HomeMy WebLinkAbout09 10 12 City Council work session - fiber network and bonding issuesCity of Prior Lake, Minnesota
Economic Development Authority
Fiber Optic Network Financing Options
Background
In June 2012, the City of Prior Lake’s Economic Development Authority received the Broadband Advisory Committee
Fiber Optic Network Feasibility Study prepared by Look out Point Communication. The report considered the
economic impacts and qualitative benefits of advanced fiber optic networks in Prior Lake. Several options for access
and operation of the Fiber-to-the Premise were explored and the Broadband Advisory Board recommended an Open
Access – Hybrid Concept Model.
The Open Access - Hybrid Model is described as a blend between City-controlled services and private enterprise
offering services. The concept is that the City would provi de directly or through a management contract, triple play
services (phone, TV and Internet access). All other services would be provided by the private sector. The report cites
73 potential services and 12 business sectors.
The $28 million capital costs required to provide Fiber-to-the Premise would be financed by the City. Revenues from
services and leases by the private sector would be used to repay capital costs.
Springsted was asked to provide information to the committee about how the capital costs could be financed, the
process and how the financing would be repaid. The scope is outlined below.
Scope of Report
The Scope of our review includes determining the financial viability of financing an Open Access –Hybrid Concept
Model as described in the Fiber Optic Feasibility Study pr epared by Lookout Point Communications. We are using
the capital costs presented in the report to determine the bond size and the revenue streams presented in the report
to repay the bonds. We will identify the types of debt that may be issued, determine how much debt may be
supported from the revenue streams, discuss the process fo r each type of bond, the timing and risk/reward of each.
Further, we will share the experiences of other communitie s, in particular some in Minnesota, that provides
perspective as the City considers the next steps.
Stating what is not in our scope of services is as impor tant as noting what is. The revenue streams projected by
Lookout Point Communications have not been verified or tested. We are simply relying on them for debt projection
purposes. The items included as capital outlay have not been reviewed; we are using the capital cost provided by
Lookout Point Communications. We have not been asked to verify any data in the Lookout Point Communications
report. Our role is to identify the financing tools available assuming the financial data in the Fiber Optic Feasibility
Study prepared by Lookout Point Communications is reasonable.
Capital Costs to be Financed
Total capital, plant and equipment to be financed is $28,128,892. This is shown on page 65 of the Fiber Optic
Feasibility Study prepared by Lookout Point Communic ations. Costs that may be financed include:
Capital, plant and equipment
Capitalized interest (this is interest due annually until the 4 year, when interest can be funded from
th
operations)
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Debt servic e reserve
EBITDA (earnings before income tax, depreciation, and amortization)- start up operational costs may be
capitalized during the construction period and funded from bond proceeds
Issuance costs
We have taken all of these items into account for each issue type when preparing debt schedules. This will be further
discussed in the Financing Options Section.
Timing
While the timing is up to the City of Prior Lake and its EDA, we made certain assumptions in developing financing
schedules based on input from Eric Lampland of Lookout Point Communications. The timing is subject to change and
depends on the financing option selected among other variables.
There could be about $400,000 to $800,000 of costs that would be incurred for engineering, design, legal and
financial refinement work as early as late 2012 but more lik ely early 2013. This City woul d need to either cash flow
that initial cost with internal funds or issue a temporary note to finance the initial costs. Temporary notes allow a
municipality to manage startup costs without paying interest (i t accrues). The full accrued in terest plus principal must
be paid in full within 3 years of issuance of the temporary note.
It is anticipated that the full financing would be undertaken in September of 2013. The revenue model starts to collect
revenue about six months after the bonds are sold. Revenues increase as more subscribers are added each month.
The debt schedules are structured so the revenues collected are used to pay the following year’s debt service.
The long-term financing includes an amount sufficient to reimburse the City for the $400,000 to $800,000 internal
loan balance or to pay off any temporary notes. It should be noted that if the project doesn’t proceed after this work
is completed, and bonds are not issued to repay this note with revenues from broadband, the City will need to repay
it from other sources.
Financing Options
This section discusses several possible alternatives for fi nancing bonds and cites the statutory authority for each. At
the end of this section, there is a discussion of taxable ve rsus tax exempt bonds and how that affects rates. Finally
there is a table that summarizes the features of each bond.
Revenue Bonds - The City could issue revenue bonds under Minnesota Statute 475. The marketability of
revenue bonds will be based on the bond credit rating assigned, if any which is based on factors such as
history of revenues, market studies, analysis of future revenues, debt service coverage (number of times the
EBITDA can pay debt service), the debt service reserve, experience of the staff providing the service, the
desirability of the property or security pledged and th e business plan. The payments of principal and interest
on the bonds will be payable by the City solely from the net revenues of the Fiber to the Premises Project
after payment of the operation and maintenance costs. No other revenues of the City are obligated to make
the debt service of the bonds. The full faith and credit of the City’s tax base is NOT pledged nor shall a levy
of taxes be required if there is a shortfall. A default is unlikely to affect the City’s GO bond rating, unless
there are factors that indicate mismanagement or negligence.
