Report to/Rapport au :

Corporate Services and Economic Development Committee

Comité des services organisationnels et du développement économique

and Council / et au Conseil

2 April 2007 / le 2 avril 2007

Submitted by/Soumis par : Greg Geddes,

Chief Corporate Services Officer/Chef des Services généraux

Contact Person/Personne ressource : Marian Simulik, Director, Financial Services and City Treasurer/Directrice des services financiers et trésorière municipale

Financial Services/Services financiers

(613) 580-2424 x 14159, Marian.Simulik@ottawa.ca

City Wide

Ref N°: ACS2007-CRS-FIN-0008

SUBJECT:	lEASE FINANCING AGREEMENTS - ORLEANS ARTS CENTRe

OBJET :	Accords de financement des baux financiers - Centre des arts d’Orléans

REPORT RECOMMENDATIONS

Subject to Council adopting the Policy on Debt and Financing, that Corporate Services and Economic Development Committee recommend Council approve:

1. Entering into a Lease Financing Agreement with Orleans Town Centre Partnership (OTCP) and a loan guarantee, to provide financing for the construction of the Orleans Arts Centre to be repaid over a period of 30 years on the basis of the terms and conditions outlined in this report;

2. Authorize the City Solicitor and the City Treasurer to bring forward a by-law as required for this lease financing agreement for execution by Council.

RECOMMANDATIONS DU RAPPORT

Sous réserve de l’adoption de la Politique sur les dettes et le financement par le Conseil, que le Comité des services organisationnels et du développement économique recommande au Conseil :

1. d’approuver la signature d’un accord de financement des baux financiers avec le Partenariat du Centre-ville d’Orléans (PCVO) ainsi que d’une garantie d’emprunt afin de permettre le financement de la construction du Centre des arts d’Orléans qui sera remboursé sur une période de 30 ans conformément aux conditions soulignées dans le présent rapport;

2. d’autoriser le chef du contentieux et le trésorier de la Ville à présenter un règlement tel qu’il est requis pour le présent accord de financement des baux financiers pour adoption par le Conseil.

BACKGROUND

On 11 October 2006, Council adopted a report (ACS2006-POGM-ECO-0017) which, among other things, authorized staff to finalize negotiations and conclude all necessary agreements with Orleans Town Centre Partnerships (OTCP) for the design, build, finance, maintenance and ownership of a Orleans Arts Centre facility; the sale, operation, maintenance and the provision of a 25 year lease to the City of Ottawa for the Orleans Client Service Centre (CSC) building. Discussions and negotiations have been on-going and are at the point where final agreements are expected to be executed by OTCP and the City prior to 30 April 2007. Although Council authorized staff to negotiate and conclude all necessary agreements with OTCP, this report is required to comply with the requirements of Ontario Regulation 655/05 as amended by 604/06.

Prior to entering into a lease financing agreement, Ontario Regulation 653/05 as amended by Regulation 604/06 requires Council to adopt a statement of policies and goals for lease financing agreements and requires the City Treasurer to prepare a report assessing the costs and risks associated with the proposed lease. Given the advanced stage of negotiations on the Orleans Arts Complex, this report on the proposed lease financing agreement for the OAC is proceeding to CSEDC and Council for consideration at the same time as the City's proposed policy on Debt and Financing (ACS2007-CRS-FIN-0007). In addition to assessing the costs and risks of a proposed lease, the Treasurer's report is to provide a comparison with other methods of financing, indicate the effective cost of the lease, and provide a summary of any contingent payments and the assumptions applicable to any variations in the payment schedules.

