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  Item # 2.       
Meeting Date: 11/06/2019  
Submitted By: Kevin Artz, Finance
Department: Finance  

SUBJECT:
PRESENTATION, DISCUSSION AND POSSIBLE DIRECTION TO STAFF REGARDING IMPLEMENTATION OF THE TOWN COUNCIL'S OCTOBER 2, 2019, DECISION REGARDING THE TOWN'S COMMUNITY CENTER AND GOLF OPERATIONS
RECOMMENDATION:
Staff’s recommendation to finance necessary capital improvements for the golf course and community center is to blend the options that have been presented within the background section of this Council Communication.  The recommendation incurs the lowest capital and operating costs and allows the improvements to be constructed in a timely manner.  Staff recommends the following plan:
  1. Intra-fund loan for $1.9M this fiscal year to fund irrigation and other improvements for 18-holes on the Conquistador golf course.  Construction would be planned to occur from May-October 2020.  General Fund would be paid back over three fiscal years from Community Center Fund surplus, which will minimize escalation of construction costs, maximize water savings and eliminate the need to issue bonds for the golf course improvements.
  2. Tax-exempt bond financing of up to $3.2M (includes 6% escalation cost on contract) in early FY 2020/21 for the community center improvements.  Design could begin this fiscal year with construction planned for Fiscal Year 2020/21, which will minimize escalation of construction costs. Financing the community center exclusively will qualify for tax-exempt bonds with lower costs.  Total financing costs on $3.2M for 10 years totals $360,000.
  3. PAYG financing from the Community Center Fund for $2.1M (includes 9% escalation cost on contract) to fund irrigation and other improvements for the second 18-hole course (Cañada course).  Construction would occur from May-October 2021 (FY 21/22), which will minimize escalation of construction costs, maximize water savings and eliminate the need to issue bonds for the golf course.
  4. Establish a minimum fund balance policy for the Community Center Fund in the amount of $500,000, which will provide capacity for the Town to make other improvements starting FY 2022/23, such as resurfacing and reconfiguring the parking lot, and also preserve funds for unforeseen financial issues.
  5. If the performance of the Community Center Fund does not meet forecast sufficient to fund the plan, the above financing recommendation could be adjusted as follows, depending on the extent to which the forecast is not met:
    1. The repayment of the intra-fund loan could be extended to 10 years or $190,000 annually.
    2. The bond repayment would be fixed at $356,000 per year.
    3. The PAYG improvements for the second 18-holes could be deferred one year (or until funds in the Community Center Fund are available).
EXECUTIVE SUMMARY:
This report serves as a response to the October 2, 2019 action by Council for staff to review and provide an analysis and recommendation on financing options for the capital investments needed for the Town’s community center and 36 holes of golf.

In addition to the financing option information contained in this communication, at the November 4 meeting, staff will present Council with a general implementation schedule of the Council’s decision regarding the continuation of the 36 holes of golf and related issues, specifically identifying key decision points that will need to be made in order to progress in a timely manner.  A follow-up special meeting and discussion has been scheduled for Wednesday, November 20 at 6:00 p.m. in the Town Council Chambers for a continuation of the discussion, to include obtaining the Town Council’s input on the Request for Proposal procurement vehicle that will be required to solicit proposals for the operation of the 36 holes, one of the conditions included in the October 2 Council-approved motion.
 
BACKGROUND OR DETAILED INFORMATION:
On October 2, 2019, the Town Council directed staff to bring options and recommendations to finance the necessary capital improvements for the Town to implement the Council’s decision of continuing 36 holes of golf and making improvements to the community center building.  Staff has analyzed several options that include: pay-as-you-go financing, intra-fund loans, Municipal bonds, and a combination of the options.

Assumptions

In order to provide a comparable cost analysis and recommendation, staff has used a set of assumptions when comparing the different options.  The assumptions used are not intended to create strict parameters for the scoping of the project.  For example, a total project budget of $6.8M has been used in the assumptions for the financing options; however, in the future, a detailed project scope will be required to determine an appropriate project construction budget and will likely differ from the $6.8M used for these assumptions.  Final project costs will require future Council action. 

The following assumptions have been used for this analysis:
  • Project budget of $6.8M, which comprises $3.8M for the golf course improvements and $2.6M (adjusted to $3.0M for inflation attributed to vertical construction) for the community center improvements.  The $2.6 million represents the prior Council’s conclusion to improve the building as recommended by staff ($2.25M), with the addition of an estimated $350,000 to also address the reconstruction of the front entry way to eliminate stairs to the ground level, eliminate the portico, and expand parking availability.  The estimates for the community center improvements are 18 months old; therefore, staff adjusted the cost estimates by 12% and used a $3.0M budget for this analysis.
  • Staff spoke with a construction estimator for a large contractor in the Tucson area, and they have experienced an annual 6% increase in construction cost over the past several years. They are also anticipating the trend to continue in the near-term.  Therefore, staff utilized a construction cost price index increase of 6% for the current year, 6% for fiscal year 20/21 and then 3% annually thereafter. 
  • Taxable bond terms – staff structured the financing as taxable bonds with a 10-year callable term and a 2.67% interest rate.  Taxable bonds were utilized in the analysis, which increases the financing costs by 70 basis points (.7%) because additional analysis needs to be performed to determine if tax-exempt financing for the golf course would meet the requirements of private-use tests.  If tax-exempt financing is an option, the interest rate would drop to 1.97% (in today’s market).
  • Fund balance projections – the community center fund balance projections were estimated utilizing the 10-year pro formas, including additional revenue from the day-play policy change and the HOA contributions.
  • Water savings – staff has previously estimated that improvements to the 30+ year-old irrigation system would result in approximately 15%, or $105,000 of savings in water costs.  Cash flow projections for the investment options were modified to reflect the realization of those savings following the capital investments.
Options
 
