Debt Policy City of Aurora, Colorado

Debt Policy City of Aurora, Colorado The following policies are adopted to establish conditions for the use of debt and to create procedures and policies that minimize the City's debt service and issuance costs, retain the highest practical credit rating, and maintain full and complete financial disclosure and reporting. The policies apply to all general obligation debt issued by the City, any lease revenue debt issued by the City including lease purchase contracts, revenue debt issued by the City s Enterprise funds, debt guaranteed by the City, and any other forms of obligation of indebtedness. Regular, updated debt policies can be an important tool to ensure the use of the City's resources to meet its commitments to provide needed services, including capital assets, to the citizens of the City and to maintain sound financial management practices. These policies are therefore guidelines for general use, and allow for exceptions in extraordinary or specific conditions. These policies have been approved and adopted by the City Council by resolution. Creditworthiness Objectives Policy 1. Credit Ratings: The City of Aurora seeks to maintain the highest practical credit ratings for all categories of short- and long-term General Obligation and Revenue debt that can be achieved without compromising delivery of City services and achievement of City goals. The City recognizes that external economic, natural, or other events may from time-to-time affect the creditworthiness of its debt. Nevertheless, the City is committed to ensuring that actions within its control are prudent and responsive. Policy 2. Financial Disclosure: The City is committed to full and complete financial disclosure, and to cooperating fully with rating agencies, underwriters of its securities, institutional and individual investors, City departments and agencies, other levels of government, and the general public to share clear, comprehensible, and accurate financial information. The City is committed to meeting secondary disclosure requirements on a timely and comprehensive basis. The Finance Department shall be responsible for ongoing disclosure to established national information repositories and for maintaining compliance with applicable disclosure standards promulgated by state and national regulatory bodies. Policy 3. Debt Limits: The City will keep outstanding debt at levels consistent with its creditworthiness objectives as outlined in Policy 1. Purposes and Uses of Debt Policy 4. Capital Financing: Debt will be issued for a capital project generally when it is an appropriate means to achieve a fair allocation of costs between current and future beneficiaries, or in the case of emergency. Debt shall not, in general, be used for projects solely because insufficient funds are budgeted at the time of acquisition or construction or for operating deficiencies. 07/05/06 DEBT POLICY.doc 1

Policy 5. Asset Life: The City will consider long-term financing for the acquisition, maintenance, replacement, or expansion of physical assets (including land and water rights) only if they have a useful life of at least five years. Debt will be used only to finance capital projects and equipment, except in case of emergency. City debt will not be issued for periods exceeding 120% of the useful life or average useful lives of the project or projects to be financed. Debt Standards and Structure Policy 6. Length of Debt: Debt will generally be structured for the shortest period consistent with a fair allocation of costs to current and future beneficiaries or users. Policy 7. Debt Structure: Debt will be structured to achieve the lowest possible net cost to the City given market conditions, the urgency or importance of the capital project or asset, and the nature and type of security provided. Moreover, to the extent possible, the City will design the repayment of its overall debt so as to recapture rapidly its debt capacity for future use. Policy 8. Backloading: The City will seek to structure debt with level principal and interest costs over the life of the debt. "Backloading" of costs (deferring principal and/or interest to later periods) will be considered only when natural disasters or extraordinary or unanticipated external factors make the short-term cost of the debt prohibitive, when the benefits derived from the debt issuance can clearly be demonstrated to be greater in the future than in the present, when such structuring is beneficial to the City's overall amortization schedule, or when such structuring will allow debt service to more closely match project revenues during the early years of the project's operation. Policy 9. Variable Rate Debt: The City may choose to issue securities that pay a rate of interest that varies according to a pre-determined formula or results from a periodic remarketing of the securities, consistent with state law and covenants of pre-existing bonds, and depending on market conditions. See Attachment 1, Alternative Financing Instruments. Policy 10. Second Lien Debt: The City shall issue second lien debt only if it is financially beneficial to the City or consistent with creditworthiness objectives. Policy 11. Derivatives: The City will consider the use of derivative products on a case by case basis and consistent with financial prudence. See Attachment 1, Alternative Financing Instruments. Policy 12. Refundings: Periodic reviews of all outstanding debt will be undertaken to determine refunding opportunities. Refunding will be considered (within federal tax law constraints) if and when there is a net economic benefit of the refunding or the refunding is desirable in order to modernize covenants essential to operations and management. In general, advance or current refundings for economic savings will be undertaken when sufficient net present value savings from a conventional fixed rate refunding structure can be demonstrated. Factors including the length of time until the call date, the structure of the 07/05/06 DEBT POLICY.doc 2

