Redevelopment Agency of the City of San José Merged Area Redevelopment Project Housing Set-Aside Tax Allocation Bonds $10,445,000 $119,275,000

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1 NEW ISSUE FULL BOOK-ENTRY RATINGS: Moody s: Aaa (A2 underlying) Standard & Poor s: AAA (A underlying) Fitch: AAA (A underlying) (See BOND INSURANCE and RATINGS ) In the opinion of Nixon Peabody LLP, Bond Counsel, under existing law and assuming compliance with the tax covenants described herein and the accuracy of certain representations and certifications made by the Agency and described herein, interest on the Series 2005A Bonds is excluded from gross income for federal income tax purposes under Section 103 of the Internal Revenue Code of 1986, as amended (the Code ). Bond Counsel is further of the opinion that interest on the Series 2005A Bonds is not treated as a preference item in calculating the alternative minimum tax imposed under the Code with respect to individuals and corporations, but such interest is included in the adjusted current earnings of certain corporations for purposes of computing the alternative minimum tax imposed on such corporations. NO ATTEMPT HAS BEEN MADE OR WILL BE MADE TO COMPLY WITH CERTAIN REQUIREMENTS RELATING TO THE EXCLUSION FROM GROSS INCOME FOR FEDERAL INCOME TAX PURPOSES OF INTEREST ON THE SERIES 2005B TAXABLE REFUNDING BONDS, AND INTEREST ON SAID BONDS WILL BE SUBJECT TO ALL APPLICABLE FEDERAL TAXATION. Bond Counsel is further of the opinion that under existing law interest on the Series 2005A Bonds and on the Series 2005B Bonds is exempt from California personal income taxes. See TAX MATTERS regarding certain other tax considerations. Redevelopment Agency of the City of San José Merged Area Redevelopment Project Housing Set-Aside Tax Allocation Bonds $10,445,000 $119,275,000 Tax-Exempt Refunding Tax Allocation Bonds Taxable Refunding Tax Allocation Bonds Series 2005A Series 2005B Dated: Date of Delivery Due: August 1, as shown on inside cover This cover page contains certain information for general reference only. It is not intended to be a summary of the security or terms of this issue. Potential investors are advised to read the entire Official Statement to obtain information essential to the making of an informed investment decision. Capitalized terms used on this cover page not otherwise defined shall have the meanings set forth herein. The Redevelopment Agency of the City of San José (the Agency ) is issuing its Merged Area Redevelopment Project Housing Set-Aside Tax-Exempt Refunding Tax Allocation Bonds, Series 2005A (the Series 2005A Bonds ) and its Merged Area Redevelopment Project Housing Set-Aside Taxable Refunding Tax Allocation Bonds, Series 2005B (the Series 2005B Bonds, and together with the Series 2005A Bonds, the Bonds ), for the purpose of refinancing certain outstanding obligations of the Agency (the Refunded Bonds ) and repaying certain amounts outstanding under a line of credit (the Line of Credit ) maintained by the Agency with The Bank of New York. See PLAN OF FINANCING. Interest on the Bonds is payable on February 1, 2006, and semi-annually thereafter on each February 1 and August 1. The Bonds will be issued in denominations of $5,000 or integral multiples thereof. The Bonds, when delivered, will be issued in fully registered form without coupons in the name of Cede & Co., as nominee of The Depository Trust Company ( DTC ), New York, New York. DTC will act as securities depository for the Bonds as described in APPENDIX G DTC AND BOOK-ENTRY ONLY SYSTEM ; no physical distribution of the Bonds will be made to the public under this arrangement. The Bonds are special obligations of the Agency and are payable solely from and secured by a pledge of Housing Set-Aside Amounts, which consist of Tax Increment Revenues required to be deposited into the Low and Moderate Income Housing Fund pursuant to the Redevelopment Law, as further discussed herein. The Agency has previously issued seven series of Merged Area Redevelopment Project Housing Set-Aside Tax Allocation Bonds. Upon the issuance of the Bonds and the refunding of the Refunded Bonds, five series of Senior Bonds (as defined herein and which include the Bonds) in the aggregate principal amount of $212,525,000 will be outstanding. The outstanding Senior Bonds are equally and ratably secured by the pledge and lien of Housing Set-Aside Amounts under the Fiscal Agent Agreement, dated as of February 1, 1993, between the Agency and Wells Fargo Bank, National Association, as successor fiscal agent, as supplemented and amended (as further described herein, the Agreement ). Simultaneously with the issuance of the Bonds, the Agency intends to issue two series of Merged Area Redevelopment Project Subordinate Housing Set-Aside Tax Allocation Variable Rate Demand Bonds in the combined approximate aggregate principal amount of $66,150,000, which will be secured by the Housing Set-Aside Amounts on a basis subordinate to the payment of debt service on the Senior Bonds. The Bonds are subject to optional and mandatory sinking fund redemption prior to maturity, in whole or in part, as described herein. See THE BONDS Redemption Provisions. The scheduled payment of principal of and interest on the Series 2005A Bonds and the Series 2005B Bonds, respectively, when due will be guaranteed by two separate municipal bond insurance policies to be issued concurrently with the delivery of the Bonds by Financial Guaranty Insurance Company. THE BONDS ARE SPECIAL OBLIGATIONS OF THE AGENCY SECURED BY AN IRREVOCABLE PLEDGE OF, AND PAYABLE AS TO PRINCIPAL, PREMIUM, IF ANY, AND INTEREST SOLELY FROM HOUSING SET-ASIDE AMOUNTS DESCRIBED HEREIN AND OTHER FUNDS HELD UNDER THE AGREEMENT. ALL OF THE BONDS ARE EQUALLY SECURED BY A PLEDGE OF AND CHARGE AND LIEN UPON, ALL OF THE HOUSING SET-ASIDE AMOUNTS, AND THE HOUSING SET-ASIDE AMOUNTS CONSTITUTE A TRUST FUND FOR THE SECURITY AND PAYMENT OF THE INTEREST ON, THE PRINCIPAL OF AND PREMIUM, IF ANY, OF THE BONDS AND ANY OTHER PARITY OBLIGATIONS (AS DEFINED HEREIN) ISSUED BY THE AGENCY IN ACCORDANCE WITH THE AGREEMENT. THE PRINCIPAL AMOUNT OF THE BONDS, THE INTEREST THEREON AND ANY PREMIUMS PAYABLE UPON THE REDEMPTION OR PURCHASE THEREOF, IS NOT A DEBT OF THE CITY OF SAN JOSE (THE CITY ), THE STATE OF CALIFORNIA (THE STATE ) OR ANY OF ITS POLITICAL SUBDIVISIONS OTHER THAN THE AGENCY, AND NEITHER THE CITY, THE STATE NOR ANY OF ITS POLITICAL SUBDIVISIONS OTHER THAN THE AGENCY IS LIABLE THEREON, NOR IN ANY EVENT SHALL THE PRINCIPAL OF, PREMIUM, IF ANY, OR INTEREST ON THE BONDS BE PAYABLE OUT OF ANY FUNDS OR PROPERTIES OTHER THAN THE HOUSING SET-ASIDE AMOUNTS OF THE AGENCY AS SET FORTH IN THE AGREEMENT. THE BONDS DO NOT CONSTITUTE AN INDEBTEDNESS WITHIN THE MEANING OF ANY CONSTITUTIONAL OR STATUTORY DEBT LIMITATION OR RESTRICTION. NEITHER THE MEMBERS OF THE AGENCY NOR ANY PERSONS EXECUTING THE BONDS ARE LIABLE PERSONALLY ON THE BONDS BY REASON OF THEIR ISSUANCE. MATURITY SCHEDULE ON INSIDE FRONT COVER The Bonds are delivered when, as and if issued, subject to the approval of validity by Nixon Peabody LLP, Bond Counsel, and certain other conditions. Certain legal matters will be passed upon for the Agency by its General Counsel and by Nixon Peabody LLP, as Disclosure Counsel, for the City by the City Attorney, and for the Underwriters by their counsel, Hawkins Delafield & Wood LLP. It is anticipated that the Bonds will be available for delivery through DTC on or about June 30, Citigroup BANC OF AMERICA SECURITIES LLC STONE & YOUNGBERG LLC E. J. DE LA ROSA & CO., INC. UBS FINANCIAL SERVICES INC. Dated: June 14, 2005 Financial Guaranty Insurance Company

2 Redevelopment Agency of the City of San José Merged Area Redevelopment Project Housing Set-Aside Tax Allocation Bonds Maturity Schedule $10,445,000 Tax-Exempt Refunding Tax Allocation Bonds Series 2005A $10,445,000 Series 2005A Serial Bonds Maturity (August 1) Principal Amount Interest Rate Yield CUSIP 2018 $ 970, % 3.990% YZ , ZA , ZB ,010, ZC * 2,060, ZD * 2,165, ZE * 2,270, ZF4 * Priced to call on August 1, $119,275,000 Taxable Refunding Tax Allocation Bonds Series 2005B $22,680,000 Series 2005B Serial Bonds Maturity (August 1) Principal Amount Interest Rate Yield CUSIP 2006 $ 950, % 3.890% ZG ,560, ZH ,620, ZJ ,685, ZK ,765, ZL ,840, ZM ,105, ZN ,235, ZP ,385, ZQ ,535, ZR8 $17,505, % Term Bond due August 1, % CUSIP ZS6 $21,335, % Term Bond due August 1, % CUSIP ZT4 $57,755, % Term Bond due August 1, % CUSIP ZU1

3 REDEVELOPMENT AGENCY OF THE CITY OF SAN JOSE REDEVELOPMENT AGENCY BOARD AND CITY COUNCIL Ron Gonzales, Chair and Mayor Linda J. LeZotte, Member, District 1 Forrest Williams, Member, District 2 Cindy Chavez, Member, District 3, and Vice Mayor Chuck Reed, Member, District 4 Nora Campos, Member, District 5 Ken Yeager, Member, District 6 (District 7 position currently vacant) David D. Cortese, Member, District 8 Judy Chirco, Member, District 9 Nancy Pyle, Member, District 10 AGENCY STAFF Harry S. Mavrogenes, Executive Director Richard Doyle, General Counsel Sharon L. Landers, Assistant Executive Director David C. Baum, Director of Finance and Administration / Chief Financial Officer Abraham M. Andrade, Assistant Director of Finance and Administration Patricia A. Deignan, Chief Deputy General Counsel CITY STAFF Del D. Borgsdorf, City Manager Richard Doyle, City Attorney Scott P. Johnson, Director of Finance Leslye Corsiglia, Director of Housing Julia H. Cooper, Deputy Director of Finance Ed Moran, Senior Deputy City Attorney PROFESSIONAL SERVICES BOND COUNSEL AND DISCLOSURE COUNSEL Nixon Peabody LLP San Francisco, California FINANCIAL ADVISOR Ross Financial San Francisco, California FISCAL CONSULTANT Urban Analytics, LLC San Francisco, California FISCAL AGENT AND ESCROW AGENT Wells Fargo Bank, National Association Los Angeles, California VERIFICATION AGENT The Arbitrage Group, Inc.

4 No dealer, broker, salesperson or other person has been authorized by the Agency or the Underwriters to give any information or to make any representations with respect to the Bonds, other than those in this Official Statement, and if given or made, such other information or representations must not be relied upon as having been authorized by any of the forgoing. This Official Statement does not constitute an offer to sell or the solicitation of any offer to buy, and there shall not be any sale of the Bonds by any person in any jurisdiction in which it is unlawful for such person to make such offer, solicitation or sale. The information contained herein has been obtained from the Agency and sources other than the Agency that are believed to be reliable, but it is not guaranteed as to accuracy or completeness by and is not to be relied upon or construed as a promise or representation by the Agency or the Underwriters. The information and expressions of opinion herein are subject to change without notice, and neither the delivery of this Official Statement nor any sale made hereunder shall, under any circumstances, create any implication that there has been no change in the affairs of the Agency or DTC since the date hereof. Copies of documents referred to herein and information concerning the Bonds are available prior to August 8, 2005 from David Baum, Director of Finance and Administration, Redevelopment Agency of the City of San José, 50 West San Fernando Street, Suite 900, San José, California 95113, telephone and after August 8, 2005, from David Baum, Director of Finance and Administration, Redevelopment Agency of the City of San José, 200 East Santa Clara Street, San José, California 95113, telephone The Agency may impose a charge for copying, mailing and handling. The Underwriters have provided the following sentence for inclusion in this Official Statement: The Underwriters have reviewed the information in this Official Statement in accordance with, and as part of, their respective responsibilities to investors under the federal securities laws as applied to the facts and circumstances of this transaction, but the Underwriters do not guarantee the accuracy or completeness of such information. Certain statements contained in this Official Statement do not reflect historical facts but are forecasts and forward-looking statements. No assurance can be given that the future results discussed herein will be achieved, and actual results may differ materially from the forecasts described herein. In this context, the words estimate, forecast, project (when used as a verb), anticipate, expect, intend, plan (when used as a verb), believe and similar expressions are intended to identify forward-looking statements. All projections, forecasts, assumptions and other forward-looking statements are expressly qualified in their entirety by the cautionary statements set forth in this Official Statement. This Official Statement is not a contract with the purchasers of the Bonds. Statements contained in this Official Statement that involve estimates, forecasts or matters of opinion, whether or not expressly so described herein, are intended solely as such and are not to be construed as representations of fact. The summaries and references to documents, statutes and constitutional provisions referred to herein do not purport to be comprehensive or definitive and are qualified in their entireties by reference to each such document, statute and constitutional provision. This Official Statement is submitted in connection with the sale of the Bonds and may not be reproduced or used, in whole or in part, for any other purpose, unless authorized in writing by the Agency. THE BONDS HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED, OR UNDER ANY STATE SECURITIES LAW, AND THE AGREEMENT HAS NOT BEEN QUALIFIED UNDER THE TRUST INDENTURE ACT OF 1939, AS AMENDED, IN RELIANCE UPON THE EXEMPTIONS CONTAINED IN SUCH ACTS. THE BONDS WILL NOT BE LISTED ON ANY STOCK OR OTHER SECURITIES EXCHANGE. THE BONDS HAVE NOT BEEN RECOMMENDED BY ANY FEDERAL OR STATE SECURITIES COMMISSION OR REGULATORY AUTHORITY AND NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY OTHER FEDERAL, STATE OR GOVERNMENTAL ENTITY OR AGENCY WILL HAVE PASSED UPON THE ACCURACY OR ADEQUACY HEREOF. ANY REPRESENTATION TO THE CONTRARY MAY BE A CRIMINAL OFFENSE. IN CONNECTION WITH THIS OFFERING, THE UNDERWRITERS MAY OVERALLOT OR EFFECT TRANSACTIONS THAT STABILIZE OR MAINTAIN THE MARKET PRICE OF THE BONDS AT LEVELS ABOVE THOSE WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN MARKET. SUCH STABILIZING TRANSACTIONS, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME. THE UNDERWRITERS MAY OFFER AND SELL THE BONDS TO CERTAIN DEALERS, INSTITUTIONAL INVESTORS AND OTHERS AT PRICES LOWER THAN THE INITIAL PUBLIC OFFERING PRICES, AND SAID PUBLIC OFFERING PRICES MAY BE CHANGED FROM TIME TO TIME BY THE UNDERWRITERS.

5 TABLE OF CONTENTS INTRODUCTION...1 General... 1 Other Parity Agency Housing Set-Aside Tax Allocation Bonds... 2 The Agency... 2 The Merged Area Redevelopment Project... 2 Authorization and Purpose; Means of Sale... 3 Sources of Payment for the Bonds... 3 Bond Insurance... 3 Parity Obligations... 4 Terms of the Bonds... 4 Continuing Disclosure... 4 Other Information... 4 PLAN OF FINANCING...5 ESTIMATED SOURCES AND USES OF FUNDS...6 THE BONDS...6 Purpose of the Issue... 6 Authorized Denominations and Maturities... 6 Payment of Principal and Interest... 6 Redemption Provisions... 7 Book-Entry Only System... 9 AGGREGATE DEBT SERVICE...10 SECURITY AND SOURCES OF PAYMENT FOR THE BONDS...10 General...10 Pledge of Housing Set-Aside Amounts...11 Reserve Requirement...12 Issuance of Parity Obligations...13 BOND INSURANCE...13 Payments Under the Municipal Bond Insurance Policies...13 Debt Service Reserve Fund Policies...15 Financial Guaranty Insurance Company...15 Financial Guaranty s Credit Ratings...17 FACTORS AFFECTING TAX ALLOCATION FINANCING...17 Property Tax Collection Procedures...17 Property Tax Limitations: Article XIIIA of the California Constitution...19 Article XIIIB of the California Constitution...20 Articles XIIIC and XIIID of the California Constitution...20 Proposition Unitary Property...20 Tax Increment Revenue Limitation...21 Redevelopment Time Limits...22 THE REDEVELOPMENT AGENCY OF THE CITY OF SAN JOSE...23 The City and the Agency...23 Agency Powers and Duties...23 Agency Financial Statements...23 Fiscal Consultant s Report...23 Merged Area Redevelopment Project...23 Land Use within the Merged Project Area...26 Tax Rates...26 Historic Assessed Value and Housing Set-Aside Amounts...27 Twenty Largest Taxpayers...27 Assessment Appeals and Assessor Reductions...28 Debt Secured by Housing Set-Aside Amounts...30 Projected Debt Service Coverage...31 SPECIAL RISK FACTORS...33 Tax Increment Revenue Limitation...33 Reduction in Taxable Value...33 Risks to Real Estate Market...34 Local Economy...34 Assessment Appeals and Assessor Reductions to Assessed Value...34 Levy and Collection of Taxes...35 Personal Property on the Unsecured Tax Roll...35 i

6 State Budget Deficits...35 Reductions in Inflationary Rate...36 Statement of Indebtedness...36 Bankruptcy and Foreclosure...36 Estimated Revenues...36 Earthquake Risk...37 Hazardous Substances...37 Changes in the Law...37 Federal Tax-Exempt Status of the Series 2005A Bonds...37 THE COOPERATION AGREEMENT AND CITY OF SAN JOSE DEPARTMENT OF HOUSING...38 Cooperation Agreement...38 City of San José Department of Housing...38 TAX MATTERS...38 Tax Matters Series 2005A Bonds...38 Tax Matters Series 2005B Bonds...41 CONTINUING DISCLOSURE...43 APPROVAL OF LEGALITY...44 LITIGATION...44 VERIFICATION OF COMPUTATIONS...44 UNDERWRITING...44 RATINGS...45 FINANCIAL ADVISOR...45 MISCELLANEOUS...46 APPENDIX A THE CITY OF SAN JOSE: DEMOGRAPHIC AND ECONOMIC INFORMATION... A-1 APPENDIX B SUMMARY OF CERTAIN PROVISIONS OF THE AGREEMENT...B-1 APPENDIX C AUDITED FINANCIAL STATEMENTS OF THE AGENCY FOR FISCAL YEAR ENDED JUNE 30, C-1 APPENDIX D REPORT OF FISCAL CONSULTANT... D-1 APPENDIX E FORM OF PROPOSED LEGAL OPINION OF BOND COUNSEL...E-1 APPENDIX F FORM OF CONTINUING DISCLOSURE AGREEMENT...F-1 APPENDIX G DTC AND BOOK-ENTRY ONLY SYSTEM... G-1 APPENDIX H FORMS OF MUNICIPAL BOND INSURANCE POLICIES AND DEBT SERVICE RESERVE FUND POLICIES... H-1 ii

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9 OFFICIAL STATEMENT Redevelopment Agency of the City of San José Merged Area Redevelopment Project Housing Set-Aside Tax Allocation Bonds $10,445,000 Tax-Exempt Refunding Tax Allocation Bonds Series 2005A INTRODUCTION $119,275,000 Taxable Refunding Tax Allocation Bonds Series 2005B This Introduction is subject in all respects to the more complete information included and referred to elsewhere in this Official Statement, and the offering of the Bonds to potential investors is made only by means of the entire Official Statement. Capitalized terms used in this Introduction and not otherwise defined shall have the respective meanings assigned to them elsewhere in this Official Statement. See APPENDIX B SUMMARY OF CERTAIN PROVISIONS OF THE AGREEMENT for summaries of provisions referred to herein and definitions of certain words and terms used herein. GENERAL This Official Statement, including the cover page and the appendices hereto, is provided to furnish certain information in connection with the sale and issuance by the Redevelopment Agency of the City of San José (the Agency ) of $10,445,000 aggregate principal amount of its Merged Area Redevelopment Project Housing Set-Aside Tax-Exempt Refunding Tax Allocation Bonds, Series 2005A (the Series 2005A Bonds ) and $119,275,000 aggregate principal amount of its Merged Area Redevelopment Project Housing Set-Aside Taxable Refunding Tax Allocation Bonds, Series 2005B (the Series 2005B Bonds ). The Series 2005A Bonds and the Series 2005B Bonds are referred to collectively as the Bonds. The Series 2005A Bonds bear interest excludable from gross income for federal income tax purposes, while the Series 2005B Bonds bear interest which is not excludable from such income. See TAX MATTERS for a more detailed description of the differing tax treatment of the Series 2005A Bonds and the Series 2005B Bonds. The Series 2005A Bonds are being issued to refund the Agency s outstanding Merged Area Redevelopment Project Housing Set-Aside Tax Allocation Bonds, Series 1993D (the Series 1993D Bonds ) and to pay costs of issuance of the Series 2005A Bonds. The Series 2005B Bonds are being issued to refund the Agency s outstanding Merged Area Redevelopment Project Housing Set-Aside Taxable Tax Allocation Bonds, Series 2000F (the Series 2000F Bonds ) and a portion of the Agency s outstanding Merged Area Redevelopment Project Housing Set-Aside Taxable Revenue Bonds, Series 2002G (the Series 2002G Bonds ) and Series 2002H (the Series 2002H Bonds and together with the Series 2002G Bonds, the Series 2002 Bonds and collectively with the Series 1993D Bonds and the Series 2000F Bonds, the Refunded Bonds ), to repay certain amounts outstanding under a line of credit (the Line of Credit ) maintained by the Agency with The Bank of New York and to pay costs of issuance of the Series 2005B Bonds. See PLAN OF FINANCING Plan of Refunding. The Bonds will be issued pursuant to a Fiscal Agent Agreement, dated as of February 1, 1993 (the Original Fiscal Agent Agreement ), between the Agency and First Interstate Bank of California, as succeeded by Wells Fargo Bank, National Association, as fiscal agent thereunder (the Fiscal Agent ), as heretofore supplemented and amended, and as supplemented by a Seventh Supplemental Agreement, dated as of June 1, 2005 (the Seventh Supplemental Agreement and, collectively with the Original Fiscal Agent Agreement, as supplemented, the Agreement ), by and between the Agency and the Fiscal Agent. Certain capitalized terms used herein are defined in APPENDIX B SUMMARY OF CERTAIN PROVISIONS OF THE AGREEMENT. The Bonds will be secured on a parity basis with $82,805,000 of outstanding Prior Bonds (defined below) of the Agency. See OTHER PARITY AGENCY HOUSING SET-ASIDE TAX ALLOCATION BONDS.

10 Simultaneously with the issuance of the Bonds, the Agency intends to issue two series of Merged Area Redevelopment Project Subordinate Housing Set-Aside Tax Allocation Bonds in the combined approximate aggregate principal amount of $66,150,000 (collectively, the Subordinate Bonds ), which will be secured by the Housing Set-Aside Amounts on a basis subordinate to the payment of debt service on the Senior Bonds. The proceeds of the Subordinate Bonds will be applied to finance and refinance affordable housing projects in the City of San José, including by refunding a portion of the Series 2002 Bonds. OTHER PARITY AGENCY HOUSING SET-ASIDE TAX ALLOCATION BONDS Pursuant to the Agreement, the Agency previously issued seven series of bonds (collectively, the Prior Bonds and, together with the Bonds, the Senior Bonds ) secured on a parity basis by the Housing Set-Aside Amounts (as defined herein). Following the issuance of the Bonds and the refunding of the Refunded Bonds, the following series of Prior Bonds will remain outstanding: Merged Area Redevelopment Project Housing Set-Aside Tax Allocation Bonds, Series 1997E, issued in the original aggregate principal amount of $17,045,000 (the Series 1997E Bonds ), $17,045,000 of which will remain outstanding; Merged Area Redevelopment Project Housing Set-Aside Taxable Tax Allocation Bonds, Series 2003J, issued in the original aggregate principal amount of $55,265,000 (the Series 2003J Bonds ), $52,930,000 of which will remain outstanding; and Merged Area Redevelopment Project Housing Set-Aside Tax Allocation Bonds, Series 2003K, issued in the original aggregate principal amount of $13,760,000 (the Series 2000K Bonds ), $12,830,000 of which will remain outstanding. THE AGENCY The Agency was activated by the City Council of the City of San José (the City ) in 1956, upon the determination by the City Council that there was a need for redeveloping portions of the City. In 1975, the City Council replaced an appointed governing board and declared itself to be the Agency Board. Certain of the constituent redevelopment project areas within the Merged Project Area receive tax increment revenue and are referred to herein as the Merged Project Area. See THE REDEVELOPMENT AGENCY OF THE CITY OF SAN JOSE. The Community Redevelopment Law, constituting Part 1 of Division 24 (commencing with Section 33000) of the Health and Safety Code of the State of California (the Redevelopment Law ), requires that, unless a specified finding is made, no less than 20% of tax allocations for specified redevelopment project areas be utilized to increase, improve and preserve the supply of low and moderate income housing within the City. The Agency has delegated to the City its obligation and authority to administer the low and moderate income housing program required by the Redevelopment Law pursuant to an agreement entered into in 1987, which agreement is currently embodied in the Cooperation Agreement dated as of September 28, 1990, as amended (the Cooperation Agreement ). See THE COOPERATION AGREEMENT AND CITY DEPARTMENT OF HOUSING. THE MERGED AREA REDEVELOPMENT PROJECT The Merged Area Redevelopment Project was formed in 1981 from the merger of existing Agency project areas. The Agency has designated 21 redevelopment project areas that have been merged for the purpose of allocating certain tax revenues of the Agency. Other project areas have been subsequently established and added to the Merged Area Redevelopment Project. Only 16 of the 21 merged project areas are authorized to generate tax increment revenue. These 16 project areas are collectively referred to herein as the Merged Project 2

11 Area. The Merged Project Area is composed of approximately 8,110 acres. For Fiscal Year , the Merged Project Area has a total assessed valuation of approximately $15 billion, which is down from a high of approximately $18.7 billion in Fiscal Year The Agency attributes this approximately $3.7 billion decline to assessment reductions by the Santa Clara County Assessor under its Proposition 8 authority for research and development and office properties by the Santa Clara County Assessor in recognition of ongoing economic weakness. See THE REDEVELOPMENT AGENCY OF THE CITY OF SAN JOSE Merged Area Redevelopment Project. AUTHORIZATION AND PURPOSE; MEANS OF SALE The Bonds are being issued pursuant to authority granted under the Redevelopment Law and the provisions of the Agreement. On May 24, 2005, the Agency and the City adopted resolutions which authorized the issuance, sale and delivery of the Bonds and the execution and delivery of the Seventh Supplemental Agreement. The Bonds are being issued by the Agency to refinance certain Agency indebtedness, the proceeds of which were applied to finance and refinance loans and programs implemented to increase, improve and/or preserve the supply of very low, low and moderate income housing in the City. In order to facilitate a negotiated sale of the Bonds to the Underwriters, the City of San José Financing Authority has agreed to purchase the Bonds from the Agency for immediate resale to the Underwriters. See PLAN OF FINANCING and UNDERWRITING. SOURCES OF PAYMENT FOR THE BONDS The Bonds are special obligations of the Agency and are payable from and secured by a pledge of Housing Set-Aside Amounts, which are the amounts of Tax Increment Revenues (as defined and discussed under SECURITY AND SOURCES OF PAYMENT FOR THE BONDS Pledge of Housing Set-Aside Amounts ) required to be deposited into the Low and Moderate Income Housing Fund pursuant to Sections , or of the Redevelopment Law, but not to exceed 20% of the Tax Increment Revenues. Section of the Redevelopment Law establishes the low and moderate income housing set-aside requirement for merged project areas, and currently requires that 20% of the tax allocations for merged redevelopment projects be set aside for low and moderate income housing purposes. See SECURITY AND SOURCES OF PAYMENT FOR THE BONDS General. The Bonds will be equally and ratably secured by the pledge of Housing Set-Aside Amounts, as provided in the Agreement. The Housing Set-Aside Amounts do not secure, and are not subject to the pledge and lien of, any indebtedness of the Agency other than the Bonds and any Parity Obligations (as hereinafter defined) issued in accordance with the Agreement. The Bonds are not payable from, and are not secured by, Tax Increment Revenues of the Agency other than the Housing Set-Aside Amounts or any loan payments received by the Agency. See SECURITY AND SOURCES OF PAYMENT FOR THE BONDS Pledge of Housing Set-Aside Amounts. See SPECIAL RISK FACTORS Reduction in Taxable Value and Assessment Appeals and Assessor Reductions to Assessed Value for a discussion of recent developments concerning assessment appeals, settlements and related policies. BOND INSURANCE The scheduled payment of principal of and interest on the Series 2005A Bonds and the Series 2005B Bonds, respectively, when due will be guaranteed by two separate municipal bond insurance policies (the Policies ) to be issued concurrently with the delivery of the Bonds by Financial Guaranty Insurance Company ( Financial Guaranty ). Financial Guaranty will also issue two separate municipal bond debt service reserve fund policies (the Reserve Policies ) in connection with the issuance of the Bonds. See BOND INSURANCE. 3

12 PARITY OBLIGATIONS The Agreement provides that the Agency may issue additional housing set-aside tax allocation bonds (including without limitation, bonds, notes, interim certificates, debentures or other obligations) (the Parity Obligations ) on a parity with outstanding Senior Bonds for the purpose of increasing, improving and/or preserving the supply of low and moderate income housing within the City, provided that Housing Set-Aside Amounts to be received by the Agency based upon the most recent taxable valuation of property in the Merged Project Area total at least 1.15 times the maximum annual debt service on Senior Bonds reasonably expected to be outstanding and any Parity Obligations to be issued. The Agency may exercise its option each year to use all remaining Housing Set-Aside Amounts for other lawful purposes after all remaining debt service requirements have been satisfied. See SECURITY AND SOURCES OF PAYMENT FOR THE BONDS Issuance of Parity Obligations and APPENDIX B SUMMARY OF CERTAIN PROVISIONS OF THE AGREEMENT Issuance of Parity Obligations. Estimated Fiscal Year Housing Set-Aside Amounts are expected to provide 1.93 times debt service coverage on all outstanding Parity Obligations, including the Bonds. See AGGREGATE DEBT SERVICE and THE REDEVELOPMENT AGENCY OF THE CITY OF SAN JOSE Projected Debt Service Coverage. TERMS OF THE BONDS The Bonds will be dated their date of delivery. The Bonds will be issued as fully registered bonds and, when delivered, will be registered in the name of Cede & Co., as nominee of The Depository Trust Company, New York, New York ( DTC ). DTC will act as securities depository for the Bonds. Purchases of beneficial interests in the Bonds will be made in book- entry only form, in denominations of $5,000 or any integral multiple thereof. See APPENDIX G DTC AND BOOK-ENTRY ONLY SYSTEM. Payments. Interest on the Bonds is payable commencing February 1, 2006, and semiannually thereafter on each February 1 and August 1. Interest and principal on the Bonds are payable by the Fiscal Agent to DTC, which will be responsible for remitting such principal and interest to its Participants, which will in turn be responsible for remitting such principal and interest to the Beneficial Owners of the Bonds. See THE BONDS Payment of Principal and Interest and APPENDIX G DTC AND BOOK-Entry ONLY SYSTEM. Redemption Provisions. The Series 2005A Bonds maturing on and after August 1, 2016 and the Series 2005B Bonds maturing on and after August 1, 2016 may be redeemed prior to maturity at the option of the Agency beginning on or after August 1, 2015 and August 1, 2015, respectively, but such optional redemptions may be rescinded if for any reason funds are not available on the date fixed for redemption for the payment in full of the Bonds then called for redemption. The Bonds are also subject to mandatory sinking fund redemption as described herein. See THE BONDS Redemption Provisions. CONTINUING DISCLOSURE The Agency has covenanted to provide annually certain financial information and operating data relating to the Agency and notices of the occurrence of certain enumerated events, if material. See CONTINUING DISCLOSURE. The specific timing and nature of the information to be contained in the annual reports filed by or on behalf of the Agency or the notices of material events are set forth in APPENDIX F FORM OF CONTINUING DISCLOSURE AGREEMENT. OTHER INFORMATION This Official Statement speaks only as of its date, and the information contained herein is subject to change. 4

13 Copies of documents referred to herein and information concerning the Agency and the Bonds are available prior to August 8, 2005 from David Baum, Director of Finance and Administration, Redevelopment Agency of the City of San José, 50 West San Fernando Street, Suite 900, San José, California 95113, telephone and after August 8, 2005, from David Baum, Director of Finance and Administration, Redevelopment Agency of the City of San José, 200 East Santa Clara Street, San José, California 95113, telephone The Agency may impose a charge for copying, mailing and handling. PLAN OF FINANCING Issuance of the Bonds. The Series 2005A Bonds are being issued by the Agency, in part, to refund the Agency s outstanding Series 1993D Bonds, and the Series 2005B Bonds are being issued by the Agency, in part, to refund the Agency s outstanding Series 2000F Bonds and a portion of the Agency s outstanding Series 2002 Bonds (collectively with the Series 1993D Bonds and the Series 2000F Bonds, the Refunded Bonds ) and to repay certain amounts outstanding under the Line of Credit. Proceeds of the Refunded Bonds were used to fund loans for the purpose of increasing, improving and/or preserving the supply of very low, low and moderate income housing in the City. Issuance of Subordinate Bonds. Simultaneously with the issuance of the Bonds, the Agency intends to issue two series of Subordinate Bonds in the combined approximate aggregate principal amount of $66,150,000, which will be secured by the Housing Set-Aside Amounts on a basis subordinate to the payment of debt service on the Senior Bonds. The proceeds of the Subordinate Bonds will be applied to finance and refinance affordable housing projects in the City of San José, including by refunding a portion of the Agency s outstanding Series 2002 Bonds. Plan of Refunding. Portions of the proceeds of the sale of the Series 2005A Bonds and the Series 2005B Bonds, respectively, will be used to fund escrows with Wells Fargo Bank, National Association, as escrow agent, for the Series 1993D Bonds and Series 2000F Bonds, respectively. Such amounts, together with any amounts transferred from certain funds held under the Agreement for the Series 1993D Bonds and the Series 2000F Bonds, respectively, will be invested in United States Treasury Securities that mature in such amounts and at such times and bear interest at such rates as to provide amounts sufficient to pay the principal of, and the interest and any redemption premium on Series 1993D Bonds and the Series 2000F Bonds, respectively, upon their optional redemption on August 1, 2005 and August 1, 2006, respectively. See VERIFICATION OF COMPUTATIONS. Simultaneously with issuance of the Bonds, the fiscal agent for the Series 2002G Bonds and the Series 2002H Bonds will draw on the letter of credit currently in effect with respect to the Series 2002G Bonds and the letter of credit currently in effect with respect to the Series 2002H Bonds, respectively, in the amount necessary to redeem in full the Series 2002G Bonds and the Series 2002H Bonds, respectively, and will apply such amounts to the redemption in full of the Series 2002G Bonds and the Series 2002H Bonds, respectively. A portion of the proceeds of the sale of the Series 2005B Bonds, together with a portion of the proceeds of the sale of the Subordinate Bonds, will be applied to reimburse The Bank of New York, as issuer of such letters of credit (the 2002 Letter of Credit Bank ), for such draws. 5

14 ESTIMATED SOURCES AND USES OF FUNDS The following table sets forth the estimated sources and uses of funds related to the Bonds: Series 2005A Bonds Series 2005B Bonds Total Estimated Sources Par amount $10,445, $119,275, $129,720, Net Premium 395, , Funds held for the Refunded Bonds 302, ,719, ,021, TOTAL $11,142, $120,994, $132,137, Estimated Uses Deposit to Escrow Funds $10,905, $48,015, $58,920, Reimbursement to 2002 Letter of Credit Bank (1) -- 62,000, ,000, Repayment of Line of Credit -- 8,050, ,050, Costs of Issuance (2) 207, ,467, ,675, Underwriters Discount 30, , , TOTAL $11,142, $120,994, $132,137, (1) (2) The remainder of the amount necessary to reimburse the 2002 Letter of Credit Bank will be derived from proceeds of the Subordinate Bonds. Includes the Agency s and the City s expenses, fiscal agent, bond insurance and reserve surety premiums, ratings, financial advisory and legal fees and expenses and other miscellaneous expenses associated with the issuance of the Bonds. THE BONDS PURPOSE OF THE ISSUE The Agency is issuing the Series 2005A Bonds in the aggregate principal amount of $10,445,000 and the Series 2005B Bonds in the aggregate principal amount of $119,275,000 to provide funds to refund outstanding bonds of the Agency previously issued for the purpose of increasing, improving and/or preserving the supply of very low, low and moderate income housing within the City. Proceeds of the Bonds will also be applied to purchase bond insurance policies and debt service reserve fund reserve policies for the Reserve Accounts for the Bonds, and to pay the costs of issuance for the Bonds. See PLAN OF FINANCING. AUTHORIZED DENOMINATIONS AND MATURITIES The Bonds will be issued in Authorized Denominations of $5,000 or any integral multiple thereof and will have the maturity dates set forth on the inside cover page hereof, provided that no Bond shall have principal maturing on more than one principal maturity date. PAYMENT OF PRINCIPAL AND INTEREST The Bonds will be dated their date of delivery. Interest on the Bonds (calculated on the basis of a 360-day year composed of twelve 30-day months) is payable on each February 1 and August 1, commencing February 1, 2006 (each an Interest Payment Date ), by check mailed first class by the Fiscal Agent to the Holders at their addresses shown on the registration books kept by the Fiscal Agent at the close of business on the 6

15 fifteenth day of the calendar month immediately preceding such Interest Payment Date (the Record Date ); provided that payment of interest may be paid by federal wire transfer to an account in the United States designated by any Holder of Bonds in the aggregate principal amount of $1,000,000 or more, upon provision of written notice received by the Fiscal Agent prior to the applicable Record Date. Principal of, and redemption premiums, if any, on the Bonds is payable upon the surrender thereof in lawful money of the United States of America at the principal corporate office of the Fiscal Agent in Los Angeles, California, or at such other office as designated by the Fiscal Agent. REDEMPTION PROVISIONS Mandatory Sinking Fund Redemption Series 2005B Term Bonds. The Series 2005B Bonds maturing August 1, 2020, are subject to mandatory redemption in part by lot prior to their maturity date, upon notice as described below, on each August 1, commencing August 1, 2016, solely from money which has been deposited into the Series 2005B Principal Account in amounts and upon the dates established for such Series 2005B Term Bonds, as follows: Year Ending August 1 Mandatory Sinking Fund Payments Maturity $3,710, ,885, ,125, ,290, ,495,000 Series 2005B Term Bonds. The Series 2005B Bonds maturing August 1, 2025, are subject to mandatory redemption in part by lot prior to their maturity date, upon notice as described below, on each August 1, commencing August 1, 2021, solely from money which has been deposited into the Series 2005B Principal Account in amounts and upon the dates established for such Series 2005B Term Bonds, as follows: Year Ending August 1 Mandatory Sinking Fund Payments Maturity $3,685, ,570, ,750, ,940, ,390,000 7

16 Series 2005B Term Bonds. The Series 2005B Bonds maturing August 1, 2035, are subject to mandatory redemption in part by lot prior to their maturity date, upon notice as described below, on each August 1, commencing August 1, 2026, solely from money which has been deposited into the Series 2005B Principal Account in amounts and upon the dates established for such Series 2005B Term Bonds, as follows: Year Ending August 1 Mandatory Sinking Fund Payments Maturity $6,715, ,350, ,300, ,725, ,575, ,985, ,140, ,425, ,845, ,000 If Bonds of a given series are redeemed in part prior to their stated maturity date from moneys other than mandatory sinking fund payments, the remaining mandatory sinking fund payments for such series of Bonds will be revised and reduced in the manner determined by the Agency. Optional Redemption Series 2005A Bonds. The Series 2005A Bonds maturing on or after August 1, 2016, shall be subject to redemption as a whole or in part among such maturities as designated by the Agency (and by lot within any one maturity) prior to their respective maturity dates, upon notice as described below, at the option of the Agency, on any date on or after August 1, 2015, from funds derived by the Agency from any legally available source, at a redemption price equal to the percentage of the principal amount of the Series 2005A Bonds called for redemption, together with interest accrued thereon to the date of redemption. Series 2005B Bonds. The Series 2005B Bonds maturing on or after August 1, 2016, shall be subject to redemption as a whole or in part among such maturities as designated by the Agency (and by lot within any one maturity) prior to their respective maturity dates, upon notice as described below, at the option of the Agency, on any date on or after August 1, 2015, from funds derived by the Agency from any legally available source, at a redemption price equal to the percentage of the principal amount of the Series 2005B Bonds called for redemption, together with interest accrued thereon to the date of redemption. General Redemption Provisions Selection of Bonds for Redemption. Whenever provision is made by the Agency for the redemption of less than all of the Series 2005A Bonds or the Series 2005B Bonds or any given portion thereof, the Agency shall select the maturities of the Series 2005A Bonds or Series 2005B Bonds, as applicable, to be redeemed from all Series 2005A Bonds or Series 2005B Bonds, as applicable, subject to redemption or such given portion thereof not previously called for redemption, and the Fiscal Agent shall select the Series 2005A Bonds or Series 2005B Bonds, as applicable, to be redeemed within any maturity by lot in any manner that the Fiscal Agent, in its sole discretion, shall deem appropriate and fair. Notice of Redemption. Notice of redemption shall be given by the Fiscal Agent for and on behalf of the Agency, by first-class mail, not more than 60 and not less than 30 days, to the Information Services and 8

17 Securities Depositories, and the Holder of each Bond called for redemption, at its address as it appears on the registration books for that purpose, but neither failure to mail such notice to any Holder of a Bond nor any defect in any notice so mailed shall affect the sufficiency of the proceedings for the redemption of any of the Bonds with respect to which such failure or defect shall have occurred. Each notice of redemption shall state the redemption date, the place of redemption, the principal amount, if less than all the Bonds are called for redemption, the distinctive series and numbers of the Bonds to be redeemed, and shall also state that the interest on the Bonds in such notice designated for redemption shall cease to accrue from and after such redemption date and that on said date there will become due and payable on each of said Bonds the principal amount thereof to be redeemed, interest accrued thereon to the redemption date and the premium, if any, thereon (such premium to be specified). If DTC or its nominee is the registered owner of any Bond to be redeemed, notice of redemption will be given to DTC or its nominee as a registered owner of such Bond. Any failure on the part of DTC or failure on the part of a nominee of a Beneficial Owner of any Bond to be redeemed shall not affect the validity of the redemption of such Bond. Rescission of Optional Redemption. The Agency shall have the right to rescind any optional redemption by written notice to the Fiscal Agent on or prior to the date fixed for redemption. Each notice of redemption relating to an optional redemption shall state that such redemption may be rescinded by the Agency. Any such notice of optional redemption shall be cancelled and annulled if for any reason funds are not available on the date fixed for redemption for the payment in full of the Bonds then called for redemption, and such cancellation shall not constitute an default under the Agreement. The Fiscal Agent shall mail notice of rescission of redemption in the same manner notice of redemption was originally provided. Effect of Redemption. After the date filed for redemption, notice of such redemption shall have been duly given and funds available for the payment of such redemption price of the Bonds or portions thereof so called for redemption shall have been duly provided as set forth in the Agreement, no interest shall accrue on the Bonds or portions thereof after the redemption date specified in such notice and said Bonds shall cease to be entitled to any lien, benefit or security under the Agreement, and the Holders of said Bonds shall have no rights in respect thereof except to receive payment of the redemption price. Defeasance. For a description of procedures and requirements for discharging the Bonds and the Agreement, see APPENDIX B SUMMARY OF CERTAIN PROVISIONS OF THE AGREEMENT Discharge of Indebtedness. BOOK-ENTRY ONLY SYSTEM The Bonds will be available in book-entry form only. DTC will act as securities depository for the Bonds. The Bonds will be issued as fully-registered securities registered in the name of Cede & Co. (DTC s partnership nominee). Payments of principal, premium, if any, and interest on the Bonds will be paid by the Fiscal Agent to DTC, which is obligated in turn to remit such principal, premium, if any, and interest to its DTC Participants for subsequent disbursement to the beneficial owners of the Bonds. See APPENDIX G DTC AND BOOK-ENTRY ONLY SYSTEM. So long as Cede & Co. is the registered owner of the Bonds, references herein to the Bondholders or Registered Owners of the Bonds mean Cede & Co. and not the beneficial owners of the Bonds. The Agency cannot and does not give any assurance that DTC will distribute to DTC Participants or that DTC Participants or others will distribute to the beneficial owners payments of principal of and interest and premium, if any, on the Bonds or any redemption or other notices, or that they will do so on a timely basis or will serve and act in the manner described in this Official Statement. The Agency is not responsible or liable for the failure of DTC or any DTC Participant or DTC Indirect Participant to make any payments or give any notice to a beneficial owner with respect to the Bonds or any error or delay relating thereto. 9