As approved by Council, this public private partnership involves the design, construction maintenance for a visual and performing art centre on a 30 year lease, the sale of the Orleans Client Service Centre (CSC) with a 25 year lease back to the City and the partnership arrangement will also initiate the sale and development of approximately 6.5 hectares of City land that is expected to result in more than $220 million worth of construction value to occur. The arrangements also involves a $9 million loan from the proceeds of the sale of the land and CSC by the City to the OTCP partnership payable only at the end of the 30 year term. At year 30 the City will also have the option to purchase the OAC for the same amount as the accrued value of the loan to OTCP. The lease financing arrangement involved in the development of the Orleans Arts Centre falls within the intent and definition of a lease financing agreement under the City's proposed policy on Debt and Financing and has been reviewed as follows. Although the lease of the Orleans CSC is an integral component of the overall project financing, it is not being entered into for the purpose of obtaining long-term financing for the City and therefore a separate Treasurer's report is not required.

Orleans Arts Centre Lease Agreement:

OTCP requested financing proposals from a variety of financial organizations, including banks, life insurance companies, pension funds and private placements. A proposal from TD Capital with funding from a private investor has been recommended as the lowest cost solution. TD Capital will provide financing of approximately $ 28.8 million to fund construction of the OAC to be repaid through irrevocable lease payments from the City over 30 years from a date certain representing the expected date of project completion. The monthly lease payments will increase at a rate of 2.5% per year over the term to amortize the full amount of the loan. The interest rate will be fixed for the full term of the financing and will be based on a spread over the applicable Government of Canada bond. The rate will be set on an agreed date approximately two to three weeks prior to funding. On the basis of prevailing interest rates the fixed rate of interest would be 4.89%. Interest will accrue during the construction period with payments only starting on commencement of the lease. In order to attract the best available financing terms the loan will be guaranteed by the City as indicated in the Request for Proposals and approved by Council on 11 October 2006.

The cost of the proposed lease financing for the OAC is the lowest offer obtained from OTCP. The cost of a direct City debenture for a similar financing structure with a 18 to 24 month construction period to be paid in approximately equal monthly payments over 30 years would be similar and is estimated to be the same spread over Government of Canada bonds. The City would normally finance costs during the construction period from internal cashflows and reserves and issue debt once sufficient spending has occurred on a project or it has been completed. The proposed lease financing agreement provides construction period financing with interest accruing during this period which is added to the amount of the loan. Although this increases the amount of the loan, interest will be earned by investing these funds during construction which will partially offset the cost of construction financing.

A significant benefit resulting from this structure, is to fix the interest rate for the lease payments for the full 30 year term at the beginning of construction. This provides certainty on the cost of financing and sets the base lease payments for the entire 30 years. With a traditional City debenture issue the interest rate is only determined when debentures are issued thus leaving the City exposed to changes in interest rates during the construction period. The proposed lease financing reduces the financial risk of unfavourable movements in interest rates and meets the requirements for a fixed rate loan for the entire period.

A comparison of the proposed lease to a City debenture is attached in Annex A. This analysis is based on interest rates prevailing at this time and takes into consideration the expected interest earnings which will result from funds held in trust under the lease financing agreement. These funds will be held in a trust arrangement to be released to make progress payments as construction milestones are achieved. To provide an equivalent comparison, the present value of a City debenture also takes into consideration lost investment earnings as under this scenario progress payments during construction would be funded from City cash balances and investment portfolios. This analysis indicates that a City debenture would have a present value of $29.0 million compared to the lease agreement with $29.4 million. However, as indicated previously this assumes that the interest rate for a City debenture to be issued in 21 months will be the same as today's rates while there is really no certainty that current interst rates will exist at that time.

Interest rates are continually changing in response to various economic events and investor expectations for future trends in rates. A review of rates over the past ten years indicates that 10 year Government of Canada bond yields averaged 4.52% with a range from 3.78% to 6.68%. Over the same ten year period the long Governemnt of Canada bond (30-33 years) averaged 5.40% with a range from 4.02% to 7.38%. The outlook for interest rates even over the next twelve to eighteen months varys widely. Some forecasts expect rates to remain near current levels or decline while others are expecting longer-term rates to increase by 60 basis points.