Pay-as-you-go
Pay-as-you-go (PAYG) is the practice of funding new projects with cash saved from current or prior appropriations, with the expectation to utilize those savings to pay for the capital project. 

Staff has evaluated the Community Center Fund and forecasted contracted revenues, dedicated sales tax revenues and contracted expenditures to determine a projected timeline for accumulating sufficient funds.  The accumulated savings would then be utilized to construct the golf course and community center improvements.  The attached table (Attachment A) provides those projections.
 
As indicated in Attachment A, staff forecasts that the Community Center Fund could accumulate $6.7M of fund balance (savings) by the end of Fiscal Year 2023/24.  If the entire costs of the improvements are funded with PAYG, the capital improvements could start in three years ($2.9M in FY 22/23) and the balance in five years ($3.9M in FY 2024/25).  This also assumes that there would be no other capital expenditures that are paid from the fund balance during this period (i.e., tennis court repairs, building repairs, etc.).  It is likely that a portion of the final improvements will need to be included in year six (FY 2025/26).

As staff indicated in the assumptions, construction costs have increased by 6% in each of the past two years and are expected to continue that trend in the near future.  If construction costs escalate at 6% the first year, and 3% per year for FY 21/22 to FY 24/25, the estimated project budget of $6.8M is forecasted to increase to $7.76M (assuming $2.9 contract in FY 22/23 and $3.9 contract in FY 24/25), or an increase of $960,000, during that period.

In addition, staff and the Town's management company, Troon, have previously estimated that the leaking irrigation system is causing an estimated 15% increase in water usage for the golf courses.  The increase in water usage translates into approximately $105,000 of additional cost per year from the pro formas presented during the option evaluation process.  If the irrigation system improvements for the golf courses are funded PAYG in FY 24/25, the fund would incur an additional $525,000 of water costs.  Staff also projects if the irrigation improvements are funded PAYG, Variation B of the 10-year forecast, which Council approved October 2, 2019, would need to be adjusted to increase the utility budget until the capital improvements are completed.

PAYG financing for the golf courses and community center is projected to increase costs by $1.5M due to escalating construction costs and increased water costs.  PAYG would delay the start of the improvements for three to five years.  
 
Intra-Fund Loans
An intra-fund loan is an internal borrowing from a fund that has excess fund balance available, in this case, the General Fund.  The internal borrowing could be established with or without an interest component. 

At June 30, 2019, the General Fund is estimated to have a fund balance of $19.7M, with an unassigned fund balance of approximately $6.5M (total fund balance less 25% contingency reserve and fund balance allocated in the FY 19/20 budget).  A portion of the General Fund unassigned fund balance could be loaned to the Community Center Fund for golf course or community center improvements.  The General Fund does not have adequate capacity to fund the entire $6.8M of estimated improvements.

If an intra-fund loan is utilized, there may be other necessary capital improvements (i.e., park or street projects) that are delayed or postponed until the loan can be repaid, although with a remaining $4M+ unassigned fund balance, there is still strong capacity to fund expected capital projects for next fiscal year.  However, golf course and community center needs could potentially be prioritized over other Town capital needs.

The benefits of the intra-fund loan are that the projects can begin sooner, thereby, reducing a significant portion of the inflationary and water costs from PAYG financing.  An intra-fund loan would also reduce or eliminate the financing and closing cost of municipal bonds.

Municipal Bonds
A municipal bond is a debt instrument issued by a city or town to finance capital improvements.  A bond is similar to an individual’s mortgage, in that there is an interest rate, and a repayment schedule with principal and interest. 

Municipal bonds can be tax-exempt or taxable.  Tax-exempt bonds afford the Town a lower borrowing cost or interest rate than taxable bonds.  In order to qualify for tax-exempt bonds, the projects financed by the bonds have to serve a governmental purpose.  If the projects financed benefit a private individual or corporation, or if the payment of the obligation is received from a private firm that benefits from the project, the bonds are generally taxable and have a higher borrowing cost to the Town.

Staff has not discussed the potential structure of the bonds (specifically bonds for improvements of the golf course) with the Town’s bond attorney to determine if they will qualify for tax-exempt status, given the use of a commercial operator for the golf course.  Bonds for community center improvements do qualify for tax-exempt status.  Therefore, staff is presenting interest rates for both tax-exempt and taxable bonds for this analysis.
 