18 AGGREGATE DEBT SERVICE The table below sets forth the debt service associated with the Series 2005A Bonds, the Series 2005B Bonds and the aggregate annual scheduled debt service on all Bonds and Prior Bonds outstanding following the refunding of the Series 1993D Bonds, the Series 2000F Bonds, the Series 2002G Bonds and the Series 2002H Bonds: Bond Year Ending August 1 AGGREGATE DEBT SERVICE FOR ALL SENIOR BONDS Prior Bonds Debt Service Series 2005A Principal Series 2005A Interest Series 2005B Principal Series 2005B Interest Total Debt Service 2005 $7,004, $ 7,004, ,008, $523,058 $ 950,000 $ 6,725,994 15,207, ,011, ,588 1,560,000 6,155,777 15,208, ,013, ,588 1,620,000 6,092,285 15,206, ,014, ,588 1,685,000 6,023,759 15,204, ,011, ,588 1,765,000 5,950,124 15,207, ,010, ,588 1,840,000 5,872,288 15,203, ,830, ,588 3,105,000 5,789,672 15,206, ,842, ,588 3,235,000 5,648,705 15,207, ,838, ,588 3,385,000 5,498,924 15,204, ,849, ,588 3,535,000 5,339,152 15,204, ,846, ,588 3,710,000 5,170,533 15,208, ,856, ,588 3,885,000 4,981,323 15,204, ,847,734 $ 970, ,588 3,125,000 4,783,188 15,207, ,865, , ,213 3,290,000 4,623,813 15,204, ,859, , ,013 3,495,000 4,456,023 15,206, ,868,663 1,010, ,413 3,685,000 4,277,778 15,207, ,190,283 2,060, ,750 3,570,000 4,083,578 14,228, ,192,473 2,165, ,750 3,750,000 3,895,439 14,224, ,206,065 2,270, ,500 3,940,000 3,697,814 14,227, ,345, ,390,000 3,490,176 14,225, ,357, ,715,000 3,153,423 14,225, ,362, ,350,000 2,786,784 11,499, , ,300,000 2,549,274 11,328, , ,725,000 2,096,094 9,301, ,575,000 1,728,909 9,303, ,985,000 1,315,314 9,300, ,140, ,333 6,019, ,425, ,689 6,023, ,845, ,484 5,147, ,000 37, ,947 SECURITY AND SOURCES OF PAYMENT FOR THE BONDS GENERAL Tax Allocation Generally. The Redevelopment Law provides a means for financing redevelopment projects based upon an allocation of taxes collected within a project area. The taxable valuation of a project area last equalized prior to adoption of the redevelopment plan, or base roll, is established in the base year. Thereafter, except for any period during which the taxable valuation drops below the base year level, the taxing bodies receive the taxes produced by the levy of the then-current tax rate upon the base roll. Taxes collected upon any increase in taxable valuation over the base roll (with the exception of taxes derived from increases in the tax rate imposed by taxing agencies to support new bonded indebtedness) are allocated to the redevelopment agency and may be pledged to the repayment of any indebtedness incurred in financing or refinancing redevelopment. Redevelopment agencies themselves have no authority to levy property taxes and must look exclusively to such allocation of taxes. The Agency s ability to collect tax increment under the Redevelopment 10

19 Law is limited not only by the time limits on the repayment of debt, but also by the cap on total tax increment to be received from the Merged Project Area. As provided in the redevelopment plans, as amended, of certain of the project areas composing the Merged Project Area (collectively referred to herein as the Merged Project Area ; see THE REDEVELOPMENT AGENCY OF THE CITY OF SAN JOSE Merged Area Redevelopment Project ), and pursuant to Article 6 of Chapter 6 of the Redevelopment Law (commencing with Section 33670) and Section 16 of Article XVI of the California Constitution, taxes (other than taxes imposed by taxing agencies for the purpose of paying for bonded indebtedness approved by the voters after January 1, 1989) levied upon taxable property in the Merged Project Area each year by or for the benefit of the State of California and any city, county, city and county or other public corporation for fiscal years beginning after the effective dates of each of the respective redevelopment projects, are divided for each project area as follows: (1) Taxing agencies: The portion equal to the amount of those taxes that have been produced by the current tax rate, applied to the taxable valuation of such property in the redevelopment project area as last equalized prior to the establishment of the redevelopment project, or base roll, is paid into the funds of those respective taxing agencies as taxes by or for said taxing agencies; and (2) The Agency: The portion of said levied taxes each year in excess of the amount referred to in (1) above is allocated to, and when collected, is paid into the Special Fund of the Agency. Such excess is referred to as Gross Tax Allocations. Section of the Redevelopment Law provides that the calculation of the amount of tax revenues will be made separately for each of the project areas composing the Merged Project Area. As a result, a reduction in assessed value of property within any project area below the base year value for that project area will not cause a reduction in the tax revenues eligible for allocation to the Agency from any of the other project areas. Housing Set-Aside. The Redevelopment Law requires that, unless a specified finding is made, redevelopment agencies set aside at least 20% of all Gross Tax Allocations derived from redevelopment project areas into a low and moderate income housing fund, to be used for the purpose of increasing, improving and preserving the supply of very low, low and moderate income housing. Section of the Redevelopment Law establishes the low and moderate income housing set-aside requirement for merged project areas, and thus governs the Merged Project Area. Pursuant to Section 33487, the Agency sets aside 20% of its Gross Tax Allocations for very low, low and moderate income housing purposes within the City. See THE REDEVELOPMENT AGENCY OF THE CITY OF SAN JOSE Historic Assessed Value and Housing Set-Aside Amounts. PLEDGE OF HOUSING SET-ASIDE AMOUNTS The Bonds are secured by a first lien on and pledge of revenues, consisting of (i) Housing Set-Aside Amounts and (ii) any moneys deposited and held from time to time by the Fiscal Agent under the Agreement, except as provided therein. Pursuant to the Agreement, all right, title and interest of the Agency in Housing Set-Aside Amounts payable to or receivable by the Agency are irrevocably pledged to secure the payment of principal of and interest on the Bonds. The Agreement defines Housing Set-Aside Amounts as that portion of Tax Increment Revenues required to be set aside and deposited in the Low and Moderate Income Housing Fund pursuant to Sections , or of the Redevelopment Law, but not to exceed 20% of Tax Increment Revenues. Tax Increment Revenues is defined as the Gross Tax Allocations for the Merged Project Area, plus all payments and reimbursements, if any, to the Agency specifically attributable to ad valorem taxes lost by reason of tax exemptions and tax rate limitations. In the event of an amendment or revision to the Redevelopment Law that would allow the Agency to set aside less than the Housing Set-Aside Amounts required to be set aside as of the date of execution of the Agreement, the Agency has covenanted that it will continue to set aside a sufficient amount of Tax Increment 11

20 Revenues to pay the Annual Debt Service on the Bonds and Parity Obligations and to make deposits to the Reserve Account as required by the Agreement. Such Tax Increment Revenues required to be so deposited shall be deemed to be Housing Set-Aside Amounts under the Agreement and shall be subject to the lien and pledged under the Agreement. THE BONDS ARE SPECIAL OBLIGATIONS OF THE AGENCY SECURED BY AN IRREVOCABLE PLEDGE OF, AND PAYABLE AS TO PRINCIPAL, PREMIUM, IF ANY, AND INTEREST SOLELY FROM HOUSING SET-ASIDE AMOUNTS DESCRIBED HEREIN AND OTHER FUNDS HELD UNDER THE AGREEMENT. ALL OF THE BONDS ARE EQUALLY SECURED BY A PLEDGE OF AND CHARGE AND LIEN UPON, ALL OF THE HOUSING SET-ASIDE AMOUNTS, AND THE HOUSING SET-ASIDE AMOUNTS CONSTITUTE A TRUST FUND FOR THE SECURITY AND PAYMENT OF THE INTEREST ON, THE PRINCIPAL OF AND PREMIUM, IF ANY, OF THE BONDS AND ANY OTHER PARITY OBLIGATIONS ISSUED BY THE AGENCY IN ACCORDANCE WITH THE AGREEMENT. THE PRINCIPAL AMOUNT OF THE BONDS, THE INTEREST THEREON AND ANY PREMIUMS PAYABLE UPON THE REDEMPTION OR PURCHASE THEREOF, IS NOT A DEBT OF THE CITY, THE STATE OF CALIFORNIA (THE STATE ) OR ANY OF ITS POLITICAL SUBDIVISIONS OTHER THAN THE AGENCY, AND NEITHER THE CITY, THE STATE NOR ANY OF ITS POLITICAL SUBDIVISIONS OTHER THAN THE AGENCY IS LIABLE THEREON, NOR IN ANY EVENT SHALL THE PRINCIPAL OF, PREMIUM, IF ANY, OR INTEREST ON THE BONDS BE PAYABLE OUT OF ANY FUNDS OR PROPERTIES OTHER THAN THE HOUSING SET-ASIDE AMOUNTS OF THE AGENCY AS SET FORTH IN THE AGREEMENT. THE BONDS DO NOT CONSTITUTE AN INDEBTEDNESS WITHIN THE MEANING OF ANY CONSTITUTIONAL OR STATUTORY DEBT LIMITATION OR RESTRICTION. NEITHER THE MEMBERS OF THE AGENCY NOR ANY PERSONS EXECUTING THE BONDS ARE LIABLE PERSONALLY ON THE BONDS BY REASON OF THEIR ISSUANCE. Pursuant to the terms of the Agreement, if during any Bond Year (i) all deposits required to be made with respect to such Bond Year to fund the interest and principal accounts pursuant to the Agreement have been made, (ii) the amounts on deposit in the Reserve Account equal or exceed the Reserve Requirement, (iii) any Qualified Surety Bonds used to fund the Reserve Account are fully replenished and all interest on amounts advanced under such Qualified Surety Bonds has been paid to the provider thereof, and (iv) the Agency is not in default under the Agreement, then the City, at the direction of the Agency, may cease its deposit of any additional Housing Set-Aside Amounts until commencement of the next Bond Year and any moneys then on deposit in the Housing Special Fund may be used in any manner provided by law for the purpose of aiding in financing the Housing Project, including early redemption or purchase of the Bonds and Parity Obligations, as provided in the Agreement and permitted by the Redevelopment Law. RESERVE REQUIREMENT To secure the payment of principal of and interest on the Bonds, the Agency is required to maintain on deposit in the Reserve Account created pursuant to the Agreement an amount equal to the Reserve Requirement. The Reserve Requirement equals the Maximum Annual Debt Service with respect to the Bonds and Parity Obligations from the date of such determination through the maturity date of all of the Bonds and Parity Obligations that are then outstanding. If the amount in the Reserve Account is less than an amount equal to the Reserve Requirement, the Fiscal Agent will, from available Housing Set-Aside Amounts and other moneys held under the Agreement, transfer for deposit to the Reserve Account, an amount, if necessary, in order to cause the amount on deposit therein to equal the Reserve Requirement. Money in the Reserve Account will be transferred by the Fiscal Agent to the Interest Accounts and Principal Accounts without preference or priority and, in the event of any insufficiency of such moneys, ratably without any discrimination or preference to pay the Bonds and Parity Obligations when they become due to the extent Housing Set-Aside Amounts are insufficient therefor. See APPENDIX B SUMMARY OF CERTAIN PROVISIONS OF THE AGREEMENT Housing Special Fund; Establishment and Maintenance of Accounts for Use of Moneys in the Housing Special Fund. 12

21 In lieu of funding the Reserve Account with cash or Investment Securities, the Agency, at its option, may fund all or any portion of the Reserve Requirement by providing to the Fiscal Agent (a) an irrevocable, unconditional letter of credit issued by a bank or savings and loan association whose long-term uncollateralized debt obligations are rated in one of the three highest rating categories by each Rating Agency then rating the Bonds, or if the Bonds are not then rated, by any Rating Agency or (b) a qualified surety bond approved in writing by the Rating Agency then rating the Bonds. The Reserve Requirement for the Senior Bonds at the time of delivery of the Bonds will be $15,208,892. The portion of the Reserve Requirement with respect to the Bonds will be satisfied with the Reserve Policies issued by Financial Guaranty in the face amount of $1,084, with respect to the Series 2005A Reserve Policy and $9,858, with respect to the Series 2005B Reserve Policy (each as hereinafter defined). See BOND INSURANCE. The following table sets forth certain information with respect to the various debt service reserve fund surety bonds that the Agency has provided to the Fiscal Agent to fund the Reserve Requirement with respect to the outstanding Prior Bonds. Each of following debt service reserve fund surety bonds secure only their respective Series of Prior Bonds and no others Series of Prior Bonds. Series Issuer Amount* Series 1997E MBIA $3,884,695 Series 2003J&K XL Capital Assurance Inc. $6,176,891 * The aggregate amount of all debt service reserve fund surety bonds deposited in the Reserve Account to date exceeds the Reserve Requirement for the Prior Bonds because certain of such surety bonds secure only their Series of Prior Bonds and no others. ISSUANCE OF PARITY OBLIGATIONS The Agreement provides that the Agency may issue Parity Obligations secured on a parity with the Bonds if, among other conditions, the Agency delivers to the Fiscal Agent a certificate showing (i) Maximum Annual Debt Service with respect to the Bonds reasonably expected to be Outstanding, including the Parity Obligations then being delivered; (ii) for the then current Bond Year, the Housing Set-Aside Amounts to be received by the Agency based upon the most recent taxable valuation of property in the Merged Project Area provided by the appropriate officer of the County of Santa Clara (the County ), plus supplemental assessments for projects that have been completed and will be reflected on the tax roll for the next succeeding Bond Year and projects the ownership of which has changed, all as confirmed by the appropriate officer of the County; and (iii) that Housing Set-Aside Amounts referred to in clause (ii) above, are at least 1.15 times the Maximum Annual Debt Service referred to in clause (i). See APPENDIX B SUMMARY OF CERTAIN PROVISIONS OF THE AGREEMENT Issuance of Parity Obligations for a description of the conditions precedent to issuing Parity Obligations. BOND INSURANCE The following information under this caption BOND INSURANCE has been furnished by Financial Guaranty for inclusion in this Official Statement. Reference is made to APPENDIX H for specimens of the Policies and the Reserve Policies to be issued concurrently with the delivery of the Series 2005A Bonds and the Series 2005B Bonds. No representation is made by the Agency or the Underwriters as to the accuracy or completeness of this information. PAYMENTS UNDER THE MUNICIPAL BOND INSURANCE POLICIES Concurrently with the issuance of the Bonds, Financial Guaranty Insurance Company, doing business in California as FGIC Insurance Company ( Financial Guaranty ) will issue its Municipal Bond New Issue Insurance Policy for the Series 2005A Bonds and its Municipal Bond New Issue Insurance Policy for the Series 13

22 2005B Bonds (collectively, the Policies and each a Policy ). Each Policy unconditionally guarantees the payment of that portion of the principal of and interest on the Series 2005A Bonds or the Series 2005B Bonds, as applicable, which has become due for payment, but shall be unpaid by reason of nonpayment by the Agency. Financial Guaranty will make such payments to U.S. Bank Trust National Association, or its successor as its agent (the Financial Guaranty Fiscal Agent ), on the later of the date on which such principal or interest (as applicable) is due or on the business day next following the day on which Financial Guaranty shall have received notice (in accordance with the terms of each Policy) from an owner of the Series 2005A Bonds or the Series 2005B Bonds, as applicable, or the Fiscal Agent of the nonpayment of such amount by the Agency. The Financial Guaranty Fiscal Agent will disburse such amount due on any Series 2005A Bond or the Series 2005B Bond, as applicable, to its owner upon receipt by the Financial Guaranty Fiscal Agent of evidence satisfactory to the Financial Guaranty Fiscal Agent of the owner s right to receive payment of the principal or interest (as applicable) due for payment and evidence, including any appropriate instruments of assignment, that all of such owner s rights to payment of such principal or interest (as applicable) shall be vested in Financial Guaranty. The term nonpayment in respect of a Series 2005A Bond or a Series 2005B Bond, as applicable, includes any payment of principal or interest (as applicable) made to an owner of a Series 2005A Bond or a Series 2005B Bond, as applicable, which has been recovered from such owner pursuant to the United States Bankruptcy Code by a trustee in bankruptcy in accordance with a final, nonappealable order of a court having competent jurisdiction. Once issued, each Policy is non-cancellable by Financial Guaranty. Each Policy covers failure to pay principal of the Series 2005A Bonds or the Series 2005B Bonds, as applicable, on their respective stated maturity dates and their respective mandatory sinking fund redemption dates, and not on any other date on which the Series 2005A Bonds or the Series 2005B Bonds, as applicable, may have been otherwise called for redemption, accelerated or advanced in maturity. Each Policy also covers the failure to pay interest on each Interest Payment Date. In the event that payment of the Series 2005A Bonds or the Series 2005B Bonds, as applicable, is accelerated, Financial Guaranty will only be obligated to pay principal and interest in the originally scheduled amounts on the originally scheduled payment dates with respect to the Series 2005A Bonds or the Series 2005B Bonds, as applicable. Upon such payment, Financial Guaranty will become the owner of the Series 2005A Bond or the Series 2005B Bond, as applicable, appurtenant coupon or right to payment of principal or interest on such Series 2005A Bond or the Series 2005B Bond, as applicable, and will be fully subrogated to all of the Bondholder s rights thereunder. Each Policy does not insure any risk other than Nonpayment by the Agency, as defined in such Policy. Specifically, each Policy does not cover: (i) payment on acceleration, as a result of a call for redemption (other than mandatory sinking fund redemption) or as a result of any other advancement of maturity; (ii) payment of any redemption, prepayment or acceleration premium; or (iii) nonpayment of principal or interest caused by the insolvency or negligence or any other act or omission of the Fiscal Agent. As a condition of its commitment to insure the Series 2005A Bonds or the Series 2005B Bonds, as applicable, Financial Guaranty may be granted certain rights under the Seventh Supplemental Agreement. The specific rights, if any, granted to Financial Guaranty in connection with its insurance of the Series 2005A Bonds or the Series 2005B Bonds, as applicable, may be set forth in the description of the Agreement attached hereto as APPENDIX B and reference should be made thereto. Each Policy is not covered by the Property/Casualty Insurance Security Fund specified in Article 76 of the New York Insurance Law. Each Policy is not covered by the California Insurance Guaranty Association (California Insurance Code, Article 14.2) 14

23 DEBT SERVICE RESERVE FUND POLICIES Concurrently with the issuance of the Bonds, Financial Guaranty Insurance Company, doing business in California as FGIC Insurance Company ( Financial Guaranty ) will issue its Municipal Bond Debt Service Reserve Fund Policy for the Series 2005A Bonds (the Series 2005A Reserve Policy ) and its Municipal Bond Debt Service Reserve Fund Policy for the Series 2005B Bonds (the Series 2005B Reserve Policy and together with the Series 2005A Reserve Policy the Reserve Policies and each a Reserve Policy ). Each Reserve Policy unconditionally guarantees the payment of that portion of the principal of and interest on the Series 2005A Bonds or the Series 2005B Bonds, as applicable, which has become due for payment, but shall be unpaid by reason of nonpayment by the Agency, provided that the aggregate amount paid under the respective Reserve Policy may not exceed the maximum amount set forth in the Series 2005A Reserve Policy, $1,084,010.40, or in the Series 2005B Reserve Policy, $9,858, Financial Guaranty will make such payments to the Fiscal Agent on the later of the date on which such principal and interest (as applicable) is due or on the business day next following the day on which Financial Guaranty shall have received telephonic or telegraphic notice subsequently confirmed in writing or written notice by registered or certified mail from the Fiscal Agent of the nonpayment of such amount by the Agency. The term nonpayment in respect of a Series 2005A Bond or a Series 2005B Bond, as applicable, includes any payment of principal or interest (as applicable) made to an owner of a Series 2005A Bond or a Series 2005B Bond, as applicable, which has been recovered from such owner pursuant to the United States Bankruptcy Code by a trustee in bankruptcy in accordance with a final nonappealable order of a court having competent jurisdiction. Each Reserve Policy is non-cancellable and the respective premium will be fully paid at the time of delivery of the Series 2005A Bonds or the Series 2005B Bonds, as applicable. Each Reserve Policy covers failure to pay principal of the Series 2005A Bonds or the Series 2005B Bonds, as applicable, on their respective stated maturity dates, or dates on which the same shall have been called for mandatory sinking fund redemption, and not on any other date on which the Series 2005A Bonds or the Series 2005B Bonds, as applicable, may have been accelerated. Each Reserve Policy also covers the failure to pay an installment of interest on each Interest Payment Date. The Series 2005A Reserve Policy shall terminate on the earlier of the scheduled final maturity date of the Series 2005A Bonds or the date on which no Series 2005A Bonds are outstanding under the Agreement. The Series 2005B Reserve Policy shall terminate on the earlier of the scheduled final maturity date of the Series 2005B Bonds or the date on which no Series 2005B Bonds are outstanding under the Agreement. Generally, in connection with its issuance of a Reserve Policy, Financial Guaranty requires, among other things, (i) that, so long as it has not failed to comply with its payment obligations under a Reserve Policy, Financial Guaranty be granted the power to exercise any remedies available at law or under the Agreement other than (A) acceleration of the Series 2005A Bonds or Series 2005B Bonds, as applicable, or (B) remedies which would adversely affect holders in the event that the Agency fails to reimburse Financial Guaranty for any draws on a Reserve Policy; and (ii) that any amendment or supplement to or other modification of the Agreement be subject to Financial Guaranty s consent. The specific rights, if any, granted to Financial Guaranty in connection with its issuance of each Reserve Policy may be set forth in the description of the Agreement attached hereto as APPENDIX B and reference should be made thereto for a discussion of the circumstances, if any, under which the Agency is required to provide additional or substitute credit enhancement, and related matters. Each Reserve Policy is not covered by the Property/Casualty Insurance Security Fund specified in Article 76 of the New York Insurance Law. Each Reserve Policy is not covered by the California Insurance Guaranty Association (California Insurance Code, Article 14.2). FINANCIAL GUARANTY INSURANCE COMPANY Financial Guaranty Insurance Company, a New York stock insurance corporation doing business in California as FGIC Insurance Company ( Financial Guaranty ), is a direct, wholly-owned subsidiary of FGIC Corporation, a Delaware corporation, and provides financial guaranty insurance for public finance and 15

24 structured finance obligations. Financial Guaranty is licensed to engage in financial guaranty insurance in all 50 states, the District of Columbia and the Commonwealth of Puerto Rico and, through a branch, in the United Kingdom. On December 18, 2003, an investor group consisting of The PMI Group, Inc. ( PMI ), affiliates of The Blackstone Group L.P. ( Blackstone ), affiliates of The Cypress Group L.L.C. ( Cypress ) and affiliates of CIVC Partners L.P. ( CIVC ) acquired FGIC Corporation (the FGIC Acquisition ) from a subsidiary of General Electric Capital Corporation ( GE Capital ). PMI, Blackstone, Cypress and CIVC acquired approximately 42%, 23%, 23% and 7%, respectively, of FGIC Corporation s common stock. FGIC Corporation paid GE Capital approximately $284.3 million in pre-closing dividends from the proceeds of dividends it, in turn, had received from Financial Guaranty, and GE Capital retained approximately $234.6 million in liquidation preference of FGIC Corporation s convertible participating preferred stock and approximately 5% of FGIC Corporation s common stock. Neither FGIC Corporation nor any of its shareholders is obligated to pay any debts of Financial Guaranty or any claims under any insurance policy, including the Policies and the Reserve Policies, issued by Financial Guaranty. Financial Guaranty is subject to the insurance laws and regulations of the State of New York, where it is domiciled, including Article 69 of the New York Insurance Law ( Article 69 ), a comprehensive financial guaranty insurance statute. Financial Guaranty is also subject to the insurance laws and regulations of all other jurisdictions in which it is licensed to transact insurance business. The insurance laws and regulations, as well as the level of supervisory authority that may be exercised by the various insurance regulators, vary by jurisdiction, but generally require insurance companies to maintain minimum standards of business conduct and solvency, to meet certain financial tests, to comply with requirements concerning permitted investments and the use of policy forms and premium rates and to file quarterly and annual financial statements on the basis of statutory accounting principles ( SAP ) and other reports. In addition, Article 69, among other things, limits the business of each financial guaranty insurer, including Financial Guaranty, to financial guaranty insurance and certain related lines. For the three months ended March 31, 2005, and the years ended December 31, 2004, and December 31, 2003, Financial Guaranty had written directly or assumed through reinsurance, guaranties of approximately $14.8 billion, $59.5 billion and $42.4 billion par value of securities, respectively (of which approximately 71%, 56% and 79%, respectively, constituted guaranties of municipal bonds), for which it had collected gross premiums of approximately $84.4 million, $323.6 million and $260.3 million, respectively. For the three months ended March 31, 2005, Financial Guaranty had reinsured, through facultative and excess of loss arrangements, approximately 0.5% of the risks it had written. As of March 31, 2005, Financial Guaranty had net admitted assets of approximately $3.215 billion, total liabilities of approximately $2.040 billion, and total capital and policyholders surplus of approximately $1.175 billion, determined in accordance with statutory accounting practices prescribed or permitted by insurance regulatory authorities. The unaudited financial statements of Financial Guaranty as of March 31, 2005, the audited financial statements of Financial Guaranty as of December 31, 2004, and the audited financial statements of Financial Guaranty as of December 31, 2003, which have been filed with the Nationally Recognized Municipal Securities Information Repositories ( NRMSIRs ), are hereby included by specific reference in this Official Statement. Any statement contained herein under the heading BOND INSURANCE, or in any documents included by specific reference herein, shall be modified or superseded to the extent required by any statement in any document subsequently filed by Financial Guaranty with such NRMSIRs, and shall not be deemed, except as so modified or superseded, to constitute a part of this Official Statement. All financial statements of Financial Guaranty (if any) included in documents filed by Financial Guaranty with the NRMSIRs subsequent to the date of this Official Statement and prior to the termination of the offering of the Bonds shall be deemed to be included by specific reference into this Official Statement and to be a part hereof from the respective dates of filing of such documents. 16

25 Financial Guaranty also prepares quarterly and annual financial statements on the basis of generally accepted accounting principles. Copies of Financial Guaranty s most recent GAAP and SAP financial statements are available upon request to: Financial Guaranty Insurance Company, 125 Park Avenue, New York, NY 10017, Attention: Corporate Communications Department. Financial Guaranty s telephone number is (212) FINANCIAL GUARANTY S CREDIT RATINGS The financial strength of Financial Guaranty is rated AAA by Standard & Poor s, a Division of The McGraw-Hill Companies, Inc., Aaa by Moody s Investors Service, and AAA by Fitch Ratings. Each rating of Financial Guaranty should be evaluated independently. The ratings reflect the respective ratings agencies current assessments of the insurance financial strength of Financial Guaranty. Any further explanation of any rating may be obtained only from the applicable rating agency. These ratings are not recommendations to buy, sell or hold the Bonds, and are subject to revision or withdrawal at any time by the rating agencies. Any downward revision or withdrawal of any of the above ratings may have an adverse effect on the market price of the Bonds. Financial Guaranty does not guarantee the market price or investment value of the Bonds nor does it guarantee that the ratings on the Bonds will not be revised or withdrawn. Neither Financial Guaranty nor any of its affiliates accepts any responsibility for the accuracy or completeness of the Official Statement or any information or disclosure that is provided to potential purchasers of the Bonds, or omitted from such disclosure, other than with respect to the accuracy of information with respect to Financial Guaranty or the Policies and the Reserve Policies under this heading BOND INSURANCE. In addition, Financial Guaranty makes no representation regarding the Bonds or the advisability of investing in the Bonds. FACTORS AFFECTING TAX ALLOCATION FINANCING PROPERTY TAX COLLECTION PROCEDURES Classifications. In California, property which is subject to ad valorem taxes is classified as secured or unsecured. Secured and unsecured property are entered on separate parts of the assessment roll maintained by the county assessor. The secured classification includes property on which any property tax levied by a county becomes a lien on that property. A tax levied on unsecured property does not become a lien against the unsecured property, but may become a lien on certain other property owned by the taxpayer. Every tax which becomes a lien on secured property has priority over all other liens on the secured property, regardless of the time of the creation of such other liens. Generally, ad valorem taxes are collected by a county (the Taxing Authority ) for the benefit of the various entities (cities, school districts and special districts) that share in the ad valorem tax (each a taxing entity) and redevelopment agencies eligible to receive tax increment revenues. Collections. Secured and unsecured property are entered on separate parts of the assessment roll maintained by the county assessor. The method of collecting delinquent taxes is substantially different for the two classifications of property. The taxing authority has three ways of collecting unsecured personal property taxes: (1) a civil action against the taxpayer; (2) filing a certificate in the office of the county clerk specifying certain facts in order to obtain a lien on certain property of the taxpayer; and (3) seizure and sale of the personal property, improvement or possessory interests belonging or assessed to the assessee. The exclusive means of enforcing the payment of delinquent taxes with respect to property on the secured roll is the sale of property securing the taxes to the State for the amount of taxes which are delinquent. Penalty. A 10% penalty is added to delinquent taxes which have been levied with respect to property on the secured roll. In addition, on or about June 30 of the fiscal year, property on the secured roll on which taxes 17

26 are delinquent is declared in default by operation of law and declaration of the tax collector. Such property may thereafter be redeemed by payment of the delinquent taxes and a delinquency penalty, plus a redemption penalty of 1.5% per month to the time of redemption. If taxes are unpaid for a period of five years or more, the property is subject to sale by the county tax collector. A 10% penalty also applies to delinquent taxes on property on unsecured roll, and further, an additional penalty of 1.5% per month accrues with respect to such taxes beginning on varying dates related to the tax bill mailing date. It is the County s practice to retain all such penalties and interest. Delinquencies. The County currently allocates property taxes to the Agency based on 100% of the tax levy, notwithstanding any delinquencies. However, there can be no assurance the County will continue such practice. The valuation of property is determined as of the January 1 lien date as equalized in August of each year and equal installments of taxes levied upon secured property become delinquent on the following December 10 and April 10. Taxes on unsecured property are due March 1 and become delinquent August 31. Supplemental Assessments. A bill enacted in 1983, Senate Bill ( SB ) 813 (Statutes of 1983, Chapter 498), provides for the supplemental assessment and taxation of property upon the occurrence of a change in ownership or completion of new construction. Previously, statutes enabled the assessment of such changes only as of the next tax lien date following the change and thus delayed the realization of increased property taxes from the new assessments. As enacted, Chapter 498 allows for increased revenue to redevelopment agencies to the extent that supplemental assessments of new construction or changes of ownership occur within the boundaries of redevelopment projects subsequent to the January 1 lien date, as equalized in August. To the extent such supplemental assessments occur within the Merged Project Area, Agency tax increment revenues may increase. Property Tax Administrative Costs. In 1990, the Legislature enacted SB 2557 (Statutes of 1990, Chapter 466) which allows counties to charge fees to local jurisdictions (including redevelopment agencies) for the cost of preparing and overseeing the tax roll. For Fiscal Year the estimated administrative fees being charged to the Agency by the County for such services is $1.7 million, which is approximately 1.13% of the total Gross Tax Allocations for the Merged Project Area. These fees are not payable from and do not reduce the Housing Set-Aside Amounts pledged to the payment of the Bonds. Statutory Pass-through Payments. In adopting the provisions of AB 1342 extending the time limit on debt incurrence (see REDEVELOPMENT TIME LIMITS below), the Agency triggered statutory tax sharing, commencing with Fiscal Year , with those taxing entities that do not have tax sharing agreements with the Agency. As the County is the only taxing entity that has a tax sharing agreement with the Agency, all of the Agency s tax-sharing entities except the County will receive statutory pass-through payments. Statutory tax sharing will be calculated based on the increase in assessed valuation after the year in which the limitation would otherwise have become effective, and, unless subordinated by the entities receiving the tax sharing payments, is senior to the obligations of a redevelopment agency with respect to bonded indebtedness. The Agency has not obtained, and does not expect to obtain, the subordination of such statutory tax sharing payments to the Agency s obligations with respect to the Bonds. Based on calculations performed by the County and Urban Analytics, LLC, the Agency s fiscal consultant (the Fiscal Consultant ), the Agency s pass-through payment obligation to the taxing entities eligible for statutory payments for Fiscal Year is expected to be approximately $664,000. Pursuant to the formulas under AB 1342, statutory pass-through payments will increase in future years. Because the Housing Set-Aside Amounts represent 20% of the Agency s Gross Tax Allocations, the amount of Housing Set-Aside Amounts should not be affected by any increase in statutory pass-through payments. 18

27 Filing of Statement of Indebtedness. Under the Redevelopment Law, the Agency must file with the County a statement of indebtedness for the Merged Project Area by October 1 of each year. As described below, the statement of indebtedness controls the amount of Tax Increment Revenue that will be paid to the Agency in each fiscal year. Each statement of indebtedness is filed on a form prescribed by the State Controller and specifies, among other things: (i) the total amount of principal and interest payable on all loans, advances or indebtedness (including the Bonds and all Parity Obligations) (the Debt ), both over the life of the Debt and for the current fiscal year, and (ii) the amount of available revenue as of the end of the previous fiscal year. Available Revenue is calculated by subtracting the total payments on Debt during the previous fiscal year from the total revenues (both Tax Increment Revenues and other revenues) received during the previous fiscal year, plus any carry forward from the prior fiscal year. The County may pay Tax Increment Revenue to the Agency in any fiscal year only to the extent that the total remaining principal and interest on all Debt exceeds the amount of available revenues as shown on the statement of indebtedness. The statement of indebtedness constitutes prima facie evidence of the indebtedness of the Agency; however, the County may dispute the statement of indebtedness in certain cases within certain time limits established under State law. Any such dispute may be adjudicated in court, but only the amount of the Debt not its validity (or any related contract or expenditures) may be contested. No challenge can be made to payments to a trustee or fiscal agent in connection with a bond issue or payments to a public agency in connection with payments by that public agency with respect to a lease or a bond issue. PROPERTY TAX LIMITATIONS: ARTICLE XIIIA OF THE CALIFORNIA CONSTITUTION California voters, on June 6, 1978, approved an amendment (commonly known as both Proposition 13 and the Jarvis-Gann Initiative) to the California Constitution. This amendment, which added Article XIIIA to the California Constitution, among other things affects the valuation of real property for the purpose of taxation in that it defines the full cash property value to mean the county assessor s valuation of real property as shown on the tax roll under full cash value, or thereafter, the appraised value of real property when purchased, newly constructed, or a change in ownership has occurred after the 1975 assessment. The full cash value may be adjusted annually to reflect inflation at a rate not to exceed 2% per year, or reduction in the consumer price index or comparable local data at a rate not to exceed 2% per year, or reduced in the event of declining property value caused by damage, destruction or other factors including a general economic downturn. The amendment further limits the amount of any ad valorem tax on real property to one percent of the full cash value except that additional taxes may be levied to pay debt service on indebtedness approved by the voters prior to July 1, 1978, and bonded indebtedness for the acquisition or improvement of real property approved on or after July 1, 1978 by two-thirds of the votes cast by the voters voting on the proposition. Both the United States Supreme Court and the California Supreme Court have upheld the validity of Article XIIIA. While it appears that the constitutional challenges to Article XIIIA are exhausted, the Agency cannot predict what impact any future developments might have on the Agency s receipt of tax increment revenues. In the general election held November 4, 1986, voters of the State approved two measures, Propositions 58 and 60, which further amended Article XIIIA. Proposition 58 amended Article XIIIA to provide that the terms purchase and change of ownership, for the purposes of determining full cash value of property under Article XIIIA, do not include the purchase or transfer of (1) real property between spouses and (2) the principal residence and the first $1,000,000 of other property between parents and children. This amendment to Article XIIIA may reduce the rate of growth of local property tax revenues. Proposition 60 amended Article XIIIA to permit the Legislature to allow persons over the age of 55 who sell their residence and buy or build another of equal or lesser value within two years in the same county, to transfer the old residence assessed value to the new residence. As a result of the Legislature s action, the growth of property tax revenues may decline. 19

28 Legislation enacted by the Legislature to implement Article XIIIA provides that all taxable property is shown at full assessed value as described above. In conformity with this procedure, all taxable property value included in this Official Statement is shown at 100% of assessed value and all general tax rates reflect the $1 per $100 of taxable value (except as noted). Tax rates for voter-approved bonded indebtedness and pension liabilities are also applied to 100% of assessed value. ARTICLE XIIIB OF THE CALIFORNIA CONSTITUTION On November 6, 1979, California voters approved Proposition 4, the Gann Initiative, which added Article XIIIB to the California Constitution. The principal effect of Article XIIIB is to limit the annual appropriations of the State and any city, county, school district, authority or other political subdivision of the State to the level of appropriations for the prior fiscal year, as adjusted for changes in the cost of living, population and services rendered by the government entity. The starting point for establishing such appropriation limit is fiscal year and the limit is to be adjusted annually to reflect changes in population, consumer prices and certain increases in the cost of services provided by these public agencies. Appropriations subject to Article XIIIB include generally the proceeds of taxes levied by the State or other entity of local government, exclusive of certain State subventions, refunds of taxes, benefit payments from retirement, unemployment insurance and disability insurance funds. Effective September 30, 1980, the Legislature added Section to the Redevelopment Law which provides that the allocation of taxes to a redevelopment agency for the purpose of paying principal of, or interest on, loans, advances, or indebtedness will not be deemed the receipt by the agency of proceeds of taxes levied by or on behalf of the agency within the meaning of Article XIIIB or any statutory provision enacted in implementation thereof. The constitutionality of Section has been upheld by the Second and Fourth District Courts of Appeal in two decisions: Bell Redevelopment Agency v. Woosely and Brown v. the Redevelopment Agency of the City of Santa Ana. ARTICLES XIIIC AND XIIID OF THE CALIFORNIA CONSTITUTION At the election held on November 5, 1996, Proposition 218 was passed by the voters of California. The initiative added Articles XIIIC and XIIID to the California Constitution. Provisions in the two articles affect the ability of local government to raise revenues. The Bonds are secured by sources of revenues that are not subject to limitation by Proposition 218. PROPOSITION 87 On November 8, 1988, the voters of the State approved Proposition 87, which amended Article XVI, Section 16 of the California Constitution to provide that property tax revenue attributable to the imposition of taxes on property within a redevelopment project area for the purpose of paying debt service on bonded indebtedness issued by a taxing entity (not the Agency) and approved by the voters of the taxing entity after January 1, 1989 will be allocated solely to the payment of such indebtedness and not to redevelopment agencies. Because this provision is not retroactive, such bonded indebtedness approved prior to January 1, 1989 will continue to provide tax overrides to the Agency so long as such indebtedness remains outstanding. See THE REDEVELOPMENT AGENCY OF THE CITY OF SAN JOSE Tax Rates. UNITARY PROPERTY Assembly Bill ( AB ) 2890 (Statutes of 1986, Chapter 1457) provides that, commencing with fiscal year , assessed value derived from State-assessed unitary property (consisting mostly of operational property owned by utility companies) is to be allocated county-wide as follows: (i) each tax rate area will receive 20

29 that same amount from each assessed utility received in the previous fiscal year unless the applicable county-wide values are insufficient to do so, in which case values will be allocated to each tax rate area on a pro-rata basis; and (ii) if values to be allocated are greater than in the previous fiscal year, each tax rate area will receive a pro-rata share of the increase from each assessed utility according to a specified formula. Additionally, the lien date on State-assessed property is changed from March 1 to January 1. AB 454 (Statutes of 1987, Chapter 921) further modifies chapter 1457 regarding the distribution of tax revenues derived from property assessed by the State Board of Equalization. Chapter 921 provides for the consolidation of all State-assessed property, except for regulated railroad property, into a single tax rate area in each county. Chapter 921 further provides for a new method of establishing tax rates on State-assessed property and distribution of property tax revenue derived from State-assessed property to taxing jurisdictions within each county in accordance with a new formula. Railroads will continue to be assessed and revenues allocated to all tax rate areas where railroad property is sited. Chapters 1457 and 921 provide for redevelopment agencies to receive their appropriate share of revenue generated from the property assessed by the State Board of Equalization. The Agency s collection of tax increment revenue from such State-assessed property for Fiscal Year was approximately $3.7 million. The Agency is estimating approximately $2.3 million in unitary taxes in Fiscal Year TAX INCREMENT REVENUE LIMITATION The Agency was required in 1986 to adopt a limit on the amount of tax increment revenue the Agency may receive with respect to the Merged Project Area. The maximum amount of tax increment revenue the Agency may receive from the Merged Project Area was set at $7.6 billion. Based on Agency records, as of June 30, 2004, the Agency has received approximately $1.9 billion of tax increment revenue from the Merged Project Area. The Agency expects to receive approximately $150 million in additional increment by June 30, Depending on the growth rate of assessed value of property in the Merged Project Area, the Merged Project Area may reach its tax increment revenue limitation before the Bonds mature. The Fiscal Consultant has prepared a tax increment projection and sensitivity analysis that projects the Agency s Merged Project Area tax increment revenues over time, assuming various increment growth rates. With increment projected using an annual growth rate of two percent, the projection shows that the Agency would reach its tax increment cap in Fiscal Year With increment projected using an annual growth rate of five percent, the projection shows that the Agency would reach its tax increment cap in Fiscal Year With increment projected using an annual growth rate of seven percent, the projection shows that the Agency would reach its tax increment cap in Fiscal Year See APPENDIX D REPORT OF FISCAL CONSULTANT Tax Increment Cap and Tax Increment Projection and Sensitivity Analysis. In the event that the Agency reaches its tax increment cap, it would not collect any additional tax increment to pay debt service on the Bonds. However, in the Seventh Supplemental Agreement, the Agency covenants, commencing December 1, 2005, to calculate annually the remaining amount available under its tax increment revenue limitation and the amount of obligations that exist to be paid from tax increment revenue, including obligations payable from the Housing Set-Aside Amounts. If, based on such review, the allocation of Housing Set-Aside Amounts to the Agency in any of the next three succeeding fiscal years will cause an amount equal to 90% of the Housing Set-Aside Amounts remaining to be allocated under the Merged Project Area Redevelopment Plans to fall below the obligations payable from the Housing Set-Aside Amounts, the Agency will be obligated either to use Housing Set-Aside Amounts not needed to pay such obligations to retire or defease Bonds or to adopt a plan approved by a qualified redevelopment consultant which demonstrates the Agency's continuing ability to pay debt service on the Bonds. See APPENDIX B SUMMARY OF CERTAIN PROVISIONS OF THE AGREEMENT Covenants Plan Limit. 21