Lease Revenue Bonds issued by the EDA Economic development authorities have a range of financing
powers, including lease revenue bonds. The EDA would issue lease revenue bonds to finance the
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improvements and lease the project back to the City. The City would then pledge an annual appropriation
for the lease payment equal to the amount needed to make the debt service payment. Each year that the
Fiber to the Premises net revenues are sufficient to pay the debt service, the annual levy would be
cancelled. If the City determines at any time upon learning that net revenues are insufficient to cover debt
service, that they will not annually appropriate, they must notify bondholders within the prescribed
timeframe. This is not a general obligation backed bond, but there is a commitment to appropriate each
year to cover debt service, if needed. A default will negatively affect the City’s bond rating.
General Obligation ( GO) Referendum Bonds Cities may issue referendum bonds if they conduct a
referendum following Minnesota Statutes Section 205.16 and if the referendum passes. The full faith and
credit of the City is pledged to the bonds.
The debt service would be repaid from the net revenues of the Fiber to the Premises Project after payment
of the operation and maintenance costs. Each year there are sufficient revenues, the levy is cancelled. In
any year that there are not sufficient project revenues, the City would be required to levy for the debt
service. This is a full faith and credit pledge by the City.
General Obligation Abatement Bonds Cities may use the abatement powers of sections 469.1813 to,
among other things, “finance or provide public infrastructure” or “increase or preserve tax base.” Although
the term “public infrastructure” is not defined, it has been defined in other contexts to include
telecommunications. The abatement bond would enable a city to provide either general obligation or a
limited obligation financing for the project. If abatement bonds are issued, the proceeds must be used to
“pay for public improvements that benefit the property,” to “acquire and convey land or other property” or to
“reimburse the property owner for the cost of improv ements made to the property.” Although abatements
have a term of no longer than 20 years, the various abat ement areas that benefit can be staggered so that a
25-year bond may be issued.
Abatement Bonds would be repaid from the net revenues of the Fiber to the Premises Project after payment
of the operation and maintenance costs. Each year there are sufficient revenues, the abatement levy is
cancelled. In any year that there are not sufficient project revenues, the City would be required to levy for
the debt service. This is a full faith and credit pledge by the City.
General Obligation (GO) Equipment Certificates
To the extent the items to be purchased qualify as eq uipment, that portion of the project could be financed
using Equipment Certificates. These certificates have a term limit of 10 years and are backed by the full faith
and credit of the City. Since not all of the costs are equipment, this option would need to be used in
conjunction with another bond type. The ease of use and lowest interest rate may be helpful to the City
when financing the project in full.
Based on our review, we believe the most appropriate bonds to consider are Revenue Bonds, Lease
Revenue Bonds and General Obligation Bonds. We have structured bonds for each of these three options
assuming the revenue streams proposed in the Fiber Optic Feasibility Study prepared by Lookout Point
Communications.
The City has not made a determination of the business model they would use regarding who will operate the
system, how that management agreemen t will be structured and how the private usage agreements will be
set up, so we cannot determine whether it is more appropriate to assume the bonds will be tax-exempt or
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taxable. Generally, if the Fiber to the Premises proj ect is owned and operated by the City then it is tax-
exempt. As private partners take on larger roles or ar e benefitted in the fee arrangements to share in the
profits, the bonds could become taxable. Taxable bonds generally have a higher interest rate than tax-
exempt bonds and so if the City determines that tax- exempt bonds are appropriate, it will be important for
the City to consider the characteristics that will keep the bonds tax exempt.
Financial Viability of the Options
The table below provides a summary of the debt schedules we prepared for the Revenue, Lease Revenue and GO
Bond options discussed above assuming both taxable and ta x-exempt bonds. Equipment certificates are not included
in the table as they do not stand alone since the project is more than equipment.
Lease GO Lease
GO Bonds Revenue Revenue
Description Revenue Bonds Revenue
Tax-Exempt Tax-exempt Taxable
Tax-exempt Taxable Taxable
Bond issue size $29,850,000 $33,695,000 $35,040,000 $30,100,000 $34,710,000 $36,370,000
Term 25 years 25 years 25 years 25 years 25 years 25 years
Interest rate 3.57% 5.31% 5.56% 4.18% 6.49% 6.73%
Total interest $15,473,851 $27,240,710 $29,992,587 $18,652,877 $35,393,220 $38,745,319
Coverage 2.82 times 2.15 times 2.0 times 2. 65 times 1.90 ti mes 1.76 times
Coverage Desired
2.0 times 2.0 times 2.0 times 2.0 times 2.0 times 2.0 times
to Market
GO Pledge
Yes No, But No Yes No, But No
As the schedule illustrates the GO backed bonds are least costly and the revenue bond is most costly when
considering bond types. Springsted developed the 2 times coverage threshold as a target for marketable bonds
based on feedback from underwriters and experiences where the number of subscribers were less than anticipated
due to unforeseen factors. Using this benchmark, all tax-ex empt options result in coverage equal to or in excess of
the desired coverage. Only the GO taxable bonds exceed the desired minimum.
