio of 200% for programs with large ongoing capital needs and 150% for programs without such needs, using historical and/or projected net revenues to cover annual debt service for bonds issued on a subordinate basis which have a 100% legal coverage ratio requirement. The City will require a rate increase to cover both operations and debt service costs, and create debt service reserve funds to maintain the required coverage ratios.
Structure of Debt
Term of Debt
Debt will be structured consistent with a fair allocation of costs to current and future beneficiaries or users. Borrowings by the City should be of a duration that does not exceed the useful life of the improvement that it finances and where feasible, should be shorter than the projected economic life. The standard term of long-term borrowing is typically 15-30 years.
The City shall pay all interest and repay all debt in accordance with the terms of the bond ordinance and bond covenants. To the extent possible, the City will seek level or declining debt service repayment schedules.
When appropriate, the City may choose to issue securities that pay a rate of interest that varies according to a pre-determined formula or results from a periodic remarketing of the securities. Due to the potential volatility of such instruments, the City will limit the use of variable-rate debt to the greater of $50 million or 20% of outstanding principal.
The City will not use derivatives when structuring debt.
Where appropriate, interest may be capitalized for the construction period of a revenue-producing project so that debt service expense does not begin until the project is expected to be operational and producing revenues.
In addition, for lease back arrangements, such as those used for lease revenue bond transactions, interest may be capitalized for the construction period, until the asset is operational. Only under extraordinary circumstances will interest be capitalized for a period longer than the construction period. Capitalized interest is sometimes referred to as “funded interest.”
Call Options/Redemption Provisions
A call option, or optional redemption provision, gives the City the right to prepay or retire debt prior to its stated maturity. This option may permit the City to achieve interest savings in the future through refunding, or in some cases, full or partial redemption of the bonds. Generally, fixed rate tax-exempt municipal bonds are structured with a 10-year call at par (no premium). Because the cost of call options can vary widely, depending largely on market conditions, an evaluation of factors such as the following will be conducted in connection with each issuance:
- The time until the bonds may be called
- The price at which the bonds may be called
- The potential to generate future interest cost savings (or call option value)
- Any need for additional flexibility with respect to repayment
Method of Sale
The City will generally issue its debt through a competitive process but may use a negotiated process under the following conditions.
- The bond issue is, or contains, a refinancing that is dependent on market/interest rate timing.
- At the time of issuance, the interest rate environment or economic factors that affect the bond issue are volatile.
- The nature of the debt is unique and requires particular skills from the underwriter(s) involved.
- The debt issued is bound by a compressed time line due to extenuating circumstances such that time is of the essence and a competitive process cannot be accomplished.
When determined appropriate by the City Treasurer, the City will negotiate financing terms with banks and financial institutions for specific borrowings on a private offering basis. Typically, private placements are carried out by the City when extraneous circumstances preclude public offerings, such as an interim financing, or to avoid the costs of a public offering for smaller issuances.
The City Treasurer will consult with the City’s Financial Advisor on an issue by issue basis to determine the appropriate method of sale to be used.
The City’s Finance Department shall be responsible for the solicitation and selection of professional services that are required to administer the City’s debt program, which will follow the City’s Procurement Policy. The City Attorney’s Office will take the lead to solicit and select bond counsel. The financial advisor, bond and disclosure counsel, and trustee costs associated with the bond issuance will be paid with bond proceeds. Eligible City staff costs related to issuance of long term bonds may also be reimbursed from bond proceeds.
A Financial Advisor(s) will be used to assist in the issuance of the City’s debt. The Financial Advisor will provide the City with objective advice and analysis on debt issuance. This includes, but is not limited to, monitoring market opportunities, structuring and pricing debt, and preparing official statements of disclosure.
The City Attorney’s Office will take the lead in selecting and contracting with the Bond Counsel and Disclosure Counsel. All debt issued by the City will include a written opinion by bond counsel affirming that the City is authorized to issue the proposed debt. The opinion shall include confirmation that the City has met all City and state constitutional and statutory requirements necessary for issuance, a determination of the proposed debt’s federal income tax status and any other components necessary for the proposed debt. Bond counsel is also responsible for preparing all financing documents including Trust Indentures and Bond resolutions and assists in preparation of Official Statements. Disclosure Counsel shall be required to deliver a customary 10(b)-5 opinion on City offering documents. The Disclosure Counsel will work with City staff to draft all disclosure documents for a bond financing. The City Attorney’s Office may engage separate firms in the capacity of Bond and Disclosure Counsel or one single firm to perform bond and disclosure counsel functions.
An Underwriter(s) will be used for all debt issued in a negotiated or private placement sale method. The Underwriter is responsible for purchasing negotiated or private placement debt and reselling the debt to investors.
Trustee/ Fiscal Agent
A Fiscal Agent will be used to provide accurate and timely securities processing and timely payment to bondholders. If there are unspent bond proceeds, funds will be held by a third part trustee.