30 REDEVELOPMENT TIME LIMITS In 1993, the State Legislature passed AB 1290, which, among other things, required redevelopment agencies to adopt time limits in each redevelopment plan specifying: (1) the last date to incur debt for a redevelopment project; (2) the last date to undertake redevelopment activity within a project area; and (3) the last date to collect tax increment revenue from a project area to repay debt. Pursuant to AB 1290, which took effect January 1, 1994, the San José City Council adopted ordinances amending each redevelopment plan in the Merged Project Area to impose limits on plan activity in each area, as well as a date past which tax increment revenue could not be collected. In 2001, the California Legislature enacted SB 211, Chapter 741, Statutes 2001, effective January 1, 2002 ( SB 211 ), which authorized, among other things, the deletion by ordinance of the legislative body of the AB 1290 limitation on incurring indebtedness contained in a redevelopment plan adopted prior to January 1, On November 5, 2002, the City Council adopted an ordinance, pursuant to the authorization contained in SB 211, deleting the limit on the Agency s authority to incur loans, advances and indebtedness with respect to the Merged Project Area for redevelopment plans adopted prior to January 1, Senate Bill 1045, Chapter 260, Statutes 2003, effective September 1, 2003 ( SB 1045 ) provides, among other things, that, for the purpose of determining whether the limit on the tax increment revenue that may be allocated to the Agency has been reached, the aggregate amount of Education Revenue Augmentation Fund payments made by the Agency in prior Fiscal Years from tax increment revenue may be deducted from the amount of tax increment revenue deemed to have been received by the Agency. SB 1045 also permits the redevelopment plan to be amended to add one year to the duration of the plan and to the period for collection of tax increment revenues and the repayment of debt. The San José City Council has amended each of the redevelopment plans within the Merged Project Area to add one year to each of the redevelopment plans effectiveness dates and tax increment collection dates. Legislation passed in 2004 (SB 1096) permits redevelopment agencies to extend their ability to collect tax increment in certain project areas by one year for each ERAF payment made in and The extensions apply by right to plans with existing limits on the effectiveness of the plan that are less than 10 years from the last day of the fiscal year in which the ERAF payment is made. Plans that have effective dates expiring between 10 and 20 years from the last day of the fiscal year of the ERAF payment may also be extended by one year, but only if certain findings are made by the City Council. Those findings are: (1) Compliance with the 20% Housing Set-Aside requirements; (2) Compliance with the Implementation Plan requirements of the Redevelopment Law; (3) Compliance with the inclusionary housing and replacement housing requirements of the Redevelopment Law; and (4) that the Agency is not subject to sanctions for having an excess surplus in the 20% Housing Set-Aside Fund. All Agency tax increment-producing plans, with the exception of Almaden Gateway and Monterey Corridor, qualify for the extension. On March 29, 2005, the City Council approved ordinances necessary to extend the qualifying plans by one year for the ERAF payment. Final adoption of the ordinances occurred on April 5, 2005 and became effective on May 5, The Agency plans to submit identical ordinances in for City Council approval of another one-year extension as permitted under SB With the ERAF-related extensions, the plan expiration dates for the Merged Project Area range from January 1, 2011 (Park Center Plaza and San Antonio Plaza) to April 7, 2029 (Almaden Gateway). The Agency can repay indebtedness with tax increment in each of the sub-areas for ten years after the plan termination dates, with the exception of Monterey Corridor. Adopted after January 1, 1994, Monterey Corridor is subject to a statutory limit of 45 years from the plan adoption date for the repayment of indebtedness. As noted above, the Merged Project Area has a tax increment cap of $7.6 billion that may take effect prior to the time limit on the repayment of indebtedness. The time limits apply individually to each plan within the Merged Project Area, as well as individually to specific territory added by amendments to redevelopment plans. See Table 1 for information on tax increment revenue collection termination dates. 22

31 THE REDEVELOPMENT AGENCY OF THE CITY OF SAN JOSE THE CITY AND THE AGENCY The City of San José (the City ) covers nearly 178 square miles and is the county seat of Santa Clara County. The City has a population of 944,857 estimated by the California Department of Finance as of January 1, 2005, and is the nation s 11 th largest city and California s third largest city (after Los Angeles and San Diego). The City is at the southern end of San Francisco Bay (see REGIONAL MAP ). Having originated as a Spanish pueblo established in 1777, the City is the oldest city in California. From a former rich agricultural setting, San José has become the capital of the innovative, high-technology based Silicon Valley so named for the principal material used in producing semiconductors. During the 1980 s and 1990 s the City experienced an economic resurgence with expansion in manufacturing, service, retail and tourist industries. However, the recent national economic slowdown and the retraction in the telecommunications and technology industries have caused a decline in economic activity in the City. Established in 1956 under State law, the Agency is one of the largest redevelopment agencies in the State, both in terms of project area size and in tax increment revenue generated. The City Council serves as the Agency s governing board, with the Mayor as Chair. AGENCY POWERS AND DUTIES All powers of the Agency are vested in its eleven members. The Agency exercises all of the governmental functions authorized under the Redevelopment Law and has, among other powers, the authority to acquire, administer, develop and sell or lease property, including the right of eminent domain, and the right to issue bonds and expend the proceeds. The Agency can clear buildings and other improvements, can develop as a building site any real property owned or acquired, and in connection with such development can cause streets, highways and sidewalks to be constructed or reconstructed and public utilities to be installed. AGENCY FINANCIAL STATEMENTS The Agency s Audited Financial Statements for Fiscal Year attached as APPENDIX C to this Official Statement have been audited by Macias, Gini & Company LLP, independent auditors. Macias, Gini & Company LLP has not been requested to consent to the use or to the inclusion of its report in this Official Statement and has not reviewed this Official Statement. FISCAL CONSULTANT S REPORT In connection with the issuance of the Bonds, the Agency has engaged Urban Analytics, LLC, San Francisco, California (the Fiscal Consultant ) to prepare a Fiscal Consultant Report dated June 7, See APPENDIX D REPORT OF FISCAL CONSULTANT. MERGED AREA REDEVELOPMENT PROJECT The Merged Area Redevelopment Project was formed in 1981 from the merger of existing Agency project areas. Other project areas have been subsequently established and added to the Merged Project Area. The Agency has designated 21 redevelopment project areas that have been merged for the purpose of allocating certain tax revenues of the Agency. However, only 16 of these 21 project areas are authorized to generate tax increment revenue. These 16 project areas are collectively referred to herein as the Merged Project Area. Table 1 below sets forth the 16 existing project areas that generate tax increment revenue within the Merged Project Area and estimates this Fiscal Year s tax increment revenue, the approximate size of each 23

32 project area, and the last date on which the Agency can repay debt from tax increment revenue generated by each project area. The Agency s bond issues have been structured to take these termination dates into account. Table 1 REDEVELOPMENT AGENCY OF THE CITY OF SAN JOSE MERGED PROJECT AREA REDEVELOPMENT PROJECT Project Area Acreage, Debt Termination, Tax Increment Revenue and Other Information Sub-Area Acres (a) Adopted On Plan Plan Terminates On (b) Debt Repayment Deadline (b) Tax Increment Park Center 61 7/24/1961 1/1/2011 1/1/2021 $ 4,976,525 San Antonio Plaza 50 1/3/1968 1/1/2011 1/1/2021 4,387,109 Rincon Original 1,872 7/16/1974 7/16/2016 7/16/ ,758,548 Pueblo Uno 12 7/8/1975 7/8/2017 7/8/2027 1,617,396 Julian Stockton 330 7/15/1976 7/15/2018 7/15/2028 4,149,935 Olinder 158 7/15/1976 7/15/2018 7/15/2028 2,013,544 Edenvale 1,050 7/15/1976 7/15/2018 7/15/ ,062,179 Rincon Expansion 1,224 7/3/1979 7/3/2021 7/3/ ,083,713 Edenvale East 995 9/1/1981 9/1/2023 9/1/2033 8,373,179 Rincon North 1,699 6/8/1982 6/8/2024 6/8/ ,449,430 Rincon South (c) -- 6/8/1982 6/8/2024 6/8/ ,693,475 Guadalupe Auzerais 73 5/19/1983 5/19/2025 5/19/2035 2,929,757 Market Gateway 32 11/8/ /8/ /8/ ,267 Century Center 18 11/8/ /8/ /8/2035 1,264,121 Almaden Gateway 21 4/7/1988 4/7/2029 4/7/ ,229 Monterey Corridor /13/ /13/ /13/2040 1,455,791 (a) Acreages reflect an in-depth GIS analysis of the tax generating project areas as of December 21, (b) Reflects extensions as permitted under SB 1045 and SB (c) Acreage combined for Rincon South/Rincon North. Source: The Agency The Agency s project areas can be grouped into three categories: Downtown, Neighborhoods and Industrial. These categories are described below. Downtown. Eight project areas form the 369-acre core of downtown San José, both geographically and culturally: Almaden Gateway, Pueblo Uno, Century Center, Park Center, San Antonio Plaza, Guadalupe-Auzerais, Market Gateway and Civic Plaza (a non-tax increment revenue generating area formed in 1999). Neighborhood Business Districts. The Agency started its Neighborhood Business District ( NBD ) program in 1982 to revitalize older commercial areas that had become blighted. Six non-tax increment revenue generating NBDs have become project areas since 1988: East Santa Clara Street, Alum Rock Avenue, West San Carlos Street, The Alameda, Story Road and Japantown. These districts represent historically active commercial centers of the City, and all serve as gateways to downtown San José with the exception of Story Road, which supports major residential areas to the east and south of downtown. In 2001, the Agency adopted the Neighborhood Business Clusters Redevelopment Project Area, which, like the NBD program, does not generate tax increment revenue. This project area is comprised of six non-contiguous business clusters located throughout the City, and they are referred to as Bascom Station, Fruitdale Station, Union and Foxworthy, Union and Camden, White and Quimby, and Monterey and Roeder. 24

33 Historically, the Agency s primary redevelopment focus has been on downtown San José, major commercial corridors, and industrial areas. In recent years, Agency Board and public interest has been growing in the preservation and revitalization of the older residential neighborhoods in the City. The Strong Neighborhoods Initiative ( SNI ) is a partnership of the City, the Agency and the community to revitalize and redevelop neighborhoods in a new project area (the SNI Project Area ) with public improvement projects such as streetscape improvements, traffic calming, transit and parking improvements and community based projects such as community centers, libraries, public schools, open space and recreational facilities. In total, the SNI Project Area encompasses approximately 9,865 acres and consists of 22 neighborhoods grouped within six non-contiguous sub-areas. The SNI Project Area consists predominantly of residential land uses. The remainder of the SNI Project Area is developed with a mixture of commercial, industrial, public/quasi-public, open space/recreation, agricultural and vacant land uses. The redevelopment plan for the SNI Redevelopment Project Area was adopted in June The SNI Project Area is a non-tax increment-revenue-generating redevelopment project. Industrial. Five project areas are in this category: Rincon de los Esteros has four components comprising a total of 4,795 acres and is zoned primarily for industrial park uses. Approximately 247 acres are currently undeveloped. Also known as the Innovation Triangle, this area contains one of Silicon Valley s largest concentrations of businesses including research and development, office, manufacturing, light industrial, and warehouse uses. The Agency estimates that more than 1,200 businesses employing more than 54,000 people are located in the area. Major employers include Cisco Systems, Agilent, Analog Devices, Brocade, Siemens, Novellus, Sony America, Cypress Semiconductors, ebay, BEA, Samsung, Sanmina, Canon, Philips Components, Atmel, Altera, Cadence Design and KLA Tencor. The Agency has invested more than $172 million since 1977 in infrastructure improvements in this industrial project area. The area is adjacent to the Norman Y. Mineta San José International Airport and is bounded by Routes 237, U.S. 101 and Interstate 880. It is served by the Light Rail Transit System and other public transportation facilities and is connected to the downtown by Route 87. Edenvale has two components totaling 2,045 acres and is zoned primarily for light industrial uses, including research and development, office and manufacturing uses. Approximately 300 acres remain undeveloped. Located 10 miles south of downtown, it is currently home to approximately 300 firms employing approximately 13,000 people. Major employers include Hitachi, IBM, IDT, Electroglas, Northrop Grumman, Solectron, M/A-Com, Tyco Electronics, Clinimetrics, Power Integration, Stryker Endoscopy, Western Digital, Jabil Circuits, Helio Solutions and Ionics. The Agency has invested nearly $90 million in infrastructure improvements to prepare the area for industrial development. The widening of U.S. 101, the extension of light rail transit and the opening of Route 85 provide greater accessibility to the industrial park. Julian-Stockton, in the older portion of the central business district at the northern entrance to the downtown area, is an area where current uses are primarily light manufacturing, warehousing, small office and commercial. The area is home to approximately 330 employers with approximately 2,500 employees. Three major public projects in this area include the HP Pavilion at San José, the Guadalupe Parkway (Route 87) and the Guadalupe River Park. Major employers in the area include PG&E, Gandiff Industries, Fire Clay Tile, Comerica Bank, Aramark and Milligan News. The Agency has invested nearly $14 million in infrastructure improvements since Olinder is an older light industrial area at the intersection of U.S. 101 and Route 280 just south of downtown. This area has approximately 83 employers with approximately 1,425 employees. Major employers include Air Systems, Jennings Technology and Sal J. Acosta Sheetmetal. The Agency has invested over $1.5 million in infrastructure improvements in this project area. Monterey Corridor was established in There are more than 286 employers with approximately 6,728 employees in the area. Major employers include US Healthworks, Office Records Management, 25

34 Simsmetal USA, Southern Lumber and San José Mailing. The Agency has invested over $14 million in infrastructure improvements in this project area. The industrial project areas expanded rapidly in terms of job growth and leaseable research and development, industrial, warehouse and office space during the technology boom leading up to the year The occupancy rate for leaseable space peaked in the first quarter of 2000 at approximately 98% (i.e., a vacancy rate of 2%). Since this peak, the technology sector has contracted, and as of the fourth quarter of 2004, the occupancy rate in these industrial project areas has dropped to approximately 80% (i.e., a vacancy rate of approximately 20%). Job loss has also been significant in these areas during the same period. LAND USE WITHIN THE MERGED PROJECT AREA The following Table 2 sets forth the various land uses within the Merged Project Area by assessed valuation as of Fiscal Year Industrial Commercial Residential Vacant Other Urban Agricultural Totals Land Use Table 2 LAND USE WITHIN THE MERGED PROJECT AREA Secured Percentage of Total Number of Assessed Valuation Assessed Valuation Parcels $5,576,937,352 3,200,222,372 1,628,401, ,772, ,854,256 41,504,604 $10,988,692,633 Note: Assessed valuation includes homeowner s exemptions. Sources: County of Santa Clara; Urban Analytics, LLC % % , ,238 Percentage of Total Parcels 17.53% % TAX RATES The difference between the actual tax rate and the 1.00% rate established by Article XIIIA of the California Constitution is attributable to the tax rates levied to service debt approved by the voters. The estimated tax override rate for representative tax rate areas ( TRAs ) for the past fiscal year is set forth in Table 3. TRAs shown in Table 3 have been selected by the Fiscal Consultant as representative of the tax rates prevailing in the areas comprising the Merged Project Area. Except with respect to the County retirement levy, the tax override rates will be reduced as the debt supported by such tax override rates is retired. Tax override rates for debt issued on or after January 1, 1989, are not taken into account in determining the amount of tax increment revenue allocable to the Agency. See FACTORS AFFECTING TAX ALLOCATION FINANCING Proposition

35 Sub Area Rincon San Antonio Plaza Edenvale Olinder (a) Table 3 TAX LEVIES IN REPRESENTATIVE TAX RATE AREAS MERGED PROJECT AREA, FISCAL YEAR (a) (Levies in Percentages) Tax Rate Area Code (b) Basic Levy County Retirement Levy Oak Grove School District Levy Total Levy All Rolls Santa Clara Valley Water District (c) Excludes debt service levies not allocated to the Agency. (b) Tax rate area codings were consolidated by the County for the Fiscal Year (c) Santa Clara Valley Water District levy applies to land and improvements assessed value only. Total levy excludes 0.008% for State and Local Water Project indebtedness assessed on land and improvement value only. Sources: Santa Clara County Controller; Urban Analytics, LLC. HISTORIC ASSESSED VALUE AND HOUSING SET-ASIDE AMOUNTS Table 4 below sets forth historical information on assessed value, tax increment revenues and Housing Set-Aside Amounts for the Merged Project Area through Fiscal Year Table 4 ACTUAL ASSESSED VALUE AND HOUSING SET-ASIDE AMOUNTS FROM FISCAL YEAR THROUGH FISCAL YEAR Supplemental Gross Tax Revenues (b) (a) Change Tax Increment Assessments Percentage Fiscal Year Assessed Value $ 7,016, % $ 67,878 $ 355 $ 68, ,680, ,372 1,650 76, ,292, ,113 5,100 96, ,228, ,298 5, , ,382, ,982 9, , ,761, ,649 7, , ,886, ,926 12, , ,732, ,448 10, , ,962, ,015 2, , ,040, ,767 1, ,272 Note: all dollar amounts in thousands. (a) Total assessed value for the Merged Project Area. Tax increment revenue calculated on incremental assessed value, after subtracting base year assessed value from total assessed value. The Merged Project Area s current base year value is $1,097,107,127. (b) Includes unitary roll revenue. Source: The Agency; Urban Analytics, LLC. TWENTY LARGEST TAXPAYERS Table 5 lists the twenty largest taxpayers in the Merged Project Area and each property owner s percentage of the total assessed value in the Merged Project Area (which is $15,040,831,200 for Fiscal Year ). 27

36 Table 5 TWENTY LARGEST TAXPAYERS FOR FISCAL YEAR (1) Taxpayer Secured and Utility Unsecured Total Percentage Cisco Systems, Inc. Hitachi Global Storage Techs Inc. (2) Spieker Properties Irvine Community Development Company Sobrato Companies Adobe Systems Inc. Carramerica Realty Corp. Agilent Technologies, Inc. Novellus Systems Inc. Los Esteros Critical Energy Facility ABN AMRO Leasing Inc. ebay Inc. Maxim Integrated Products Inc. KLA Instruments Corp. Cadence Design Systems Inc. Mission West Properties LP Sony Corporation America Shea River Oaks Associates LP WXI/ZAN Real Estate LP Peery Richard Top 20 Totals $ 586,080, ,124, ,409, ,897, ,206, ,865, ,461, ,177, ,103, ,696, ,534, ,319, ,432, ,698, ,509, ,959, ,666, ,453, ,524,865 $ 4,042,122,086 $1,374,074, ,631,151 91,055 16, ,477, ,196, ,035,613 16,088, , $1,640,820,947 $ 1,960,154, ,124, ,409, ,897, ,206, ,496, ,552, ,194, ,477, ,103, ,696, ,731, ,319, ,467, ,787, ,509, ,959, ,875, ,453, ,524,865 $ 5,682,943, % % Agency Totals $11,197,792,219 $3,843,038,981 $15,040,831, % (1) Combined secured and unsecured rolls. (2) Historically, IBM has been among the top twenty taxpayers in the Merged Project Area, but it recently sold a large site within the Merged Project Area to Hitachi. Source: County of Santa Clara; Urban Analytics, LLC. Cisco Systems, Inc. ( Cisco ), the largest taxpayer in the Merged Project Area, manufactures and sells networking and communications products and provides services associated with that equipment and its use. The company reports more than 34,000 employees worldwide and Fiscal Year 2004 revenue of approximately $22 billion. The company has been headquartered in San José since 1994 and employs approximately 16,000 people in the City. Cisco has been the largest property owner in the Project Area since Fiscal Year Cisco s assessed value has increased from approximately $1.03 billion in Fiscal Year to approximately $1.96 billion in Fiscal Year However, Cisco has filed an appeal as to the assessed value of its properties in each of the past three fiscal years. See Tables 8 and 10 of the Fiscal Consultant s Report for Cisco s assessed value in the Project Area over the five most recent fiscal years. ASSESSMENT APPEALS AND ASSESSOR REDUCTIONS Pursuant to California law, a property owner may apply for a reduction of the property tax assessment for such owner's property by filing a written application, in the form prescribed by the State Board of Equalization, with the appropriate county assessment appeals board (a "Proposition 8" appeal). In addition to reductions in assessed value resulting from Proposition 8 appeals, Proposition 8 also allows assessors to reduce assessed value unilaterally to reflect reductions in market value. In Santa Clara County (the County ), a property owner desiring to reduce the assessed value of such owner's property in any one year must submit an application to the Santa Clara County Assessment Appeals Board (the Appeals Board ). Applications for any tax year must be submitted by September 15 of such tax year. Following a review of the application by the County Assessor's Office (the Assessor ), the Assessor may offer to the property owner to stipulate to a reduced assessment, or may confirm the assessment. If no stipulation 28

37 is agreed to, and the applicant elects to pursue the appeal, the matter is brought before the Appeals Board for a hearing and decision. The Appeals Board generally is required to determine the outcome of appeals within two years of each appeals filing date. Any reduction in the assessment ultimately granted applies only to the year for which application is made and during which written application is filed. The assessed value increases to its pre-reduction level for fiscal years following the year for which the reduction application is filed. However, if the taxpayer establishes through proof of comparable values that the property continues to be overvalued (known as ongoing hardship ), the Assessor has the power to grant a reduction not only for the year for which application was originally made, but also for the then current year as well. In a similar manner, the Assessor may reassert the pre-appeal level of assessed value depending on the Assessor's determination of current value. Appeals of property value assessments by property owners in the Merged Project Area and unilateral reductions by the Assessor can result in reductions in assessed valuations that affect the Agency s collection of tax increment revenues. The County calculates and pays the Agency tax increment revenue based on the full enrolled valuation at the beginning of the fiscal year and makes no adjustment to the Agency s revenue from roll changes occurring during the year. Successful appeals resulting in refunds to property owners have not been charged back to the Agency. The Agency cannot give any assurances that the County will continue this practice. Thus far, the one exception to this practice occurred in Fiscal Year when the Agency reimbursed the County for the successful appeal by a consortium of computer companies of unsecured property. See SPECIAL RISK FACTORS Reduction in Taxable Value and Appeals and Assessor Reductions to Assessed Value. Table 6 lists the assessment appeal results with respect to the Merged Project Area for Fiscal Years through Fiscal Year Table 6 ASSESSMENT APPEAL RESULTS, MERGED PROJECT AREA FISCAL YEARS THROUGH Resolved Appeals County Roll Value Applicant Opinion of Value Final Roll Value Percentage of Roll Value Retained $ 4,719,044,470 $ 2,305,728,402 $ 4,667,854, % ,211,724,489 2,551,114,193 5,161,069, ,085,715,521 3,005,096,188 5,072,465, ,605,431,994 2,503,024,064 4,567,651, ,719,155,099 2,338,646,428 4,608,744, ,816,695,553 3,715,681,272 6,435,619, ,256,337,761 1,786,860,581 3,023,282, ,979, ,010, ,541, Total 2,733 $ 34,616,084,291 $18,324,161,230 $ 33,737,229, % Source: County of Santa Clara, Urban Analytics, LLC Based on records provided by the County and compiled by the Fiscal Consultant, there are 782 appeals currently pending within the Merged Project Area as of June 7, 2005 (i.e., the date of the Fiscal Consultant Report), with a combined valuation in dispute of approximately $4.7 billion. Among these are 124 appeals filed by large property owners in the Merged Project Area for Fiscal Year with an aggregate disputed value differential ( ADVD ) of $950.6 million; 66 large-owner properties pending appeal for Fiscal Year with an ADVD of $662.1 million; and 45 large-owner properties pending appeal for Fiscal Year with an ADVD of $380.2 million. For the eight fiscal years ending with Fiscal Year , a total of 2,733 appeals have been resolved, with a cumulative taxable value retention on the tax rolls of 97.46%. The resolved appeals 29

38 involved ADVD of $16.3 billion, but the net cumulative reduction in taxable value on resolved appeals was $878.9 million. For additional information on assessment appeals in the Merged Project Area, see APPENDIX D REPORT OF FISCAL CONSULTANT Assessment Appeals. The future success of appeals and resulting reductions in the Merged Project Area taxable valuation may vary from past averages, and no assurance is given that any past rate of value retention will be similar to any future rate. Successful appeals and changes in County practices could adversely affect the available Housing Set-Aside Amounts to pay debt service on the Bonds and Parity Obligations. In addition to reductions in assessed value resulting from Proposition 8 appeals, California law also allows assessors to reduce assessed value unilaterally. For example, in Fiscal Year the County Assessor reduced assessed values county-wide by a cumulative amount of approximately $8 billion (approximately $2.3 billion in the Merged Project Area) and in Fiscal Year by a cumulative amount of $10.6 billion ($2.9 billion in the Merged Project Area). The County Assessor s Office notes that Proposition 8 reductions are temporary and are expected to be eliminated under Proposition 13 if and when market conditions improve; however, no assurance is given that such reductions will be eliminated. See THE REDEVELOPMENT AGENCY OF THE CITY OF SAN JOSE Assessment Appeals and Assessor Reductions and APPENDIX D REPORT OF FISCAL CONSULTANT Assessment Appeals (including Tables 9 and 10 therein). In a media release dated May 26, 2005 (the Release ), the County Assessor s Office stated that the market value of commercial and industrial properties in the County remained essentially unchanged from that of last year, while the market value of residential properties rose substantially over last year s value. The Release further stated that the number of commercial and industrial properties countywide eligible for temporary property tax relief due to declines in the marketplace is expected to remain the same as last year at 1,500 properties, while the number of residential properties eligible for temporary property tax relief has dropped from 23,000 to 3,000. According to information provided by the County Assessor s Office subsequent to the Release, the total countywide reduction from base year assessed value for land and improvements continues to be approximately $9.5 billion, of which approximately $8.6 billion represents reductions in the assessed value of commercial and industrial properties (personal property is not subject to such temporary property tax relief). The Release does not indicate what portion of the reductions are for properties within the Project Area. The information set forth in the Release is preliminary. The final assessed values for have yet to be released. No assurance can be given that the actual final assessed values for will not reflect information that differs substantially from the information set forth in the Release. See PROJECTED DEBT SERVICE COVERAGE below and SPECIAL RISK FACTORS Reduction in Taxable Value and Assessment Appeals and Assessor Reductions to Assessed Value. DEBT SECURED BY HOUSING SET-ASIDE AMOUNTS Senior Bonds. Upon the issuance of the Bonds and the refunding of the Refunded Bonds, the Agency will have outstanding $212,525,000 of its Merged Project Area Redevelopment Project Housing Set-Aside Tax Allocation Bonds secured on a parity basis solely by Housing Set-Aside Amounts and other amounts available under the Agreement. All of this debt is fixed rate. Subordinate Bonds. Simultaneously with the issuance of the Bonds, the Agency intends to issue two series of Subordinate Bonds in the combined approximate aggregate principal amount of $66,150,000 which will be secured by the Housing Set-Aside Amounts on a basis subordinate to the payment of debt service on the Senior Bonds. Line of Credit Agreement. The Agency and the City have entered into a Line of Credit Agreement with The Bank of New York, dated as of March 1, 2003 (the Line of Credit Agreement ) under which the Agency has a revolving line of credit (the Line of Credit ) in an amount not to exceed $50,000,000, to provide interim funding for acquisition, construction and rehabilitation of low and moderate income housing projects. The Agency s repayment obligations under the Line of Credit Agreement are secured by the 20% housing set-aside 30

39 tax increment revenues on a basis subordinate to the Senior Bonds, the Series 2002 Bonds and the Subordinate Bonds. PROJECTED DEBT SERVICE COVERAGE Table 7 sets forth estimated Housing Set-Aside Amounts and projected annual debt service on the Bonds. Debt service coverage is based on estimates of Fiscal Year Housing Set-Aside Amounts held constant for the future while taking into account termination of tax revenue collection in certain project areas. Assuming no growth in assessed valuation thereafter and including the budgeted reduction in valuation for of approximately 1.6%, debt service coverage on the Bonds is approximately 1.93 to 1 for the next 30 years (through the Bond Year ending August 1, 2035). Through the Bond Year ending August 1, 2035, the lowest projected debt service coverage ratio for the outstanding Senior Bonds upon the issuance of the Bonds will be not less than approximately 1.93 to 1. [REMAINDER OF PAGE INTENTIONALLY LEFT BLANK] 31

40 Table 7 PROJECTED DEBT SERVICE COVERAGE Bond Year Ending August 1 Projected Housing Set-Aside Amounts (1) Prior Bonds Debt Service (2) Debt Service on the Bonds Total Senior Bonds Debt Service Subordinate Bonds Debt Service (3) Total Debt Service Estimated Coverage (times) Estimated Combined Coverage (times) 2005 $29,753,334 $7,004, $ 7,004,928 $ 214,580 $ 7,219, x 4.12x ,393,009 7,008,928 $ 8,199,052 15,207,980 4,107,550 19,315, x 1.52x ,393,009 7,011,528 8,197,364 15,208,892 4,106,130 19,315, x 1.52x ,393,009 7,013,048 8,193,872 15,206,920 4,110,689 19,317, x 1.52x ,393,009 7,014,618 8,190,346 15,204,964 4,113,337 19,318, x 1.52x ,393,009 7,011,243 8,196,712 15,207,954 4,107,625 19,315, x 1.52x ,393,009 7,010,036 8,193,875 15,203,911 4,111,585 19,315, x 1.52x ,393,009 5,830,436 9,376,259 15,206,695 4,110,584 19,317, x 1.52x ,393,009 5,842,573 9,365,292 15,207,865 4,108,657 19,316, x 1.52x ,393,009 5,838,566 9,365,512 15,204,078 4,112,000 19,316, x 1.52x ,393,009 5,849,159 9,355,740 15,204,898 4,109,675 19,314, x 1.52x ,393,009 5,846,761 9,362,120 15,208,881 4,106,758 19,315, x 1.52x ,393,009 5,856,641 9,347,910 15,204,551 4,113,898 19,318, x 1.52x ,393,009 5,847,734 9,359,775 15,207,509 4,109,200 19,316, x 1.52x ,393,009 5,865,080 9,339,025 15,204,105 4,114,110 19,318, x 1.52x ,393,009 5,859,870 9,347,035 15,206,905 4,112,173 19,319, x 1.52x ,393,009 5,868,663 9,339,190 15,207,853 4,111,303 19,319, x 1.52x ,500,238 4,190,283 10,038,328 14,228,611 3,846,825 18,075, x 1.52x ,500,238 4,192,473 10,032,189 14,224,662 3,846,555 18,071, x 1.52x ,500,238 4,206,065 10,021,314 14,227,379 3,843,870 18,071, x 1.52x ,500,238 4,345,128 9,880,176 14,225,304 3,848,779 18,074, x 1.52x ,500,238 4,357,574 9,868,423 14,225,997 3,847,990 18,073, x 1.52x ,223,175 4,362,445 7,136,784 11,499,229 3,106,995 14,606, x 1.52x ,897, ,375 10,849,274 11,328,649 3,064,819 14,393, x 1.52x ,980, ,125 8,821,094 9,301,219 2,513,841 11,815, x 1.52x ,980, ,303,909 9,303,909 2,511,520 11,815, x 1.52x ,980, ,300,314 9,300,314 2,515,860 11,816, x 1.52x ,638, ,019,333 6,019,333 1,632,285 7,651, x 1.52x ,638, ,023,689 6,023,689 1,627,695 7,651, x 1.52x ,954, ,147,484 5,147,484 1,391,795 6,539, x 1.52x ,420, , , , , x 1.51x TOTAL $770,257,851 $134,193,275 $255,904,336 $390,097,611 $103,786,082 $493,883,692 1 The Projected Housing-Set Aside Amounts include a budgeted reduction of approximately 1.6% in valuation in and no growth thereafter. The projections also include nineteen properties identified by the Agency as having sold in the Project Area since January 1, 2004, the lien date for the roll. These properties are expected to add $67.3 million in new valuation to the roll. 2 See AGGREGATE DEBT SERVICE. 3 Assuming an interest rate of 3.7%. 32

41 SPECIAL RISK FACTORS The following information should be considered by prospective investors in evaluating the Bonds. However, this is not an exclusive listing of risks and other considerations that may be relevant to investing in the Bonds, and the order in which the following information is presented is not intended to reflect the relative importance of any such risks and considerations. The various legal opinions to be delivered concurrently with the issuance of the Bonds will be qualified as to the enforceability of the various legal instruments by limitations imposed by State and federal laws, rulings and decisions affecting remedies, and by bankruptcy, reorganization or other laws of general application affecting the enforcement of creditors rights, including equitable principles. TAX INCREMENT REVENUE LIMITATION The Agency s ability to collect tax increment is limited not only by the time limits on the repayment of debt, but also by the cap on total tax increment to be received from the Merged Project Area. The cumulative tax increment that the Agency may receive from the Merged Project Area is capped at $7.6 billion. The total amount of tax increment received by the Agency through June 30, 2004 is approximately $1.9 billion. The Agency expects to receive approximately $150 million in additional increment by June 30, Depending upon the rate of growth in tax increment received from the Merged Project Area, it is possible that the Agency may reach its overall tax increment cap prior to reaching the time limits on the repayment of debt and/or prior to the final maturity of the Bonds. The Fiscal Consultant has prepared a tax increment projection and sensitivity analysis that projects the Agency s Merged Project Area tax increment revenues over time, assuming various increment growth rates. With increment projected using an annual growth rate of two percent, the projection shows that the Agency would reach its tax increment cap in Fiscal Year With increment projected using an annual growth rate of five percent, the projection shows that the Agency would reach its tax increment cap in Fiscal Year With increment projected using an annual growth rate of seven percent, the projection shows that the Agency would reach its tax increment cap in Fiscal Year See APPENDIX D REPORT OF FISCAL CONSULTANT Tax Increment Cap and Tax Increment Projection and Sensitivity Analysis. In the event that the Agency reaches its tax increment cap, it would not collect any additional tax increment to pay debt service on the Bonds. However, in the Seventh Supplemental Agreement, the Agency covenants, commencing December 1, 2005, to calculate annually the remaining amount available under its tax increment revenue limitation and the amount of obligations that exist to be paid from tax increment revenue, including obligations payable from the Housing Set-Aside Amounts. If, based on such review, the allocation of Housing Set-Aside Amounts to the Agency in any of the next three succeeding fiscal years will cause an amount equal to 90% of the Housing Set-Aside Amounts remaining to be allocated under the Merged Project Area Redevelopment Plans to fall below the obligations payable from the Housing Set-Aside Amounts, the Agency will be obligated either to use Housing Set-Aside Amounts not needed to pay such obligations to retire or defease Senior Bonds or to adopt a plan approved by a qualified redevelopment consultant which demonstrates the Agency's continuing ability to pay debt service on the Senior Bonds. See APPENDIX B SUMMARY OF CERTAIN PROVISIONS OF THE AGREEMENT Covenants Plan Limit. REDUCTION IN TAXABLE VALUE Tax increment revenue allocated to the Agency is determined by the amount of incremental taxable value in the Merged Project Area and the current rate or rates at which property in the Merged Project Area is taxed. The reduction of taxable values of property in the Merged Project Area caused by economic factors beyond the Agency s control, such as relocation out of the Merged Project Area by one or more major property owners, sale of property to a non-profit corporation exempt from property taxation, or the complete or partial destruction of such property caused by, among other eventualities, earthquake or other natural disaster, could cause a reduction in the Housing Set-Aside Amounts that secure the Bonds. Such reduction of Housing 33

42 Set-Aside Amounts could have an adverse effect on the Agency s ability to make timely payments of principal of and interest on the Bonds. As described in greater detail under FACTORS AFFECTING TAX ALLOCATION FINANCING Property Tax Limitations: Article XIIIA of the California Constitution, Article XIIIA provides that the full cash value base of real property used in determining taxable value may be adjusted from year to year to reflect the inflation rate, not to exceed a two percent increase for any given year, or may be reduced to reflect a reduction in the consumer price index, comparable local data or any reduction in the event of declining property value caused by damage, destruction or other factors (as described above). Such measure is computed on a calendar year basis. Any resulting reduction in the full cash value base over the term of the Bonds could reduce Housing Set-Aside Amounts securing the Bonds. In addition to the other limitations on and State-required set-asides of tax increment revenue described herein under FACTORS AFFECTING TAX ALLOCATION FINANCING, the State electorate or Legislature could adopt a constitutional or legislative property tax reduction with the effect of reducing tax increment revenues payable to the Agency and thus available Housing Set-Aside Amounts. There is no assurance that the State electorate or Legislature will not at some future time approve additional limitations that could reduce the tax increment revenue and adversely affect the security of the Bonds. RISKS TO REAL ESTATE MARKET The Agency s ability to make payments on the Bonds will be dependent upon the economic strength of the Merged Project Area. The general economy of the Merged Project Area will be subject to all of the risks generally associated with real estate markets. Real estate prices and development may be adversely affected by changes in general economic conditions, fluctuations in the real estate market and interest rates, unexpected increases in development costs and by other similar factors. Further, real estate development within the Merged Project Area could be adversely affected by limitations of infrastructure or future governmental policies, including governmental policies to restrict or control development. In addition, if there is a decline in the general economy of the Merged Project Area, the owners of property within the Merged Project Area may be less able or less willing to make timely payments of property taxes or may petition for reduce assessed valuation causing a delay or interruption in the receipt of tax increment revenue by the Agency from the Merged Project Area. See LOCAL ECONOMY below. LOCAL ECONOMY The technology business sector contributes significantly to the Silicon Valley economy, including property values within the Merged Project Area. The recent contraction of the technology business sector has led to significant reductions in property values both in Silicon Valley and in the Merged Project Area. While improvement in this business sector may lead to increased property values, the continued importance of technology business to the area economy may continue to affect property values. ASSESSMENT APPEALS AND ASSESSOR REDUCTIONS TO ASSESSED VALUE Pursuant to California law, a property owner may apply for a reduction of the property tax assessment for such owner s property by filing a written application, in the form prescribed by the State Board of Equalization, with the appropriate county assessment appeals board (a Proposition 8 appeal). In addition to reductions in assessed value resulting from Proposition 8 appeals, Proposition 8 also allows assessors to reduce assessed value unilaterally. To the extent assessed values are reduced through the assessment appeal or unilateral reduction process, tax increment revenue securing the Bonds will be reduced. A reduction in taxable values within the Merged Project Area and the refund of taxes which may arise out of successful appeals by property owners or unilateral reduction by the County Assessor will affect the amount of Housing Set-Aside Amounts available for payment of the Bonds. See THE REDEVELOPMENT AGENCY OF THE CITY OF SAN 34

43 JOSE Assessment Appeals and Assessor Reductions and APPENDIX D REPORT OF FISCAL CONSULTANT Assessment Appeals. LEVY AND COLLECTION OF TAXES The Agency has no power to levy or collect property taxes. Any reduction in the tax rate or the implementation of any constitutional or legislative property tax decrease could reduce the Housing Set-Aside Amounts, and accordingly, could have an adverse effect on the ability of the Agency to pay debt service on the Bonds. Likewise, delinquencies in the payment of property taxes and the impact of bankruptcy proceedings on the legal ability to collect property taxes could have an adverse effect on the Agency s ability to make timely debt service payments. However, since 1993 the County s practice has been to allocate to the Agency its proportionate share of property taxes collected Countywide regardless of delinquencies, but the County could discontinue this practice at any time. PERSONAL PROPERTY ON THE UNSECURED TAX ROLL Approximately $3.8 billion (about 25%) of the assessed value for Fiscal Year in the Merged Project Area is personal property that is on the unsecured tax roll. In general, the assessed value of this type of personal property has been and may be subject to a high degree of fluctuation. Factors contributing to fluctuations include relocation of personal property out of the Merged Project Area, obsolescence and rapid depreciation. See FACTORS AFFECTING TAX ALLOCATION FINANCING PROPERTY TAX COLLECTION PROCEDURES. STATE BUDGET DEFICITS In approving recent budgets, the State Legislature has enacted legislation which, among other things, reallocated funds from redevelopment agencies to school districts by shifting a portion of each redevelopment agency s tax increment, net of amounts due to other taxing agencies, to school districts for such Fiscal Years for deposit in the Education Revenue Augmentation Fund ( ERAF ). The amount required to be paid by a redevelopment agency was apportioned based on tax increment collected. In approving the budget for Fiscal Year , the Legislature fixed the aggregate ERAF transfer for the year at $135 million, of which the Agency paid approximately $10.1 million as its allocated share. In connection with its approval of the budget for Fiscal Year , the Legislature fixed the ERAF transfer at $250 million each for Fiscal Year and The Agency s Fiscal Year share is approximately $18.6 million. In so doing, the Legislature also authorized redevelopment agencies to extend the effective dates of their redevelopment plans. These transfers are not payable from Housing Set-Aside Amounts. The amounts paid into ERAF are deducted from the cumulative tax increment revenue receipts applied to the tax increment cap. See FACTORS AFFECTING TAX ALLOCATION FINANCING Redevelopment Time Limits above. The State s projected budget deficits continue to be substantial and may lead to subsequent ERAF transfers or other actions which might reduce the Agency s available Housing Set Aside Amounts and the Agency s ability to pay principal and interest on the Bonds and Parity Obligations. Prospective purchasers of the Bonds may wish to review information presented by the State at (maintained by the State Department of Finance) and (analysis by the State Office of the Legislative Analyst). The Agency does not prepare such information and cannot assume any responsibility for its accuracy, completeness or timeliness (or the continued accuracy of internet address information). Whether or not this information is accurate, complete or timely, prospective purchasers of the Bonds should observe that the posting or release of such information may change the perceived outlook for the Agency s continued receipt of Housing Set-Aside Amounts and thus the market price for the Bonds. 35

44 The State s budget deficit has yet to be resolved, and litigation is pending to challenge some of the measures already taken to reduce the deficit. Future legislation, litigation and other measures affecting the Agency s receipt of Housing Set-Aside Amounts in connection with the State budget situation cannot be predicted and may materially and adversely affect the Agency s ongoing ability to pay principal and interest on the Bonds and Parity Obligations. REDUCTIONS IN INFLATIONARY RATE As described in greater detail herein, Article XIIIA of the California Constitution provides that the full cash value base of real property used in determining taxable value may be adjusted from year to year to reflect the inflationary rate, not to exceed a 2% increase for any given year, or may be reduced to reflect a reduction in the consumer price index or comparable local data. Such measure is computed on a calendar year basis. Decreases in property values could cause a reduction in tax increment revenue received by the Agency. The inflation rate applicable to the assessment roll in Fiscal Year was 1.853%, the rate for Fiscal Year was 2%, the rate for Fiscal Year was also 2%, the rate for Fiscal Year was 2%, the rate for Fiscal Year was 2%, the rate for Fiscal Year is 1.867% and the rate for Fiscal Year will be 2.0%. See FACTORS AFFECTING TAX ALLOCATION FINANCING. STATEMENT OF INDEBTEDNESS Under Redevelopment Law, the Agency must file with the County a statement of indebtedness for the Merged Project Area by October 1, each year. The statement of indebtedness controls the amount of tax increment revenue that will be paid to the Agency in each fiscal year. See FACTORS AFFECTING TAX ALLOCATION FINANCING PROPERTY TAX COLLECTION PROCEDURES Filing of Statement of Indebtedness. In the event the Agency were to fail to file an annual statement of indebtedness, tax increment revenue available to the Agency could be adversely affected. BANKRUPTCY AND FORECLOSURE The payment of the tax increment revenue and the ability of the County to foreclose the lien of a delinquent unpaid tax may be limited by bankruptcy, insolvency, or other laws generally affecting creditors rights or by the laws of the State relating to judicial foreclosure. The various legal opinions to be delivered concurrently with the delivery of the Bonds (including Bond Counsel s approving legal opinion) will be qualified as to the enforceability of the various legal instruments by bankruptcy, insolvency, reorganization, moratorium, or other similar laws affecting creditors rights, by the application of equitable principles and by the exercise of judicial discretion in appropriate cases. Although bankruptcy proceedings would not cause the liens to become extinguished, bankruptcy of a property owner could result in a delay in prosecuting superior court foreclosure proceedings. Such delay would increase the likelihood of a delay or default in payment of the principal of and interest on the Bonds and the possibility of delinquent tax installments not being paid in full. ESTIMATED REVENUES In estimating that Housing Set-Aside Amounts will be sufficient to pay debt service on the Bonds, the Agency has made certain assumptions with regard to present and future assessed valuation in the Merged Project Area, future tax rates and percentage of taxes collected. The Agency believes these assumptions to be reasonable, but there is no assurance these assumptions will be realized and to the extent that the assessed valuation and the tax rates are less than expected, the Housing Set-Aside Amounts available to pay debt service on the Bonds will be less than those projected and such reduced Housing Set-Aside Amounts may be insufficient to provide for the payment of principal of, premium (if any) and interest on the Bonds. 36