refunding debt and expectations of future interest rates shall be reviewed in determining if savings are sufficient. Additional potential savings (savings that are subject to tax risk, basis risk, or similar risks) shown from a synthetic or derivative refunding structure will not be considered in determining the sufficiency of savings. Refundings with lesser or negative savings will not be considered unless there is a compelling public policy objective. Policy 13. BANs: Use of short-term borrowing, such as (but not limited to) bond anticipation notes (BANs), tax-exempt commercial paper, and reverse repurchase agreements will be undertaken only if the transaction costs plus interest on the debt are less than the cost of internal financing, or available cash is insufficient to meet both capital improvements and working capital requirements. Policy 14. Credit Enhancements: Credit enhancement (letters of credit, bond insurance, etc.) may be used when debt service on the bonds is reduced by more than the costs of the enhancement as determined on a net present value basis. Credit enhancement may also be considered when there is no net present value advantage if there is a compelling debt structure or public policy objective. Debt Administration and Process Policy 15. Bond Sales: After a favorable review of a project and financing concept by City Council or Council Committee(s), the Finance Department shall, in conjunction with the City's Bond Counsel, Office of the City Attorney, and Department benefiting from any financing, produce appropriate ordinance(s) and, if needed, bond sale documents for consideration and approval by the City Council. Policy 16. Bond Fund: All payment of general obligation and general fund revenue bond debt service shall be from the City Debt Service Fund. The Finance Department shall make other debt service payments, including payments on Enterprise debt, by transferring the amounts from the appropriate accounts. Policy 17. Investment of Bond Proceeds: All general obligation and revenue bond proceeds shall be invested as part of the City's consolidated cash pool unless otherwise specified by the bond legislation or unless otherwise determined by City staff that a segregated investment is more appropriate. Investments will be consistent with those authorized by applicable state and local law and by the City's investment policies. Policy 18. The Finance Department will assess a fee as part of the costs of issuance on all debt instruments issued by the City. This fee will assist in offsetting the internal costs of issuance and management of debt. Policy 19. Costs and Fees: All costs and fees related to issuance of bonds will be paid out of bond proceeds or by the benefiting Department. 07/05/06 DEBT POLICY.doc 3

Policy 20. Method of Sale: As stated in City Charter, 11-25, bonds shall be sold to the highest and best bidder for cash at public sale, or at private sale, after advertisement for public sales, and to the best advantage of the city. The City Council shall have the option to authorize a private/negotiated sale without advertisement for public sale if the city manager has certified to the city council that such sale would be to the best advantage of the city. If sold through competitive sale, bids will be awarded on a true interest cost basis (TIC), provided other bidding requirements are satisfied and subject to the right of the City to waive defects and irregularities in bids, or to reject any and all bids. Policy 21. Final terms and conditions for a bond sale or other debt obligation will be specified in the enabling legislation, a Supplemental Resolution of Council or a Final Terms Certificate executed by the Director of Finance. Policy 22. Underwriters: For all competitive sales, underwriters will be required to post a good faith deposit. For all negotiated sales, underwriters will be required to demonstrate sufficient capitalization and experience related to the debt issuance. Policy 23. Disclosure Counsel: Every issuance of securities to the public by the City shall be made pursuant to a disclosure document prepared with the assistance of counsel of the City s choosing. Opinions of such counsel shall be addressed to the City and to the underwriter of the securities, whether at negotiated or competitve sale. Policy 24. Bond Counsel: The City will retain external bond counsel for all publicly offered debt issues. All publicly offered debt issued by the City will include a written opinion by bond counsel affirming that the City is authorized to issue the debt, that the debt creates a binding obligation, stating that the City has met all state constitutional and statutory requirements necessary for issuance, and determining the debt's federal and state income tax status. Policy 25. Underwriter's Counsel: The City will not pay for underwriter s counsel, however, underwriter s counsel may be utilized on a case by case basis at the expense and discretion of the underwriter. Policy 26: Financial Advisor: The City will retain a financial advisor, to be selected for a term of up to four years, through a professional services selection process administered by the City's Finance Department. If it is deemed appropriate, separate or additional financial advisors may be retained for their particular expertise for a specific transaction or project. The utilization of the financial advisor for particular bond sales will be at the discretion of the Department of Finance on a case-by-case basis and pursuant to the financial advisory services contract. Upon expiration of a contract, the City may choose to extend the existing contract or undergo a new full professional services selection process. For each City bond sale, the financial advisor will provide the City with information on pricing and underwriting compensation for comparable sales by other issuers. In general, the City s Financial Advisor shall not be allowed to participate as an underwriter in the competitive or negotiated sale of any of the City s securities for which it has acted within the prior six months as the City s Financial Advisor. 07/05/06 DEBT POLICY.doc 4