The City will maintain good communication with bond rating agencies about its financial condition. This effort will include providing periodic updates on the City’s general financial condition, coordinating meetings, and presentations in conjunction with a new issuance. The City will continually strive to maintain its bond rating by improving financial policies, budgets, forecasts and the financial health of the City.
Credit enhancements may be used to improve or establish a credit rating on a City debt obligation. Credit enhancements should only be used if cost effective.
A debt refunding is a refinance of debt typically done to take advantage of lower interest rates.
A current refunding is one in which the refunding bonds are issued no more than 90 days before the date upon which the refunded bonds will be redeemed.
An advance refunding is one in which the refunding bonds are issued more than 90 days prior to the date upon which the refunded bonds will be redeemed. Advance refundings are used to refinance outstanding debt before the date the outstanding debt becomes due or callable. Internal Revenue Code §149(d)(3) provides that governmental bonds issued after 1985 may only be advanced refunded once over the life of a bond issuance.
Unless otherwise justified, such as a desire to remove or change a bond covenant, a debt refunding will require a minimum present value savings of 3%. This savings requirement for a refunding may be waived by the City Treasurer upon a finding that such a refunding is in the City’s overall best financial interest.
Debt Service Reserve Fund/Surety Policy
In instances where there is no market or credit rating agency requirement to fund a debt service reserve, or where there is an economic cost associated with borrowing to fund a reserve fund, the City will attempt to avoid their use. If a debt service reserve funded by bond proceeds is determined to be necessary or in the City’s best interest, the debt service reserve fund will be held by and available to the Trustee to make principal and interest payments to bondholders in the event that pledged revenues are insufficient to do so. The maximum size of the reserve fund is generally governed by tax law, which permits the lesser of: 1) 10% of par; 2) 125% of average annual debt service and 3) 100% of maximum annual debt service. Reserve funds are typically equal to approximately one year’s maximum debt service on the bonds. On a case-by-case basis, assuming there is no economic or credit disadvantage, the City may issue bonds with a debt service reserve fund that is sized at a lower level.
The reserve fund requirement may also be satisfied by a surety policy, a form of insurance provided by a bond insurer to satisfy a reserve fund requirement for a bond issuance. Under this arrangement, instead of depositing cash in a reserve fund, the issuer buys a surety policy by paying a one-time premium equal to a percentage of the face amount of the policy. The City may use a surety policy instead of a debt service reserve fund when economically feasible.
The City will not rely on any uncollateralized credit instruments for any reserve requirement unless justified by significant financial advantage.
Arbitrage Rebate Monitoring and Reporting
The City will, unless otherwise justified, use bond proceeds within the established time frame pursuant to the bond ordinance, contract or other documents to avoid arbitrage rebate. Arbitrage is the interest earned on the investment of the bond proceeds at a rate above the interest rate paid on the debt. If arbitrage occurs, the City may be required to pay the amount of the arbitrage to the Federal Government as required by Internal Revenue Service Regulation 1.148-11. The City will maintain a system of recordkeeping and reporting to meet the arbitrage rebate compliance requirement of the IRS regulation. For each bond issue not used within the established time frame, the recordkeeping shall include tracking investment earnings on bond proceeds, calculating rebate payments, and remitting any rebateable earnings to the federal government in a timely manner in order to preserve the tax-exempt status of the outstanding debt.
The City will comply with all covenants stated in the bond ordinance, contract, etc.
The City will meet secondary disclosure requirements in a timely and comprehensive manner, as stipulated by the SEC Rule 15c2-12. The City Treasurer shall be responsible for providing ongoing disclosure information to the Municipal Securities Rulemaking Board’s (MSRB’s) Electronic Municipal Market Access (EMMA) system, the central depository designated by the SEC for ongoing disclosures by municipal issuers. The City Treasurer is responsible for maintaining compliance with disclosure standards promulgated by state and national regulatory bodies, including the Government Accounting Standards Board (GASB), the National Federation of Municipal Analysts, the Securities and Exchange Commission (SEC), and Generally Accepted Accounting Principles (GAAP). The City may also employ the services of firms that improve the availability of or supplement the City’s EMMA filings.
Investment of Bond Proceeds
The proceeds of the bond sales will be invested until used for the intended project in order to maximize utilization of the public funds. The investments will be made to obtain the highest level of safety. The City of Santa Monica Investment Policy and the bond indentures govern objectives and criteria for investment of bond proceeds. The City Treasurer and Assistant City Treasurer, or the bond trustees under the direction of the City Treasurer or Assistant City Treasurer, will invest the bond proceeds in a manner to avoid, if possible, and minimize any potential negative arbitrage over the life of the bond issuance, while complying with arbitrage and tax provisions.
In certain cases, particularly for bond reserve funds, it may be fiscally prudent to invest funds using a forward delivery agreement or some other type of guaranteed investment contract. Such agreements should be obtained under a competitive bid process under consultation with the Financial Advisor.
State and Local Government Securities (SLGS) are the preferred investment option rather than open market securities for escrows for refunded bonds to allow for better matching of settlement dates and fewer arbitrage regulation compliance issues.