45 EARTHQUAKE RISK The City is located within ten miles of the San Andreas Fault, the Hayward Fault and the Calaveras Fault, each known to be active faults. The City has experienced earthquakes with a Richter magnitude of 6.0 or greater and with the epicenter being within the San Francisco Bay Area. Widespread earthquake damage in the Merged Project Area would adversely affect assessed valuation and therefore the Housing Set-Aside Amounts available to pay debt service on the Bonds. HAZARDOUS SUBSTANCES An additional environmental condition that may result in the reduction in the assessed value of property would be the discovery of a hazardous substance that would limit the beneficial use of taxable property within the Merged Project Area. In general, the owners and operators of a property may be required by law to remedy conditions of the property relating to releases or threatened releases of hazardous substances. The owner or operator may be required to remedy a hazardous substance condition of property whether or not the owner or operator has anything to do with creating or handling the hazardous substance. If this situation were to occur with property within the Merged Project Area, the costs of remedying it could reduce the marketability and taxable value of the property. CHANGES IN THE LAW There can be no assurance that the California electorate will not at some future time adopt initiatives or that the Legislature will not enact legislation that will amend the Redevelopment Law or other laws or the Constitution of the State resulting in a reduction of Housing Set-Aside Amounts, which could have an adverse effect on the Agency s ability to pay debt service on the Bonds. In the event of an amendment or revision to the Redevelopment Law that would allow the Agency to set aside less than the Housing Set-Aside Amounts required to be set aside by the Agency as of the date of execution of the Agreement, the Agency has covenanted that it will continue to set aside a sufficient amount of Tax Increment Revenues to pay the Annual Debt Service on the Bonds and Parity Obligations and to make deposits to the Reserve Account as required by the Agreement. See SECURITY AND SOURCES OF PAYMENT FOR THE BONDS Pledge of Housing Set-Aside Amounts. FEDERAL TAX-EXEMPT STATUS OF THE SERIES 2005A BONDS Tax-Exempt Status of Interest on the Series 2005A Bonds. The Internal Revenue Code of 1986, as amended (the Code ) imposes a number of requirements that must be satisfied for interest on state and local obligations, such as the Series 2005A Bonds, to be excludable from gross income for federal income tax purposes. These requirements include limitations on the use of Bond proceeds, limitations on the investment earnings of Bond proceeds prior to expenditure, a requirement that certain investment earnings on Bond proceeds be paid periodically to the United States and a requirement that the issuers file an information report with the Internal Revenue Service (the IRS ). The Agency has covenanted in certain of the documents referred to herein that they will comply with such requirements. Failure to comply with the requirements stated in the Code and related regulations, rulings and policies may result in the treatment of interest on the Series 2005A Bonds as taxable, retroactively to the date of issuance of such Bonds. These considerations do not apply to interest on the Series 2005B Bonds, which is not intended to be excludable from gross income for federal income tax purposes. Audit. In December 1999, as a part of a larger reorganization of the IRS, the IRS commenced operation of its Tax Exempt and Government Entities Division (the TE/GE Division ), as the successor to its Employee Plans and Exempt Organizations division. The new TE/GE Division has a subdivision that is specifically devoted to tax-exempt bond compliance. Public statements by IRS officials indicate that the number of tax-exempt bond examinations is expected to increase significantly under the new TE/GE Division. There is no assurance that an IRS examination of the Series 2005A Bonds will not adversely affect the market value of such Bonds. See TAX MATTERS. 37

46 THE COOPERATION AGREEMENT AND CITY OF SAN JOSE DEPARTMENT OF HOUSING COOPERATION AGREEMENT Pursuant to the Redevelopment Law, Housing Set-Aside Amounts shall be utilized to increase, improve and/or preserve the supply of low and moderate income housing (the 20% Housing Program ). In order to provide for unified administration of various housing programs within the City, the Agency delegated to the City its obligation and authority to administer the 20% Housing Program and to distribute Housing Set-Aside Amounts, pursuant to a cooperation agreement entered into in 1987, which agreement is currently embodied in the Cooperation Agreement dated as of September 28, 1990, as amended (the Cooperation Agreement ). This delegation of authority includes the obligations to adopt or amend, from time to time, any 20% Housing Program policies, guidelines or procedures, consistent with the requirements of the Redevelopment Law, as may be necessary or convenient to achieve the ultimate purposes of the 20% Housing Program. The delegation also includes the authority to take any action or make any findings on behalf of the Agency with regard to the administration of the 20% Housing Program as required or permitted by law; provided, however, that Agency has retained the authority to issue or to approve the issuance of any bonds or other indebtedness secured by Housing Set-Aside Amounts. CITY OF SAN JOSE DEPARTMENT OF HOUSING The City of San José Department of Housing (the Department ) was established in late 1987 and was charged with the mission of preserving and improving the City s supply of decent, safe and sanitary housing affordable to low and moderate income households and, where appropriate, to ensure the long-term affordability of such housing and contribute to neighborhood revitalization. The Department was also given the responsibility to carry out the authority delegated under the Cooperation Agreement. Leveraging funds from a variety of federal, State, local and private sources, the Department administers a two-pronged approach to achieve City housing goals. First, it implements a number of comprehensive financial and technical assistance programs, all designed to increase and preserve the supply of decent, safe and sanitary housing affordable to low and moderate income households. These programs involve a wide array of activities that include rehabilitation of owner-occupied and rental properties, predevelopment assistance, property acquisition, new construction financing and second mortgage loans to qualified first-time homebuyers. The second prong to this approach involves following an agenda of policy initiatives identified to complement City production goals. These activities include policy research and development, legislative analysis and strategic planning. TAX MATTERS TAX MATTERS SERIES 2005A BONDS A. Federal Income Taxes The Internal Revenue Code of 1986, as amended (the Code ), imposes certain requirements that must be met subsequent to the issuance and delivery of the Series 2005A Bonds for interest thereon to be and remain excluded from gross income for Federal income tax purposes. Noncompliance with such requirements could cause the interest on the Series 2005A Bonds to be included in gross income for Federal income tax purposes retroactive to the date of issue of the Bonds. Pursuant to the Agreement and other instruments, the Agency and certain 501(c)(3) organizations who received loans that were refinanced with proceeds of the Series 1993D Bonds, which will be refunded with proceeds of the Series 2005A Bonds (the Borrowers ), have covenanted to comply with the applicable requirements of the Code in order to maintain the exclusion of the interest on the 38

47 Series 2005A Bonds from gross income for Federal income tax purposes pursuant to Section 103 of the Code. In addition, the Agency and the Borrowers have made certain representations and certifications in the Agreement and other instruments. Bond Counsel will also rely on the opinions of counsel to the Borrowers as to all matters concerning the status of the Borrowers as organizations described in Section 501(c)(3) of the Code and exempt from Federal income tax under Section 501(a) of the Code. Bond Counsel will not independently verify the accuracy of those representations and certifications or those opinions. In the opinion of Nixon Peabody LLP, Bond Counsel, under existing law and assuming compliance with the aforementioned covenant, and the accuracy of certain representations and certifications made by the Agency described above, interest on the Series 2005A Bonds is excluded from gross income for Federal income tax purposes under Section 103 of the Code. Bond Counsel is also of the opinion that interest on the Series 2005A Bonds is not treated as a preference item in calculating the alternative minimum tax imposed under the Code with respect to individuals and corporations. Interest on the Series 2005A Bonds is, however, included in the adjusted current earnings of certain corporations for purposes of computing the alternative minimum tax imposed on such corporations. B. State Taxes Bond Counsel is of the opinion that interest on the Series 2005A Bonds is exempt from California personal income taxation. C. Original Issue Discount Bond Counsel is further of the opinion that the difference between the principal amount of the Series 2005A Bonds maturing August 1, 2018 through August 1, 2021, inclusive (collectively the Discount Bonds ) and the initial offering price to the public (excluding bond houses, brokers or similar persons or organizations acting in the capacity of underwriters or wholesalers) at which price a substantial amount of such Discount Bonds of the same maturity was sold constitutes original issue discount which is excluded from gross income for federal income tax purposes to the same extent as interest on the Series 2005A Bonds. Further, such original issue discount accrues actuarially on a constant interest rate basis over the term of each Discount Bond and the basis of each Discount Bond acquired at such initial offering price by an initial purchaser thereof will be increased by the amount of such accrued original issue discount. The accrual of original issue discount may be taken into account as an increase in the amount of tax-exempt income for purposes of determining various other tax consequences of owning the Discount Bonds, even though there will not be a corresponding cash payment. Owners of the Discount Bonds are advised to consult with their own advisors with respect to the state and local tax consequences of owning such Discount Bonds. D. Original Issue Premium The Series 2005A Bonds maturing on August 1, 2022 through August 1, 2024, inclusive (collectively, the Premium Bonds ) are being offered at prices in excess of their principal amounts. An initial purchaser with an initial adjusted basis in a Premium Bond in excess of its principal amount will have amortizable bond premium which is not deductible from gross income for federal income tax purposes. The amount of amortizable bond premium for a taxable year is determined actuarially on a constant interest rate basis over the term of each Premium Bond based on the purchaser s yield to maturity (or, in the case of Premium Bonds callable prior to their maturity, over the period to the call date, based on the purchaser s yield to the call date and giving effect to any call premium). For purposes of determining gain or loss on the sale or other disposition of a Premium Bond, an initial purchaser who acquires such obligation with an amortizable bond premium is required to decrease such purchaser s adjusted basis in such Premium Bond annually by the amount of amortizable bond premium for the taxable year. The amortization of bond premium may be taken into account as a reduction in the amount of tax-exempt income for purposes of determining various other tax consequences of owning such Series 2005A Bonds. Owners of the Premium Bonds are advised to consult with their own advisors with respect to the state and local tax consequences of owning such Premium Bonds. 39

48 E. Certain Federal Tax Information with respect to the Series 2005A Bonds General. The following is a discussion of certain additional Federal income tax matters under existing statutes. It does not purport to deal with all aspects of Federal taxation that may be relevant to particular investors. Prospective investors, particularly those who may be subject to special rules, are advised to consult their own tax advisors regarding the Federal tax consequences of owning and disposing of the Series 2005A Bonds, as well as any tax consequences arising under the laws of any state or other taxing jurisdiction. Social Security and Railroad Retirement Payments. The Code provides that interest on tax-exempt obligations is included in the calculation of modified adjusted gross income in determining whether a portion of Social Security or railroad retirement benefits received are to be included in taxable income. Branch Profits Tax. The Code provides that interest on tax-exempt obligations is included in effectively connected earnings and profits for purposes of computing the branch profits tax on certain foreign corporations doing business in the United States. Borrowed Funds. The Code provides that interest paid (or deemed paid) on borrowed funds used during a tax year to purchase or carry tax-exempt obligations is not deductible. In addition, under rules used by the Internal Revenue Service for determining when borrowed funds are considered used for the purpose of purchasing or carrying particular assets, the purchase of obligations may be considered to have been made with borrowed funds even though the borrowed funds are not directly traceable to the purchase of such obligations. Property and Casualty Insurance Companies. The Code contains provisions relating to property and casualty insurance companies whereunder the amount of certain loss deductions otherwise allowed is reduced (in certain cases below zero) by a specified percentage of, among other things, interest on tax-exempt obligations acquired after August 7, Financial Institutions. The Code provides that commercial banks, thrift institutions and other financial institutions may not deduct the portion of their interest expense allocable to tax-exempt obligations acquired after August 7, 1986, other than certain qualified obligations. The Series 2005A Bonds are not qualified obligations for this purpose. S Corporations. The Code imposes a tax on excess net passive income of certain S corporations that have subchapter C earnings and profits. Interest on tax-exempt obligations must be included in passive investment income for purposes of this tax. Earned Income Credit. For any taxable year beginning after December 31, 1995, the Code denies the earned income credit to persons otherwise eligible for it if the aggregate amount of disqualified income of the taxpayer for the taxable year exceeds $2,200, subject to adjustment for inflation for taxable years beginning after December 31, Interest on the Series 2005A Bonds will constitute disqualified income for this purpose. Changes in Federal Tax Law and Post-Issuance Events. From time to time proposals are introduced in Congress that, if enacted into law, could have an adverse impact on the potential benefits of the exclusion from gross income for Federal income tax purposes of the interest on the Series 2005A Bonds, and thus on the economic value of the Series 2005A Bonds. This could result from reductions in Federal income tax rates, changes in the structure of the Federal income tax rates, changes in the structure of the Federal income tax or its replacement with another type of tax, repeal of the exclusion of the interest on the Series 2005A Bonds from gross income for such purposes, or otherwise. It is not possible to predict whether any legislation having an adverse impact on the tax treatment of holders of the Series 2005A Bonds may be proposed or enacted. Bond Counsel has not undertaken to advise in the future whether any events after the date of issuance and delivery of the Series 2005A Bonds may affect the tax status of interest on the Series 2005A Bonds. Bond Counsel expresses no opinion as to any Federal, State or local tax law consequences with respect to the Series 40

49 2005A Bonds, or the interest thereon, if any action is taken with respect to the Series 2005A Bonds or the proceeds thereof upon the advice or approval of other counsel. TAX MATTERS SERIES 2005B BONDS The following is a summary of certain anticipated United States federal income tax consequences of the purchase, ownership and disposition of the Series 2005B Bonds. The summary is based upon the provisions of the Code, the regulations promulgated thereunder and the judicial and administrative rulings and decisions now in effect, all of which are subject to change. The summary generally addresses Series 2005B Bonds held as capital assets and does not purport to address all aspects of federal income taxation that may affect particular investors in light of their individual circumstances or certain types of investors subject to special treatment under the federal income tax laws, including but not limited to financial institutions, insurance companies, dealers in securities or currencies, persons holding such Bonds as a hedge against currency risks or as a position in a straddle for tax purposes, or persons whose functional currency is not the United States dollar. Potential purchasers of the Series 2005B Bonds should consult their own tax advisors in determining the federal, state or local tax consequences to them of the purchase, holding and disposition of the Series 2005B Bonds. The advice set forth in this section was not intended or written by Bond Counsel to be used and cannot be used by an owner of the Series 2005B Bonds for the purpose of avoiding penalties that may be imposed on the owner of the Series 2005B Bonds. The advice set forth herein is written to support the promotion or marketing of the Series 2005B Bonds. Each owner of the Series 2005B Bonds should seek advice based on its particular circumstances from an independent tax advisor. A. Federal Income Taxes In the opinion of Nixon Peabody LLP, Bond Counsel, interest on the Series 2005B Bonds is not excluded from gross income for federal income tax purposes and so will be fully subject to federal income taxation. Purchasers other than those who purchase Series 2005B Bonds in the initial offering at their principal amounts will be subject to federal income tax accounting rules affecting the timing and/or characterization of payments received with respect to such bonds. In general, interest paid on the Series 2005B Bonds and recovery of accrued original issue and market discount, if any, will be treated as ordinary income to a bondholder and, after adjustment for the foregoing, principal payments will be treated as a return of capital. B. State Taxes Bond Counsel is of the opinion that interest on the Series 2005B Bonds is exempt from California personal income taxation. C. Market Discount Any owner who purchases a Series 2005B Bond at a price which includes market discount in excess of a prescribed de minimis amount (i.e., at a purchase price that is less than its adjusted issue price in the hands of an original owner) will be required to recharacterize all or a portion of the gain as ordinary income upon receipt of each scheduled or unscheduled principal payment or upon other disposition. In particular, such owner will generally be required either (a) to allocate each such principal payment to accrued market discount not previously included in income and to recognize ordinary income to that extent and to treat any gain upon sale or other disposition of such a Series 2005B Bond as ordinary income to the extent of any remaining accrued market discount (under this caption) or (b) to elect to include such market discount in income currently as it accrues on all market discount instruments acquired by such owner on or after the first day of the taxable year to which such election applies. The Code authorizes the Treasury Department to issue regulations providing for the method for accruing market discount on debt instruments the principal of which is payable in more than one installment. 41

50 Until such time as regulations are issued by the Treasury Department, certain rules described in the legislative history of the Tax Reform Act of 1986 will apply. Under those rules, market discount will be included in income either (a) on a constant interest basis or (b) in proportion to the accrual of stated interest. An owner of a Series 2005B Bond who acquires such Bond at a market discount also may be required to defer, until the maturity date of such Series 2005B Bonds or the earlier disposition in a taxable transaction, the deduction of a portion of the amount of interest that the owner paid or accrued during the taxable year on indebtedness incurred or maintained to purchase or carry a Series 2005B Bond in excess of the aggregate amount of interest (including original issue discount) includable in such owner s gross income for the taxable year with respect to such Series 2005B Bond. The amount of such net interest expense deferred in a taxable year may not exceed the amount of market discount accrued on the Series 2005B Bond for the days during the taxable year on which the owner held the Series 2005B Bond and, in general, would be deductible when such market discount is includable in income. The amount of any remaining deferred deduction is to be taken into account in the taxable year in which the Series 2005B Bond matures or is disposed of in a taxable transaction. In the case of a disposition in which gain or loss is not recognized in whole or in part, any remaining deferred deduction will be allowed to the extent gain is recognized on the disposition. This deferral rule does not apply if the bondowner elects to include such market discount in income currently as described above. D. Bond Premium A purchaser of a Series 2005B Bond who purchases such Series 2005B Bond at a cost greater than its then principal amount (or, in the case of a Series 2005B Bond issued with original issue premium, at a price in excess of its adjusted issue price) will have amortizable bond premium. If the holder elects to amortize the premium under Section 171 of the Code (which election will apply to all bonds held by the holder on the first day of the taxable year to which the election applies, and to all bonds thereafter acquired by the holder), such a purchaser must amortize the premium using constant yield principles based on the purchaser s yield to maturity. Amortizable bond premium is generally treated as an offset to interest income, and a reduction in basis is required for amortizable bond premium that is applied to reduce interest payments. Purchasers of any Series 2005B Bonds who acquire such Bonds at a premium (or with acquisition premium) should consult with their own tax advisors with respect to the determination and treatment of such premium for federal income tax purposes and with respect to state and local tax consequences of owning such Series 2005B Bonds. E. Sale or Redemption of Series 2005B Bonds A bondowner s tax basis for a Series 2005B Bond is the price such owner pays for the Series 2005B Bond plus the amount of any original issue discount and market discount previously included in income, reduced on account of any payments received (other than qualified periodic interest payments) and any amortized bond premium. Gain or loss recognized on a sale, exchange or redemption of a Series 2005B Bond, measured by the difference between the amount realized and the Series 2005B Bond basis as so adjusted, will generally give rise to capital gain or loss if the Series 2005B Bond is held as a capital asset (except as discussed above under Market Discount ). F. Backup Withholding A bondowner may, under certain circumstances, be subject to backup withholding (currently the rate of this withholding tax is 30% (although the rate is scheduled to be reduced over the next few years)) with respect to interest or original issue discount on the Series 2005B Bonds. This withholding generally applies if the owner of a Series 2005B Bond (a) fails to furnish the Trustee or other payor with its taxpayer identification number; (b) furnishes the Trustee or other payor an incorrect taxpayer identification number; (c) fails to report properly interest, dividends or other reportable payments as defined in the Code; or (d) under certain circumstances, fails to provide the Trustee or other payor with a certified statement, signed under penalty of perjury, that the taxpayer identification number provided is its correct number and that the holder is not subject to backup withholding. Backup withholding will not apply, however, with respect to certain payments made to 42

51 bondowners, including payments to certain exempt recipients (such as certain exempt organizations) and to certain Nonresidents (as defined below). Owners of the Series 2005B Bonds should consult their tax advisors as to their qualification for exemption from backup withholding and the procedure for obtaining the exemption. The amount of reportable payments for each calendar year and the amount of tax withheld, if any, with respect to payments on the Series 2005B Bonds will be reported to the bondowners and to the Internal Revenue Service. G. Nonresident Bondowners Under the Code, interest and original issue discount income with respect to Series 2005B Bonds held by nonresident alien individuals, foreign corporations or other non-united States persons ( Nonresidents ) generally will not be subject to the United States withholding tax (or backup withholding) if the Agency (or other person who would otherwise be required to withhold tax from such payments) is provided with an appropriate statement that the beneficial owner of the Series 2005B Bond is a Nonresident. Notwithstanding the foregoing, if any such payments are effectively connected with a United States trade or business conducted by a Nonresident bondowner, they will be subject to regular United States income tax, but will ordinarily be exempt from United States withholding tax. H. ERISA The Employees Retirement Income Security Act of 1974, as amended ( ERISA ), and the Code generally prohibit certain transactions between a qualified employee benefit plan under ERISA or tax-qualified retirement plans and individual retirement accounts under the Code (collectively, the Plans ) and persons who, with respect to a Plan, are fiduciaries or other parties in interest within the meaning of ERISA or disqualified persons within the meaning of the Code. All fiduciaries of Plans, in consultation with their advisors, should carefully consider the impact of ERISA and the Code on an investment in any Series 2005B Bonds. CONTINUING DISCLOSURE The Agency has covenanted for the benefit of the beneficial owners of the Bonds to provide certain financial information and operating data relating to the Agency by not later than the last day of the ninth month after the end of the Agency s fiscal year (the Annual Report ), commencing with the report related to fiscal year , and to provide notices of the occurrence of certain enumerated events, if material. The Annual Report will be filed by the Fiscal Agent with each Nationally Recognized Municipal Securities Information Repository and with a State Depository, if any. The notices of material events will be filed by the Fiscal Agent on behalf of the Agency with the Municipal Securities Rulemaking Board. The specific nature of the information to be contained in the Annual Report or the notices of material events is summarized in APPENDIX F FORM OF CONTINUING DISCLOSURE AGREEMENT. Any filing pursuant to the Continuing Disclosure Agreement may be made by filing the same with any agent, including a central post office, which is responsible for accepting notices, documents or information for transmission to such Nationally Recognized Municipal Securities Information Repository or State Depository, if any, to the extent permitted by the Securities and Exchange Commission These covenants have been made in order to assist the Underwriters in complying with S.E.C. Rule 15c2-12(b)(5). The Agency filed its annual disclosure report due February 1, 2003 relating to certain of its outstanding bonds on or about May 30, Other than this late filing, the Agency has never failed to comply in all material respects with its previous undertakings to provide annual reports or notices of material events. 43

52 APPROVAL OF LEGALITY The validity of the issuance of the Bonds is subject to the approval of Nixon Peabody LLP, San Francisco, California, acting as Bond Counsel. Said firm is also serving the Agency as Disclosure Counsel. Certain legal matters will be passed upon for the Underwriters by Hawkins Delafield & Wood LLP, for the Agency by its General Counsel, for the Authority by its counsel and for the City by the City Attorney. LITIGATION Other than as described below, there is no pending or, to the best knowledge of the Agency, threatened litigation seeking to restrain or enjoin the issuance, sale, execution or delivery of the Bonds, or in any way contesting or affecting the validity of the Bonds or any proceeding of the Agency taken with respect to the issuance or sale thereof, the pledge or application of any moneys or security provided for the payment of the Bonds, or existence or powers of the Agency, or the authority of the Agency to enter into any document relating to the Agreement or the Bonds. In August 2004, the City and the Agency filed a lawsuit seeking a judicial determination as to whether the County had breached an agreement entered into among the parties in May 2001 (the 2001 Agreement ). The 2001 Agreement included provisions regarding redevelopment tax increment allocation and the application of land use procedures in County territory within the San José urban service area. The City and the Agency contend that under the 2001 Agreement, the County was required to abide by City land use procedures before it entered into agreements with private entities for the development of a theater on the County Fairgrounds. In April 2005, the County filed a cross complaint against the City and the Agency alleging, among other things, breach of the 2001 Agreement, breach of the 2001 Agreement s implied covenant of good faith and fair dealing, and intentional interference with prospective economic relations. The County s cross complaint alleges no specific amount of damages and seeks damages and restitution according to proof. However, the County also alleges, without explanation, that an assessment by Harvey Rose Corporation indicates that the amounts of the County s loss are in excess of $2.1 billion. To the knowledge of the City Attorney and the Agency General Counsel, the only Harvey Rose assessment regarding tax increment is a report to the County Finance Committee, dated February 1, 2005, which concluded that over the past 10 years, the tax increment collected by all nine redevelopment agencies in the County was approximately $2.1 billion. The report does not address any damages suffered by the County as a result of the causes of action alleged in the County s cross complaint. If the County were to prevail in this cross complaint, the City and the Agency are unable to predict the nature or amount of the damages that can be proven. VERIFICATION OF COMPUTATIONS The mathematical sufficiency of amounts deposited in each escrow with respect to each series of Refunded Bonds, together with interest earnings thereon, has been verified by The Arbitrage Group, Inc. UNDERWRITING The Agency will sell the Bonds to the City of San José Financing Authority (the Authority ), which will immediately resell the Bonds to the Underwriters shown on the cover page hereof. The Underwriters have agreed to purchase from the Authority the Series 2005A Bonds at a purchase price equal to $10,809,956.16, 44

53 representing the aggregate principal amount of the Series 2005A Bonds, plus an original issue premium of $395,104.00, less an Underwriters discount of $30, and the Series 2005B Bonds at a purchase price equal to $118,814,331.73, representing the aggregate principal amount of the Series 2005B Bonds, less an Underwriters discount of $460, The Bond Purchase Agreement among the Authority, the Agency and the Underwriters provides that the Underwriters will purchase all of the Bonds, if any are purchased. Bonds may be offered and sold by the Underwriters to certain dealers and others at prices lower than the public offering prices set forth on the inside cover page of this Official Statement, and such public offering prices may be changed by the Underwriters from time to time without notice. RATINGS Moody s Investors Service, Inc., Standard & Poor s Ratings Services, a division of The McGraw-Hill Companies, Inc. and Fitch, Inc. have assigned their ratings of Aaa, AAA and AAA, respectively to the Bonds with the understanding that upon delivery of the Bonds, policies insuring the payment when due of the principal of and interest on the Series 2005 A Bonds and the principal of and interest on the Series 2005B Bonds will be issued by Financial Guaranty. See BOND INSURANCE. Underlying ratings of A2, A and A, respectively, have been assigned by such rating agencies to the Bonds. Such ratings reflect only the views of the rating agencies and any desired explanation of the significance of such ratings should be obtained from the rating agencies. Generally, a rating agency bases its rating on the insurance and the information and materials furnished to it and on investigations, studies and assumptions of its own. There is no assurance such ratings will continue for any given period of time or that such ratings will not be revised downward or withdrawn entirely by a rating agency, if in the judgment of such rating agency, circumstances so warrant. Any such downward revision or withdrawal of such rating may have an adverse effect on the market price of the Bonds. FINANCIAL ADVISOR The Agency has retained the services of Ross Financial, as Financial Advisor. Payment of fees to the Financial Advisor is contingent upon issuance of the Bonds. [REMAINDER OF PAGE INTENTIONALLY LEFT BLANK] 45

54 MISCELLANEOUS The summaries or description of provisions in the Agreement contained herein and all references to other materials not purporting to be quoted in full are only brief outlines of certain provisions thereof and do not constitute complete statements of such provisions and do not summarize all the pertinent provisions of such documents. For further information, reference should be made to the complete documents, copies of which will be on file at the offices of the Underwriters prior to the delivery of the Bonds and thereafter at the designated office of the Fiscal Agent for examination. All projections, forecasts and other information in this Official Statement involving matters of opinion, whether or not expressly so stated, are intended as such and not as representations of fact. This Official Statement is not to be construed as a contract or agreement between the Agency and the purchasers or holders of any of the Bonds. The attached APPENDICES A through H are integral parts of this Official Statement and must be read together with all of the foregoing statements. REDEVELOPMENT AGENCY OF THE CITY OF SAN JOSE By: /s/ David C. Baum Chief Financial Officer 46

55 APPENDIX A THE CITY OF SAN JOSE: DEMOGRAPHIC AND ECONOMIC INFORMATION General Description The City is the eleventh largest city in the United States and the third largest city in California (the State ) with a January 1, 2005 population estimated at 944,857, according to the California Department of Finance. The territory of the City encompasses approximately square miles. Located at the southern end of the San Francisco Bay, the City is the county seat of the County of Santa Clara (the County ). Having originated as a Spanish pueblo established in 1777, the City is the oldest city in the State. From a former rich agricultural setting, San José has become the capital of the innovative, high-technology based Silicon Valley - so named for the principal material used in producing semiconductors. During the 1980 s and 1990 s the City experienced an economic resurgence with expansion in manufacturing, service, retail and tourist industries. However, the more recent national economic slowdown and the contraction in the telecommunications and technology industries have caused a decline in economic activity in the City. San José Municipal Government The City is governed by the City Council, consisting of a Mayor and ten other council members (one council seat is currently vacant). The Mayor is elected at large for a four-year term. Council members are elected by district for staggered four-year terms. The Mayor and the council members are limited to two consecutive four-year terms. The City is a charter city, which means the City, through its charter (the Charter ), may regulate municipal affairs, subject only to restrictions and limitations provided in the Charter; in matters other than municipal affairs, the City is subject to State law. The City Council appoints the City Manager who is responsible for the operation of all municipal functions except the offices of City Attorney, City Clerk, City Auditor and Independent Police Auditor. The officials heading these offices are appointed by the City Council and carry out the policies set forth by the City Council. The City provides a full range of services contemplated by statute or charter, including those functions delegated to cities under State law. These services include public safety, sanitation and health, environmental enforcement, recreational and cultural activities, public improvements, planning, zoning and general administrative services. Demographic and Economic Information Introduction The demographic and economic information provided below has been collected from sources that the City has determined to be reliable. Because it is difficult to obtain complete and timely regional economic and demographic information, the City s economic condition may not be fully apparent in all of the publicly available regional economic statistics provided herein. A-1

56 Population City residents account for approximately half of the population of the County, which is the most populous of the San Francisco Bay Area counties. While the period from 1960 to 1980 was characterized by extremely rapid population growth in both the City and County, the last two decades reflect a trend of slower but steady growth. Table 1 below shows the population of the City, the County and the State according to the U.S. Census for the years 1960, 1970, 1980, 1990 and 2000 and the California Department of Finance for 2001 through Table 1 CITY, COUNTY AND STATE POPULATION STATISTICS City of San José County of Santa Clara State of California , ,315 15,717, ,913 1,064,714 19,953, ,442 1,295,071 23,667, ,248 1,497,577 29,760, ,943 1,682,585 33,871, ,522 1,701,060 34,441, ,761 1,715,051 35,088, ,368 1,726,628 35,691, ,232 1,740,699 36,271, ,857 1,759,585 36,810,358 Source: U.S. Census ( ), California Department of Finance ( ). Employment Table 2 on the next page sets forth employment figures for the City and the County and unemployment rates for the City, the State and the United States for the five most recent years. The City s unemployment rate rose sharply after 2000 as a result of the contraction in the telecommunications and technology industries that dominate the City s employment base. Although the City s unemployment rate decreased from 9.9% in 2002 to 5.8% as of April 2005, the labor force in Santa Clara County during the same period declined by 128,000, or 13.6%. A-2

57 Table 2 SANTA CLARA COUNTY ESTIMATED AVERAGE ANNUAL EMPLOYMENT AND UNEMPLOYMENT OF RESIDENT LABOR FORCE Civilian Labor Force (in thousands) (1) City of San José Employed Unemployed Total (2) County of Santa Clara Employed Unemployed Total (2) Unemployment Rates City % 9.9% 9.6% 7.2% 5.8% County State United States (1) Preliminary, not seasonally adjusted, data are for April (2) Totals may not add due to independent rounding. Source: California Employment Development Department, Labor Market Information Division; U.S. Bureau of Labor Statistics. The City occupies the geographic center of Silicon Valley. The high technology industry component of the City s economy is diversified in research, development, manufacturing, marketing and management. Development of high technology has been supported by the area s proximity to Stanford University, San José State University, Santa Clara University and other institutions of higher education, and such research and development facilities as SRI International (formerly the Stanford Research Institute), the Stanford Linear Accelerator Center and Ames Research Center (NASA). While the County is known worldwide as Silicon Valley, the silicon-based semiconductor industry is only a part of the industrial picture. Other industries include information systems, computers, peripherals, instruments, software and a wide array of communication electronics. These industries have all seen contractions in employment beginning in year 2000 and continuing through today. Table 3 displays the composition of employment in the San José Metropolitan Area by general category for the most recent three years available. A-3

58 Table 3 SAN JOSE METROPOLITAN STATISTICAL AREA EMPLOYMENT BY CATEGORY ANNUAL AVERAGES (in thousands) Percent Percent 2002 of Total 2003 of Total 2004 Percent of Total Farm 6, % 6, % 6, % Natural Resources & Mining Construction 43, , , Manufacturing 203, , , Wholesale Trade 36, , , Retail Trade 85, , , Transport., Warehousing, Utilities 15, , , Information 34, , , Financial Activities 35, , , Professional & Business Services 173, , , Educational & Health Services 91, , , Leisure & Hospitality 68, , , Other Services 26, , , Government 101, , , Total (1) 922, , ,700 (1) Totals may not add due to independent rounding. Source: California Employment Development Department, Labor Market Information Division. Major Employers Table 4 shows fifteen selected major employers in San José, ranked by the number of their employees, estimated as of November Table 4 SELECTED MAJOR SAN JOSE EMPLOYERS Company/Organization Type of Industry Number of Employees 1. Cisco Systems Computer Equipment 16, Santa Clara County Government 15, IBM Corporation Computer Equipment 8, City of San José Government 6, San José State University Education 5, San José Unified School District Education 3, Hitachi Storage Software 2, Agilent Technologies Communications/ Life Sciences 2, Novellus Systems Semiconductor Equipment 2, Xilinx Semiconductor 2, ebay On-Line Auction 2, Adobe Systems Inc. Computer Software 2, Good Samaritan Health System Health Care 1, KLA Tencor Instruments Optical Inspection 1, Cadence Design Systems Inc. Computer Software 1,700 Source: City of San José Office of Economic Development, as of November A-4

59 Effective Buying Income Effective Buying Income ( EBI ), also referred to as disposable or after tax income, consists of personal income less personal tax and certain non-tax payments. Personal income includes wages and salaries, other labor-related income (such as employer contributions to private pension funds), and certain other income (e.g. proprietor s income, rental income, dividends and interest, pensions, and welfare assistance). Deducted from this total are personal taxes (federal, state and local), certain non-tax payments (e.g. fines, fees and penalties), and personal contributions to a retirement program. Table 5 shows the top ten metropolitan markets (as defined by Sales and Marketing Management Magazine) in median EBI for 2003, among which the San José Metropolitan Area ranked second. Table TOP TEN METROPOLITAN AREAS MEDIAN HOUSEHOLD EFFECTIVE BUYING INCOME Los Alamos, New Mexico... $65,663 San José-Sunnyvale-Santa Clara, California... 62,138 Bridgeport-Stamford-Norwalk, Connecticut... 56,743 Juneau, Alaska... 55,478 San Francisco-Oakland-Fremont, California... 53,820 Washington-Arlington-Alexandria, D.C.-Virginia-Maryland-West Virginia... 53,275 Edwards, Colorado... 52,497 Oxnard-Thousand Oaks-Ventura, California... 51,433 Boulder, Colorado... 50,267 Anchorage, Alaska... 49,953 U.S. Median... $38,201 Source: Sales & Marketing Management Magazine, 2004 Survey of Buying Power and Media Markets, published Retail Sales Table 6 on the next page sets forth a history of taxable sales for the City from calendar year 2000 through A comparison of the total taxable sales in the City between the first two quarters of 2003 and the first two quarters of 2004 (the most recent data available) shows an increase of approximately $272 million, or 5.4%. A-5

60 Table 6 CITY OF SAN JOSE TAXABLE SALES (in thousands) Apparel stores... $ 277,068 $ 318,569 $ 334,087 $ 344,800 $ 372,107 General merchandise stores... 1,171,342 1,272,431 1,213,970 1,147,174 1,145,069 Food stores , , , , ,685 Eating and drinking establishments , , , , ,859 Home furnishings and appliances , , , , ,072 Building materials and farm implements , , , , ,588 Auto dealers and auto supplies... 1,497,093 1,779,967 1,582,391 1,442,279 1,463,891 Service stations , , , , ,517 Other retail stores... 1,589,478 1,879,859 1,617,105 1,410,114 1,362,282 Retail Stores Total... $ 7,304,879 $ 8,487,210 $ 7,927,868 $ 7,358,770 $ 7,458,070 All other outlets... 4,012,234 5,123,559 4,426,922 3,328,201 3,373,127 TOTAL ALL OUTLETS... $11,317,113 $13,610,769 $12,354,790 $10,686,971 $10,831,197 Source: California State Board of Equalization. Construction Activity A history of construction valuation and new dwelling units for the most recent five calendar years appears in Table 7 below. Table 7 CITY OF SAN JOSE CONSTRUCTION VALUATION AND NEW DWELLING UNITS (valuation in thousands) (1) Valuation: (2) Residential... $ 678,358 $ 456,009 $ 378,779 $ 630,681 $ 476,060 Non-Residential.. 1,154, , , , ,431 TOTAL $1,832,511 $1,374,894 $ 910,641 $ 928,931 $ 794,492 New Dwelling Units: Single Family... 1, Multi-Family... 3,131 2,710 1,863 3,631 2,017 TOTAL 4,459 3,369 2,484 4,518 2,977 (1) Totals may not add due to independent rounding. (2) Valuation figures are adjusted to 2004 dollars per Bureau of Labor Statistics Consumer Price Index, San José-San Francisco, Oakland, all items index. Source: City of San José, Department of Building, Planning and Code Enforcement, January A-6

61 Education For the school year , there were an estimated 253,090 students were enrolled in the County s 233 elementary schools; 58 middle schools and junior high schools; 40 high schools; 57 community, alternative, special education, continuation and juvenile hall schools; and 19 charter schools. In addition, there are a number of private schools serving the residents of the County. The County has seven community colleges (within four community college districts: Foothill-DeAnza, Gavilan Joint, San Jose- Evergreen, and West Valley-Mission). Major universities in the County include Stanford University, Santa Clara University, and San José State University. The City is served by 18 of the 32 public school districts in the County. These school districts cross municipal boundaries. Principal public school systems serving the City are the San José Unified School District (grades K-12), with an estimated enrollment for school year of 31,874, and the East Side Union High School District with an estimated enrollment of 25,496. Transportation The San José area is served by a network of freeways providing regional, national and international access. U.S. 101, a major north-south highway between San Francisco and Los Angeles, provides access to the deepwater seaports at San Francisco and Redwood City, and to air passenger and cargo facilities at Norman Y. Mineta San José International Airport (the Airport ) and San Francisco International Airport. Interstate 880 connects San José with the Oakland International Airport and the Port of Oakland. Interstates 280 and 680 provide access to the peninsula and eastern regions of the San Francisco Bay Area, respectively, and State Route 17 serves to connect San José with the Pacific Coast at Santa Cruz. Additional freeways serving the local area are State Routes 85, 87 and 237. During the past two decades, approximately $1.8 billion has been invested by the State and the County to expand and improve the area freeway system. The Santa Clara Valley Transportation Authority (VTA) has begun improvements to the Coleman/880 interchange adjacent to the Airport. The project is estimated to cost $81 million. Construction began in March 2004 and is expected to be completed in September The VTA provides public transit service throughout Santa Clara County. Transit services are readily accessible to residents of San José, as most residences and businesses in the city are within a quarter mile of bus or light rail service. VTA's bus network is made up of 69 bus routes and over 4,300 bus stops. The backbone of the bus network is Line 22, which operates between Eastridge Shopping Center in San José and the Menlo Park Caltrain Station, and carries almost six million passengers per year. Express routes offer a commute alternative to employment centers located throughout the County. The Guadalupe Light Rail Line runs 26.6 miles of service from the residential neighborhoods of south San José, through Downtown San José, the high technology employment centers in north San José, Milpitas, and serves residences in East San José. The Tasman Light Rail Line extends the light rail system another 10.3 miles from the Baypointe Station in North San José, servicing stations in Sunnyvale and Mountain View, and connecting with Caltrain commuter rail service at the Mountain View Caltrain Station. The 5.3-mile Vasona Light Rail Line is currently under construction from Downtown San José to Downtown Campbell and Winchester Boulevard. The Vasona Light Rail Line is scheduled to open in August VTA also partners with Altamont Commuter Express and Caltrain to provide commuter rail service, and with Santa Cruz Metro to provide regional bus service from Santa Cruz to Downtown San José. In the November 2000 election, the voters of the County approved a 30-year, half-cent sales tax to commence collection in 2006 upon the expiration of the current one-half cent sales tax. This sales tax will finance various transit projects, including the possible extension of the Bay Area Rapid Transit A-7

62 (BART) system to the City. BART is a heavy rail rapid transit system currently serving Alameda, Contra Costa, and San Francisco Counties and portions of San Mateo County. The main coast line of the Union Pacific Railroad traverses the City, providing connections to San Francisco, Oakland, Sacramento and Los Angeles. Commuter rail service operates on this line between Gilroy and San Francisco. The Union Pacific Railroad also operates a branch line in the City serving heavy industry. The Airport is located on approximately 1,000 acres of land approximately two miles north of Downtown San José, between the Bayshore Freeway (Highway 101) and Interstate 880. The Airport is a commercial service and general aviation airport and is classified by the FAA as a medium hub (an airport that enplanes at least 0.25% but less than 1.0% of the total number of passenger boardings at all commercial service airports in the United States). During fiscal year , the Airport served approximately 5.5 million enplaned passengers and accommodated 197,756 operations (takeoffs and landings). According to preliminary traffic statistics by the Airports Council International-North America ( ACI-NA ), in calendar year 2004 the Airport was the 37th busiest airport in North America in terms of total passengers and the 44th busiest in terms of total cargo. The City has a foreign trade zone that is located near the Airport in an approximately 374-acre business park. Foreign and domestic merchandise may be moved into the zone for storage, exhibition, manipulation, manufacturing or other processing without payment of federal duties or excise taxes until the goods leave the zone. Property Taxes and Assessed Valuations The assessed valuation of property is established by the County Assessor, and reported at 100% of the full cash value as of January 1, except for public utility property, which is assessed by the State Board of Equalization. The County collects the ad valorem property taxes. Taxes arising from the one percent levy are apportioned among local taxing agencies on the basis of a formula established by State law in Under this formula, the City receives a base year allocation plus an allocation on the basis of growth in assessed value (consisting of new construction, change of ownership and inflation). Taxes relating to voter-approved indebtedness are allocated to the relevant taxing agency. Beginning in FY (with the adoption of new State legislation), the County deducts the pro-rata cost of collecting property taxes from the City s allocation. The California Community Redevelopment Law authorizes redevelopment agencies to receive the allocation of tax revenues resulting from increases in assessed valuations of properties within designated project areas. In effect, the other local taxing authorities realize tax revenues from such properties only on the base year valuations which are frozen at the time a redevelopment project area is created. The tax revenues which result from increases in assessed valuations flow to the redevelopment areas. The City has created redevelopment project areas pursuant to California law. Generally, funds must be spent within the redevelopment areas in which the tax increment revenues were generated, and may only be spent on projects which qualify under California redevelopment law. Table 8 below sets forth a ten-year history of the City s assessed valuation. A-8