Policy 27. Compensation for Services: Compensation for bond counsel, disclosure counsel, underwriter's counsel or other special counsel, financial advisors, and other financial services will be consistent with industry standards. Policy 28. Negotiated Underwriting: The Director of Finance shall make all final determinations of selection for underwriters. The determination will be made following review of competitive bids or responses to requests for proposals (RFPs) or requests for qualifications (RFQs). Policy 29. Other Service Providers: The Director of Finance shall have the authority to periodically select other service providers (e.g., escrow agents, verification agents, trustees, arbitrage consultants, etc.) as necessary to meet legal requirements and minimize net City debt costs. These services can include debt restructuring services and security or escrow purchases. The Director of Finance may select firm(s) to provide such financial services related to debt consistent with City purchasing guidelines and applicable law. Policy 30. Arbitrage Compliance: The Finance Department shall maintain a system of record keeping and reporting to meet the arbitrage rebate compliance requirements of federal internal revenue tax code applicable to particular issues of City securities. Policy 31. Financing Proposals: Any capital financing proposal to a City Department involving the pledge or other extension of the City's credit through sale of securities, execution of loans or leases, marketing guarantees, or otherwise involving directly or indirectly the lending or pledging of the City's credit, or the City acting as a conduit for the sale of securities, shall be referred to the Finance Department for review. 07/05/06 DEBT POLICY.doc 5

Attachment I Alternative Financing Instruments This policy will govern the use by the City of Aurora of variable rate debt (obligations which bear interest rate reset exposure prior to final amortization of the asset financed) and financial derivative products, such as swaps, swaptions, caps, floors and collars ("derivatives"), otherwise referred to herein as alternative financing instruments. Before entering into an alternative financing instrument, the City shall evaluate all the risks inherent in the transaction. These risks to be evaluated should include the Interest Rate Risk, Counterparty Risk, Rollover Risk, Termination Risk, Amortization Risk, Basis Risk, and Tax Event Risk. RISK DEFINITIONS Interest Rate Risk: (a) the inherent risk accepted by not fixing the interest rate of a debt issue to the final amortization of the asset financed, or (b) how the movement of interest rates over time affects the market value of an interest rate-linked alternative financing instrument Counterparty Risk: the failure of the counterparty to make required payments Rollover Risk: the mismatch of the maturity of an interest rate swap and the maturity of the underlying bonds Termination Risk: the need to terminate the transaction in a market that requires a termination payment by the City Amortization Risk: the mismatch of bond and swap amortization schedules Basis Risk: the mismatch between actual variable rate debt service and variable rate indices used to determine swap payments Tax Event Risk: the risk that tax events will cause swap or interest rate payments for existing instruments to change, independent of any other change in the credit markets. PURPOSE: Alternative financing instruments may be used for the following purposes only: 1. To achieve significant savings as compared to a product available in the conventional fixed rate bond market. Significant savings shall be calculated after adjusting for (a) applicable fees, including takedown, remarketing fees, credit enhancement and legal fees, and (b) call options that may be available on the bonds. Examples may include variable rate debt, synthetic fixed rate debt and synthetic variable rate debt or other such derivative financial products. Alternatively, significant savings are deemed to occur if the use of alternative financing instruments helps to achieve diversification of a particular bond offering. 2. To prudently hedge risk in the context of a particular financing or the overall asset/liability management of the City. Examples may include buying interest rate caps and entering into delayed start swaps. 3. To incur variable rate exposure within prudent and acceptable guidelines, such as buying 07/05/06 DEBT POLICY.doc 6