It should be noted that for revenue bonds, the desired minimum is coverage desired to market the bonds. While we
are using 2 times coverage, the market may allow less. The 2 times coverage assumes the interest rates shown, but
a lower coverage amount may be marketable, but likely at a higher interest rate than estimated above. For the lease
revenue and GO options, the same desired coverage as revenue bonds is used to provide the same protection to the
City that the bondholders in the revenue bond options have, and to minimize the likelihood of any levy if there is a
shortfall.
It should be noted that interest rates are based on today’s market rates plus 75 basis points for market movement.
We have no control over the market and the actual rate depends on the markets at the time of sale.
Risk Reward When C onsidering Bond Options
The reason for the range in interest rates is the difference in the perceived likelihood of repayments
GO bonds pledge the full faith and credit of the City. This provides the greatest assurance to the investor
that they will be repaid. The City must levy fo r any debt service not covered by the revenues.
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Lease Revenue bonds are annual appropriation bonds so there is an opportunity to levy should there be a
shortfall, which isn’t as strong as a GO pledge, but provides greater assurance of repayment.
Revenue bonds are repaid solely from revenues without any other option and provide the least assurance of
repayment.
Conversely, while the City would save interest by issuing the GO backed bonds, the City also is committing to repay
the bonds from taxes, if needed. The highest cost option, Re venue Bonds is also the lowest risk in terms of the ability
to default without requiring a tax levy. Lease Revenue Bonds also allow for a default, but the intention of the City to
levy may make it more difficult to default and a default would have a greater impact on the rating than Revenue
Bonds, where no levy is anticipated.
If the City wants the project and is willing to levy in order to keep it, then saving interest by using GO bonds is
appropriate. However, if the City is completing the proj ect without any intention of ever levying, then using the
Revenue Bond and paying higher interest costs may be worth it.
Process to Issue Bonds
Each issue type has a separate process and a comparison or summary is shown below:
Description GO Referendum GO Abatement EDA Lease Revenue Revenue
Desirable Desirable
Market Survey/Study Required Required
Desirable Desirable
In Depth Financial Required Required
Referendum for Bond Yes No No No
Referendum for
Maybe Maybe Maybe
Maybe
Telephone Switch
Public Hearing No Yes No No
EDA Approval No No Yes No
Yes Yes Yes
City Council Approval Yes
Bond Sale Method Competitive Competitive
Negotiated Negotiated
Timing for Study
3-6 months 3-6 months 3-6 months
3-6 months
Timing for Approvals
6-9 months 60 days 30 days 30 days
Timing for Sale
60 days 60 days 90 days 90 days
MN Municipality’s Experiences with Broadband efforts
During the presentation on Monday, September 10, Springst ed will share the experiences of a few communities who
have implemented, took steps towards or are working on Fiber to the Premises initiatives including:
The City of Monticello
The City of North St. Paul
Carver County/Cologne
Pipestone/Lyon/Rock Counties
Sibley/Renville Counties (several cities provide reserves
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Items to Consider
Our analysis indicates that the revenue streams proposed are sufficient to repay all tax-exempt bond options and a
GO taxable bond option. It’s important to note that we didn’t validate the assumptions and projections used. We
simply relied on the Broadband Advisory Committee Fiber Op tic Network Feasibility Study prepared by Lookout Point
Communications. We strongly encourage an independent market study and a process to assess the community’s
interest in becoming customers.
Other municipalities have found existing providers of telephone, internet and cable services to be formidable
opponents when they learn of the Fiber to the Premises Project and the potential competition from the City. These
municipalities did not anticipate a) the amount of money the existing providers would spend to fight the project b)
their ability to scare citizens with fabricated statements nor c) the price sl ashing they may do once the City’s system
is installed in an effort to force the project to fail. Lookout Point Communications has included funds for marketing
and to address the competition. While that is a step in the right direction, the political will to play in this arena and fully
understanding what this will me an for the City is important.
The City’s strengths are its ability to finance capital and leverage the infrastructure to incent development. However,
their weakness is knowledge of the Fiber to the Premise an d Triple play services. Fortunately, there are businesses
in the community who are very knowledgeable and they would make better partners than competitors. It may be
worthwhile to explore a public/private partnership to utilize the strengths of each to arrive at a better community
solution. Perhaps a franchise fee to reimburse the City for financing some or all of the infrastructure capital could be
considered while the private sector continues to provide the services through an agreement. Discounts to residents
and price concessions could also be part of the package.
There are other scenarios to consider, including phasing in the infrastructure and equipment purchases to align with
customer demand. This may help the City manage the amount of debt and risk. As the project continues to succeed
and hit certain thresholds, more bonds could be issued. The benefit of phasing may be impractical from an
implementation standpoint and it may cost more overall to phase it in, but this should be weighed against the benefit
of lower debt costs and reducing risk if the project isn’t successful.
We thank you for the opportunity to assist in analyzing this important community project and look forward to
discussing it further at the meeting on September 10.
Springsted Incorporated September 7, 2012
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