63 Table 8 CITY OF SAN JOSE HISTORICAL ASSESSED VALUE OF PROPERTY (in thousands) Gross Assessed Valuation Percentage Change Fiscal Year $46,074,404 (0.62)% ,400, ,441, ,669, ,777, ,316, ,432, ,699, ,634, ,414, Sources: City of San José Comprehensive Annual Financial Reports for FY through FY Property Tax receipts collected for the City by the County are set forth in Table 9. Under current County policy, the City s allocation of total ad valorem taxes is received in approximately the following cumulative percentages: 40% by mid-december, 50% by the first week of January, 85% by the third week of April, 90% by the end of April and 100% by the end of June. The County Board of Supervisors approved the implementation of an alternative method of distribution of tax levies and collections and of tax sale proceeds (a Teeter Plan ), as provided for in Section 4701 et seq. of the California Revenue and Taxation Code. Under the Teeter Plan, the County apportions secured property taxes on an accrual basis when due (irrespective of actual collections) to its local political subdivisions, including the City, for which the County acts as the tax-levying or tax-collecting agency. The County then receives all future delinquent payments, penalties and interest. The Teeter Plan was effective in the County beginning the fiscal year commencing July 1, The Teeter Plan is applicable to all tax levies for which the County acts as the tax-levying or taxcollecting agency, or for which the County treasury is the legal depository of tax collections. As adopted by the County, the Teeter Plan excludes Mello-Roos Community Facilities Districts and special assessment districts that provide for accelerated judicial foreclosure of property for which special taxes or assessments are delinquent. The Teeter Plan is to remain in effect unless the County Board of Supervisors orders its discontinuance or unless, prior to the commencement of any fiscal year of the County (which commences on July 1), the Board of Supervisors receives a petition for its discontinuance joined in by resolutions adopted by at least two-thirds of the participating revenue districts in the County, in which event the Board of Supervisors is to order discontinuance of the Teeter Plan effective at the commencement of the subsequent fiscal year. The Board of Supervisors may, by resolution adopted no later than July 15 of the fiscal year for which it is to apply, after holding a public hearing on the matter, discontinue the procedures under the Teeter Plan with respect to any political subdivision in the County if the rate of secured property tax delinquency in that political subdivision in any year exceeds three percent (3%) of the total of all taxes and assessments levied on the secured rolls for that political subdivision. If the Teeter Plan is discontinued subsequent to its implementation, only those secured property taxes actually collected would be allocated to political subdivisions (including the City) for which the County acts as the tax-levying or tax-collecting agency. A-9

64 Table 9 CITY OF SAN JOSE PROPERTY TAX RECEIPTS (in thousands) Percentage of Fiscal Year Property Tax Receipts General Fund Revenues $ 88, % , , Modified Budget as of 3/31/05 (1) 136, Proposed Budget (1) 143, (1) Includes motor vehicle license fee (MVLF) property tax replacement revenue, less $11.1 million in each year reflecting the impact of the State s Budget Act and the anticipated impact of the State s Budget Act. Sources: Annual Reports, City Manager s Office, for FY to FY ; FY Proposed Operating Budget for FY through FY Property Tax receipts collected for the City by the County are set forth in Table 9 above. In preparing its budget, the City forecasts property taxes based on each of the specific categories of receipts (secured and unsecured, current and delinquent receipts, supplemental, and State replacement funds). Current receipts are based on the County Assessor s estimate of growth in assessed valuation, adjusted for estimates in growth for redevelopment project areas. Estimates of other property tax receipts are primarily based on historical collections. Total Property Tax receipts in the FY Modified Budget are approximately $136.2 million, representing 23.6% of General Fund revenue and a 42.4% increase from FY Total Property Tax receipts in the FY Proposed Budget are approximately $144.0 million, representing 25.5% of budgeted General Fund revenues and a 5.7% increase from FY Both the Modified Budget and the Proposed Budget amounts include motor vehicle license fee (MVLF) property tax replacement revenue, less $11.1 million in each year reflecting the impact of the State s Budget Act and the anticipated impact of the State s Budget Act. According to the County Assessor s Annual Report, the assessed values of 10,877 properties located in the City of San José were reduced by the Assessor s Office, as of the lien date January 1, 2004, to reflect changes in market conditions for a total reduction of $4.11 billion. This represents a 28.74% decline from what would have been the assessed value of these properties had the market value not declined below the Proposition 13 protected assessed value. Countywide, almost 95% of properties with such reductions were residential, but over 75% of the reduced value came from commercial, industrial and office properties. Investment Policy and Practices of the City The City and its related entities are required to invest all funds under the Director of Finance s control funds in accordance with principles of sound treasury management and in accordance with the provisions of the California Government Code, the Charter of the City of San José, the City Municipal Code and the City Investment Policy (the Policy ). The Policy was originally adopted by the City Council in its present format on April 2, 1985 (Resolution No ) and is reviewed annually by the City Council. The City Council most recently amended the Policy on December 14, The Policy has been certified by the Association of Public Treasurers of the United States and Canada. A-10

65 The primary objectives of the Policy, in their order of priority, are to (1) provide for the safe preservation of principal, (2) ensure that there is sufficient liquidity for operating needs, and (3) attain the maximum yield possible as long as investment practices are consistent with the first two stated objectives. Current Investment Portfolio As of April 30, 2005, the book value of the City s pooled investment fund was $1,038,612,054, while the market value was $1,028,415,811. The fund is classified by different types of investment securities. The composition of the fund, including the weighted average days to maturity and yield, is provided in Table 10 shown below. General Fund moneys invested in the fund represented approximately 14.99% of the fund. Table 10 CITY OF SAN JOSE POOLED INVESTMENT FUND GENERAL POOL INVESTMENTS As of April 30, 2005 (1) Percent of Portfolio Market Value Weighted Average Days to Maturity Weighted Average Yield Book Value U.S. Treasury Bills and Notes... $ 79,871, % $ 79,220, % Federal Agency Securities ,474, ,638, Medium Term Notes (corp.) Bankers Acceptance... 14,389, ,455, Commercial Paper... 49,476, ,701, Repurchase Agreements... 48,000, ,000, Money Market Mutual Fund State of California LAIF (2)... 43,399, ,399, (1) $1,038,612, % $1,028,415, % Totals may not round due to independent rounding. (2) Estimated based upon City s participation in the Local Agency Investment Fund (LAIF). Weighted average yield for LAIF is based upon the most recently reported quarterly earnings rate. Source: City of San José Finance Department. A-11

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67 APPENDIX B SUMMARY OF CERTAIN PROVISIONS OF THE AGREEMENT The following is a summary of certain provisions of the Agreement. This summary does not purport to be complete or definitive and is qualified in its entirety by reference to the full terms of the Agreement, which may be obtained as described under INTRODUCTION Other Information in this Official Statement. Capitalized terms not defined in this Official Statement shall have the meaning set forth in the Agreement. Definitions Agreement means the Original Agreement, as amended and supplemented from time to time by the Supplemental Agreements, including the Seventh Supplemental Agreement. Annual Debt Service means, for each Bond Year, the sum of: (1) the interest falling due on (A) the 1993 Bonds (i.e., the Series 1993A Bonds and Series 1993B Bonds) in such Bond Year, assuming that all Outstanding 1993 Bonds are retired as scheduled, and (B) all Parity Obligations in such Bond Year, assuming that Parity Obligations in the nature of serial bonds are retired as scheduled and that Parity Obligations in the nature of term bonds, are redeemed from a sinking account as may be scheduled, but less in either case any interest the payment of which has been provided for with the proceeds of the 1993 Bonds or Parity Obligations or other moneys which have been irrevocably set aside for such purpose; (2) the principal amount of the 1993 Bonds and Parity Obligations in the nature of serial bonds, if any, falling due by their terms in such Bond Year; and (3) the minimum amount of the 1993 Bonds and Parity Obligations in the nature of term bonds required to be paid or called and redeemed in such Bond Year. The term Maximum Annual Debt Service means the largest Annual Debt Service during the period from the date of such determination through the maturity date of the Bonds. Bond Year means each successive one-year period ending on August 1. Cooperation Agreement means the Cooperation Agreement, dated September 28, 1990, by and between the City and the Agency, as amended by First Amendment to the Cooperation Agreement, dated December 28, 1990, and Second Amendment to the Cooperation Agreement, dated August 20, 1992, which agreement is an extension of the 1987 delegation of authority by the Agency to the City to administer the Agency s Low and Moderate Income Housing Fund. Costs of Issuance means items of expense payable or reimbursable directly or indirectly by the Agency and related to the authorization, sale and issuance of the Series 2005 Bonds, which items of expense shall include, but not be limited to, bond insurance and surety bond premiums, printing costs, costs of reproducing and binding documents, closing costs, filing and recording fees, initial fees and charges of the Fiscal Agent including its first annual administration fee, legal fees and charges of bond counsel, fees and charges of financial advisor, charges for execution, transportation and safekeeping of the Series 2005 Bonds and other costs, charges and fees in connection with the foregoing. County means the County of Santa Clara. Defeasance Obligations means, with respect to the Prior Bonds, Federal Securities, and with respect to the Series 2005 Bonds and any Additional Bonds issued after the issuance of the Series 2005 Bonds, any of the following which at the time acquired or made are legal investments for the Agency under applicable State laws and the Investment Policy (unless compliance with the Investment Policy is waived in writing by the City), for the moneys held under the Agreement then proposed to be invested therein: (i) Federal Securities B-1

68 (ii) bonds or other obligations of any state of the United States of America or of any agency, instrumentality or local governmental unit of any such state (x) which are not callable at the option of the obligor or otherwise prior to maturity or as to which irrevocable notice has been given by the obligor to call such bonds or obligations on the date specified in the notice, (y) timely payment of which is fully secured by a fund consisting only of cash or obligations of the character described in clause (i) or (iii) which fund may be applied only to the payment when due of such bonds or other obligations and (z) rated AAA by S&P and in one of the two highest long-term rating categories by Moody s and Fitch (if rated by Fitch); and (iii) Bonds, debentures, notes or other evidence of indebtedness issued or guaranteed by any of the following federal agencies and provided such obligations are backed by the full faith and credit of the United States of America (stripped securities are only permitted if they have been stripped by the agency itself): (i) direct obligations or fully guaranteed certificates of beneficial ownership of the U.S. Export-Import Bank; (ii) certificates of beneficial ownership of the Rural Economic Community Development Administration (formerly the Farmers Home Administration); (iii) obligations of the Federal Financing Bank; (iv) debentures of the Federal Housing Administration; (v) participation certificates of the General Services Administration; (vi) guaranteed Title XI financings of the U.S. Maritime Administration; and (vii) project notes, local authority bonds, new communities debentures and U.S. public housing notes and bonds of the U.S. Department of Housing and Urban Development. Escrow Agent means Wells Fargo Bank, National Association, as escrow agent under the Escrow Agreements. Escrow Agreements means the Series 1993D Escrow Agreement and the Series 2000F Escrow Agreement, collectively. Federal Securities means United States treasury notes, bonds, bills or certificates of indebtedness, or obligations for which the faith and credit of the United States of America are pledged for the payment of principal and interest (including obligations issued or held in book-entry form on the books of the Department of Treasury of the United States of America and, if they become legal investments under the laws of the State for moneys held under the Agreement, securities which represent an undivided interest in such direct obligations), and also any securities authorized, the principal of and/or interest on which is guaranteed directly by the full faith and credit of the United States of America, as and to the extent that such securities are eligible for the legal investment of City or Agency funds. First Supplemental Subordinate Agreement means the First Supplemental Subordinate Agreement dated as of May 1, 2005 between the Agency and Wells Fargo Bank, National Association, as fiscal agent. Fiscal Agent means Wells Fargo Bank, National Association, as fiscal agent under the Agreement, as successor to U.S. Bank National Association, as successor to First Trust of California, National Association, as successor to First Interstate Bank of California, as the original fiscal agent under the Original Agreement. Fiscal Year means the calendar year commencing on July 1, or any other annual accounting period selected and designated by the Agency as its Fiscal Year in accordance with the Law. Housing Project means those projects approved and assisted by the City under the Cooperation Agreement, which increase, improve and/or preserve the supply of low and moderate income housing within the City and such other uses as may lawfully be expended in accordance with the Law. Housing Set-Aside Amounts means the portion of Tax Increment Revenues required to be set-aside and deposited in the Low and Moderate Income Housing Fund pursuant to Section , or of the Law or such greater amount of Tax Increment Revenues as provided by the Agreement, but in any event not to exceed 20% of the Tax Increment Revenues. B-2

69 Housing Special Fund means that fund, together with accounts created therein, established pursuant to Article IV of the Original Agreement. Information Services means Financial Information, Inc. s Daily Called Bond Service, 30 Montgomery Street, 10th Floor, Jersey City, New Jersey 17302, Attention: Editor; Kenny Information Services Called Bond Service, 55 Broad Street, 28th Floor, New York, New York 10004; Moody s Municipal and Government, 99 Church Street, 8th Floor, New York, New York 10007, Attention: Municipal News Reports; and S&P s Called Bond Service, 25 Broadway, 3rd Floor, New York, New York 10004; or, in accordance with the then current guidelines promulgated by the Securities and Exchange Commission, such other addresses and/or such other information services providing information with respect to called bonds as the Agency may designate in a Certificate of the Agency delivered to the Fiscal Agent. Investment Policy means the City s Investment Policy, as previously adopted and as most recently amended by the City Council prior to the date of the issuance and delivery of the Series 2005 Bonds, and as it may hereafter be amended. Investment Securities means, for so long as the Series 2005A Insurance Policy or the Series 2005B Insurance Policy is outstanding, the following, when such term is used in this Seventh Supplemental Agreement: 1. Direct obligations of the United States of America and securities fully and unconditionally guaranteed as to the timely payment of principal and interest by the United States of America ( U.S. Government Securities ). 2. Direct obligations * of the following federal agencies which are fully guaranteed by the full faith and credit of the United States of America: (a) (b) (c) Export-Import Bank of the United States Direct obligations and fully guaranteed certificates of beneficial interest Federal Housing Administration debentures General Services Administration participation certificates (d) Government National Mortgage Association ( GNMAs ) guaranteed mortgage-backed securities and guaranteed participation certificates (e) (f) (g) (h) Small Business Administration guaranteed participation certificates and guaranteed pool certificates U.S. Department of Housing & Urban Development local authority bonds U.S. Maritime Administration guaranteed Title XI financings Washington Metropolitan Area Transit Authority guaranteed transit bonds * The following are explicitly excluded from the securities enumerated in 2 and 3: (i) All derivative obligations, including without limitation inverse floaters, residuals, interest-only, principal-only and range notes; (ii) Obligations that have a possibility of returning a zero or negative yield if held to maturity; (iii) Obligations that do not have a fixed par value or those whose terms do not promise a fixed dollar amount at maturity or call date; and (iv) Collateralized Mortgage-Backed Obligations ( CMOs ). B-3

70 3. Direct obligations * of the following federal agencies which are not fully guaranteed by the faith and credit of the United States of America: (a) (b) (c) (d) (e) Federal National Mortgage Association ( FNMAs ) senior debt obligations rated Aaa by Moody s Investors Service ( Moody s ) and AAA by Standard & Poor s Ratings Services ( S&P ) Federal Home Loan Mortgage Corporation ( FHLMCs ) participation certificates and senior debt obligations rated Aaa by Moody s and AAA by S&P Federal Home Loan Banks consolidated debt obligations Student Loan Marketing Association debt obligations Resolution Funding Corporation debt obligations 4. Direct, general obligations of any state of the United States of America or any subdivision or agency thereof whose uninsured and unguaranteed general obligation debt is rated, at the time of purchase, A2 or better by Moody s and A or better by S&P, or any obligation fully and unconditionally guaranteed by any state, subdivision or agency whose uninsured and unguaranteed general obligation debt is rated, at the time of purchase, A2 or better by Moody s and A or better by S&P. 5. Commercial paper (having original maturities of not more than 270 days) rated, at the time of purchase, P-1 by Moody s and A-1 or better by S&P. 6. Certificates of deposit, savings accounts, deposit accounts or money market deposits in amounts that are continuously and fully insured by the Federal Deposit Insurance Corporation ( FDIC ), including the Bank Insurance Fund and the Savings Association Insurance Fund. 7. Certificates of deposit, deposit accounts, federal funds or bankers acceptances (in each case having maturities of not more than 365 days following the date of purchase) of any domestic commercial bank or United States branch office of a foreign bank, provided that such bank s short-term certificates of deposit are rated P-1 by Moody s and A-1 or better by S&P (not considering holding company ratings). 8. Investments in money-market funds rated AAAm or AAAm-G by S&P. 9. State-sponsored investment pools rated AA- or better by S&P. 10. Repurchase agreements that meet the following criteria: (a) A master repurchase agreement or specific written repurchase agreement, substantially similar in form and substance to the Public Securities Association or Bond Market Association master repurchase agreement, governs the transaction. * The following are explicitly excluded from the securities enumerated in 2 and 3: (i) All derivative obligations, including without limitation inverse floaters, residuals, interest-only, principal-only and range notes; (ii) Obligations that have a possibility of returning a zero or negative yield if held to maturity; (iii) Obligations that do not have a fixed par value or those whose terms do not promise a fixed dollar amount at maturity or call date; and (iv) Collateralized Mortgage-Backed Obligations ( CMOs ). B-4

71 (b) (c) (d) (e) (f) (g) (h) Acceptable providers shall consist of (i) registered broker/dealers subject to Securities Investors Protection Corporation ( SIPC ) jurisdiction or commercial banks insured by the FDIC, if such broker/dealer or bank has an uninsured, unsecured and unguaranteed rating of A3/P-1 or better by Moody s and A-/A-1 or better by S&P, or (ii) domestic structured investment companies approved by Financial Guaranty and rated Aaa by Moody s and AAA by S&P. The repurchase agreement shall require termination thereof if the counterparty s ratings are suspended, withdrawn or fall below A3 or P-1 from Moody s, or A- or A-1 from S&P. Within ten (10) days, the counterparty shall repay the principal amount plus any accrued and unpaid interest on the investments. The repurchase agreement shall limit acceptable securities to U.S. Government Securities and to the obligations of GNMA, FNMA or FHLMC described in 2(d), 3(a) and 3(b) above. The fair market value of the securities in relation to the amount of the repurchase obligation, including principal and accrued interest, is equal to a collateral level of at least 104% for U.S. Government Securities and 105% for GNMAs, FNMAs or FHLMCs. The repurchase agreement shall require (i) the Trustee or the Agent to value the collateral securities no less frequently than weekly, (ii) the delivery of additional securities if the fair market value of the securities is below the required level on any valuation date, and (iii) liquidation of the repurchase securities if any deficiency in the required percentage is not restored within two (2) business days of such valuation. The repurchase securities shall be delivered free and clear of any lien to the bond trustee (herein, the Trustee ) or to an independent third party acting solely as agent ( Agent ) for the Trustee, and such Agent is (i) a Federal Reserve Bank, or (ii) a bank which is a member of the FDIC and which has combined capital, surplus and undivided profits or, if appropriate, a net worth, of not less than $50 million, and the Trustee shall have received written confirmation from such third party that such third party holds such securities, free and clear of any lien, as agent for the Trustee. A perfected first security interest in the repurchase securities shall be created for the benefit of the Trustee, and the issuer and the Trustee shall receive an opinion of counsel as to the perfection of the security interest in such repurchase securities and any proceeds thereof. The repurchase agreement shall have a term of one year or less, or shall be due on demand. The repurchase agreement shall establish the following as events of default, the occurrence of any of which shall require the immediate liquidation of the repurchase securities, unless Financial Guaranty directs otherwise: (i) (ii) (iii) insolvency of the broker/dealer or commercial bank serving as the counterparty under the repurchase agreement; failure by the counterparty to remedy any deficiency in the required collateral level or to satisfy the margin maintenance call under item 10(d) above; or failure by the counterparty to repurchase the repurchase securities on the specified date for repurchase. B-5

72 11. Investment agreements (also referred to as guaranteed investment contracts) that meet the following criteria: (a) (b) (c) (d) (e) (f) A master agreement or specific written investment agreement governs the transaction. Acceptable providers of uncollateralized investment agreements shall consist of (i) domestic FDIC-insured commercial banks, or U.S. branches of foreign banks, rated at least Aa2 by Moody s and AA by S&P; (ii) domestic insurance companies rated Aaa by Moody s and AAA by S&P; and (iii) domestic structured investment companies approved by Financial Guaranty and rated Aaa by Moody s and AAA by S&P. Acceptable providers of collateralized investment agreements shall consist of (i) registered broker/dealers subject to SIPC jurisdiction, if such broker/dealer has an uninsured, unsecured and unguaranteed rating of A1 or better by Moody s and A+ or better by S&P; (ii) domestic FDIC-insured commercial banks, or U.S. branches of foreign banks, rated at least A1 by Moody s and A+ by S&P; (iii) domestic insurance companies rated at least A1 by Moody s and A+ by S&P; and (iv) domestic structured investment companies approved by Financial Guaranty and rated Aaa by Moody s and AAA by S&P. Required collateral levels shall be as set forth in 11(f) below. The investment agreement shall provide that if the provider s ratings fall below Aa3 by Moody s or AA- by S&P, the provider shall within ten (10) days either (i) repay the principal amount plus any accrued and interest on the investment; or (ii) deliver Permitted Collateral as provided below. The investment agreement must provide for termination thereof if the provider s ratings are suspended, withdrawn or fall below A3 from Moody s or A- from S&P. Within ten (10) days, the provider shall repay the principal amount plus any accrued interest on the agreement, without penalty. The investment agreement shall provide for the delivery of collateral described in (i) or (ii) below ( Permitted Collateral ) which shall be maintained at the following collateralization levels at each valuation date: (i) (ii) U.S. Government Securities at 104% of principal plus accrued interest; or Obligations of GNMA, FNMA or FHLMC (described in 2(d), 3(a) and 3(b) above) at 105% of principal and accrued interest. (g) The investment agreement shall require the Trustee or Agent to determine the market value of the Permitted Collateral not less than weekly and notify the investment agreement provider on the valuation day of any deficiency. Permitted Collateral may be released by the Trustee to the provider only to the extent that there are excess amounts over the required levels. Market value, with respect to collateral, may be determined by any of the following methods: (i) (ii) the last quoted bid price as shown in Bloomberg, Interactive Data Systems, Inc., The Wall Street Journal or Reuters; valuation as performed by a nationally recognized pricing service, whereby the valuation method is based on a composite average of various bid prices; or B-6

73 (iii) the lower of two bid prices by nationally recognized dealers. Such dealers or their parent holding companies shall be rated investment grade and shall be market makers in the securities being valued. (h) (i) (j) Securities held as Permitted Collateral shall be free and clear of all liens and claims of third parties, held in a separate custodial account and registered in the name of the Trustee or the Agent. The provider shall grant the Trustee or the Agent a perfected first security interest in any collateral delivered under an investment agreement. For investment agreements collateralized initially and in connection with the delivery of Permitted Collateral under 11(f) above, the Trustee and Financial Guaranty shall receive an opinion of counsel as to the perfection of the security interest in the collateral. The investment agreement shall provide that moneys invested under the agreement must be payable and putable at par to the Trustee without condition, breakage fee or other penalty, upon not more than two (2) business days notice, or immediately on demand for any reason for which the funds invested may be withdrawn from the applicable fund or account established under the authorizing document, as well as the following: (i) (ii) (iii) (iv) (v) In the event of a deficiency in the debt service account; Upon acceleration after an event of default; Upon refunding of the bonds in whole or in part; Reduction of the debt service reserve requirement for the bonds; or If a determination is later made by a nationally recognized bond counsel that investments must be yield-restricted. Notwithstanding the foregoing, the agreement may provide for a breakage fee or other penalty that is payable in arrears and not as a condition of a draw by the Trustee if the issuer s obligation to pay such fee or penalty is subordinate to its obligation to pay debt service on the bonds and to make deposits to the debt service reserve fund. (k) The investment agreement shall establish the following as events of default, the occurrence of any of which shall require the immediate liquidation of the investment securities, unless: (i) (ii) (iii) (iv) Failure of the provider or the guarantor (if any) to make a payment when due or to deliver Permitted Collateral of the character, at the times or in the amounts described above; Insolvency of the provider or the guarantor (if any) under the investment agreement; Failure by the provider to remedy any deficiency with respect to required Permitted Collateral; Failure by the provider to make a payment or observe any covenant under the agreement; B-7

74 (v) (vi) The guaranty (if any) is terminated, repudiated or challenged; or Any representation of warranty furnished to the Trustee or the issuer in connection with the agreement is false or misleading. (l) The investment agreement must incorporate the following general criteria: (i) (ii) (iii) (iv) (v) (vi) (vii) Cure periods for payment default shall not exceed two (2) business days; The agreement shall provide that the provider shall remain liable for any deficiency after application of the proceeds of the sale of any collateral, including costs and expenses incurred by the Trustee or Financial Guaranty; Neither the agreement or guaranty agreement, if applicable, may be assigned (except to a provider that would otherwise be acceptable under these guidelines) or amended without the prior consent of Financial Guaranty; If the investment agreement is for a debt service reserve fund, reinvestments of funds shall be required to bear interest at a rate at least equal to the original contract rate. The provider shall be required to immediately notify Financial Guaranty and the Trustee of any event of default or any suspension, withdrawal or downgrade of the provider s ratings; The agreement shall be unconditional and shall expressly disclaim any right of set-off or counterclaim; The agreement shall require the provider to submit information reasonably requested by Financial Guaranty, including balance invested with the provider, type and market value of collateral and other pertinent information. 12. Forward delivery agreements in which the securities delivered mature on or before each interest payment date (for debt service or debt service reserve funds) or draw down date (construction funds) that meet the following criteria: (a) (b) (c) A specific written investment agreement governs the transaction. Acceptable providers shall be limited to (i) any registered broker/dealer subject to the Securities Investors Protection Corporation jurisdiction, if such broker/dealer or bank has an uninsured, unsecured and unguaranteed obligation rated A3/P-1 or better by Moody s and A-/A-1 or better by S&P; (ii) any commercial bank insured by the FDIC, if such bank has an uninsured, unsecured and unguaranteed obligation rated A3/P-1 or better by Moody s and A-/A-1 or better by S&P; and (iii) domestic structured investment companies approved by Financial Guaranty and rated Aaa by Moody s and AAA by S&P. The forward delivery agreement shall provide for termination or assignment (to a qualified provider hereunder) of the agreement if the provider s ratings are suspended, withdrawn or fall below A3 or P-1 from Moody s or A- or A-1 from S&P. Within ten (10) days, the provider shall fulfill any obligations it may have with respect to shortfalls in market value. There shall be no breakage fee payable to the provider in such event. B-8

75 (d) (e) Permitted securities shall include the investments listed in 1, 2 and 3 above. The forward delivery agreement shall include the following provisions: (i) (ii) (iii) (iv) (v) The permitted securities must mature at least one (1) business day before a debt service payment date or scheduled draw. The maturity amount of the permitted securities must equal or exceed the amount required to be in the applicable fund on the applicable valuation date. The agreement shall include market standard termination provisions, including the right to terminate for the provider s failure to deliver qualifying securities or otherwise to perform under the agreement. There shall be no breakage fee or penalty payable to the provider in such event. Any breakage fees shall be payable only on debt service payment dates and shall be subordinated to the payment of debt service and debt service reserve fund replenishments. The provider must submit at closing a bankruptcy opinion to the effect that upon any bankruptcy, insolvency or receivership of the provider, the securities will not be considered to be a part of the provider s estate, and otherwise acceptable to Financial Guaranty. The agreement may not be assigned (except to a provider that would otherwise be acceptable under these guidelines) or amended without the prior written consent of Financial Guaranty. 13. Forward delivery agreements in which the securities delivered mature after the funds may be required but provide for the right of the issuer or the Trustee to put the securities back to the provider under a put, guaranty or other hedging arrangement, only with the prior written consent of Financial Guaranty. 14. Maturity of investments shall be governed by the following: (a) (b) (c) Investments of monies (other than reserve funds) shall be in securities and obligations maturing not later than the dates on which such monies will be needed to make payments. Investments shall be considered as maturing on the first date on which they are redeemable without penalty at the option of the holder or the date on which the Trustee may require their repurchase pursuant to repurchase agreements. Investments of monies in reserve funds not payable upon demand shall be restricted to maturities of five years or less. Law means the Community Redevelopment Law of the State of California (being Part I of Division 24 of the Health and Safety Code of the State of California, as amended), and all laws amendatory thereof or supplemental thereto. Low and Moderate Income Housing Fund means the Low and Moderate Income Housing Fund established with respect to the Merged Area Redevelopment Project all in accordance with Section , or of the Law. B-9

76 Merged Area Redevelopment Plans means the redevelopment plans constituting the Merged Area Redevelopment Project approved and adopted by Ordinance No , adopted by the City Council of the City of San José on June 23, 1981, together with any amendment made pursuant to the Law. Merged Area Redevelopment Project means the redevelopment projects established by the Agency and commonly known as Rincon de los Esteros Redevelopment Project, Pueblo Uno Redevelopment Project, Edenvale Redevelopment Project, Olinder Redevelopment Project, Julian-Stockton Redevelopment Project, San Antonio Plaza Redevelopment Project, Guadalupe-Auzerais Redevelopment Project, Market Gateway Redevelopment Project and Century Center Redevelopment Project, together with certain other non-revenue generating redevelopment projects and additional redevelopment projects as they may be added from time to time. Original Agreement means the Fiscal Agent Agreement dated as of February 1, 1993, by and between the Agency and First Interstate Bank of California, as fiscal agent. Original Subordinate Agreement means the Fiscal Agent Agreement, dated as of May 1, 2002, by and between the Agency and Wells Fargo Bank, National Association, as fiscal agent. Parity Obligations means any additional tax allocation bonds (including without limitation bonds, notes interim certificates, debentures or other obligations) issued by the Agency and secured by Housing Set-Aside Amounts on a parity with the 1993 Bonds as permitted by the Agreement. Reserve Fund Policy Agreement means either the Series 2005A Reserve Fund Policy Agreement or the Series 2005B Reserve Fund Policy Agreement, as applicable. Reserve Requirement means the Maximum Annual Debt Service with respect to the Bonds from the date of such determination through the maturity date of all of the Bonds which are then Outstanding as calculated by the Agency. Securities Depositories means The Depository Trust Company, 55 Water Street, 50th Floor, New York, New York , Fax (212) ; and, in accordance with then current guidelines of the Securities and Exchange Commission, such other addresses and/or such other securities depositories as the Agency may designate in a Certificate of the Agency delivered to the Fiscal Agent. Series 1993D Escrow Agreement means that certain Escrow Agreement, dated the date of issuance of the Series 2005 Bonds, relating to the defeasance of the Series 1993D Bonds, by and between the Agency and the Escrow Agent. Series 1993D Escrow Fund means the fund by that name established and maintained under the Series 1993D Escrow Agreement. Series 2000F Escrow Agreement means that certain Escrow Agreement, dated the date of issuance of the Series 2005 Bonds, relating to the defeasance of the Series 2000F Bonds, by and between the Agency and the Escrow Agent. Series 2000F Escrow Fund means the fund by that name established and maintained under the Series 2000F Escrow Agreement. Series 2005 Bonds means the Series 2005A Bonds and the Series 2005B Bonds, collectively. Series 2005 Continuing Disclosure Agreement means that certain Continuing Disclosure Agreement executed by the Agency and dated the date of issuance and delivery of the Series 2005 Bonds, as originally executed and as it may be amended from time to time in accordance with the terms thereof. B-10

77 Series 2005 Insurance Policies means the Series 2005A Insurance Policy and the Series 2005B Insurance Policy, collectively. Series 2005 Insurer means the Series 2005A Insurer and the Series 2005B Insurer, collectively. Series 2005 Reserve Policies means the Series 2005A Reserve Policy and the Series 2005B Reserve Policy, collectively. Series 2005A Insurance Policy means the municipal bond new issue insurance policy issued by the Series 2005A Insurer guaranteeing the scheduled payment of the principal of and interest on the Series 2005A Bonds. Series 2005A Insurer means Financial Guaranty Insurance Company, or any successor thereto or assignee thereof. Series 2005A Reserve Policy means the municipal bond debt service reserve fund policy issued by the Series 2005A Insurer with respect to the portion of the Reserve Requirement attributable to the Series 2005A Bonds. Series 2005A Reserve Fund Policy Agreement means the Debt Service Reserve Fund Policy Agreement dated the date of issuance of the Series 2005 Bonds relating to the Series 2005A Reserve Policy by and between the Agency and the Series 2005A Insurer. Series 2005B Insurance Policy means the municipal bond new issue insurance policy issued by the Series 2005B Insurer guaranteeing the scheduled payment of the principal of and interest on the Series 2005B Bonds. Series 2005B Insurer means Financial Guaranty Insurance Company, or any successor thereto or assignee thereof. Series 2005 Reserve Policies means the Series 2005A Reserve Policy and the Series 2005B Reserve Policy, collectively. Series 2005B Reserve Policy means the municipal bond debt service reserve fund policy issued by the Series 2005B Insurer with respect to the portion of the Reserve Requirement attributable to the Series 2005B Bonds. Series 2005B Reserve Fund Policy Agreement means the Debt Service Reserve Fund Policy Agreement dated the date of issuance of the Series 2005 Bonds, 2005 relating to the Series 2005B Reserve Policy by and between the Agency and the Series 2005B Insurer. Seventh Supplemental Agreement means the Seventh Supplemental Agreement dated as of May 1, 2005 between the Agency and Wells Fargo Bank National Association, as fiscal agent. Sixth Supplemental Agreement means the Sixth Supplemental Agreement dated as of July 1, 2003 between the Agency and Wells Fargo Bank National Association, as fiscal agent. Subordinate Agreement means the Original Subordinate Agreement, as amended and supplemented from time to time, including as amended and supplemented by the First Supplemental Subordinate Agreement. Subordinate Indebtedness means any indebtedness issued under the Subordinate Agreement, including the Agency s $35,000,000 Merged Area Redevelopment Project Housing Set-Aside Taxable Revenue B-11

78 Bonds, Series 2002G and its $35,000,000 Merged Area Redevelopment Project Housing Set-Aside Taxable Revenue Bonds, Series 2002H. Supplemental Agreement means the First Supplemental Agreement and any further agreement supplemental or amendatory of the Original Agreement which is duly executed and delivered in accordance with the provisions of the Original Agreement. Tax Increment Revenues means all taxes allocated and paid to the Agency pursuant to Article 6 of Chapter 6 of the Law and Section 16 of Article XVI of the Constitution of the State of California, and as provided in the Merged Area Redevelopment Plans, including all payments and reimbursements, if any, to the Agency specifically attributable to ad valorem taxes lost by reason of tax exemptions and tax rate limitations. Treasurer or Treasurer of the Agency means the officer who is then performing functions of the Director of Finance and Administration of the Agency. Underwriters means, Citigroup Global Markets Inc., Banc of America Securities LLC, Stone & Youngberg LLC, E.J. De La Rosa & Co. Inc. and UBS Financial Services Inc., as the underwriters of the Series 2005 Bonds. Pledge of Housing Set-Aside Amounts The Housing Set-Aside Amounts received by the Agency on or after the date of issuance of the Series 2005 Bonds, as provided in Article IV of the Original Agreement and Article III of the Seventh Supplemental Agreement, are irrevocably pledged to the punctual payment of the interest on and principal of and redemption premiums, if any, on the Bonds. The Housing Set-Aside Amounts and such other moneys held under the Agreement, unless as otherwise provided in the Agreement, shall not be used for any other purpose while any of the Series 2005 Bonds remain Outstanding. This pledge constitutes a first lien on the Housing Set-Aside Amounts and such other moneys held under the Agreement for the payment of the Bonds and any Parity Obligations issued, all in accordance with the terms thereof. Housing Special Fund; Establishment and Maintenance of Accounts for Use of Moneys in the Housing Special Fund There is continued a special fund called the City of San José, California, Housing Project Special Fund (the Housing Special Fund ), to be held by the City on behalf of the Agency. All Housing Set-Aside Amounts, and other moneys identified in the Agreement, received in any Bond Year shall be deposited in the Housing Special Fund in accordance with the provisions of the Agreement promptly upon receipt thereof by the City on behalf of the Agency. Moneys accumulated in the Housing Special Fund shall be transferred by the City on behalf of the Agency to the Fiscal Agent for deposit in the following accounts in the following priority; provided, however, that to the extent that deposits have been made in any of the accounts referred to below from the proceeds of the sale of the Bonds or otherwise, the deposits below need not be made: (a) Interest Accounts. On or before five days prior to each Interest Payment Date, transfers shall be made by the City on behalf of the Agency to the Fiscal Agent from the Housing Special Fund to the Interest Accounts so that the amount in said Interest Accounts on said date shall be equal to the aggregate amount of interest becoming due and payable on the then Outstanding Bonds on the next succeeding Interest Payment Date. Moneys in the Interest Accounts shall be used by the Fiscal Agent for the payment of interest on the respective series of Bonds as the same becomes due. The City on behalf of the Agency shall also, from the Housing Special Fund, transfer to the bond interest account established with respect to any Parity Obligations; without preference or priority, and in the event of any insufficiency of such moneys ratably without any discrimination or preference, any other interest becoming due and payable on such outstanding Parity Obligations on the next succeeding interest payment date with respect thereto. B-12

79 (b) Principal Accounts. After the deposits have been made pursuant to subparagraph (a) above and beginning five days prior to each August 1, transfers shall be made by the City on behalf of the Agency to the Fiscal Agent from the Housing Special Fund to the Principal Accounts so that the balance in said Accounts on said date shall equal to the principal and sinking fund payments coming due on the then Outstanding Bonds on the next succeeding August 1. Moneys in the Principal Accounts shall be used by the Fiscal Agent for the payment of principal and sinking fund payments on the respective series of Bonds as they become due. The City on behalf of the Agency shall also, from the Housing Special Fund, transfer to the principal account established with respect to any Parity Obligations, without preference or priority, and in the event of any insufficiency of such moneys ratably without any discrimination or preference, any other principal or sinking fund payments becoming due and payable on such outstanding Parity Obligations on the next succeeding principal or sinking fund payment date with respect thereto. In lieu of redemption as provided in the above paragraph, moneys in the Principal Accounts may be used and withdrawn by the Fiscal Agent for purchase of Outstanding Bonds, upon the filing with the Fiscal Agent a Written Request of the Agency requesting such purchase prior to selection of Bonds for redemption, at public or private sale as and when, and at such prices (including brokerage and other charges) as such Written Request of the Agency may provide, but in no event may Bonds be purchased at a price in excess of the principal amount thereof, plus interest accrued to the date of purchase. (c) Reserve Account. After deposits have been made pursuant to subparagraphs (a) and (b) above, the City on behalf of the Agency shall from available Housing Set-Aside Amounts and other moneys held under the Agreement, transfer to the Fiscal Agent for deposit to the Reserve Account (the Reserve Account ) an amount, if necessary, in order to cause the amount on deposit therein to equal the Reserve Requirement. Money in the Reserve Account, shall be transferred by the Fiscal Agent to the Interest Accounts and Principal Accounts, and in the event of any insufficiency of such moneys ratably without any discrimination or preference, to pay interest on and principal of the Bonds and Parity Obligations as they become due to the extent Housing Set-Aside Amounts are insufficient therefor. Any portion of the Reserve Account which is in excess of the Reserve Requirement for the Bonds and any Parity Obligations shall, semiannually on or after February 1 and August 1 of each year, be transferred by the Fiscal Agent to the City on behalf of the Agency to be used for any Housing Project. In lieu of funding the Reserve Account with cash or Investment Securities, the Agency, at its option, may fund all or any portion of the Reserve Requirement by providing to the Fiscal Agent (a) an irrevocable, unconditional letter of credit issued by a bank or savings and loan association whose long-term uncollateralized debt obligations are rated at least A (or the equivalent thereof) or higher by each Rating Agency then rating the Bonds, or if the Bonds are not then rated, by any Rating Agency or (b) a Qualified Surety Bond approved in writing by the Rating Agency then rating the Bonds. If during any Bond Year (i) Housing Set-Aside Amounts remain in the Housing Special Fund after providing (or otherwise reserving) for all deposits required by clauses (a) and (b) with respect to such Bond Year, (ii) the amounts on deposit in the Reserve Account equal or exceed the Reserve Requirement, (iii) any Qualified Surety Bonds used to fund the Reserve Account are fully replenished and all interest on amounts advanced under such Qualified Surety Bonds has been paid to the provider thereof, and (iv) the Agency is not in default hereunder, then the City, at the direction of the Agency, may cease its deposit of any additional Housing Set-Aside Amounts until commencement of the next Bond Year and any money then on deposit in the Housing Special Fund may be used in any manner provided by law for the purpose of aiding in financing the Housing Project, including early redemption or purchase of the Bonds and Parity Obligations, as provided in the Agreement and permitted by the Law. B-13

80 Establishment of Funds; Low and Moderate Income Housing Fund Pursuant to the Cooperation Agreement, a special fund called the City of San José, California, Merged Area Low and Moderate Income Housing Fund (hereinafter sometimes called the Low and Moderate Income Housing Fund ) is continued with the City, on behalf of the Agency, with special subaccounts established and contained therein and known as the Series 2005A Subaccount of the Low and Moderate Income Housing Fund and the Series 2005B Subaccount of the Low and Moderate Income Fund (referred to as the Subaccounts of the Low and Moderate Income Housing Fund ). The Bond proceeds set aside in the Subaccounts of the Low and Moderate Income Housing Fund as provided in the Agreement shall remain therein until from time to time expended solely for the purpose of financing or refinancing certain programs to increase, improve and/or preserve the supply of low and moderate income housing in the City, and any respective Costs of Issuance not paid by the Fiscal Agent pursuant to the Agreement. If any sum remains in the Subaccounts of the Low and Moderate Income Housing Fund after the full accomplishment of the objects and purposes for which the Series 2005 Bonds were issued, said sum shall be deposited by the City on behalf of the Agency in the Housing Special Fund. The City shall expend the moneys deposited in the Subaccounts of the Low and Moderate Income Housing Fund in compliance with the Law. Deposit and Investment of Moneys in Funds Subject to the provisions of the Agreement, all moneys held by the City on behalf of the Agency in the Subaccount of the Low and Moderate Income Housing Fund and the Housing Special Fund or by the Fiscal Agent in the accounts created therein, shall be invested in Investment Securities. Issuance of Parity Obligations The Agency may provide for the issuance of, and sell, Parity Obligations in such principal amounts as it estimates will be needed for the Housing Project purposes. The issuance and sale of any Parity Obligations shall be subject to the following conditions precedent: (1) The Fiscal Agent shall have received a certificate of the Agency to the effect that the Agency is in compliance with all covenants contained in the Agreement; (2) The Parity Obligations shall be on such terms and conditions as may be set forth in a fiscal agent agreement or similar agreement or resolution, which may be a Supplemental Agreement, which shall provide for (i) bonds substantially in accordance with the Agreement, and (ii) the deposit of a portion of the Parity Obligation proceeds into a debt service reserve fund in an amount equal to any reserve requirement established for such Parity Obligations under its authorizing document; (3) Receipt by the Fiscal Agent of a certificate of the Agency showing: (i) Maximum Annual Debt Service with respect to the Bonds reasonably expected to be Outstanding, including the Parity Obligations then being delivered; (ii) For the current Bond Year, the Housing Set-Aside Amounts to be received by the Agency based upon the most recent taxable valuation of property in the Merged Area Redevelopment Project provided by the appropriate officer of the County plus supplemental assessments for projects which have been completed and will be reflected on the tax roll for the next succeeding Bond Year, and projects the ownership of which has changed, all as confirmed by the appropriate officer of the County; and B-14