interest rate caps or floors, or entering into a swap agreement in which the City s payment obligation is variable rate. 4. To achieve more flexibility in meeting overall financial objectives than can be achieved in conventional markets. An example may include a swaption with an upfront payment. SPECULATION: Alternative financing instruments shall not be used for speculative purposes outside of prudent risks that are appropriate for the City to take. All risks associated with a derivative transaction shall be evaluated including: Interest Rate Risk, Counterparty Risk, Rollover Risk, Termination Risk, Amortization Risk, Basis Risk, and Tax Event Risk (see Risk Definitions above). LEGALITY: The City must receive an opinion acceptable to the market from a nationally recognized bond counsel firm that the agreement relating to the alternative financing instrument is a legal, valid and binding obligation of the City and entering into the transaction complies with applicable City, State and Federal laws. The City Council shall approve alternative financing instrument transactions before execution. METHODS OF SOLICITING AND PROCURING ALTERNATIVE FINANCING INSTRUMENTS In general the City should procure alternative financing instruments in the spirit and manner outlined in the Method of Sale policy (Policy 20) in the Debt Policy. A competitive bid should limit the number of firms solicited to no fewer than three. The City shall determine which parties it will allow to participate in a competitive transaction. In situations in which the City wishes to achieve diversification of counterparty exposure, or to promote its interests by encouraging and rewarding innovation, the City may allow a firm or firms not submitting the bid that produces the lowest cost to match the lowest bid and be awarded up to a specified percentage of the notional amount of the alternative financing instrument. In addition, to encourage competition, the City may allow the second and third place bidders to match the winning bid up to a specified amount of the notional amount as long as their bid is no greater than a specified spread from the winning bidder. The parameters for the bid and any matching bid permitted must be disclosed in writing to all potential bidders. Notwithstanding the above, the City may procure alternative financing instruments by negotiated methods in the following manner: 1. The City may enter into an alternative financing instrument transaction on a negotiated basis if the City makes a determination that due to the size or complexity of a particular transaction, a negotiated transaction would result in the most favorable outcome. The City should use a financial advisory firm to assist in the price negotiations. 2. The City may enter into alternative financing instrument transactions on a negotiated 07/05/06 DEBT POLICY.doc 7

basis if it determines, in light of the facts and circumstances, that doing so will promote its interests by encouraging and rewarding innovation. Regardless of the method of procurement, the City shall obtain an independent finding that the terms and conditions of any alternative financing instrument entered into reflect a fair market value of such alternative financing instrument as of the date of its execution. RISK PARAMETERS Alternative financing instruments are subject to different risk factors than conventional fixed rate financing instruments. Those risk factors are defined above. While all relevant risk factors will be analyzed prior to entering into a transaction, the City has determined that interest rate risk and tax event risk should be specifically limited, based on the source of funds for repayment. The following table outlines the maximum exposure to interest rate risk and tax event risk. The measure of exposure will be determined when a transaction is entered into. Tax-exempt obligations that are subject to interest rate risk are assumed to also be subject to tax event risk. Therefore, the percent of obligations subject to tax event risk includes the percent of tax exempt obligations subject to interest rate risk. Revenue Source Maximum exposure as a percent of outstanding debt Special risk issues Interest rate risk Tax event risk Enterprise Funds 1 25% 50% A General Fund 2 25% 50% A, B GO Property Tax 0% 50% Special risk issues A-Specific assets that are temporarily financed with short-term instruments (i.e. not part of a regular short-term borrowing program) will not count against the interest rate risk or tax event risk exposure if it is planned that (a) the short-term instrument will be re-financed with long-term debt no later than the next time long term borrowing occurs, or (b) the short term instrument is paid off prior to the next time long-term borrowing occurs. B-When obligations paid from General fund revenues have interest rate risk, an interest rate risk mitigation account could be established and funded from early year savings. Further, the City shall endeavor to diversify its counterparty risk. To that end, before entering into a transaction, it should determine its exposure to the relevant counterparty or counterparties and determine how the proposed transaction would affect the exposure. The exposure should not be measured solely in terms of notional amount, but rather how changes in interest rates would affect the City s exposure to a counterparty. This analysis should be based on any and all outstanding derivative transactions of the City with a particular counterparty. The City may also elect to take into account the exposure of any related entities to a particular counterparty. 1 Currently water, wastewater, and golf funds 2 Includes ACLC payments from general fund revenues, and Sports Park 07/05/06 DEBT POLICY.doc 8