Tax-exempt Bonds $6.8M Principal
Amortization Assumed rate Avg. annual debt service Total debt service
5-year 2.00% $1,443,000 $7,215,000
10-year 1.97% $756,000 $7,560,000
15-year 2.00% $529,000 $7,935,000
 
Taxable Bonds $6.8M Principal
Amortization Assumed rate Avg. annual debt service Total debt service
5-year 2.67% $1,471,000 $7,335,000
10-year 2.67% $784,000 $7,840,000
15-year 2.74% $559,000 $8,385,000
 
A key consideration when issuing debt is ongoing revenue capacity to pay the annual debt service.  The Community Center Fund is projected to have a surplus of approximately $1.2M (contracted revenues and dedicated sales tax less contracted expenditures, capital outlay, transfers out and debt service) in FY 20/21.

Per the table above, the Community Center Fund is not projected to have surplus capacity to issue bonds with a 5-year term (while maintaining a minimum fund balance).  The fund does have capacity to issue 10-year or 15-year bonds.  If the Town were to issue 10-year term taxable bonds, the financing cost would total $1,040,000.  The bonds could be issued with a pre-pay feature, which would allow the Town to pay off the bonds early to reduce the financing costs, should there be additional surpluses allowing to pay additional payments.  In addition, bond issuance costs are estimated to be $70,000 for a total cost to finance of approximately $1,110,000.

The benefit of issuing bonds is the projects can begin sooner, reducing a significant portion of the inflationary and water costs from PAYG financing.  Bonds do incur financing cost which are higher than PAYG or intra-fund loans.

Summary
In summary, each of the options has benefits and challenges, and below is a recap of each option.

PAYG
  • Escalation of construction cost over 3-5 years                      $960,000
  • Water Costs                                                                           $525,000
  • Project construction starts                                                     3-5 years
  • Environmental impacts of leaking irrigation
Intra-fund Loans
  • Inadequate capacity to fund entire $6.8M project
  • Other needs in the Town may have to be delayed (opportunity costs)
  • Lowest potential financial cost of options
  • Project construction begins sooner

Municipal Bonds
  • Financing costs (Tax exempt-Taxable)                    $760,000-$1,040,000
  • Closing costs                                                                               $70,000
  • Project construction begins sooner
Recommendation
Staff’s recommendation to finance necessary capital improvements for the golf course and community center is to blend the options that have been presented.  The recommendation incurs the lowest capital and operating costs and allows the improvements to be constructed in a timely manner.  Staff recommends the following plan:
  1. Intra-fund loan for $1.9M this fiscal year to fund irrigation and other improvements for 18-holes on the Conquistador golf course.  Construction would be planned to occur from May-October 2020.  General Fund would be paid back over three fiscal years from Community Center Fund surplus, which will minimize escalation of construction costs, maximize water savings and eliminate the need to issue bonds for the golf course improvements.
  2. Tax-exempt bond financing of $3.2M (includes 6% escalation cost on contract) in early FY 2020/21 for the community center improvements.  Design could begin this fiscal year with construction planned for Fiscal Year 2020/21, which will minimize escalation of construction costs. Financing the community center exclusively will qualify for tax-exempt bonds with lower costs.  Total financing costs on $3.2M for 10 years totals $360,000.
  3. PAYG financing from the Community Center Fund for $2.1M (includes 9% escalation cost on contract) to fund irrigation and other improvements for the second 18-hole course (Cañada course).  Construction would occur from May-October 2021 (FY 21/22), which will minimize escalation of construction costs, maximize water savings and eliminate the need to issue bonds for the golf course.
  4. Establish a minimum fund balance policy for the Community Center Fund in the amount of $500,000, which will provide capacity for the Town to make other improvements starting FY 2022/23, such as resurfacing and reconfiguring the parking lot, and also preserve funds for unforeseen financial issues.
  5. If the performance of the Community Center Fund does not meet forecast sufficient to fund the plan, the above financing recommendation could be adjusted as follows, depending on the extent to which the forecast is not met:
    1. The repayment of the intra-fund loan could be extended to 10 years or $190,000 annually.
    2. The bond repayment would be fixed at $356,000 per year.
    3. The PAYG improvements for the second 18-holes could be deferred one year (or until funds in the Community Center Fund are available).
The following table displays the financing costs for $3.2M of tax-exempt bonds for the community center:
Amortization Assumed rate Avg. annual debt Total debt service
5-year 2.00% $679,000 $3,395,000
10-year 1.97% $356,000 $3,560,000
15-year 2.00% $249,000 $3,735,000
 
The impacts of staff’s recommendation (general fund loan repayment, PAYG financing and annual debt service) to the community center fund are presented in Attachment B of this communication.
 
FISCAL IMPACT:
The potential fiscal impacts are detailed within the background or detailed information section of this Council Communication.
SUGGESTED MOTION:
I MOVE to...
Attachments
Attachment A - CC fund balance
Attachment B - fund balance


    

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