81 (iii) That Housing Set-Aside Amounts referred to in clause (ii) above, are at least 1.15 times the Maximum Annual Debt Service referred to in clause (i). (4) A certificate of an officer of the Agency showing that, upon the delivery of the proposed Parity Obligations, the amount of cash and/or the principal amount of one or more Qualified Surety Bonds on deposit in the Reserve Account will equal the Reserve Requirement. (5) An Opinion of Counsel to the effect that (i) the Agency has the right and power under the Law to execute and deliver a fiscal agent agreement or Supplemental Agreement referred to in clause (2) above and such agreement or Supplemental Agreement has been duly and validly executed and delivered by the Agency, is in full force and effect and is valid and binding upon the Agency and enforceable in accordance with its terms (except as enforcement may be limited by bankruptcy, insolvency, reorganization and other similar laws relating to the enforcement of creditors rights), and no other authorization for such agreement is required; (ii) the fiscal agent agreement or Supplemental Agreement creates the valid pledge which it purports to create of the Housing Set-Aside Amounts and other amounts as provided in the Agreement; and (iii) such Parity Obligations have been duly and validly authorized and issued in accordance with the Law and such fiscal agent agreement or Supplemental Agreement are valid and binding special obligations of the Agency, enforceable in accordance with their terms (except as enforcement may be limited by bankruptcy, insolvency, reorganization and other similar laws relating to the enforcement of creditors rights). Certain Other Covenants of the Agency (1) Punctual Payment. The Agency will punctually pay or cause to be paid the interest on and principal of and redemption premium, if any, to become due with respect to the Bonds, in strict conformity with the terms of the Bonds and of the Agreement and will faithfully satisfy, observe and perform all conditions, covenants and requirements of the Bonds and of the Agreement. (2) Complete Redevelopment Project, Amendment to Redevelopment Plans. The Agency covenants and agrees that it will diligently carry out and continue to completion, with all practicable dispatch, the Merged Area Redevelopment Project in accordance with the Law and the Merged Area Redevelopment Plans and in a sound and economical manner. The Merged Area Redevelopment Plans may be amended as provided in the Law but no amendment shall be made unless it will not substantially impair the security of the Bonds or the rights of the Bondholders. (3) Use of Proceeds. The Agency covenants and agrees that the proceeds of the sale of the Bonds will be deposited and used as provided in the Agreement. (4) No Priority. The Agency covenants and agrees that it will not issue any obligations payable, either as to principal or interest, from the Housing Set-Aside Amounts which have, or purport to have, any lien upon the Housing Set-Aside Amounts prior or superior to the lien of the Bonds authorized in the Agreement and the Agency represents that it does not have outstanding any indebtedness which is secured by a lien on the Housing Set-Aside Amounts superior to or on a parity with the lien of the Bonds on the Housing Set-Aside Amounts. Except as permitted by the Agreement, it will not issue any obligations payable as to principal or interest, from the Housing Set-Aside Amounts, which have, or purport to have, any lien upon the Housing Set-Aside Amounts on a parity with the Bonds authorized in the Agreement. Notwithstanding the foregoing, nothing in the Agreement shall prevent the Agency or the City (i) from issuing and selling pursuant to law, refunding obligations payable from and having any lawful parity lien upon the Housing Set-Aside Amounts, if such refunding obligations are issued for the purpose of, and are sufficient for the purpose of, refunding all or any portion of the Outstanding Bonds, or (ii) from issuing and selling obligations which have, or purport to have, any lien upon the Housing Set-Aside Amounts which is junior to the Bonds, or (iii) from issuing and selling bonds or other obligations which are payable in whole or in part from sources other than the Housing Set-Aside B-15

82 Amounts. As used herein, obligations shall include, without limitation, bonds, notes, interim certificates, debentures or other obligations. (5) Payment of Taxes and Other Charges. The Agency covenants and agrees that it will from time to time pay and discharge, or cause to be paid and discharged, all payments in lieu of taxes, service charges, assessments or other governmental charges which may lawfully be imposed upon the Agency or any of the properties then owned by it in the areas constituting the Merged Area Redevelopment Project, or upon the revenues and income therefrom, and will pay all lawful claims for labor, materials and supplies which if unpaid might become a lien or charge upon any of said properties, revenues or income or which might impair the security of the Bonds or the use of Housing Set-Aside Amounts or other legally available funds to pay the principal of and interest thereon, all to the end that the priority and security of the Bonds shall be preserved; provided, however, that nothing in the Agreement shall require the Agency to make any such payment so long as the Agency in good faith shall contest the validity thereof. (6) Eminent Domain. Unless the Agency certifies to the Fiscal Agent that the failure to do so will not substantially impair the Bondholders rights, the Agency covenants and agrees that if all or any part of the areas constituting the Merged Area Redevelopment Project should be taken from it without its consent, by eminent domain proceedings or other proceedings authorized by law, for any public or other use under which the property will be tax exempt, the Agency will use its best efforts to have the base assessment roll reduced by the amount of the assessment of said property as shown on said base assessment roll. (7) Disposition of Property. The Agency covenants and agrees that it will not dispose of more than ten percent (10%) of the land area in the areas constituting the Merged Area Redevelopment Project (except property shown in the Merged Area Redevelopment Plans in effect on the date of the Agreement as planned for public use, or property to be used for public streets, public offstreet parking, sewage facilities, parks, easements or right-of-way for public utilities, or other similar uses) to public bodies or other persons or entities whose property is tax exempt, unless such disposition will not result in the security of the Bonds or the rights of Bondholders being substantially impaired. (8) Tax Revenue Statement of Indebtedness. The Agency will comply with all requirements of the Law to insure the allocation and payment to it of the Tax Increment Revenues and the allocation and payment to the City of the Housing Set-Aside Amounts pursuant to the Cooperation Agreement. The Agency will also timely file with appropriate officials of the County or the State, as the case may be, any necessary statements of indebtedness or other filings, including but not limited to those necessary statements of indebtedness or other filings, required to be filed under Sections to , Section 33675, Section and Section of the Law. In the event that the Agency elects to make the findings provided in Sections or of the Law and reduce the Housing Set-Aside Amounts used for Housing Project in any Bond Year, the Agency shall provide that any such finding is expressly subordinate to the pledge of such Housing Set-Aside amounts made under the Agreement. The Agency expressly finds and determines that the pledge, payment and setting aside of Housing Set-Aside Amounts as provided for in the Agreement is not subject to any limitation contained in Article XIII B of the Constitution of the State of California. (9) Protection of Security and Rights of Bondholders. In the event of an amendment or revision to the Law which would allow the Agency to set-aside less than the Housing Set-Aside Amounts required to be set-aside by the Agency as of the date of execution of the Agreement, the Agency covenants with the Holders of the Bonds that it shall continue to set-aside a sufficient amount of its Tax Increment Revenues to pay the Annual Debt Service and to make the deposits to the Reserve Accounts as required by the Agreement, and notwithstanding any such change or revision to the Law, such Tax Increment Revenue required to be so deposited shall be deemed to be Housing Set-Aside Amounts under the Agreement and shall be subject to the first lien and pledge created under the Agreement. B-16

83 (10) Against Encumbrances. The Agency will not encumber, pledge or place any charge or lien upon any of the Housing Set-Aside Amounts superior to or on a parity with the pledge and lien created in the Agreement for the benefit of the Bonds, except as permitted by the Agreement. (11) Taxation of Leased Property. Whenever any property in the areas constituting the Merged Area Redevelopment Project has been redeveloped and thereafter is leased by the Agency to any person or persons (other than a public agency) or whenever the Agency leases real property in the areas constituting the Merged Area Redevelopment Project to any person or persons (other than a public agency) for redevelopment, the property shall be assessed and taxed in the same manner as privately owned property, as required by Section of the Law, and the lease or contract shall provide (a) that the lessee shall pay taxes upon the assessed value of the entire property and not merely upon the assessed value of his or its leasehold interest, and (b) that if for any reason the taxes levied on such property in any year during the term of the lease or contract are less than the taxes which would have been levied if the entire property had been assessed and taxed in the same manner as privately owned property, the lessee shall pay such difference to the Agency within thirty (30) days after the taxes for such year become payable to the taxing agencies and in no event later than the delinquency date of such taxes established by law. All such payments shall be treated as Tax Increment Revenues. (12) Plan Limit. The Agency shall manage its fiscal affairs in a manner which ensures that it will have sufficient Housing Set-Aside Amounts available under the Merged Area Redevelopment Plans in the amounts and at the times required to enable the Agency to pay the principal of and interest and premium (if any) on the outstanding Bonds when due. The Agency has covenanted that it will annually review, no later than December 1 of each year (commencing December 1, 2005), the total amount of Tax Increment Revenue and Housing Set-Aside Amounts remaining available to be received by the Agency under the Merged Area Redevelopment Plans (but not including any Tax Increment Revenue otherwise excluded under the Merged Area Redevelopment Plans limitation on the amount on Tax Increment Revenue that can be allocated to the Agency), as well as (i) future cumulative Annual Debt Service, (ii) future cumulative annual debt service on any Subordinate Indebtedness issued under the Subordinate Agreement (assuming, at the time of calculation, an interest rate on such bonds equal to the 5 year average of the 30 day London Inter Bank Offering Rate or, if such average is not available, the 5 year average of the 30 day Treasury Bill rate, for so long as those bonds bear interest at an adjustable rate), (iii) the future annual cumulative debt service under the Credit Agreement or successor credit agreement, based on the amount outstanding at the time of calculation and assuming an interest rate on such Credit Agreement or successor credit agreement, as applicable, equal to the 5 year average of the 30 day London Inter Bank Offering Rate or, if such average is not available, the 5 year average of the 30 day Treasury Bill rate, in the case of taxable draws, and equal to the 5 year average of the BMA Municipal Swap Index of Municipal Market Data or, if such index is no longer available, the J.J. Kenny Index, in each case as such terms are defined in the 1992 ISDA U.S. Municipal Counterparty Definitions, in the case of tax-exempt draws, and (iv) the future annual cumulative payments on any other obligations of the Agency payable from Housing Set-Aside Amounts that are subordinate to the Bonds. If, based on such review, the allocation of Tax Increment Revenue and Housing Set-Aside Amounts to the Agency in any of the next three succeeding Fiscal Years (including the Fiscal Year during which such calculation is being made) will (assuming an increase of 2% per Fiscal Year) cause an amount equal to ninety percent (90%) of the amount of Housing Set-Aside Amounts remaining to be allocated under the Merged Area Redevelopment Plans to fall below the sum of (i), (ii), (iii) and (iv), the Agency shall either (i) defease Bonds by depositing an amount of Housing Set-Aside Amounts equal to the amount that is required to ensure continuing compliance with this covenant in a defeasance escrow to be held by the Fiscal Agent to be pledged solely to the payment of debt service on the Bonds, which escrow shall be invested in Defeasance Obligations and used for the payment of interest on and principal of and redemption premiums, if any, on the Bonds or (ii) adopt a plan approved by an Independent Redevelopment Consultant which demonstrates the Agency s continuing ability to pay debt service on the Bonds. In determining the amount to be deposited in escrow with the Fiscal Agent, the Agency may take into account projected interest earnings on the amounts so deposited. B-17

84 The Agency has also covenanted that it shall annually, no later than December 1 (commencing December 1, 2005), transmit to the Fiscal Agent, a Certificate of the Agency (which may be signed by the Executive Director of the Agency, the Assistant Executive Director of the Agency or the Director of Finance and Administration of the Agency) setting forth the calculations required by this covenant, including the total amount of Tax Increment Revenue and Housing Set-Aside Amounts remaining available to be received by the Agency under the Merged Area Redevelopment Plans, the amounts calculated pursuant to (i), (ii), (iii) and (iv) of the immediately prior paragraph, the amount of Tax Increment Revenue and Housing Set-Aside Amounts allocated to or received by the Agency during the prior Fiscal Year covered by the statement, and the amount of Housing Set-Aside Amounts, if any, that were used, or escrowed during the prior Fiscal Year for future use, to pay interest on and principal of and redemption premiums, if any, on the Bonds. Additionally, the Agency has covenanted to take all actions necessary to assure the exclusion of interest on the Series 2005A Bonds from the gross income of the Owners of the Series 2005A Bonds to the same extent as such interest is permitted to be excluded from gross income under the Code as in effect on the date of issuance of the Series 2005A Bonds and to abide by the covenants set forth in the tax certificate delivered by the Agency in connection with the issuance of the Series 2005A Bonds. Events of Default and Remedies Each of the following shall constitute an event of default under the Agreement: (1) Default in the due and punctual payment of any installment of interest on any Bond when and as such interest installment shall become due and payable; (2) Default in the due and punctual payment of the principal of or redemption premium, if any, on any Bond when and as the same shall become due and payable, whether at maturity as therein expressed, by declaration or otherwise; (3) Default made by the Agency in the observance of any of the other covenants, agreements or conditions contained in the Agreement or in the Bonds, and such default shall have continued for a period of thirty (30) days following written notice to the Agency by the Fiscal Agent or any Bondholder; (4) The Agency shall file a petition or answer seeking reorganization or arrangement under the federal bankruptcy laws or any other applicable law of the United States of America, or if a court of competent jurisdiction shall approve a petition, filed with or without the consent of the Agency, seeking reorganization under the federal bankruptcy laws or any other applicable law of the United States of America, or if, under the provisions of any other law for the relief or aid of debtors, any court of competent jurisdiction shall assume custody or control of the Agency or of the whole or any substantial part of its property; or (5) The occurrence of an event of default under the resolution, indenture, fiscal agreement or other instrument authorizing Parity Obligations. In each and every event of default described in (1) or (2) above the Fiscal Agent shall, and in each and every case of default described in (3), (4), or (5) above, the Fiscal Agent may and shall if so requested by the Holders of not less than sixty percent (60%) in aggregate principal amount of the Bonds at the time Outstanding (such request to be in writing to the Fiscal Agent and the Agency), declare the principal of all of the Bonds then Outstanding and the interest accrued thereon, to be due and payable immediately, and upon any such declaration the same shall become and shall be immediately due and payable, anything in the Agreement or in the Bonds to the contrary notwithstanding. Other than the obligations imposed on the Fiscal Agent pursuant to this paragraph, the Fiscal Agent shall have no other duties or obligations to the Agency or the Holders in the event of default described in the Agreement. B-18

85 Such declaration may be rescinded by the Holders of not less than sixty percent (60%) of the Bonds then outstanding provided the Agency cures such default or defaults including the deposit with the Fiscal Agent of a sum sufficient to pay all principal on the Bonds matured prior to such declaration and all matured installments of interest (if any) upon all the Bonds, with interest at the rates borne by such principal amount on the date of maturity or redemption, on such overdue installments of interest, so that the Agency is currently in compliance with all payment, deposit and transfer provisions of the Agreement, and an amount sufficient to pay any expenses incurred by the Fiscal Agent in connection with such default. Any Bondholder shall have the right, for the equal benefit and protection of all Bondholders similarly situated: (1) by mandamus, suit, action or proceeding, to compel the Agency and its members, officers, agents or employees to perform each and every term, provision and covenant contained in the Agreement and in the Bonds, and to require the carrying out of any or all such covenants and agreements of the Agency and the fulfillment of all duties imposed upon it by the Law; (2) by suit, action or proceeding in equity, to enjoin any acts or things which are unlawful, or the violation of any of the Bondholders rights or (3) upon the happening of any event of default, by suit, action or proceeding in any court of competent jurisdiction, to require the Agency and its members and employees to account as is it and they were the trustees of an express trust. Upon the date of the declaration of acceleration, all of the Housing Set-Aside Amounts and all other sums held or thereafter received by the Fiscal Agent under any of the provisions of the Agreement (except as otherwise provided in the Agreement) shall be deposited as follows and in the following order: Amendments First, to the payment of the fees, costs and expenses of the Fiscal Agent and then of the Bondholders and Parity Bondholders in declaring such event of default, including reasonable compensation to its or their agents, attorneys and counsel, and to the payment of the fees, costs and expenses of the Fiscal Agent (including but not limited to reasonable compensation to its agents, attorneys and counsel for their respective fees and expenses) incurred in performing or exercising its rights, powers and duties; Second, upon presentation of the Bonds or Parity Obligations, and the stamping thereon of the amount of the payment if only partially paid, or upon the surrender thereof if fully paid, to the payment of the whole amount then owing and unpaid upon the Bonds and on such Parity Obligations for interest and principal, with interest on the overdue principal and interest on the Bonds at the rates borne by such principal amount on the date of maturity or redemption, and in case such money shall be insufficient to pay in full the whole amount so owing and unpaid upon the Bonds and such Parity Obligations, then to the payment of such interest and principal without preference or priority among such interest and principal, ratably to the aggregate of such interest and principal. The Agreement and the rights and obligations of the Agency and of the Holders may be amended or supplemented only by a written amendment or Supplemental Agreement entered into between the Agency and the Fiscal Agent and consented to by the Holders of the Bonds, which consent shall become binding when the written consents of the Holders of sixty percent (60%) in aggregate principal amount of the Bonds then Outstanding, exclusive of Bonds disqualified as provided in the Agreement, are filed with the Fiscal Agent. No such amendment shall (1) extend the maturity of or reduce the interest rate on, or otherwise alter or impair the obligation of the Agency to pay the interest or principal or redemption premium, if any, at the time and place and B-19

86 at the rate and in the currency provided in the Agreement of any Bond, without the express written consent of the Holder of such Bond, or (2) permit the creation by the Agency of any mortgage, pledge or lien upon the Housing Set-Aside Amounts superior to or on a parity with the pledge and lien created in the Agreement for the benefit of the Bonds (other than Parity Obligations), or (3) reduce the percentage of Bonds required for the written consent to any such amendment, or (4) modify the rights or obligations of the Fiscal Agent without its prior written assent thereto. It shall not be necessary for the consent of the Holders to approve the particular form of any proposed Supplemental Agreement, but it shall be sufficient if such consent shall approve the substance thereof. Notwithstanding the statements in the paragraphs above, the Agreement and the rights and obligations of the Agency and of the Holders may also be amended at any time by a Supplemental Agreement executed and delivered by the Fiscal Agent and the Agency which shall become binding, without the consent of any Holders of the Bonds, but only to the extent permitted by law and only for any one or more of the following purposes: (a) to add, to the covenants and agreements of the Agency in the Agreement contained, other covenants and agreements thereafter to be observed, or to limit or surrender any right or power reserved to or conferred upon the Agency as stated in the Agreement; (b) to make such provisions for the purpose of curing any ambiguity, or of curing, correcting or supplementing any defective provision contained in the Agreement, or in regard to questions arising under the Agreement, as the Agency may deem necessary or desirable and not inconsistent with the Agreement, and which shall not adversely affect the interest of the Holders; (c) to provide for the issuance of any Parity Obligations, and to provide the terms and conditions under which such Parity Obligations may be issued, subject to and in accordance with the provisions of Article III of the Original Agreement; (d) to evidence the succession of a new Fiscal Agent under the Agreement, or to provide for the appointment of a co-fiscal agent or for a paying agent in addition to the Fiscal Agent; (e) to provide for the issuance of coupon bonds; provided, however, that the Agency and the Fiscal Agent shall have received an Opinion of Counsel to the effect that issuance of the Bonds in coupon form complies with all applicable laws and will not adversely affect the exclusion of interest on the Bonds from gross income for federal income tax purposes; (f) to modify, amend or supplement the Agreement in such manner as to permit the qualification of the Agreement under the Trust Indenture Act of 1939 or any similar federal statute hereafter in effect, and, if they so determine, to add to the Agreement or any agreement supplemental to the Agreement such other terms, conditions and provisions as may be permitted by said Trust Indenture Act of 1939 or similar federal statute, and which shall not materially adversely affect the interests of the Holders; (g) to make such additions, deletions or modifications as may be necessary or desirable to assure compliance with the Code, or otherwise to assure the exclusion from gross income under federal tax law of interest on the Bonds; and (h) to make any changes necessary to obtain or maintain a rating on the Bonds or any Parity Obligation by the Rating Agency. B-20

87 Discharge of Indebtedness If the Agency shall pay or cause to be paid, or there shall otherwise be paid, to the Holders of all Outstanding Bonds the interest due thereon and the principal thereof, at the times and in the manner stipulated therein and in the Agreement, then the Holders of such Bonds shall cease to be entitled to the pledge of Housing Set-Aside Amounts, and all covenants, agreements and other obligations of the Agency to the Holders under the Agreement shall thereupon cease, terminate and become void and be discharged and satisfied. In such event, the Fiscal Agent shall execute and deliver to the Agency all such instruments as may be desirable to evidence such discharge and satisfaction, and the Fiscal Agent shall pay over or deliver to the Agency all money or securities held by them pursuant to the Agreement which are not required for the payment of the interest due on and the principal of such Bonds. If money shall have been set aside for payment of the Bonds, (through deposit by the Agency or otherwise), to be held in trust by the Fiscal Agent for such payment at the maturity date or earlier payment date thereof, such Bonds shall be deemed, as of the date. of such setting aside, to have been paid within the meaning and with the effect expressed in the first paragraph under this caption. Any Outstanding Bond shall, prior to the maturity date thereof, be deemed to have been paid within the meaning and with the effect expressed in the first paragraph under this caption if (1) there shall have been deposited with the Fiscal Agent (a) money or (b) Defeasance Obligations paying interest and principal in an amount which shall be sufficient (in the opinion of an Independent Certified Public Accountant delivered to the Fiscal Agent) to pay the principal of such Bonds in full, and all interest accrued thereon, together with redemption premiums, if any, on any Interest Payment Date prior to the maturity thereof, (2) the Agency shall have given the Fiscal Agent in form satisfactory to it irrevocable instructions to mail, as soon as practicable, a notice to the Holders of such Bonds that the deposit required by clause (1) above has been made with the Fiscal Agent and that such Bonds are deemed to have been paid in accordance with the provisions under this caption and stating the Interest Payment Date, if any, upon which the Bonds are to be redeemed, (3) in case any of such Bonds are to be redeemed on any date prior to their maturity dates, the Agency shall have given to the Fiscal Agent in form satisfactory to it irrevocable instructions to give notice by mail in accordance with the Agreement to the Holders of such Bonds of the redemption of such Bonds on such redemption date, and (4) an Opinion of Counsel is filed with the Fiscal Agent to the effect that the action taken in connection with the discharge of the Bonds will not cause the interest on the Bonds to be includable in gross income for federal income tax purposes. Provisions Relating to the Series 2005A Insurance and the Series 2005B Insurance Policy Payments Under the Series 2005A Insurance Policy. (a) If, on the third day preceding any interest payment date for the Series 2005A Bonds there is not on deposit with the Fiscal Agent sufficient moneys available to pay all principal of and interest on the Series 2005A Bonds due on such date, the Fiscal Agent shall immediately notify the Series 2005A Insurer and U.S. Bank Trust National Association, New York, New York or its successor as its fiscal agent (the Insurer s Fiscal Agent ) of the amount of such deficiency. If, by said interest payment date, the Agency has not provided the amount of such deficiency, the Fiscal Agent shall simultaneously make available to the Series 2005A Insurer and to the Insurer s Fiscal Agent the registration books for the Series 2005A Bonds maintained by the Fiscal Agent. In addition: (i) The Fiscal Agent shall provide the Series 2005A Insurer with a list of the Bondholders entitled to receive principal or interest payments from the Series 2005A Insurer under the terms of the Series 2005A Insurance Policy and shall make arrangements for the Series 2005A Insurer and the Insurer s Fiscal Agent (1) to mail checks or drafts to Bondholders entitled to receive full or partial interest payments from the Series 2005A Insurer and (2) to pay principal of the Series 2005A Bonds surrendered to the Insurer s Fiscal Agent by the Bondholders entitled to receive full or partial principal payments from the Series 2005A Insurer; and B-21

88 (ii) The Fiscal Agent shall, at the time it makes the registration books available to the Series 2005A Insurer pursuant to (i) above, notify Bondholders entitled to receive the payment of principal of or interest on the Series 2005A Bonds from the Series 2005A Insurer (1) as to the fact of such entitlement, (2) that the Series 2005A Insurer will remit to them all or part of the interest payments coming due subject to the terms of the Series 2005A Insurance Policy, (3) that, except as provided in paragraph (b) below, in the event that any Bondholder is entitled to receive full payment of principal from the Series 2005A Insurer, such Bondholder must tender his Series 2005A Bond with the instrument of transfer in the form provided on the Series 2005A Bond executed in the name of the Series 2005A Insurer, and (4) that, except as provided in paragraph (b) below, in the event that such Bondholder is entitled to receive partial payment of principal from the Series 2005A Insurer, such Bondholder must tender his Series 2005A Bond for payment first to the Fiscal Agent, which shall note on such Series 2005A Bond the portion of principal paid by the Fiscal Agent, and then, with an acceptable form of assignment executed in the name of the Series 2005A Insurer, to the Insurer s Fiscal Agent, which will then pay the unpaid portion of principal to the Bondholder subject to the terms of the Series 2005A Insurance Policy. (b) In the event that the Fiscal Agent has notice that any payment of principal of or interest on a Series 2005A Bond has been recovered from a Bondholder pursuant to the United States Bankruptcy Code by a Fiscal Agent in bankruptcy in accordance with the final, nonappealable order of a court having competent jurisdiction, the Fiscal Agent shall, at the time it provides notice to the Series 2005A Insurer, notify all Bondholders that in the event that any Bondholder s payment is so recovered, such Bondholder will be entitled to payment from the Series 2005A Insurer to the extent of such recovery, and the Fiscal Agent shall furnish to the Series 2005A Insurer its records evidencing the payments of principal of and interest on the Series 2005A Bonds which have been made by the Fiscal Agent and subsequently recovered from Bondholders, and the dates on which such payments were made. (c) The Series 2005A Insurer shall, to the extent it makes payment of principal of or interest on the Series 2005A Bonds, become subrogated to the rights of the recipients of such payments in accordance with the terms of the Series 2005A Insurance Policy and, to evidence such subrogation, (i) in the case of subrogation as to claims for past due interest, the Fiscal Agent shall note the Series 2005A Insurer s rights as subrogee on the registration books maintained by the Fiscal Agent upon receipt from the Series 2005A Insurer of proof of the payment of interest thereon to the Bondholders of such Series 2005A Bonds and (ii) in the case of subrogation as to claims for past due principal, the Fiscal Agent shall note the Series 2005A Insurer s rights as subrogee on the registration books for the Series 2005A Bonds maintained by the Fiscal Agent upon receipt of proof of the payment of principal thereof to the Bondholders of such Series 2005A Bonds. Notwithstanding anything in this authorizing document or the Series 2005A Bonds to the contrary, the Fiscal Agent shall make payment of such past due interest and past due principal directly to the Series 2005A Insurer to the extent that the Series 2005A Insurer is a subrogee with respect thereto. Payments Under the Series 2005B Insurance Policy. (a) If, on the third day preceding any interest payment date for the Series 2005B Bonds there is not on deposit with the Fiscal Agent sufficient moneys available to pay all principal of and interest on the Series 2005B Bonds due on such date, the Fiscal Agent shall immediately notify the Series 2005B Insurer and U.S. Bank Trust National Association, New York, New York or its successor as its fiscal agent (the Insurer s Fiscal Agent ) of the amount of such deficiency. If, by said interest payment date, the Agency has not provided the amount of such deficiency, the Fiscal Agent shall simultaneously make available to the Series 2005B Insurer and to the Insurer s Fiscal Agent the registration books for the Series 2005B Bonds maintained by the Fiscal Agent. In addition: (i) The Fiscal Agent shall provide the Series 2005B Insurer with a list of the Bondholders entitled to receive principal or interest payments from the Series 2005B Insurer under the terms of the Series 2005B Insurance Policy and shall make arrangements for the Series 2005B Insurer and the Insurer s Fiscal Agent (1) to mail checks or drafts to Bondholders entitled to receive full or partial interest payments from the Series 2005B Insurer and (2) to pay principal of the Series 2005B Bonds surrendered to the Insurer s Fiscal B-22

89 Agent by the Bondholders entitled to receive full or partial principal payments from the Series 2005B Insurer; and (ii) The Fiscal Agent shall, at the time it makes the registration books available to the Series 2005B Insurer pursuant to (i) above, notify Bondholders entitled to receive the payment of principal of or interest on the Series 2005B Bonds from the Series 2005B Insurer (1) as to the fact of such entitlement, (2) that the Series 2005B Insurer will remit to them all or part of the interest payments coming due subject to the terms of the Series 2005B Insurance Policy, (3) that, except as provided in paragraph (b) below, in the event that any Bondholder is entitled to receive full payment of principal from the Series 2005B Insurer, such Bondholder must tender his Series 2005B Bond with the instrument of transfer in the form provided on the Series 2005B Bond executed in the name of the Series 2005B Insurer, and (4) that, except as provided in paragraph (b) below, in the event that such Bondholder is entitled to receive partial payment of principal from the Series 2005B Insurer, such Bondholder must tender his Series 2005B Bond for payment first to the Fiscal Agent, which shall note on such Series 2005B Bond the portion of principal paid by the Fiscal Agent, and then, with an acceptable form of assignment executed in the name of the Series 2005B Insurer, to the Insurer s Fiscal Agent, which will then pay the unpaid portion of principal to the Bondholder subject to the terms of the Series 2005B Insurance Policy. (b) In the event that the Fiscal Agent has notice that any payment of principal of or interest on a Series 2005B Bond has been recovered from a Bondholder pursuant to the United States Bankruptcy Code by a Fiscal Agent in bankruptcy in accordance with the final, nonappealable order of a court having competent jurisdiction, the Fiscal Agent shall, at the time it provides notice to the Series 2005B Insurer, notify all Bondholders that in the event that any Bondholder s payment is so recovered, such Bondholder will be entitled to payment from the Series 2005B Insurer to the extent of such recovery, and the Fiscal Agent shall furnish to the Series 2005B Insurer its records evidencing the payments of principal of and interest on the Series 2005B Bonds which have been made by the Fiscal Agent and subsequently recovered from Bondholders, and the dates on which such payments were made. (c) The Series 2005B Insurer shall, to the extent it makes payment of principal of or interest on the Series 2005B Bonds, become subrogated to the rights of the recipients of such payments in accordance with the terms of the Series 2005B Insurance Policy and, to evidence such subrogation, (i) in the case of subrogation as to claims for past due interest, the Fiscal Agent shall note the Series 2005B Insurer s rights as subrogee on the registration books maintained by the Fiscal Agent upon receipt from the Series 2005B Insurer of proof of the payment of interest thereon to the Bondholders of such Series 2005B Bonds and (ii) in the case of subrogation as to claims for past due principal, the Fiscal Agent shall note the Series 2005B Insurer s rights as subrogee on the registration books for the Series 2005B Bonds maintained by the Fiscal Agent upon receipt of proof of the payment of principal thereof to the Bondholders of such Series 2005B Bonds. Notwithstanding anything in this authorizing document or the Series 2005B Bonds to the contrary, the Fiscal Agent shall make payment of such past due interest and past due principal directly to the Series 2005B Insurer to the extent that the Series 2005B Insurer is a subrogee with respect thereto. Certain Provisions for the Benefit of the Series 2005 Insurer (a) For so long as the Series 2005A Insurance Policy or the Series 2005B Insurance Policy is outstanding, notwithstanding anything to the contrary set forth in the Agreement, the Agency agrees to the provisions in this paragraph (a): (1) Investment Securities. The term Investment Securities, when used in the Seventh Supplemental Agreement, shall have the meaning ascribed to it under Seventh Supplemental Agreement, to the extent permitted by applicable law (provided that the term Investment Securities shall have the meaning ascribed to it under the Original Agreement when used in the Original Agreement or any other Supplemental Agreement). Investment Securities held in any fund or account under this Seventh Supplemental Agreement shall be valued by the Fiscal Agent as frequently as deemed necessary by the Series 2005 Insurer, but not less often than annually, at the market value thereof, exclusive of accrued interest. Deficiencies in the amount on B-23

90 deposit in any fund or account resulting from a decline in market value shall be restored no later than the succeeding valuation date. (2) Default-Related Provisions: (i) (ii) (iii) (iv) (v) (vi) In the event of a default under Section 7.01(1) or (2) of the Original Agreement, the Fiscal Agent shall, to the extent there are no other available funds held under the Agreement, use the remaining funds in (a) the Series 2005A Subaccount of the Low and Moderate Income Housing Fund to pay principal of or interest on the Series 2005A Bonds, and (b) the Series 2005B Subaccount of the Low and Moderate Income Housing Fund to pay principal of or interest on the Series 2005A Bonds; In determining whether a default under Section 7.01(1) or (2) of the Original Agreement has occurred or whether a payment on the Series 2005 Bonds has been made under the Agreement, no effect shall be given to payments made under either of the Series 2005 Insurance Policies; Any acceleration of the Series 2005A Bonds or the Series 2005B Bonds or any annulment thereof shall be subject to the prior written consent of the Series 2005 Insurer (if it has not failed to comply with its payment obligations under the applicable Series 2005 Insurance Policy); The Series 2005 Insurer shall receive immediate notice of any default under Section 7.01(1) or (2) of the Original Agreement and notice of any other default with respect to the Series 2005A Bonds or the Series 2005B Bonds known to the Fiscal Agent or the Agency within 30 days of the Fiscal Agent s or the Agency s knowledge thereof; For all purposes of the provisions of the Agreement governing events of default and remedies, except the giving of notice of default to Bondholders, the Series 2005 Insurer shall be deemed to be the sole holder of the Series 2005 Bonds it has insured for so long as it has not failed to comply with its payment obligations under the applicable Series 2005 Insurance Policy; and The Series 2005 Insurer shall be included as a party in interest and as a party entitled to (i) notify the Agency, the Fiscal Agent or any applicable receiver of the occurrence of an event of default under the Agreement and (ii) request the Fiscal Agent or receiver to intervene in judicial proceedings that affect the Series 2005 Bonds it has insured or the security therefor. The Fiscal Agent or receiver shall be required to accept notice of default from the Series 2005 Insurer. (3) Amendments and Supplements. Any amendment or supplement to the Agreement or either Reserve Fund Policy Agreement shall be subject to the prior written consent of the Series 2005 Insurer. Any rating agency rating the Series 2005A Bonds or Series 2005B Bonds must receive notice of each amendment and a copy thereof at least 15 days in advance of its execution or adoption. The Series 2005 Insurer shall be provided with a full transcript of all proceedings relating to the execution of any such amendment or supplement relating to Series 2005A Bonds or Series 2005B Bonds. (4) Successor Fiscal Agent. No resignation or removal of the Fiscal Agent shall become effective until a successor has been appointed and has accepted the duties of Fiscal Agent. The Series 2005 Insurer shall be furnished with written notice of the resignation or removal of the Fiscal Agent and the appointment of any successor thereto. B-24

91 (5) Defeasance Provisions. Only cash, direct non-callable obligations of the United States of America and securities fully and unconditionally guaranteed as to the timely payment of principal and interest by the United States of America, to which direct obligation or guarantee the full faith and credit of the United States of America has been pledged, Refcorp interest strips, CATS, TIGRS, STRPS, or defeased municipal bonds rated AAA by S&P or Aaa by Moody s (or any combination of the foregoing) shall be used to effect defeasance of the Series 2005A Bonds or Series 2005B Bonds unless the Series 2005 Insurer otherwise approves. In the event of an advance refunding, the Agency shall cause to be delivered a verification report of an independent nationally recognized certified public accountant. If a forward supply contract is employed in connection with the refunding, (i) such verification report shall expressly state that the adequacy of the escrow to accomplish the refunding relies solely on the initial escrowed investments and the maturing principal thereof and interest income thereon and does not assume performance under or compliance with the forward supply contract, and (ii) the applicable escrow agreement shall provide that in the event of any discrepancy or difference between the terms of the forward supply contract and the escrow agreement (or the Agreement, if no separate escrow agreement is utilized), the terms of the escrow agreement or Agreement, if applicable, shall be controlling. (6) Reporting Requirements. The Series 2005 Insurer shall be provided with the following information: (i) (ii) (iii) (iv) Notice of any drawing upon or deficiency due to market fluctuation in the amount, if any, on deposit, in the Series 2005A Reserve Account or the Series 2005B Reserve Account; Notice of the redemption, other than mandatory sinking fund redemption, of any of the Series 2005A Bonds or Series 2005B Bonds, or of any advance refunding of the Series 2005A Bonds or Series 2005B Bonds, including the principal amount, maturities and CUSIP numbers thereof; Notice of any material events pursuant to Rule 15c2-12 under the Securities Exchange Act of 1934; and Such additional information as the Series 2005 Insurer may reasonably request from time to time. (7) Reimbursement of Expenses. The Agency shall pay or reimburse the Series 2005 Insurer for any and all charges, fees, costs, and expenses that the Series 2005 Insurer may reasonably pay or incur in connection with the following: (i) the administration, enforcement, defense, or preservation of any rights or security under the Agreement or either Reserve Fund Policy Agreement; (ii) the pursuit of any remedies under the Agreement or either Reserve Fund Policy Agreement, or otherwise afforded by law or equity, (iii) any amendment, waiver, or other action with respect to or related to this Agreement or either Reserve Fund Policy Agreement whether or not executed or completed; (iv) the violation by the Agency of any law, rule, or regulation or any judgment, order or decree applicable to it; (v) any advances or payments made by the Series 2005 Insurer to cure defaults of the Agency under the Agreement or either Reserve Fund Policy Agreement; or (vi) any litigation or other dispute in connection with the Agreement or either Reserve Fund Policy Agreement, or the transactions contemplated thereby, other than amounts resulting from the failure of the Series 2005 Insurer to honor its payment obligations under the applicable Series 2005 Insurance Policies. The Series 2005 Insurer reserves the right to charge a reasonable fee as a condition to executing any amendment, waiver, or consent proposed in respect of this Agreement or either Reserve Fund Policy Agreement. The obligations of the Agency to the Series 2005 Insurer shall survive discharge and termination of this Agreement. (b) For so long as either the Series 2005A Reserve Policy or the Series 2005B Reserve Policy is outstanding, notwithstanding anything to the contrary set forth in the Agreement, the Agency agrees to the provisions in this paragraph (b): B-25

92 (1) The Agency s repayment of any draws under the applicable Series 2005 Reserve Policy and related reasonable expenses incurred by the Series 2005 Insurer (together with interest thereon, from the date of such draw or incurrence of such expenses, at a rate equal to the lower of (i) the prime rate of Citibank, N.A., in effect from time to time, plus 2% per annum and (ii) the highest rate permitted by law) shall enjoy the same priority as the obligation to maintain and replenish the Series 2005A Reserve Account and the Series 2005B Reserve Account. Repayment of draws, expenses and accrued interest (collectively, Policy Costs ) shall be repaid by the Agency from any housing set-aside amounts collected by the Agency in any fiscal year pursuant to the Agreement. If and to the extent that cash has also been deposited in the Series 2005A Reserve Account or the Series 2005B Reserve Account (as applicable), all such cash shall be used (or investments purchased with such cash shall be liquidated and the proceeds applied as required) prior to any drawing under the Series 2005A Reserve Policy or the Series 2005B Reserve Policy (as applicable), and repayment of any Policy Costs shall be made prior to replenishment of any such cash amounts. If, in addition to the Series 2005A Reserve Policy or the Series 2005B Reserve Policy (as applicable), any other reserve fund substitute instrument ( Additional Reserve Policy ) is provided, drawings under the Series 2005A Reserve Policy or the Series 2005B Reserve Policy (as applicable) and any such Additional Reserve Policy, and repayment of Policy Costs and reimbursement of amounts due under the Additional Reserve Policy, shall be made on a pro rata basis (calculated by reference to the Maximum Amounts available thereunder) after applying all available cash in the related reserve account and prior to replenishment of any such cash draws, respectively. (2) If the Agency shall fail to repay any Policy Costs in accordance with the requirements of Paragraph (1) above, the Series 2005 Insurer shall be entitled to exercise any and all remedies available at law or in equity or under the Agreement other than (i) acceleration of the maturity of the Series 2005 Bonds or (ii) remedies which would adversely affect Bondholders. (3) The Agreement shall not be discharged until all Policy Costs owing to the Series 2005 Insurer shall have been paid in full. (4) As security for the Agency s repayment obligations with respect to the Series 2005 Reserve Policies, to the extent that the Agreement pledges or grants a security interest in any revenues or collateral of the Agency as security for the Series 2005 Bonds, the Series 2005 Insurer shall be granted a security interest in all such revenues and collateral, subordinate only to that of the Bondholders. (5) Prior to the issuance of any Parity Obligation pursuant to Article III of the Original Agreement, the Agency shall provide to the Series 2005 Insurer a Certificate of the Agency showing at least one times coverage of the Agency s obligations with respect to repayment of Policy Costs then due and owing. Furthermore, no Parity Obligations may be issued under the Agreement without the Series 2005 Insurer s prior written consent if any Policy Costs are past due and owing to the Series 2005 Insurer. (6) The Fiscal Agent shall ascertain the necessity for a claim upon the Series 2005A Reserve Policy or the Series 2005B Reserve Policy (as applicable) and to provide notice to the Series 2005 Insurer in accordance with the terms of the applicable Series 2005A Reserve Policy or the Series 2005B Reserve Policy (as applicable) at least two business days prior to each Interest Payment Date. (7) The Agreement shall not be modified or amended without the prior written consent of the Series 2005 Insurer. Miscellaneous Continuing Disclosure. The Agency and the Fiscal Agent covenant and agree that they will comply with and carry out all of the provisions of the Series 2005 Continuing Disclosure Agreement. Notwithstanding any other provision of the Agreement, failure of the Agency or the Fiscal Agent to comply with the Continuing Disclosure Agreement shall not be considered an Event of Default; however, the Fiscal Agent may (and, at the request of any Participating Underwriter or the Holders of at least 25% aggregate principal amount of B-26

93 Outstanding Series 2005 Bonds, shall, to the extent indemnified to its satisfaction) or any Bondholder or Beneficial Owner may take such actions as mad be necessary and appropriate, including seeking mandate or specific performance by court order, to cause the Agency or the Fiscal Agent, as the case may be, to comply with its obligations under this Section. For purposes of this Section, Beneficial Owner means any person which: (a) has the power, directly or indirectly, to vote or consent with respect to, or to dispose of ownership of, any Series 2005 Bonds (including persons holding Series 2005 Bonds through nominee, depositories or other intermediaries), or (b) is treated as the owner of any Series 2005 Bonds for federal income tax purposes. B-27

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95 APPENDIX C AUDITED FINANCIAL STATEMENTS OF THE AGENCY FOR FISCAL YEAR ENDED JUNE 30, 2004 C-1

96 (THIS PAGE INTENTIONALLY LEFT BLANK)

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98 Ì» ³ ² ¹»³»² ¼ ½«±² ²¼ ² ²¼ ¾«¼¹» ½±³ ±² ²º± ³ ±²ô»¼ ²» ½½±³ ² ²¹ ¾» ±º ½±²»² ô» ²±» ¼ ±º» ¾ ½ º ² ²½»³»² ¾ ³»² ²º± ³ ±²» ¼ ¾ ½½±«² ²¹ ²½» ¹»²» ½½»»¼ ²» ˲»¼ Í» ±º ß³» ½ ò É» ª»»¼ ½» ² ³»¼ ±½»¼ ô ½ ½±²»¼ ²½ ±º ² ±º ³ ² ¹»³»²»¹ ¼ ²¹» ³» ±¼ ±º ³» ³»² ²¼»»² ±² ±º»» ¼ ³»² ²º± ³ ±²ò ر»ª» ô» ¼ ¼ ²± «¼» ²º± ³ ±² ²¼»» ²± ± ² ±² ±² ò Ñ««¼ ½±²¼«½»¼ º±» «±» ±º º± ³ ²¹ ± ² ±² ±²» º ² ²½»³»² ½±»½ ª» ½±³»» ß¹»²½ ¾ ½ º ² ²½»³»² ò Ì» ²º± ³ ±² ¼»² º»¼ ²» ½½±³ ² ²¹ ¾» ±º ½±²»²» ² ±¼«½ ± ô ±» ³»² ²º± ³ ±²ô ²¼ ½»½ ±²»»²»¼ º± «±» ±º ¼¼ ±² ² ²¼ ²±» ¼ ±º» ¾ ½ º ² ²½»³»² ò Ì» ±» ³»² ²º± ³ ±² ¼»² º»¼ ²» ½½±³ ² ²¹ ¾» ±º ½±²»² ¾»»² «¾»½»¼ ±» «¼ ²¹ ±½»¼»¼ ²» «¼ ±º» ¾ ½ º ² ²½»³»² ²¼ô ² ±«± ² ±²ô º»¼ ² ³»»»½ ²» ±² ±» ¾ ½ º ² ²½»³»² µ»² ±»ò Ì» ² ±¼«½ ± ²¼ ½»½ ±² ª» ²± ¾»»² «¾»½»¼ ±» «¼ ²¹ ±½»¼»¼ ²» «¼ ±º» ¾ ½ º ² ²½»³»² ²¼ô ½½± ¼ ²¹ ô»»» ²± ± ² ±² ±²»³ò Ý» º»¼ Ы¾ ½ ß½½±«² ² É ²«Ý»»µô Ý º± ² Í»»³¾» íô îððì ïî