LONG-TERM IMPLICATIONS In evaluating a particular transaction involving the use of alternative financing instruments, the City shall review long-term implications associated with entering into alternative financing instruments, including costs of borrowing, historical interest rate trends, variable rate capacity, credit enhancement capacity, and other similar considerations. METHODS TO BE USED TO REFLECT SUCH CONTRACTS IN THE CITY S FINANCIAL STATEMENTS The City shall reflect the use of derivatives on its financial statements in accordance with generally accepted accounting principles. MONITORING AND REPORTING The City shall issue a report to the City Council at least annually and as requested by the Council. Such report shall include the following: 1. The report shall include the policy adopted by the Council regarding risk management of the derivative portfolio. For each transaction outstanding: 2. A summary of key terms of each alternative financing instrument, including notional amounts, interest rates, maturity and method of procurement and rationale for entering into agreement. 3. The marked-to-market value of each alternative financing instrument. 4. The aggregate marked-to-market value for each counterparty for interest rate linked alternative financing instruments and relative exposure compared to other counterparties. 5. The full name, description and credit ratings of each counterparty or the applicable guarantor for each alternative financing instrument. 6. The amounts that were required to be paid and received, and any amounts that were actually paid and received for each interest rate linked alternative financing instrument. This would include an analysis of any early termination payments and to which liability each interest rate agreement is linked. 7. Discussion of other risks associated with each transaction. 07/05/06 DEBT POLICY.doc 9

Specific Conditions With Respect to Derivatives With respect to swaps, to the extent possible the agreements entered into by the City shall contain the terms and conditions set forth in the International Swap and Derivatives Association, Inc. ("ISDA") Master Agreement, including any schedules and confirmation. The schedule should be modified to reflect specific legal requirements and business terms desired by the City. If possible, the City should attempt to negotiate the master agreement and schedule with qualified counterparties to facilitate the use of derivatives in situations in which their use is desirable. OPTIONAL TERMINATION: The City shall consider including a provision that permits the City optionally to terminate the agreement at the market value of the agreement at any time. In general, the counterparty shall not have the right to optionally terminate an agreement although such a provision may be incorporated into an agreement if it is judged beneficial to the City s interests. As practical as possible, the City shall have the right to assign its obligation to other counterparties. EVENTS OF DEFAULT: Events of default of a counterparty shall include the following: 1. Failure to make payments or transfer collateral when due 2. Breach of representations and warranties 3. Illegality 4. Failure to comply with downgrade provisions 5.Failure to comply with any other provisions of the agreement after a specified notice period 6. Bankruptcy 7. Other events as deemed by insurance and rating agencies STANDARDS AND PROCEDURES OF COUNTERPARTY SELECTION The City may enter into a derivative if (a) the counterparty shall have credit ratings from at least one nationally recognized statistical rating agency that is within the two highest investment grade categories (i.e. AAA or AA) and ratings which are obtained from any other nationally recognized statistical rating agencies shall also be within the three highest investment grade categories (i.e. AAA, AA or A), or the payment obligations of the counterparty shall be collateralized, as described below, or unconditionally guaranteed by an entity with such credit ratings, and (b) the counterparty has demonstrated experience in successfully executing derivatives and at least a minimum capitalization of $500 million. If after entering into an agreement the ratings of the counterparty are downgraded below the ratings listed above by any one of the rating agencies, then the agreement shall be subject to termination unless (a) the counterparty provides either a substitute guarantor or assigns the agreement, in either case, to a party meeting the rating criteria reasonably acceptable to the City or (b) collateralizes its obligations in accordance with the criteria set forth in the transaction documents. 07/05/06 DEBT POLICY.doc 10

PROVISIONS FOR COLLATERALIZATION If the rating (a) of the counterparty, if its payment obligations are not unconditionally guaranteed by another entity, or (b) of the entity unconditionally guaranteeing its payment obligations, if so secured, does not meet or falls below the rating required by "Standards and Procedures of Counterparty Selection" above, then the obligations of such counterparty shall be fully and continuously collateralized by 100% cash, direct obligations of, or obligations the principal and interest on which are guaranteed by, the United States of America or any agency thereof with a net market value of at least 102% of the net market value of the contract (subject to minimum threshold amounts specified by the City) to the authorized issuer and such collateral shall be deposited with the City or an agent thereof. 07/05/06 DEBT POLICY.doc 11