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100 REDEVELOPMENT AGENCY OF THE CITY OF SAN JOSE Management s Discussion and Analysis June 30, 2004 As management of the Redevelopment Agency of the City of San José (the Agency), we offer readers of the Agency s basic financial statements this narrative overview and analysis of the financial activities of the Agency for the fiscal year ended June 30, We encourage readers to consider the information presented here in conjunction with additional information that we have furnished in our letter of transmittal, which can be found beginning on page 1 of this report. FINANCIAL HIGHLIGHTS Liabilities of the Agency exceeded its assets in governmental activities at the close of fiscal year 2004 by $1,443,046,000 (net deficit). Of this amount, $7,008,000 represents investment in capital assets, and $38,040,000 represents resources restricted for debt service payment and low/moderate income housing activities. The remaining negative amount of $1,488,094,000 represents the accumulated unrestricted deficit at the close of fiscal year Total revenues in the governmental activities decreased by $114,022,000 or 34% from last year. The decrease is attributable to the decline in tax increment revenue by $27,818,000 and capital grants and contributions by $79,576,000. Total expenses in governmental activities were $139,851,000 (change in net assets) more than the $219,565,000 total revenues generated during the current year. Compared to last year, total expenses in governmental activities decreased by $176,953,000 or by 33%. The decline in expenses is attributable to the $152,960,000 or 46% decrease in community development improvement projects. At the close of the current fiscal year, the Agency s governmental funds reported combined ending fund balances of $263,561,000, an increase of $65,333,000 in comparison to the prior year. Of the combined fund balance, $144,107,000 or 55% is available for redevelopment projects at the discretion of the Agency Board/(Council). The general fund reported an increase in fund balance by $1,457,000 mainly due to a $4,350,000 or 17% decrease in general and administrative expenditures. 13

101 REDEVELOPMENT AGENCY OF THE CITY OF SAN JOSE Management s Discussion and Analysis (Continued) June 30, 2004 OVERVIEW OF THE FINANCIAL STATEMENTS This discussion and analysis is intended to serve as an introduction to the Agency s basic financial statements. The Agency s basic financial statements comprise three components: 1) government-wide financial statements, 2) fund financial statements, and 3) notes to the basic financial statements. This report also contains required and other supplementary information in addition to the basic financial statements themselves. Government-wide Financial Statements The Government-wide Financial Statements are designed to provide readers with a broad overview of the Agency s finances, in a manner similar to a private-sector business. The statement of net assets reports all financial and capital resources of the Agency. The Agency presents the statement in a format that displays assets less liabilities equal net assets/(deficit). Over time, increases or decreases in net assets may serve as a useful indicator of whether the financial position of the Agency is improving or deteriorating. The statement of activities presents information showing how the Agency s net assets changed during the most recent fiscal year. All changes in net assets are reported as soon as the underlying event giving rise to the change occurs, regardless of the timing of related cash flows. Thus, revenues and expenses are reported in this statement for some items that will result in cash flows in future fiscal periods such as revenues pertaining to uncollected taxes and earned but unused vacation and sick leave. The governmental activities of the Agency include general government, community development, housing, and debt service. The government-wide financial statements can be found on pages 26 and 27 of this report. Fund Financial Statements Fund Financial Statements are designed to report information about groupings (funds) of related accounts, which are used to maintain control over resources that have been segregated for specific activities or objectives. The Agency, like other state and local governments, uses fund accounting to ensure and demonstrate finance-related legal compliance. All funds of the Agency are categorized as governmental funds. Governmental funds are used to account for essentially the same functions reported as governmental activities in the government-wide financial statements. However, unlike the government-wide financial statements, governmental fund financial statements focus on 14

102 REDEVELOPMENT AGENCY OF THE CITY OF SAN JOSE Management s Discussion and Analysis (continued) June 30, 2004 near-term inflows and outflows of spendable resources, as well as on balances of spendable resources available at the end of the fiscal year. Such information may be useful in determining what financial resources are available in the near future to finance the Agency s redevelopment programs. Because the focus of governmental funds is narrower than that of the government-wide financial statements, it is useful to compare the information presented for governmental funds with similar information presented for governmental activities in the governmentwide financial statements. By doing so, readers may better understand the long-term impact of the government s near-term financing decisions. Both the governmental fund balance sheet and the governmental fund statement of revenues, expenditures and changes in fund balances provide a reconciliation to facilitate this comparison between governmental funds and governmental activities. The Agency maintains several individual governmental funds created according to their purpose. The individual fund information is presented separately in the governmental fund balance sheet (page 28) and in the governmental fund statement of revenues, expenditures and changes in fund balances (page 30) for all the Agency s governmental funds. Notes to the Basic Financial Statements Notes to the Basic Financial Statements provide additional information that is essential to a full understanding of the data provided in the government-wide and fund financial statements. The notes to the financial statements can be found on pages 33 to 57 of this report. Other Information In addition to the basic financial statements and accompanying notes, this report also presents required supplementary information concerning the Agency s budgetary comparison for certain governmental funds general fund and special revenue fund (pages 58 to 61). 15

103 REDEVELOPMENT AGENCY OF THE CITY OF SAN JOSE Management s Discussion and Analysis (continued) June 30, 2004 GOVERNMENT-WIDE FINANCIAL ANALYSIS As noted earlier, net assets may serve over time as a useful indicator of a government s financial position. In the case of the Agency, it is also an important determinant of its ability to finance current and future redevelopment projects. At the close of fiscal year 2004, the Agency has a net deficit of $1,443,046,000. Of this amount, $7,008,000 is invested in capital assets, $37,849,000 is restricted for debt service, and $191,000 for low and moderate-income housing. The remaining balance of ($1,488,094,000) represents a deficit, which will be covered from collection of future tax increment and other revenues. The largest portion of the Agency s deficit is caused by the outstanding long-term obligations of $2,085,325,000. Traditionally, the Agency carries a deficit to collect tax increment as mentioned earlier in the letter of transmittal. This is primarily due to the nature of tax increment financing method allowed under California law whereby a redevelopment agency issues bonds or incurs long-term debt to finance its redevelopment projects by pledging future tax increment revenues. The Agency uses debt proceeds to finance its redevelopment projects which include land, commercial and retail buildings, housing, public parking, street improvements, park improvements, transportation improvements, cultural facilities, and community centers. Once redevelopment projects that are public facilities are completed by the Agency, the responsibilities for their continued maintenance and operations are transferred to the City of San José including the capitalized redevelopment project costs. To date, such public facilities include: San José McEnery Convention Center, Children s Discovery Museum, San José Museum of Art, HP Pavilion at San José (Arena), Tech Museum of Innovation, Mexican Heritage Plaza, Guadalupe River Park and Gardens, Washington United Youth Center and Biblioteca LatinoAmericana, San José Repertory Theater, 4 th Street Parking Garage, and Alum Rock Youth Center. In addition, completed Joint Agency-Private Partnership projects with private developers are also transferred to the developers in accordance with the Development and Disposition Agreements. Although completed public facilities and Joint Agency-Private Partnership 16

104 REDEVELOPMENT AGENCY OF THE CITY OF SAN JOSE Management s Discussion and Analysis (continued) June 30, 2004 projects are transferred to the City of San José and private developers, respectively, the related debt remains with the Agency. Shown below is a comparative schedule that summarizes the Agency s net assets (net deficit): Agency s Net Assets (Deficit) Governmental Activities As of June 30, 2004 and 2003 (In thousands) Current and other assets $ 369,898 $ 328,553 Accumulated redevelopment project costs 360, ,039 Capital assets, net 7,008 6,125 Total assets 737, ,717 Long-term liabilities 2,085,325 1,901,738 Other liabilities 94, ,174 Total liabilities 2,180,169 2,028,912 Net assets: Invested in capital assets 7,008 6,125 Restricted net assets 38,040 80,481 Unrestricted net assets (deficit) (1,488,094) (1,389,801) Total Net Assets $(1,443,046) $(1,303,195) The Agency uses its accumulated redevelopment project costs and capital assets of $367,225,000 (see page 37 for additional information) to provide community development services to the citizens of the City of San José. These assets are not available for future spending and cannot be used to liquidate the Agency s debt since the resources needed to repay the debt will be provided primarily from collections of future tax increments and other revenues. 17

105 REDEVELOPMENT AGENCY OF THE CITY OF SAN JOSE Management s Discussion and Analysis (continued) June 30, 2004 Governmental activities. Overall the Agency s financial position decreased from the prior year. Under the governmental activities, the Agency s net deficit increased by $139,851,000 from the previous fiscal year. The increase accounts for 9.7 percent of the accumulated deficit. Key elements of the changes in net assets of the governmental activities are presented below: Agency s Changes in Net Assets (Deficit) For the Fiscal Years Ended June 30, 2004 and 2003 (In Thousands) Revenues: Program revenues: Operating grants and contributions $ 24,172 $ 25,093 Capital grants and contributions 18,114 97,690 General revenues: Tax increment 170, ,026 Unrestricted investment earnings 4,331 7,513 Miscellaneous 2,740 5,265 Total revenues 219, ,587 Expenses: General government 22,270 26,903 Community development 181, ,344 Housing 61,678 82,227 Debt service 94,084 92,895 Total expenses 359, ,369 Change in net assets (139,851) (202,782) Net assets/(deficit) - beginning of year (1,303,195) (1,100,413) Net assets/(deficit) - end of year $(1,443,046) $(1,303,195) 18

106 REDEVELOPMENT AGENCY OF THE CITY OF SAN JOSE Management s Discussion and Analysis (continued) June 30, 2004 Tax increment, which represents approximately 78% of total revenues, decreased from last year by $27,818,000 or 14%. The decrease was down from the 5% growth reported in the previous year due to the effects of the continuing weak local economy that triggered a rise in assessment appeals from property owners, declining value of R&D/office property in redevelopment project areas, and declining real estate transactions. Capital grants and contributions under program revenues decreased by $79,576,000 from last year. Last year s amount was higher due mainly to the reimbursement from City of San José of the costs of the site assembly for the City Hall building project, including interest, in compliance with the settlement agreement on the Ruffo case. Revenues by Source - Governmental Activities Fiscal Year % 1% 11% 8% 78% Capital grants & contributions Tax Increment Investment earnings & interest Miscellaneous Operating grants & contributions Community development expenses of $181,384,000, which represent approximately 51% of Agency s total governmental expenses (see graph on page 20), decreased by $152,960,000 or 46%. The decrease is mainly due to deferral of several redevelopment projects during the year. 19

107 REDEVELOPMENT AGENCY OF THE CITY OF SAN JOSE Management s Discussion and Analysis (continued) June 30, 2004 Housing expenses decreased by $20,549,000 from last year. This is due to the decline in payments made to the City for housing projects, resulting from lower draws on housing bond proceeds ($14,991,000) and less housing set-aside money ($5,558,000) during the year. Expenses Governmental Activities Fiscal Year % 6% 51% 17% General Government Community Development Housing Debt Service Total general government expenses of $22,270,000 decreased by $4,634,000 or 18% from last year. Of this amount, $1,120,000 represents a decrease in salaries, wages and benefits, and a $3,514,000 decrease in non-personnel services. The decrease was a result of cost cutting measures initiated by the Agency during the year, including reduction of Agency positions, no cost-of-living adjustments, no merit allowances, no health and dental benefit increases, and reduction in the use of outside consulting services. 20

108 REDEVELOPMENT AGENCY OF THE CITY OF SAN JOSE Management s Discussion and Analysis (continued) June 30, 2004 FINANCIAL ANALYSIS OF THE AGENCY S FUNDS As noted earlier, the Agency uses fund accounting to ensure and demonstrate compliance with finance-related legal requirements. Governmental funds. The focus of the Agency s governmental funds is to provide information on near-term inflows, outflows, and balances of resources that are available for spending. Such information is useful in assessing the Agency s financial requirements. In particular, unreserved fund balance may serve as a useful measure of a government s net resources available for spending at the end of the fiscal year. Individual fund information of governmental funds reported by the Agency includes general fund, special revenue fund, housing debt service fund, merged debt service fund, and capital projects fund, which are all considered major funds. At the end of the current fiscal year, the Agency s governmental funds reported combined fund balances of $263,561,000, an increase of $65,333,000 in comparison with the prior year. Of this total amount, $144,107,000 constitutes unreserved fund balance, which is available for redevelopment spending at the discretion of the Agency Board. The remainder of the fund balance is reserved to indicate that it is not available for new spending because it has been committed: 1) to pay debt service ($76,545,000), 2) to reflect the amount of assets that are long-term in nature and thus do not represent available spendable resources ($3,910,000), 3) to pay for low and moderate-income housing projects ($191,000), and 4) to liquidate contractual commitments of the period ($38,808,000). General fund. The Agency s general fund is used to account for the general and administrative expenditures. At the end of this fiscal year, the unreserved fund balance of the general fund was $5,243,000 while total fund balance was $6,706,000. Fund transfers from the capital projects fund are made to the general fund as general and administrative expenditures are incurred and deemed necessary. Special revenue fund. The special revenue fund is used to account for the portion of tax increment revenue designated for low and moderate-income housing. As required by the California Community Redevelopment Law, the Agency allocated 20 percent ($34,042,000) of the tax increment received during the year for low and moderate-income housing projects. At the end of the current year, the fund balance of the special revenue fund was zero, as the entire 20% tax increment housing set aside was transferred to the City of San José s Housing Project Fund. 21

109 REDEVELOPMENT AGENCY OF THE CITY OF SAN JOSE Management s Discussion and Analysis (continued) June 30, 2004 Debt service funds. The debt service funds have a total fund balance of $76,737,000 representing Housing Debt ($191,000) and Merged Debt ($76,546,000). The total fund balance in the Agency s debt service funds decreased by $17,694,000 from the previous year mainly from the release of the $25,873,000 debt service cash reserve fund, which was replaced by an insurance policy. The funds will be used for redevelopment projects. Capital projects fund. The fund balance in the Agency s capital projects fund had a net increase of $81,675,000 from last fiscal year as the result of total revenues and other fund financing sources ($279,845,000) being higher than the aggregate expenditures and other fund financing uses ($198,170,000). Total capital outlay expenditures of $107,533,000, which represents around 55% of the overall expenditures and other financing uses, decreased by $159,367,000 or around 60%. When compared to last year s capital activity increase of $26,954,000 or 11%, this year s decline is the result of deferral of several capital project activities due to the declining tax increment revenues caused by a downturn in the economy. General Fund Budgetary Highlights As previously mentioned the general fund only accounts for the Agency's general and administrative expenditures. During the year, changes to the general fund original budget were approved by the Board, as follow: Decrease in personnel budget by $426,900. Decrease in non-personnel budget by $2,383,287. Decrease in City Support Services by $720,539. Total actual expenditures on budgetary basis of $23.6 million were lower by $3.9 million from the original budgeted amount of $27.5 million as a result of cost cutting measures, such as elimination of a number of positions and reduction in consultant contracts not related to contractually obligated projects, initiated throughout the year. During the year, actual budgetary expenditures exceeded actual budgetary revenues by $22.5 million, which triggered the fund transfers from capital projects fund to the general fund. 22

110 REDEVELOPMENT AGENCY OF THE CITY OF SAN JOSE Management s Discussion and Analysis (continued) June 30, 2004 Accumulated Redevelopment Project Costs and Capital Assets Accumulated Redevelopment Project Costs The Agency s investment in properties for redevelopment projects for its governmental activities as of June 30, 2004 amounted to $360,217,000. This is comprised of 61% land and 39% construction in progress. Major events during the current fiscal year included the following: Construction in progress of $141 million decreased from last year by $16 million due to the deferral of several capital project activities, as stated earlier. During the year, charges to construction projects include the following: $24 million for Fox Theater, $5.6 million for 4 th /San Fernando Street Garage Parking, $3.4 million for Dr. Martin Luther King, Jr. Library, $2.5 million for Alum Rock Youth Center and $2.7 million for other public projects. Parcels of land were acquired for eventual use for redevelopment projects at a cost of $25 million. Costs of land associated with 4 th /San Fernando Street Garage Parking of $9 million, and San José Repertory Theatre of $3.2 million were transferred to the City, including $3.8 million costs of land that was transferred to private developers in accordance with Disposition and Development Agreements. Costs of completed construction projects aggregating to $52.3 million were transferred to the City of San José. These are 4 th /San Fernando Street Garage Parking ($46.6 million) and Alum Rock Youth Center ($5.7 million) At June 30, 2004, the Agency had contract commitments of $37 million for redevelopment projects. Additional information about the Agency s accumulated redevelopment project costs capital assets can be found on pages 37, 43 and 44 of notes to the financial statements. Capital Assets For the government-wide financial statement presentation, depreciable capital assets were depreciated from acquisition date to the end of the current fiscal year using the straight-line method. The Agency s capital assets consist of the parking garage ($10 million) located beneath the Fairmont Plaza Hotel in downtown San José with net book value of $5,875,000 at June 30, During the year, improvement of retail site at Fairmont Plaza 23

111 REDEVELOPMENT AGENCY OF THE CITY OF SAN JOSE Management s Discussion and Analysis (continued) June 30, 2004 Hotel Annex amounting to $1,156,000 was capitalized; fund financial statements record capital asset purchases as expenditures. Additional information about the Agency s capital assets can be found on pages 37 and 44 of notes to the financial statements. Debt Administration At June 30, 2004, the Agency had long-term bonds and notes outstanding aggregating to $2,085,140,000. Of this amount, $1,854,480,000 represents bonds backed by tax increment revenues. The remainder of the Agency s debt represents other bonds and notes secured by tax increment and other revenues such as developer payments, interest earnings and other sources. Merged Area Tax Allocation Bonds (TABs) $ 1,524,705,000 Housing Set-aside bonds 210,775,000 Merged Area Revenue Bonds 119,000,000 Sub Total 1,854,480,000 Convention Center Lease Revenue Bonds 181,390,000 4th/San Fernando Parking Revenue Bonds Pledge Obligation 45,145,000 HUD Section 108 Loans 4,125,000 Total Debt $ 2,085,140,000 During the year, the Agency issued the following bonds: A Merged Refunding Bonds for $281,985, Merged Tax allocation Bonds for $135,000, Merged Revenue Bond Series A for $45,000,000 and Series B for $15,000, Housing Set Aside Bonds Series J for $55,265,000 and Series K for $13,735,000. The ratings on Tax Allocation Bonds (TABs) with bond insurance are AAA by the rating agencies - Standard and Poor s, Moody s, and Fitch. Without bond insurance, the ratings are A by Standard Poor s, A3 by Moody s, and A by Fitch. The Housing Set-aside Bonds, comprised of various issues, are rated "A" to "AAA" except for the $70 million variable rate bonds which are rated VMIG1 - the highest short term rating from Moody s. The Agency s $11 million Merged Area Revenue Bonds are rated A+1 - the highest short term rating from Standard & Poor s. All other bonds are rated "AAA." 24

112 REDEVELOPMENT AGENCY OF THE CITY OF SAN JOSE Management s Discussion and Analysis (continued) June 30, 2004 Additional information about the Agency s long-term obligations can be found on pages 45 to 50 in the notes to the financial statements. ECONOMIC FACTORS AND NEXT YEAR'S BUDGET The Agency Board (Council) considers many factors when setting redevelopment project priorities and the budget for the ensuing year. Below are significant factors in considering the Agency s budget for the fiscal year : 12% decline of total assessed values of property in the redevelopment areas at January 1, Vacancy rate, according to Colliers Parrish International, for office property in Downtown San José was approximately 23%. Vacancy rate of R&D/office property in the Agency s Industrial Redevelopment Areas ranges from 21% to 22%. Economic outlook and budget deficit of the State of California, in particular the redevelopment agencies share in the State s Educational Revenue Augmentation Fund (ERAF). The Agency is expected to contribute approximately $18.7 million in the next fiscal year. Unemployment rate of 7.4% at July 2004 in San José/Silicon Valley as reported by California Employment Development Department, a decrease from the 9.8% rate at June 30, This compares unfavorably to the State s unemployment rate of 6.5% and national average rate of 5.7% for the same period. REQUEST FOR INFORMATION This financial report is designed to provide our citizens, taxpayers, customers, investors and creditors with a general overview of the Agency s finances. Questions concerning any of the information provided in this report or requests for additional financial information should be addressed to the Director of Finance and Administration/Chief Financial Officer, 50 West San Fernando Street, Suite 900, San José, CA Additional financial data may also be found on the Agency s website ( 25

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115 REDEVELOPMENT AGENCY OF THE CITY OF SAN JOSE Statement of Net Assets Governmental Activities June 30, 2004 ASSETS Cash and investments (Note II.A) $ 164,982,397 Receivables (net): Accrued interest 594,707 Due from the City of San Jose (Note III.C) 20,022,217 Other 1,407,831 Advances to the City of San Jose (Note III.C) 580,362 Loans receivable, net (Note II.B) 35,829,490 Deposits 62,491 Deferred charges, net 16,518,629 Restricted assets: Cash and investments (Note II.A) 129,742,802 Accrued interest receivable 157,338 Accumulated redevelopment project costs (Note II.E): Land held for redevelopment 219,087,017 Construction in progress 141,129,685 Capital assets, depreciable (Note II.F) 7,007,978 Total assets 737,122,944 LIABILITIES Accounts payable and accrued liabilities (Note II.G) 6,629,774 Deferred revenue (Note II.C) 3,952,454 Due to the City of San Jose (Note III.C) 9,403,274 Due to the County of Santa Clara (Note III.D) 15,479,470 Liabilities payable from restricted assets: Deposits, retentions and other payables 20,682,496 Accrued interest payable 38,696,149 Noncurrent liabilities (Note II.H) Due within one year 30,928,512 Due in more than one year 2,054,396,343 Total liabilities 2,180,168,472 NET ASSETS Investment in capital assets 7,007,978 Restricted for: Debt Service 37,849,359 Low and moderate income housing activities 191,312 Unrestricted deficit (1,488,094,177) Total net deficit $ (1,443,045,528) See Accompanying Notes to the Financial Statements 26

116 REDEVELOPMENT AGENCY OF THE CITY OF SAN JOSE Statement of Activities Governmental Activities For the Fiscal Year Ended June 30, 2004 General Community Debt Total Government Development Housing Service Expenses: Salaries, wages and benefits $ 13,633,606 $ 13,633,606 $ - $ - $ - Materials, supplies and other services 8,635,884 8,635, Other project expenses 242,789, ,110,699 61,678,658 - Depreciation 273, , Interest on debt 94,083, ,083,642 Total expenses 359,415,611 22,269, ,383,821 61,678,658 94,083,642 Program revenues: Operating grants and contributions 24,172,462-12,704,293 11,468,169 - Capital grants and contributions 18,113,528-18,113, Net program expense (317,129,621) $ (22,269,490) $ (150,566,000) $ (50,210,489) $ (94,083,642) General revenues: Tax increment 170,208,035 Unrestricted investment earnings 4,330,557 Miscellaneous 2,740,425 Total general revenues 177,279,017 Change in net assets (139,850,604) Net deficit, beginning of year (1,303,194,924) Net deficit, end of year $ (1,443,045,528) See Accompanying Notes to the Financial Statements 27

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118 REDEVELOPMENT AGENCY OF THE CITY OF SAN JOSE Reconciliation of the Balance Sheet of Governmental Funds to the Statement of Net Assets of Governmental Activities June 30, 2004 Amount reported for governmental activities in the statement of net assets are different because: Fund balances of all governmental funds (Page 28) $ 263,561,201 Capital assets used in governmental activities are not spendable current financial resources and, therefore, are not reported in the balance sheet of governmental funds. 7,007,978 Accumulated redevelopment costs are capitalized costs that will be transferred to the City and/or developers upon project completion. These costs are not spendable current financial resources and, therefore, are not reported in the balance sheet of the governmental funds. 360,216,702 Long-term receivables, included in loans receivable, are not available to pay for current period expenditures and, therefore, are deferred on the modified accrual basis of accounting. 33,670,966 Bond issuance costs are expended in governmental funds when paid, and are capitalized and amortized over the life of the corresponding bonds for purposes of the statement of net assets. Deferred charges, net of accumulated amortization 16,518,629 Long-term liabilities are not due and payable in the current period and, therefore, are not reported in the balance sheet of governmental funds. Tax allocation bonds $ (1,735,480,000) Revenue bonds (119,000,000) Convention Center refunding revenue bonds, net (181,390,000) Pledge obligation (4th St./San Fenrando Parking Revenue Bonds) (45,145,000) HUD Section 108 loans (4,125,000) Unamortized premiums and discounts on bonds (19,262,656) Unamortized deferred amount on refunding 20,020,496 Compensated absences (942,695) (2,085,324,855) Interest payable on long-term debt does not require the use of current financial resources and, therefore, interest payable is not accrued as a liability in the balance sheet of governmental funds. (38,696,149) Net deficit of governmental activities (Page 26) $ (1,443,045,528) See Accompanying Notes to the Financial Statements 29

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120 REDEVELOPMENT AGENCY OF THE CITY OF SAN JOSE Reconciliation of the Statement of Revenues, Expenditures and Changes in Fund Balances of Governmental Funds to the Statement of Activities of Governmental Activities For the Fiscal Year Ended June 30, 2004 Amounts reported for governmental activities in the statement of activities are different because: Net change in fund balances of all governmental funds (Page 30) $ 65,332,532 Governmental funds report capital outlays as expenditures. However, in the statement of activities the cost of these assets is either allocated over their estimated useful lives and reported as depreciation expense or accumulated as redevelopment project costs and transferred to the City or developers upon project completion. The components of capital outlay related costs not reported in the statement of activites for the current period are as follows: Costs capitalized related to accumulated redevelopment projects costs $ 63,175,689 Costs capitalized related to capital assets 1,156,100 Costs related to completed projects transferred to the City and developers (93,998,298) Depreciation expense (273,122) (29,939,631) Revenues and loans repayments recognized in the governmental funds that were earned and recognized in previous years and are reported as beginning net assets in the statement of activites: Loan repayments received (154,475) New loans given during the fiscal year 3,646,535 3,492,060 Compensated absenses reported in the statement of activities do not require the use of current financial resources and, therefore, are not reported as expenditures in governmental funds. (96,524) Bond issuance costs are expended in governmental funds when paid, however, are capitalized and amortized over the life of the corresponding bonds for the purposes of the statement of activities: Bond issuance costs 8,867,429 Amortization of bond issuance costs (624,603) 8,242,826 Repayment of long-term debt principal is reported as an expenditure in governmental funds and, thus, has the effect of reducing fund balance because current financial resources have been used. However, the principal payments reduce the liabilities in the statement of net assets and do not result in an expense in the statement of activities. The Agency's long-term debt was reduced because principal payments were made to bond holders and HUD: Tax allocation bonds 28,395,000 Convention Center refunding revenue bonds 4,050,000 Pledge obligation (4th St./San Fernando Parking Revenue Bonds) 1,225,000 HUD Section 108 loans 190,000 Payment to refunded bond escrow agent 344,522, ,382,894 (Continued on next page) See Accompanying Notes to the Financial Statements 31

121 REDEVELOPMENT AGENCY OF THE CITY OF SAN JOSE Reconciliation of the Statement of Revenues, Expenditures and Changes in Fund Balances of Governmental Funds to the Statement of Activities of Governmental Activities For the Year Ended June 30, 2004 (Continued from previous page) Accrued interest expense on long-term debt is reported in the statement of activities, but does not require the use of current financial resources. Amortization of bond premiums, discounts and deferred amounts on refunding should be expensed as a component of interest expense on the statement of activities. This amount represents the net accrued interest expense and the Amortization of bond premiums, discounts and deferred amounts on refunding not reported in governmental funds: Increase in accrued interest expense (2,619,676) Amortization of bond premiums and discounts 362,271 Amortization of deferred amounts on refunding (297,586) (2,554,991) Bonds proceeds are reported as financing sources in governmental funds and thus contribute to the change in fund balance. In the government-wide statements, however, issuing debt increases long-term liabilities in the statement of net assets and does not affect the statement of activities. Proceeds were received from: Tax allocation bonds (136,423,919) Proceeds from revenue bonds (60,000,000) Proceeds from refunding bonds (366,285,851) (562,709,770) Change in net assets of governmental activities (Page 27) $ (139,850,604) See Accompanying Notes to the Financial Statements 32

122 REDEVELOPMENT AGENCY OF THE CITY OF SAN JOSE Notes to the Basic Financial Statements June 30, 2004 I. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The basic financial statements of the Redevelopment Agency of the City of San José (the Agency) have been prepared in conformity with accounting principles generally accepted in the United States of America (GAAP) as applicable to governmental units. The Governmental Accounting Standards Board (GASB) is the accepted standard-setting body for establishing governmental accounting and financial reporting principles. The more significant accounting policies of the Agency are described below: A. Reporting Entity The Agency was established in 1956 by the San José City Council as a public entity legally separate from the City of San José (the City). In 1975, the City Council declared itself the Agency Board, replacing a separate board. The Agency has the broad authority to acquire, rehabilitate, develop, administer, and sell or lease property in a Redevelopment Area. Redevelopment projects may be developed in cooperation with private developers. Redevelopment projects are also developed under cooperation agreements between the Agency and the City. The cooperation agreements call for the City to provide general, administrative, and other services in exchange for amounts paid by the Agency. The Agency generally finances redevelopment projects through the issuance of tax allocation bonds. These bonds are payable from the incremental portion of property taxes collected within a project area relating to the increase in assessed valuation resulting from redevelopment. The County of Santa Clara (the County) collects these incremental tax revenues on behalf of the Agency. The Agency has a tax sharing agreement with the County that requires sharing of incremental tax revenues with the County. The Agency has merged all of its redevelopment areas into a single Merged Project Area in order to combine tax increment revenues to obtain greater financing power through issuance of tax allocation bonds. Under GASB Statement No. 14, The Financial Reporting Entity, the Agency is considered a component unit of the City since the Agency Board consists exclusively of the Mayor and the ten members of the City Council. Consequently, the Agency s financial statements are blended in the City s basic financial statements. B. Measurement Focus, Basis of Accounting and Basis of Presentation Government-wide Financial Statements The government-wide financial statements are reported using the economic resources measurement focus and the accrual basis of accounting. Revenues are recognized when earned and expenses are recorded when a liability is incurred regardless of the timing of related cash flows. Nonexchange transactions, in which the Agency gives (or receives) value without directly receiving (or giving) equal 33

123 REDEVELOPMENT AGENCY OF THE CITY OF SAN JOSE Notes to the Basic Financial Statements (Continued) June 30, 2004 value in exchange, include property tax increment, grants, and donations. On an accrual basis, revenue from property tax increment is recognized in the fiscal year for which the taxes are levied. Other revenues such as grants and similar items are recognized in the fiscal year in which all eligible requirements have been satisfied. The statement of net assets and statement of activities display information about the Agency as a whole and, accordingly, eliminations have been made to remove interfund activities. The statement of activities presents a comparison between direct expenses and program revenues for activities of the Agency. Direct expenses are those that are specifically associated with a program or function and, therefore, are clearly identifiable to a particular program or function. Program revenues include 1) charges paid by the recipients of goods or services offered by the programs and 2) grants and contributions that are restricted to meeting the operational or capital requirements of a particular program. Revenues that are not classified as program revenues, including all taxes, are presented instead as general revenues. When both restricted and unrestricted net assets are available, unrestricted resources are used only after the restricted resources related to grants are depleted. Fund Financial Statements The accounts of the Agency are organized and operated on the basis of funds. A fund is an independent fiscal and accounting entity with a self-balancing set of accounts. Fund accounting segregates funds according to their intended purpose and is used to aid management in demonstrating compliance with finance-related legal and contractual provisions. The minimum number of funds is maintained consistent with legal and managerial requirements. Governmental fund financial statements are reported using the current financial resources measurement focus and the modified accrual basis of accounting. Under this method, revenues are recognized as soon as they are measurable and available. Revenues are considered to be available when they are collectible within the current period or soon enough thereafter to pay liabilities of the current period. For this purpose, the Agency considers revenues to be available if they are collected within 60 days after the end of the current fiscal period. The primary revenue sources susceptible to accrual are property tax increment, intergovernmental and grant revenues, investment income, developer contributions, and rent. Expenditures are generally recorded when a liability is incurred, as under accrual accounting. However, debt service expenditures, as well as expenditures related to compensated absences and claims and judgments are recorded only when payment is due. General capital assets acquisitions are reported as expenditures in governmental funds. Proceeds of long-term debt and capital leases are reported as other financing sources. The fund financial statements provide information about the Agency s funds. The emphasis of fund financial statements is on major governmental funds, each displayed in a separate column. 34

124 REDEVELOPMENT AGENCY OF THE CITY OF SAN JOSE Notes to the Basic Financial Statements (Continued) June 30, 2004 The Agency reports the following major governmental funds: The General Fund is used to account for the Agency s general and administrative expenditures. The Special Revenue Fund is used to account for revenue sources that are legally restricted to expenditures for specified purposes. The purpose of this fund is to account for that portion of tax increment revenue designated for low and moderate-income housing. The Housing Debt Service Fund was established to account for the payment of interest and principal on the Agency s merged area housing tax allocation bonds. The primary source of revenue for this fund is intergovernmental revenue from the City of San José Housing Department representing tax increment pledged per housing bond indentures. The Merged Debt Service Fund was established to account for the payment of interest and principal on the Agency s merged area tax allocation bonds, revenue bonds, refunding revenue bonds, and HUD Section 108 loan. The primary source of revenue for this fund is the incremental property tax revenues. The Capital Projects Fund accounts for all revenues and costs of implementing the redevelopment projects in accordance with the California Community Redevelopment Law including acquisition of properties, cost of site improvements, and other costs that benefit the projects. C. Assets, Liabilities and Equity 1. Investments The Agency records investment transactions on the trade date. Investments in marketable securities, which have a remaining maturity at time of purchase of one year or less, are reported at amortized cost. All other investments are reported at fair value in accordance with GASB Statement No. 31, Accounting and Financial Reporting for Certain Investments and for External Investment Pools. Fair value is defined as the amount that the Agency could reasonably expect to receive for an investment in a current sale between a willing buyer and seller and is generally measured by quoted market prices. Investment income, including unrealized gains and losses, is recognized as revenue in both government-wide and fund financial statements. 2. Property Tax Increment Revenues Incremental property tax revenues represent taxes collected in the merged redevelopment project area from the excess of taxes levied and collected over that amount which was levied and collected in the base year (the inception year of redevelopment project areas) property tax assessment. 35

125 REDEVELOPMENT AGENCY OF THE CITY OF SAN JOSE Notes to the Basic Financial Statements (Continued) June 30, 2004 Under California Proposition 13, the regular roll value serves as the original base value of the property. Thereafter, changes to the assessment on real property value or a portion thereof, caused by new construction or changes in ownership create the base year value used in establishing the full cash value. The full cash value is the amount of cash or equivalent value of property if exposed for sale in the open market. The full cash value may be adjusted annually to reflect inflation at a rate not to exceed 2% per year, or reduction in the consumer price index or comparable local data at a rate not to exceed 2% per year, or reduced in the event of declining property values caused by damage, destruction or other factors, including a general economic downturn. The maximum basic property tax rate is 1% of the net taxable value of the property. The total tax rate may be higher for various properties because of voter-approved general obligation bonds that are secured by property taxes for the annual payment of principal and interest. The County of Santa Clara assesses properties, bills, and collects property taxes, as follows: Secured Unsecured Valuation/lien dates January 1 January 1 Levy dates October 1 July 1 Due dates (delinquent as of) 50% on November 1 (December 10) July 1 (August 31) 50% on February 1 (April 10) Taxes are secured by liens on the property being taxed. The term unsecured refers to taxes on property other than land and buildings. Supplemental property taxes are levied based on changes in assessed values between the date of real property sales and construction and the next normal assessment date. The County bills and collects property taxes and remits to the Agency its share of the amount levied. The County allocates property taxes to the Agency based on 100% of the tax levy, notwithstanding any delinquencies. Revenue is recognized when it is levied and received from the County, as discussed under section of Basis of Accounting. 3. Restricted Assets Assets that are restricted for specified uses by bonded debt requirements, grant provisions or other requirements are classified as restricted because they are maintained in separate bank accounts or by fiscal agents, and their use is limited by applicable bond covenants or agreements. Liabilities payable from such restricted assets are separately classified. 36

126 REDEVELOPMENT AGENCY OF THE CITY OF SAN JOSE Notes to the Basic Financial Statements (Continued) June 30, Accumulated Redevelopment Project Costs Accumulated redevelopment project costs consist of costs associated with land acquisition and construction in progress for redevelopment projects that will be transferred to the City or a developer (i.e. title and ownership of the assets will be given to the City or a developer) in accordance with development agreements. Because these assets will not be used in the Agency s operations, the accumulated redevelopment project costs are not considered capital assets. 5. Capital Assets The Agency defines capital assets as assets used in redevelopment operations with an initial individual cost of at least $5,000 and an estimated useful life in excess of one year. The capital assets consist of the parking garage located beneath the Fairmont Plaza Hotel and certain improvements to the Fairmont Annex retail space. The capital assets are recorded in the government-wide financial statements at historical cost and are being depreciated using the straight-line method over a 40-year and a 25-year estimated useful life, respectively. Maintenance and repairs are charged to operations when incurred. Betterments and major improvements, which significantly increase values, change capacities, or extend useful lives, are capitalized. Upon sale or retirement of capital assets, the cost and related accumulated depreciation are removed from the respective accounts and any resulting gain or loss is included in the statement of activities. However, the proceeds from the sale of capital assets are recorded as other financing sources in the governmental fund statement of revenues, expenditures and changes in fund balances. 6. Compensated Absences (Accrued Vacation and Sick Leave) As part of the employees compensation package, the Agency provides benefits to its employees by establishing a Paid Time Off (PTO) and Extended Sick Leave (ESL) benefit program. Under this program, employees are permitted to accumulate earned PTO and ESL benefits. Vested or accumulated PTO and ESL are reported as a long-term liability on the statement of net assets and are paid out of the General Fund. All regular employees scheduled to work 20 hours or more per week are entitled to the PTO and ESL benefits. The amount of PTO earned each year is based on employees continuous length of service, measured from the date of employment. The maximum PTO annual accrual per employee may not exceed 400 hours at the end of the fiscal year. ESL hours are credited at the rate of 40 hours per fiscal year for all regular employees regardless of length of service. Upon termination, payouts of PTO and ESL are calculated as earned on a bi-weekly accrual schedule. Earned and unused PTO is paid in full while only 25% of earned but unused ESL is paid out. 37

127 REDEVELOPMENT AGENCY OF THE CITY OF SAN JOSE Notes to the Basic Financial Statements (Continued) June 30, Bond Issuance Costs, Original Issue Discounts, Premiums, and Deferred Gains or Losses on Refundings In the government-wide financial statements, long-term debt and other long-term obligations are reported as liabilities in the statement of net assets. Bond issuance costs, premiums, discounts, and gains or losses occurring from refundings are deferred and amortized over the life of the bonds. Bond issuance costs are reported as deferred charges and are amortized into the appropriate functional expense category. Bonds payable are reported net of the applicable bond premiums, discounts, and deferred amounts on refunding and are amortized as a component of interest expense. In the fund financial statements, bond issuance costs, premiums, and discounts are recognized at the time bonds are issued. Issuance costs, whether or not withheld from the actual debt proceeds received, are reported as debt service expenditures and all other amounts are reported as other financing sources or uses. 8. Interfund Transactions Interfund transactions are reflected either as loans, services provided, reimbursements or transfers in the government fund financial statements. Loans between funds are reported as receivables and payables as appropriate and are subject to elimination upon consolidation and are referred to as either due to/from other funds (i.e. the current portion of interfund loans) or advances to/from other funds (i.e. the noncurrent portion of interfund loans). Services provided, deemed to be at market or near market rates, are treated as revenues and expenditures/expenses. Reimbursements are recorded when one fund incurs a cost, charges the appropriate benefiting fund, and reduces its related cost as a reimbursement. All other interfund transactions are treated as transfers. Transfers between governmental funds are netted as part of the reconciliation to the government-wide presentation. 9. Use of Estimates The preparation of the basic financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the basic financial statements, and the reported amounts of revenues and expenditures/expenses during the reporting period. Actual results could differ from those estimates. 38

128 REDEVELOPMENT AGENCY OF THE CITY OF SAN JOSE Notes to the Basic Financial Statements (Continued) June 30, 2004 II. DETAILED NOTES ON ALL FUNDS A. Cash and Investments The Agency s cash and investments consist of the following at June 30, 2004: Deposits Unrestricted cash and investments $ 164,982,397 Restricted cash and investments 129,742,802 Total cash and investments $ 294,725,199 At year-end, the carrying amount of the Agency's cash and cash deposits was $55,373,198 and the bank balance was $56,502,576. The difference between the bank balance and the carrying amount represents outstanding checks and deposits in transit. Of the bank balance, $300,000 was covered by federal depository insurance and $56,202,576 was collateralized by the pledging financial institutions as required by Section of the California Government Code. Such collateral is held by the pledging financial institutions trust department or agent in the Agency s name. Under the California Government Code, a financial institution is required to secure deposits in excess of $100,000 made by state or local governmental units by pledging securities held in the form of an undivided collateral pool. The market value of the pledged securities in the collateral pool must equal at least 110% of the total amount deposited by the public agencies. California law also allows financial institutions to secure public deposits by pledging first trust deed mortgage notes having a value of 150% of those deposits. The collateral must be held at the pledging bank s trust department or other bank, acting as the pledging bank s agent, in the Agency s name. Investments As permitted by the California Government Code, bond indentures, and contracts and agreements, the Agency is permitted to invest in the City s cash and investment pool, obligations of the U.S. Treasury or its agencies, certificates of deposits, mutual funds invested in U.S. Government securities, and other permitted investments. The Agency maintains all of its unrestricted investments in the City s cash and investment pool. It is not possible to disclose relevant information about the Agency's separate portion of the investment pool. Information regarding the characteristics of the entire investment pool can be found in the City s June 30, 2004 basic financial statements. A copy of that report may be obtained by contacting the City s Finance Department, 801 North First Street, Room 110, San José, CA, or can be found at the City s Finance Department Web Site at As of June 30, 2004, the Agency s share of the City s cash and investment pool totaled $162,951,562 and $594,707 in accrued interest. Of the Agency s $12,301,000 investment in the State of California Local Agency Investment 39

129 REDEVELOPMENT AGENCY OF THE CITY OF SAN JOSE Notes to the Basic Financial Statements (Continued) June 30, 2004 Fund (LAIF) held by a fiscal agent at June 30, 2004, the Agency s proportionate share of structured notes and asset-backed securities was $198,046 or 1.61%. The Local Investment Advisory Board (Board) has oversight responsibility for LAIF. The Board consists of five members as designated by state statute. The value of the pool shares in LAIF, which may be withdrawn upon request, is determined on an amortized cost basis, which is different from the fair value of the Agency s position in the pool. Income earned or losses arising from investments in the City s cash and investment pool are allocated on a monthly basis to the appropriate funds based on the average weekly cash balance of such funds. For financial reporting purposes, investments are categorized to give an indication of the level of custodial credit risk assumed by the Agency at year-end. Custodial credit risks are: Category 1 includes investments that are insured or registered, or for which the securities are held by the Agency or its agents in the Agency s name; Category 2 includes uninsured and unregistered investments for which securities held by the counterparty s trust department or agent in the Agency's name; and Category 3 includes uninsured and unregistered investments for which the securities are held by the Agency s counterparty, or by its trusts or agent, but not in the Agency s name. During the year, the Agency does not have any investments that are subject to categorization. A summary of the Agency s investments at June 30, 2004 is as follows: Fair Value Uncategorized investments: City of San José cash and investment pool $ 162,951,562 State of California Local Agency Investment Fund 12,301,000 Money market mutual funds 64,099,439 Total investments $ 239,352,001 Restricted Investments in the Debt Service Funds Under the provisions of the bond indentures, certain accounts with trustees were established for repayment of debt and to set aside amounts required to be held in reserve. These accounts are reported in debt service funds. As of June 30, 2004, the amounts held by the trustees aggregated $76,579,482, which is in compliance with amounts required to be held by the trustee at that date. All restricted investments held by trustees as of June 30, 2004 were invested in U.S. government securities, money market mutual funds and LAIF, and were in compliance with the bond indentures. 40

130 REDEVELOPMENT AGENCY OF THE CITY OF SAN JOSE Notes to the Basic Financial Statements (Continued) June 30, 2004 Restricted Deposits in the Capital Projects Fund Pursuant to contracts and agreements made by the Agency, certain funds are required to be held in escrow accounts that remain the property of the Agency; however, their use is restricted for a particular purpose. The program and projects for which these funds are restricted at June 30, 2004 are as follows: Montgomery Hotel $ 213,685 CIM Soil Remediation 850,000 HUD Section 108 funds (Eu Building) 1,861,996 Redevelopment Projects and Programs 25,873,298 Fountain Alley (purchase option on parking) 1,812,483 California Theatre 20,544,186 Others 2,007,672 Total restricted deposits $ 53,163,320 B. Loans Receivable Over the years, parcels of land have been sold to commercial real estate developers in exchange for various interest bearing loans. Such loans have terms ranging from 16 to 40 years, with interest rates ranging from 2% to 10%, after interest free periods of up to 10 years, and call for principal and interest payments monthly or annually over the remaining life of the loans. The recognition of revenue from the sale of the land has been deferred in the governmental fund financial statements on such loans until they are repaid since the amounts do not meet the availability criteria. As of June 30, 2004, the amount due from developers was approximately $10,986,000. In 1997, the Agency extended loans to developers using funds obtained from the U.S. Department of Housing and Urban Development Section 108 loan proceeds. These loans have a 20-year repayment schedule, bear interest at an annual rate of 3%, and require principal and interest payments to the Agency on a monthly basis. As of June 30, 2004, the amount due from the developers was approximately $3,227,000. In 1998, construction was completed on a housing project, resulting in a loan receivable from the developer for amounts previously expensed by the Agency and advanced to the developer. This loan is for 30 years and bears interest at an annual rate of 2%, with annual payments to the Agency based upon the net cash flow of the project each year. The recognition of revenue from the loan receivable has been deferred in the government fund financial statements on such loans until payments are received. As of June 30, 2004, the amount due from the developer was approximately $11,287,000. In 1999, the Agency extended a loan to a developer which consolidated all existing amounts owed the Agency and paid-off a loan due to a commercial bank. This loan has a 7-year graduated repayment schedule bearing interest at an annual rate of 4%, and requires principal and interest payments to the Agency on a monthly basis, commencing March 1, As of June 30, 2004, the amount due from the developer was approximately $1,661,

131 REDEVELOPMENT AGENCY OF THE CITY OF SAN JOSE Notes to the Basic Financial Statements (Continued) June 30, 2004 In 1999, the Agency extended a loan to a developer for rehabilitation of an apartment complex. The loan to the developer has a 19-year repayment schedule, bears interest at an annual rate of 3%, and requires principal and interest payments to the Agency on a monthly basis. As of June 30, 2004, the amount due from the developer was approximately $759,000. The Agency relocated historic single-family homes to vacant lots in downtown San José. These homes were provided to families and a non-profit agency, which provided the interior and exterior improvements. The loans are to be paid only in the event of non-compliance with the terms and conditions of the agreement. At the time residential occupancy of the house ceases or the property is transferred to anyone other than the owner by any method other than inheritance, the unamortized portion of the loan shall become due and payable in full. Unpaid principal shall bear an interest rate of 8% per annum. The total loans of approximately $3,372,000 have been offset with a 100% provision for doubtful accounts as it is anticipated that these loans will be forgiven. The Agency extended various bank-assisted loans to aid first-time homebuyers and to aid with the rehabilitation of homes. The loans accrue interest at various interest rates and are due when the related properties are sold. As of June 30, 2004, the amount due from such loans was approximately $326,000, which is net of an allowance for doubtful accounts of $73,600 recorded on both the governmental funds balance sheet and the government-wide statement of net assets. Rehabilitation loans were extended to property owners for the rehabilitation and improvements of commercial buildings. The loans accrue interest at various interest rates and are due within 60 to 240 months. At June 30, 2004, the amount due from such loans was approximately $4,148,000. In 2004, commercial loans were extended to two developers for improvements of downtown buildings. The loans accrue interest at 3% and are due in 10 and 20 years, respectively. At June 30, 2004, the amount due from such loans was approximately $3,436,000. C. Deferred Revenue At June 30, 2004, the various components of deferred revenue reported in the Capital Projects Fund and governmental activities were as follows: Amount Amounts considered unavailable related to receivables $ 33,670,966 Amounts considered unearned related to developer contributions 3,952,454 Total deferred revenue $ 37,623,420 42

132 REDEVELOPMENT AGENCY OF THE CITY OF SAN JOSE Notes to the Basic Financial Statements (Continued) June 30, 2004 D. Interfund Transactions The composition of fund transfers for the fiscal year ended June 30, 2004 is as follows: Transfer-out Fund Transfer-in Fund Amount Merged Debt Service Capital Projects $ 25,873,298 Capital Projects General Fund 22,500,000 Capital Projects Merged Debt Service 16,717,071 Housing Debt Service Capital Projects 348 Total $ 65,090,717 The $25,873,298 amount represents balances transferred from the 2002 Bonds reserve account, which upon purchase of a surety bond resulted in the release of the former cash reserve. The $22,500,000 amount represents a transfer of funds necessary to cover the general and administrative expenditures of the Agency. The $16,717,071 amount represents transfers necessary to make required debt service payments. E. Accumulated Redevelopment Project Costs For the fiscal year ended June 30, 2004, the change in accumulated redevelopment project costs consisted of the following (in thousands): Transfers, Deletions and July 1, 2003 Additions Adjustments June 30, 2004 Land held for Redevelopment $ 233,488 $ 24,957 $ (39,358) $ 219,087 Construction in Progress 157,551 38,219 (54,640) 141,130 Total $ 391,039 $ 63,176 $ (93,998) $ 360,217 During the year, the Agency transferred to the City of San Jose land costing approximately $12,627,000 (mainly involving the 4 th Street Parking Garage of $9 million) and costs of completed construction projects (4 th Street Parking Garage and Alum Rock Youth Center) aggregating $52,301,000. Approximately $3,780,000 of land costs was transferred to developers in accordance with Disposition and Development Agreements. An adjustment was recorded to land held for redevelopment account amounting to $22,951,000 due to refunds of condemnation deposits made in prior years. 43

133 REDEVELOPMENT AGENCY OF THE CITY OF SAN JOSE Notes to the Basic Financial Statements (Continued) June 30, 2004 Construction in progress as of June 30, 2004 consisted of the following (in thousands): F. Capital Assets A summary of changes in the Agency s capital assets for the fiscal year ended June 30, 2004 is as follows (in thousands): Balance July 1, 2003 Additions Balance June 30, 2004 Parking/Building Improvements $ 10,000 $1,156 $ 11,156 Less accumulated depreciation (3,875) (273) (4,148) $ 6,125 $ 883 $ 7,008 The capital assets consist of the parking garage located beneath the Fairmont Plaza Hotel, which was constructed in 1987, and certain improvements to the Fairmont Annex retail space, which were completed in G. Payables Dr. Martin Luther King, Jr. Library $ 62,700 4 th Street Parking Garage 599 Civic Plaza Streetscape 933 California Theatre 62,927 Billy DeFrank Center 1,057 Jose Theatre 7,156 Bellevue Park 2,486 Other projects 3,272 Total construction in progress $ 141,130 Agency accounts payable and accrued liabilities at June 30, 2004 are as follows: Payables Governmental Activities: General Fund Capital Projects Total Accounts payable $ 562,074 $ 5,750,046 $ 6,312,120 Accrued salaries and related payroll liabilities 317, ,654 Total $ 879,728 $ 5,750,046 $ 6,629,774 44

134 REDEVELOPMENT AGENCY OF THE CITY OF SAN JOSE Notes to the Basic Financial Statements (Continued) June 30, 2004 H. Debt Long-term Debt The following is a summary of long-term debt of the Agency as of June 30, 2004 (in thousands): Type of Indebtedness Purpose Original Issue Amount Issue Date Final Maturity Range Interest Rate Annual Principal Installments Outstanding at June 30, 2004 Tax Allocation Bonds: 1993 Merged Area Refunding Advanced refunding $692,075 12/1/93 8/1/ % $10, ,320 $ 323, Housing, Series D Low-moderate income housing 10,525 12/1/93 8/1/ % $10,525 10, Housing, Series E Low-moderate income housing 17,045 6/21/97 8/1/ % $2,420-14,625 17, Housing, Series F Low-moderate income housing 44,205 12/13/00 8/1/ % $4,935-30,720 44, Housing, Series G & H Low-moderate income housing 70,000 5/29/02 8/1/30 Variable $2,000-6,800 70, Housing, Series J & K Low-moderate income housing 69,000 7/10/03 8/1/ % $230 2,480 69, Merged Merged Area projects 106,000 3/27/97 8/1/ % $1,850-24,135 85, Merged Merged Area projects 175,000 3/19/98 8/1/ % $1,010-72, , Merged Merged Area projects 240,000 1/6/99 8/1/ % $3,275-55, , Merged Merged Area projects 350,000 1/24/02 8/1/ % $6,925-75, , Merged Merged Area projects 135,000 12/22/03 8/1/ % $25 27, , A Merged Refunding Refund portion of Merged Bonds 281,985 5/27/04 8/1/ % $250 31, ,985 Total Tax Allocation Bonds 1,735,480 Other Long-term Debt: 1996 Merged Area Revenue, Serie A/B Merged area projects 59,000 6/27/96 7/1/26 Variable $700-1,700 59, Merged Area Revenue, Series A/B Merged area projects 60,000 8/27/03 8/1/30 Variable $500 3,900 60,000 Pledge obligation - 4th/San Fernando Parking Revenue 4th/San Fernando parking facility Bonds project 48,675 3/10/01 9/1/26 Variable $1,130-8,310 45, Convention Center Convention Center refunding refunding Bonds, Series F project 190,730 7/1/01 9/1/ % $710-14, ,390 HUD Section 108 Loans Merged area projects 5,200 2/11/97 8/01/16 Variable Various 4,125 Total Other Long-term Debt 349,660 Total Long-term Debt $2,085,140 45

135 REDEVELOPMENT AGENCY OF THE CITY OF SAN JOSE Notes to the Basic Financial Statements (Continued) June 30, 2004 A summary of the changes in long-term debt during the fiscal year ended June 30, 2004 follows (in thousands): Balance July 1, 2003 Payments/ Refundings Balance June 30, 2004 Amount Due in One Year Additions Tax allocation bonds: 1993 Merged Area Refunding $ 576,400 $ - ($ 253,225) $ 323,175 $ 5, Housing, Series A 14,430 - (14,430) Housing, Series B 7,555 - (7,555) Housing, Series C 19,615 - (19,615) Housing, Series D 10, , Housing, Series E 17, , Housing, Series F 44, , Housing, Series G & H 70, , Housing, Series J & K - 69,000 69,000 3, Merged 95,725 - (9,945) 85,780 2, Merged 170,720 - (1,175) 169,545 1, Merged 229,705 - (3,720) 225,985 3, Merged 350,000 - (40,775) 309,225 7, Merged - 135,000 (5,990) 129, A Merged Refunding - 281, ,985 - Total tax allocation bonds 1,605, ,985 (356,430) 1,735,480 23,845 Other long-term debt: 1996 Merged Area Revenue, Series A/B 59, ,000 1, Merged Area Revenue, Series A/B - 60,000-60,000 - Pledge obligation 4th/San Fernando parking revenue bonds 46,370 - (1,225) 45,145 1, Convention Center Refunding Bonds, Series F 185,440 - (4,050) 181,390 4,540 HUD Section 108 loans, variable rate loans 4,315 - (190) 4, Total other long-term debt 295,125 60,000 (5,465) 349,660 7,420 Total long-term debt, before issuance discount and premiums and deferred amount on refunding 1,901, ,985 (361,895) 2,085,140 31,265 Unamortized issuance premium 3,376 16,725 (662) 19,439 1,229 Unamortized issuance discount (182) - 6 (176) (6) Unamortized deferred amount on refunding (3,352) (16,966) 297 (20,021) (1,644) Total long-term debt payable 1,900, ,744 (362,254) 2,084,382 30,844 Compensated absences (87) Total long-term obligations $ 1,901,738 $ 545,928 ($362,340) $ 2,085,325 $ 30,929 The Merged Tax Allocation Bonds are senior debt and are repaid with the tax increment. The Housing Bonds are repaid with the Housing Set-Aside Amounts. The Merged Revenue Bonds are repaid with subordinated revenues. The remaining long-term debt is repaid with other revenues. 46

136 REDEVELOPMENT AGENCY OF THE CITY OF SAN JOSE Notes to the Basic Financial Statements (Continued) June 30, Housing Bonds In July 2003, the Agency issued Housing Set-aside Taxable Tax Allocation Bonds, Series J and Housing Set-aside Tax Exempt Tax Allocation Bonds, Series 2003K aggregating to $69,000,000. The bonds were issued for the purpose of increasing, improving, and preserving the supply of very low to moderate income housing and to refund the Housing Bonds Series 1993A, Series 1993B and Series 1993C. Part of the proceeds were also used to repay the amount drawn from a bank line of credit that was used for low to moderate housing in the City of San Jose and to purchase bond insurance and surety bonds for the reserve account for Series J and K. The bonds are equally and ratably secured by the pledge and lien of the Housing Set-aside Amounts under the Fiscal Agent Agreement dated as of February 1, 1993 between the Agency and the Fiscal Agent. Proceeds of $40,471,506 and residual cash balances of $4,160,960 provided by the old debt were placed in an irrevocable trust with an escrow agent to provide for debt service payments on the old debt as per the Indenture Agreement. As a result, the debt mentioned above is considered defeased and the liabilities have been removed from the financial statements. The defeased bonds had no outstanding balance as of June 30, Although the refunding resulted in the accounting recognition of a deferred loss of $3,032,466 for the fiscal year ended June 30, 2004, the Agency in effect reduced its aggregate debt service payments by approximately $5,219,000 over the next 18 years and obtained a net economic gain (difference between the present values of the old and new debt service payments) of $5,190,000. In connection with the issuance of the 2003 Housing Bonds Series J and K, the Agency obtained a surety bond for the Reserve Account in the amount of $6,177,000 to satisfy bond indenture requirements of the Housing Bonds, Series J and K. In addition, the payment of principal and interest of the 2003 Housing Bonds, Series J and K is insured by a municipal bond and reserve insurance policies over the life of the issue Tax Allocation Revenue Bonds In August 2003, the Agency issued Merged Area Taxable Revenue Bonds Series 2003A and Merged Area Revenue Bonds Series 2003B totaling $60,000,000. The proceeds of the bonds were used mainly to finance redevelopment projects within the Merged Area. The 2003 Tax Revenue Bonds are ratably and equally secured by a pledge of the subordinated revenues and subordinate to the debt service payment of Senior Obligations of the Agency. The 2003 Tax Revenue Bonds are supported by two direct-pay letters of credit, which will terminate on August 27, 2006, unless extended by the credit provider. The 2003 Tax Revenue Bonds have a variable rate of interest at a weekly rate, until converted to bear interest at another variable rate or fixed rate at the option of the Agency. The weekly rates are the rates that result in the market value of the bonds being equal to 100% of the outstanding principal and accrued interest. For the year ended June 30, 2004, the average weekly interest rate for the 2003 bonds was 1.10% Tax Allocation Bonds 47

137 REDEVELOPMENT AGENCY OF THE CITY OF SAN JOSE Notes to the Basic Financial Statements (Continued) June 30, 2004 In December 2003, the Agency issued Tax Exempt Merged Area Tax Allocation Bonds, Series 2003 totaling $135,000,000. The proceeds of the bonds are used mainly to finance redevelopment projects within the Merged Area. The 2003 Tax Allocation Bonds are issued in parity with other outstanding Tax Allocation Bonds issued by the Agency and are secured primarily by a pledge of tax revenues, consisting of a portion of all taxes levied upon all taxable properties in the Merged Redevelopment Area. In connection with the 2003 Tax Allocation Bonds, a Bond Reserve Fund was cash funded in the amount of 125% of average annual debt service or $12,442,828 for the benefit of the bond owners. The Agency may at any time post surety bond insurance policy or letter of credit in lieu of cash funding the reserve account. 2004A Tax Allocation Refunding Bonds In May 2004, the Agency issued $281,985,000 in 2004 Merged Area Redevelopment Project Tax Allocation Refunding Bonds, Series A. The net proceeds of $292,921,482, which included a premium of $15,300,851 and $4,364,369 payment for the underwriter s discount and costs of issuance, were used to refund a portion of Merged Area Tax Allocation Bonds Series Bonds ($239,050,000), 1997 Series Bonds ($7,545,000), 2002 Series Bonds ($33,850,000), and 2003 Series Bonds ($5,990,000). Proceeds in the amount of $292,099,726 and residual cash balances of $7,790,702 provided by the old debt were placed in an irrevocable trust with an escrow agent to provide for future debt service payments on the old debt as per the Indenture Agreement. As a result, the debt mentioned above is considered defeased and the liabilities have been removed from the financial statements. Cumulatively, the defeased bonds had an outstanding balance of $286,435,000 as of June 30, Although the refunding resulted in the accounting recognition of a deferred loss of $13,933,331 for the fiscal year ended June 30, 2004, the Agency in effect reduced its aggregate debt service payments by approximately $12,044,204 over the next 15 years and obtained a net economic gain (difference between the present values of the old and new debt service payments) of $10,407,236. In connection with the issuance of the 2004 Refunding Bonds, a surety bond for approximately $63,387,458 was purchased pursuant to the requirements of the bond agreement. In addition, the payment of principal and interest is insured with a financial guaranty insurance policy over the life of the issue. The 2004 Refunding Bonds are secured primarily by a pledge of tax revenues, consisting of all taxes levied upon all taxable properties within the Merged Redevelopment Area and are secured in parity with other outstanding Merged Area Redevelopment Project Tax Allocation Bonds. 48

138 REDEVELOPMENT AGENCY OF THE CITY OF SAN JOSE Notes to the Basic Financial Statements (Continued) June 30, 2004 Convention Center Refunding In July 2001, the City of San José Financing Authority (the Authority) - a Joint Powers Authority authorized pursuant to a Joint Exercise of Powers Agreement between the City and the Agency to borrow money for the purpose of financing the acquisition and construction of assets of the City and the Agency, of which a portion of the debt issued by the Authority is reflected as debt of the Agency - issued the Convention Center Lease Revenue Refunding Bonds, Series 2001F (Tax Exempt) and Series 2001G (taxable) amounting to $186,150,000 and $4,580,000, respectively. In connection with the issuance of the 2001 Convention Center Refunding Bonds, the Agency and the City entered into the Second Amended and Restated Reimbursement Agreement under which the Agency is obligated to use tax increment to reimburse the City for lease payments made to the Authority for the project. Interest rates range from 4.0% to 5.21% for the Series 2001F (non-taxable) and 4.45% to 4.60% for the Series 2001G (taxable). The Series 2001F bonds (non-taxable) mature in 2022 and the Series 2001G bonds (taxable) matured in The bonds were issued to refund the 1993 Revenue Bonds, Series C (1993 Bonds). The net proceeds were placed in an irrevocable trust to provide future debt service payment on the refunded bonds. There were no defeased bonds outstanding as of June 30, th and San Fernando Streets Parking Facility In March 2001, the City of San José Financing Authority (the Authority) issued Revenue Bonds, Series 2001A in the amount of $48,675,000 to finance the construction of the 4 th & San Fernando Parking Facility Project. The Agency entered into the Agency Pledge Agreement with the Authority, whereby Agency payments are payable from and secured by surplus Agency Revenues. Agency payments are limited in each year to an amount equal to the annual debt service due on the bonds minus surplus revenues generated by the garage. Surplus Agency Revenues consist of (i) estimated tax increment revenues, which are pledged to the payment of the Agency s outstanding tax allocation bonds and deemed to be Surplus in the current fiscal year in accordance with the resolution or indenture pursuant to which the outstanding tax allocation bonds were issued, plus (ii) all legally available revenues of the Agency. HUD Section 108 Loans The Agency received loan proceeds of $5,200,000 under the provisions of the U.S. Department of Housing and Urban Development (HUD) Section 108. Approximately $1,862,000 for principal and interest reserves is included in the Capital Projects Fund as restricted cash and investments. The proceeds are used to finance certain projects in the Merged Project Area. At June 30, 2004, the Agency has outstanding loans due from developers of approximately $3,227,000. The notes payable to HUD mature annually through August 2016 and bear interest at 20 basis points above the LIBOR index. 49

139 REDEVELOPMENT AGENCY OF THE CITY OF SAN JOSE Notes to the Basic Financial Statements (Continued) June 30, 2004 Debt Service Requirements The debt service requirements for all debt are based upon a fixed rate of interest, except the 1996 Series A and B Bonds, 2003 Series A and B Bonds, 2002 Series G and H Bonds and the HUD Section 108 loans, which bear interest at variable rates. Interest on the 1996 Series A and B Bonds, 2003 Series A and B Bonds, and the 2002 Series G and H Bonds may be set at different interest rate calculation modes, including daily, monthly and fixed rates. On June 30, 2004, all the variable rate bonds were set in weekly modes. Interest on the HUD Section 108 loan is adjusted monthly on the first day of each month to a variable interest rate equal to 20 basis points above the applicable LIBOR rate. For purposes of calculating the annual debt service requirements as of June 30, 2004, assumed effective rates of 1.03%, 1.02%, 1.10%, 1.04%, 1.20%, 1.18% and 1.51% at June 30, 2004 have been used for the 1996 Series A and B Bonds, 2003 Series A and B Bonds, 2002 Series G and H bonds, and the HUD Section 108 loan, respectively. The annual requirements to amortize unmatured tax allocation bonds and other long-term debt outstanding as of June 30, 2004, including mandatory sinking fund payments, are as follows (in thousands): Merged Tax Allocation Bonds Housing Tax Allocation Bonds Other Revenue Bonds Other Obligations Year Ending June 30 Principal Interest Principal Interest Principal Interest Principal Interest 2005 $ 20,605 $ 85,834 $ 3,240 $ 8,614 $ 5,940 $ 9,740 $ 1,480 $ 2, ,960 87,871 3,300 8,549 6,450 9,533 1,540 2, ,560 86,104 3,370 8,482 8,085 9,306 1,610 2, ,285 84,074 3,440 8,404 8,845 9,045 1,680 1, ,170 81,562 3,530 8,310 9,560 8,742 1,750 1, , ,940 23,500 39,341 60,010 38,067 10,025 8, , ,202 38,620 33,089 78,180 25,280 11,710 6, , ,166 55,555 22,883 84,420 8,683 13,215 3, ,765 94,148 60,795 9,877 24,400 1,454 6, ,400 48,928 15,425 3,137 14, Subtotal 1,524,705 1,383, , , , ,601 49,270 29,376 Less: Unamortized discount - - (176) Unamortized deferred amount on refunding (16,844) (3,177) Add: Unamortized premium 18, Total $ 1,526,446 $1,383,829 $ 210,599 $150,686 $ 298,067 $120,601 $ 49,270 $ 29,376 Bond Limitations and Restrictions There are a number of limitations and restrictions contained in the various bond indentures. The Agency believes it is in compliance with all significant limitations and restrictions contained in the indentures. Conduit Debt 50

140 REDEVELOPMENT AGENCY OF THE CITY OF SAN JOSE Notes to the Basic Financial Statements (Continued) June 30, 2004 In April 1998, the Agency served as the conduit issuer of $38,000,000 in Multifamily Housing Revenue Bonds in order to provide funds for a mortgage loan to finance the acquisition and construction of a multifamily residential project in the Century Center Redevelopment Project Area. The Agency has no obligation for these bonds, as they will be payable solely from and secured to the extent provided in the indenture by a pledge of certain revenues and other amounts to be received by the Agency under the Loan Agreement. A developer has arranged for an initial irrevocable direct-pay letter of credit to be issued in favor of the trustee. As of June 30, 2004, there have been no principal retirements. In August 1997, the Agency served as the conduit issuer of $10,595,000 in Multifamily Housing Revenue Bonds in order to provide funds for a mortgage loan to finance a multifamily rental housing project in the Japantown Redevelopment Project Area. The Agency has no obligation for these bonds as they are secured primarily by fully modified pass-through mortgage-backed securities guaranteed as to timely payment of principal and interest by the Government National Mortgage Association. The bonds were issued for the purpose of expanding the community s supply of low to moderateincome housing, and to construct a community center and retail space. The loan is secured on a nonrecourse basis and is insured by the Federal Housing Authority pursuant to and in accordance with the provisions of Section 221(d) (4) of the National Housing Act and applicable regulations thereunder. At June 30, 2004, the outstanding balance was $10,237,228. In October 1993, the Agency served as the conduit issuer of $11,700,000 Multifamily Housing Revenue Refunding Bonds in connection with the refunding of the 1983 Floating Rate Monthly Demand Multi-Family Housing Revenue Bonds that were used to finance the acquisition and construction of a multifamily rental housing project known as the Colonade Apartments. The Agency has no obligation for these bonds, as they are payable solely from revenues and property pledged to the extent provided in the indenture. As of June 30, 2004, there have been no principal retirements. I. Net Assets/Fund Balances The government-wide financial statements utilize a net assets presentation. Net assets are categorized as follows: Invested in Capital Assets This category groups all capital assets into one component of net assets. The balance is the net of accumulated depreciation; however, all bond proceeds associated with the acquisition have been repaid and, therefore, do not reduce the net asset position of the capital assets. Restricted Net Assets This category presents external restrictions imposed by creditors, grantors, contributors or laws or regulations of other governments and restrictions imposed by law through constitutional provisions or enabling legislation. Unrestricted Net Assets (Deficit) This category represents net assets (deficit) of the Agency, not restricted for any project or other purpose. 51

141 REDEVELOPMENT AGENCY OF THE CITY OF SAN JOSE Notes to the Basic Financial Statements (Continued) June 30, 2004 Fund balances consist of reserved and unreserved amounts. Reserved fund balance represents that portion of the fund balances which is not appropriated for expenditure or is legally segregated for a specific future use. The remaining portion is unreserved fund balance that is designated to indicate tentative plans for financial resource utilization in a future period, such as for general contingencies or other capital projects. As of June 30, 2004, reservations of fund balance are described below: Long-term receivables to reflect the amount due from developers related to the HUD Section 108 loan. Such amounts do not represent available spendable resources. Advances and deposits - to reflect the amount due from other funds that are long-term in nature and amounts deposited with third parties. Such amounts do not represent available spendable resources. Debt service - to reflect the funds held by trustees or fiscal agents for future payment of bond principal, interest, and reserve accounts. These funds are legally restricted for repayment of debt. Low and moderate-income housing activities - to reflect the amounts required by state law to be used for low and moderate-income housing activities. Encumbrances - to reflect the outstanding contractual obligations for which goods and services have not yet been received. As of June 30, 2004, the designations of fund balance in the General Fund and Capital Projects Fund reflect management s intent to expend certain funds solely for planned redevelopment activities. J. Excess of expenditures over appropriations For the year ended June 30, 2004, expenditures exceeded appropriations by $547,232 in the Special Revenue Fund for low and moderate housing projects. The expenditures were made to the City based upon a formula of 20% of tax increment. Since the tax increment revenue was greater than projected, the 20% set-aside amount was equally greater, on a pro rata basis. 52

142 REDEVELOPMENT AGENCY OF THE CITY OF SAN JOSE Notes to the Basic Financial Statements (Continued) June 30, 2004 III. OTHER INFORMATION A. Contingencies Risk Management The Agency is exposed to various risks of loss related to torts, theft, damage to and destruction of assets, errors and omissions, general liability, workers compensation, and unemployment claims for which the Agency carries commercial insurance policies. The premiums are paid from the General Fund. For the fiscal year ended June 30, 2004 and 2003, there were no claims or liabilities required to be recognized. Claim expenditures and liabilities are reported when it is probable that a loss has occurred and the amount of the loss can be reasonably estimated using actuarial methods or other estimating techniques. During the past three years, there have been no instances where the amount of claim settlements exceeded insurance coverage, nor have there been any significant reductions of insurance coverage. Eminent Domain Proceedings The Agency is involved in eminent domain proceedings for the acquisition of certain properties required for redevelopment projects. As part of these proceedings, the Agency obtains appraisals of the property values and makes condemnation deposits with the court of jurisdiction associated with such properties. As of June 30, 2004, the Agency had $42,000 outstanding in condemnation deposits with the Santa Clara County Clerk and $1,011,423 deposited with the State of California Condemnation Deposit Fund. These deposits are treated as project expenditures in the fund financial statements and capitalized as accumulated redevelopment project costs in the government-wide financial statements. Litigation The Agency is subject to various claims and from time to time is involved in lawsuits in which damages are sought. As litigation is subject to many uncertainties and as the outcome of litigated matters cannot be predicted with certainty, it is reasonably possible that some of these legal actions could be decided unfavorably against the Agency. As the potential outcome or total amount of liability as of June 30, 2004 with respect to the above matters cannot be fully ascertained, the Agency s management believes that any liability that might result from these matters would not have a material effect on the basic financial statements as of June 30,

143 REDEVELOPMENT AGENCY OF THE CITY OF SAN JOSE Notes to the Basic Financial Statements (Continued) June 30, 2004 B. Commitments Capital Expenditure Projections On June 17, 2003, the Agency Board adopted the Capital and Operating Budgets for FY and Capital Improvement Program for FY The adopted budgets reflect the amount of $531 million to be spent on capital projects for the next five years. However, due to the decline in anticipated property tax increment revenues and the impact of the State mandated payment of Educational Revenue Augmentation Fund (ERAF), the Agency Board amended on September 16, 2003 the adopted budget through a Budget Rebalancing Plan and decreased the amount of the capital improvement program for fiscal year to $278 million. At June 30, 2004, the Agency had $37,387,130 in encumbrances in its Capital Project Fund, which represent contract commitments on redevelopment projects. Defined Contribution Retirement Plan In January 1995, the Agency Board adopted a defined contribution retirement plan, the Redevelopment Agency of the City of San Jose Retirement Plan (the Plan), which provides pension benefits for its employees. For eligible employees who contribute 3.5% of their annual base salary, the Agency contributes approximately 9.0%. Agency contributions are based on a formula taking into account employee annual base salary and length of service. The Agency s contributions for each employee (and interest allocated to the employee s account) are fully vested after three years of continuous service from the original date of employment. Agency contributions and interest forfeited by employees who leave employment before vesting occurs may be used to reduce the Agency's contribution requirement or to offset the plan s operating expenses. Three Agency employees are co-trustees of the Plan. The Agency contracts with an advisor to manage the Plan with all assets being held in trust by a third party custodian in the name of each of the Plan s participants. Each of the Plan s participants directs the investments of their separate account. The Agency Board must authorize changes to the Plan. The total payroll in fiscal year for the Agency s direct employees was approximately $8,667,600. Both the Agency and the participating employees made contributions to the Plan amounting to approximately $772,043 and $287,579, respectively. Line of Credit In March 2003, the Agency entered into a line of credit agreement with a bank for an amount not to exceed $50,000,000 to provide interim funding for various housing projects. The line of credit is secured by the 20% tax increment housing money, which bears interest at an annual rate of LIBOR plus 0.75%, and is available until April 1, The entire principal amount then outstanding shall be repaid in quarterly installments over five years and shall bear interest at annual rates ranging from LIBOR plus 1.35% to LIBOR plus 3.35%. While the agreement provides for long term repayment, the amount outstanding is reflected as a fund liability because historically the balance owing has been repaid with subsequent bond issues. As of June 30, 2004, the outstanding balance is $16,200,

144 REDEVELOPMENT AGENCY OF THE CITY OF SAN JOSE Notes to the Basic Financial Statements (Continued) June 30, 2004 Leases A schedule by years of future minimum rental payments required under the Agency s noncancellable operating leases for office facilities, business equipment, and land as of June 30, 2004 (net of income from subleases) is as follows (in thousands): Year Ending June 30 Minimum Payments Income from Subleases Net Minimum Payments 2005 $ 3,554 $ (301) $ 3, ,699 (98) 1, ,987-2, ,463-3,463 Total minimum payments required $ 13,646 $ (399) $13,247 The total net rent expense for operating leases in fiscal year was approximately $4,119,300. C. Related Party Transactions with the City of San José Amounts Received from and Payments to the City The Agency is required by the California Community Redevelopment Law to designate 20% of all incremental property tax revenues for low and moderate-income housing activities (the Special Revenue Fund). In addition, in fiscal 1992, the Agency elected to designate 20% of County supplemental assessment revenues for those purposes. The City s Housing Department administers funds so designated. During fiscal year , the Agency transferred to the City s Housing Department approximately $34,147,000 of property taxes in the Special Revenue Fund. Annually, the City s Housing Department makes payments to the Agency for the repayment of debt service on the Housing Bonds, Series A through K. Approximately $11,468,000 of such payments was made during fiscal year Also during fiscal year , the Agency transferred to the City s Housing Department approximately $27,531,000, representing the balance of net proceeds from the 2003 Housing Set Aside Tax Allocation Bonds, Series J and K issued in July As part of the pledge agreement entered by the Agency and the City of San José Financing Authority on the 4 th /San Fernando Garage Parking Revenue Bond - Series 2002A, the Agency transferred during the year the total amount of $3,366,000 representing principal and interest due on the bonds in the subsequent year. 55

145 REDEVELOPMENT AGENCY OF THE CITY OF SAN JOSE Notes to the Basic Financial Statements (Continued) June 30, 2004 In April 2002, the City, Agency, and the plaintiffs in the Ruffo case (a lawsuit arising out of the proposed relocation of the San José City Hall to the Civic Plaza Redevelopment Area in downtown San José) entered into a Settlement Agreement under which the parties agreed that the City would repay the Agency s site assembly costs with interest. In July 2002, the City and Agency entered into a Transfer Agreement whereby the City agreed to reimburse the Agency s costs including interest. As of June 30, 2004, the Agency has recognized a due from the City in the amount of $3,668,000. In addition, other payments are made to and received from the City. The following significant transactions were made during the year: 1) the Agency paid from its General Fund approximately $5,635,000 for City support services, 2) a payment made by the City to the Agency in the amount of $12,704,000 and reimbursed by the Agency pursuant to the Second Amended and Restated Reimbursement Agreement for the Convention Center Refunded Bonds, 3) Repayment of the ERAF loan of $10,078,000 to the City, and 4) the payments related to the San José Arena management agreement are paid from the Agency s Capital Projects Fund and totaled $316,000 for fiscal year The City owed the Agency approximately $595,000 for accrued investment earnings at June 30, In the past, the Agency advanced a portion of a loan made by the City s Housing Department to a third party providing shelter for women. The advance is recorded at its net realizable value of $580,000 and will be repaid when the loan is collected by the City s Housing Department. Cooperation Agreements with the City The Agency enters into Cooperation Agreements to assist in funding various projects constructed on its behalf by the City and to reimburse the City for the actual salaries and fringe benefits of City employees who work under the supervision of the Agency s Executive Director or designee, including other City staff in providing support services to the Agency. These agreements state the Agency s commitment for a one-year period consistent with the Agency's capital and operating budgets and are renewed on an annual basis. The agreement further calls for the Agency to submit a Project Service Memorandum (PSM) to the appropriate City Department prior to the start of the construction project. Funds are transferred to the City to cover the costs of completing the project including reasonable related administrative costs. After a PSM is approved by the Agency and agreed upon by the City, the Agency shall have no additional obligation relating to the agreed costs of the project except as may be agreed to in writing by the Agency and City. Any surplus funds in the project account are returned to the Agency. The agreement also states that the Agency may cancel the project and any unused funds shall be returned by the City to the Agency. The amounts paid for construction projects and City s personnel costs in connection with these Cooperation Agreements during fiscal year totaled $32,397,000 and $5,635,000, respectively. 56

146 REDEVELOPMENT AGENCY OF THE CITY OF SAN JOSE Notes to the Basic Financial Statements (Continued) June 30, 2004 During the year, the City paid approximately $1,514,000 to the Agency for its share of the cost of several projects and returned approximately $922,000 of unused construction money on capital projects funded by the Agency per the Cooperation Agreement. D. Tax Sharing Agreement and Other Payments to the County of Santa Clara Tax Sharing In 1983, the Agency and the County of Santa Clara (the County) entered into a tax sharing agreement under which the Agency would pay a portion of tax increment revenue generated in the Merged Area and part of the Rincon de los Esteros Project Area (the County Pass-Through Payment). On December 16, 1993, the Agency, the County, and the City entered into a Settlement Agreement, which continued the County Pass-Through Payment. On May 22, 2001, the County, the City, and the Agency approved an Amended and Restated Agreement (the "Amended Agreement"). In addition to the continued Pass-Through Payment, the Amended Agreement delegated to the County the authority to undertake redevelopment projects in or of benefit to the Merged Area, and requires the Agency to transfer funds to the County to pay for such projects (the "Delegated Payment"). Until June 30, 2004, the Delegated Payment is equal to the County Pass-Through Payment. After January 1, 2004, 20% of the proceeds of any debt secured by the Agency's Tax Revenues (excluding refunding bonds) must be paid to the County as the Delegated Payment. For the fiscal year , the Pass-Through Payment totaled $15.5 million and the Delegated Payment totaled $14.4 million. ERAF Payment In compliance with the State mandated contribution to the Educational Revenue Augmentation Fund (ERAF) to alleviate a state budget deficit, the Agency paid $10,078,000 during the year. E. Subsequent Events ERAF Payment On August 5, 2004, SB 1096 was signed into law requiring redevelopment agencies statewide to shift for the next two years ( ) the amount $250 million of property tax increment revenues to the State s Educational Revenue Augmentation Fund (ERAF) as a way to reduce the State s budget deficit. The Agency s share of this revenue shift is approximately $18.7 million for each year and payments are not expected until May 10, 2005 and May 10,

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148 REDEVELOPMENT AGENCY OF THE CITY OF SAN JOSE Schedule of Revenues, Expenditures and Changes in Fund Balance Budget and Actual on a Budgetary Basis - General Fund For the Fiscal Year Ended June 30, 2004 Actual Amounts Budgetary Basis Actual Variance with Amounts Budgetary Actual Budgeted Amounts Final Budget Budgetary to GAAP Amounts Original Final Over (Under) Basis Differences GAAP Basis Revenues: Investment income $ 62,586 $ 62,586 $ - $ 62,586 $ - $ 62,586 Rent 697, , , ,928 Other 369, , , ,224 Total revenues 1,129,738 1,129,738-1,129,738-1,129,738 Expenditures: Current: General government: Personnel services 14,002,567 13,575,667 38,585 13,537,082-13,537,082 Non-personnel services 7,111,034 4,727, ,955 4,421,792 (1,420,480) 3,001,312 Intergovernmental: Payments to the City of San Jose 6,355,881 5,635, ,634,573-5,634,573 Total expenditures 27,469,482 23,938, ,309 23,593,447 (1,420,480) 22,172,967 Excess (deficiency) of revenues over (under) expenditures (26,339,744) (22,809,018) 345,309 (22,463,709) 1,420,480 (21,043,229) Other financing sources (uses): Transfers in 22,500,000 22,500,000-22,500,000-22,500,000 Net change in fund balance (3,839,744) (309,018) 345,309 36,291 1,420,480 1,456,771 Fund balance, beginning of year 5,248,735 5,248,735-5,248,735-5,248,735 Fund balance, end of year $ 1,408,991 $ 4,939,717 $ 345,309 $ 5,285,026 $ 1,420,480 $ 6,705,506 See Accompanying Notes to Other Required Supplementary Information 58

149 REDEVELOPMENT AGENCY OF THE CITY OF SAN JOSE Schedule of Revenues, Expenditures and Changes in Fund Balance Budget and Actual on a Budgetary Basis - Special Revenue Fund For the Fiscal Year Ended June 30, 2004 Actual Amounts Budgetary Basis Actual Variance with Amounts Budgetary Actual Budgeted Amounts Final Budget Budgetary to GAAP Amounts Original Final Over (Under) Basis Differences GAAP Basis Revenues: Tax increment $ 37,642,938 $ 33,600,000 $ 441,607 $ 34,041,607 $ - $ 34,041,607 Expenditures: Intergovernmental: Payments to the City of San Jose 37,642,938 33,600,000 (547,232) 34,147,232-34,147,232 Net change in fund balance - - (105,625) (105,625) - (105,625) Fund balance, beginning of year 105, , , ,625 Fund balance, end of year $ 105,625 $ 105,625 $ (105,625) $ - $ - $ - See Accompanying Notes to Other Required Supplementary Information 59

150 REDEVELOPMENT AGENCY OF THE CITY OF SAN JOSE Notes to Other Required Supplementary Information June 30, 2004 STEWARDSHIP, COMPLIANCE AND ACCOUNTABILITY A. Budget Information The budget of the Agency is an operating plan that identifies estimated costs and results in relation to estimated revenues. Budgets are prepared according to the following guidelines for the General and Special Revenue Funds: General Fund The operating expenditures are budgeted by appropriation according to type of expenditures, categorized as personnel and non-personnel. Special Revenue Fund Twenty percent of the tax increment revenues are budgeted by the Board for payment to the low and moderate-income housing program of the City of San Jose. During the fiscal year, the procedures followed to establish the budgetary data reflected in the accompanying budget to actual schedules were as follows: Original Budget Prior to the beginning of the budget year, the Executive Director of the Agency presents to the Board the fiscal budget for the ensuing year. The budget is prepared on a budgetary basis, which does not conform with GAAP, as encumbrances are included as expenditures. Revenue estimates are presented to the Agency Board in total and are approved by revenue resolution. Prior to June 30 of each year, the annual budget is finalized through passage of the annual appropriation resolution and an annual revenue resolution by the Agency Board, which is the legal authority for enactment of the budget. Management allocates budgeted revenue to the Special Revenue Fund based on priorities established by the California Community Redevelopment Law, bond indentures, and other legal agreements. The annual appropriation resolution adopts the expenditure budget at the appropriation level (project, personnel, and non-personnel). Accordingly, the lowest level of budgetary control exercised by the Agency Board is the appropriation level. Management can transfer budgeted amounts between project activities included in each appropriation without the approval of the Agency s Board. 60

151 REDEVELOPMENT AGENCY OF THE CITY OF SAN JOSE Notes to Other Required Supplementary Information June 30, 2004 Final Budget Supplemental appropriations may be approved during the budget year if there are funds available in the capital reserve. Appropriations lapse at the close of the fiscal year to the extent that they have not been expended or encumbered. No expenditures may be made in excess of amounts appropriated by the Agency Board. The Agency Board approves changes to the revenue estimates by adoption of a supplemental revenue resolution. The budgetary data presented in the accompanying budget to actual schedules includes all revisions approved by the Agency Board. B. Budgetary Results Reconciled To GAAP The budgetary process is based upon accounting for certain transactions on a basis other than GAAP. The results of operations are presented in the budget and actual comparison statement in accordance with the budgetary process (budgetary basis) to provide a meaningful comparison with the budget. The only difference between the budgetary basis actual and GAAP basis is that the year-end encumbrances are recognized as the equivalent of expenditures in the budgetary basis schedules, while encumbered amounts are not recognized as expenditures on the GAAP basis statements until recorded as actual expenditures. C. Special Revenue Fund Expenditures in Excess of Budget The special revenue fund s expenditures exceeded the budgeted amount by $547,232. This amount represents additional payment to the City of San Jose for the 20% low and moderate housing projects, as a result of a modest increase of the Agency s budgeted tax increment revenues during the year. 61

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