By locking-in interest rates through the OAC lease agreement, the City will fix the base lease cost for the full 30 year term. An increase in rates of only 13 basis points would increase the present value of the City's debenture set out in Annex A by $400,000 thus eliminating any difference with the proposed lease financing agreement on a present value basis. Or in other words, the $400,000 present value difference in the OAC lease buys protection against an increase in rates of more than .13%. Given the changes in rates evidenced over the last ten years, an increase in rates of .13% could easily occur and the advantage of locking-in a rate for this project is recommended.

As required by the proposed policy on Debt and Financing the following additional payments and risks have been identified:

The proposed lease agreement provides an option at the sole discretion of the City to extend the term of the lease for an additional 20 years. The agreement also provides for the City to deposit a payment each year which will accumulate to an amount equivalent to 1% of the fixed price for the OAC as a life cycle renewal account.

In the event of lease termination, as a result of non-performance or default by OTCP, the City will have "step-in" rights to take ownership of the facility as long as the payments continue to be made to the investors. Thus the risk of losing the use of the facility as a result of default or non-performance by OTCP is minimal and controllable by the City.

CONSULTATION

The Orleans Arts Centre development was subject to public consultations as outlined in the previously mentioned report to Council on 11 October 2006. This report which involves a report by the City Treasurer to comply with a Provincial Regulation and related City policy, has not been subject to public consultation. Legal Counsel has been consulted, as appropriate on various documents associated with the proposed lease financing agreement.

FINANCIAL IMPLICATIONS

The yield on a direct City debenture for a similar financing structure as the proposed lease agreement for the OAC with a 18 to 24 month construction period to be paid in monthly payments over 30 years would be similar to and is estimated to be the same margin over Government of Canada yields as the proposed lease agreement. The assessment of the OAC lease should also take into consideration the overall Orleans Town Centre development which also involves the sale of the Client Service Centre and City lands which is expected to result in significant devlopment in the surrounding Town Centre lands in the order of $220 million in future years.

In accordance with Regulation 653/06 as amended and the City's proposed Policy on Debt and Financing, it is the opinion of the City Treasurer that the costs and financial and other risks of the proposed lease agreement for the OAC have been assessed and in consideration of the overall economic benefits which are expected to be generated from the development of the Orleans Town Centre area, that the City should enter into the proposed lease financing agreement.

SUPPORTING DOCUMENTATION

Annex "A" provides a comparison of the proposed lease agreement to a City debenture for the same terms.

DISPOSITION

Following consideration by Corporate Services and Economic Development Committee and subject to Corporate Services and Economic Development Committee recommending the proposed policy on Debt and Financing to Council, this recommendation will be forwarded to Council for its consideration.

Annex A

Comparison of Lease Financing Agreement to City Debenture

	Proposed Lease	City Debenture

Loan Amount	$28,730,000*	$26,400,000
Interest Rate	4.89%	4.91%
Term	21 month construction period and 30 year amortization period	30 year amortization period
Present Value net of investment earnings on funds in escrow vs. lost investment earnings if City funds construction payments.	$29,407,000	$29,000,000
Impact	The lease financing agreement for the OAC is an integral component not only for the development of an arts centre but for the overall development of the Orleans Town Centre lands as well.	A City debenture would contribute to the financing required for the arts centre only.

Lease Financing Agreements - Orleans Arts Centre

Accords de financement des baux financiers - Centre des arts d’Orléans

ACS2007-CRS-FIN-0008

Moved by Councillor R. Jellett

That the Corporate Services and Economic Development Committee approve the addition of this item for consideration by the Committee at today’s meeting, pursuant to Section 84(3) of the Procedure By-law.

Carried

At Councillor Wilkinson’s request, Ms. M. Simulik, Director of Financial Services and City Treasurer, spoke to a PowerPoint slide presentation, which served to provide the Committee with a brief overview of the staff report. A copy of her presentation is held on file with the City Clerk.

Responding to questions from Councillor Wilkinson, Ms. Simulik confirmed that the City would be loaning the partner $9M from the proceeds of the sale of the land and that at the end of the 30-year term, the City will have the option to purchase the facility for that amount plus the accrued value of the loan. She further confirmed that the lease payments, which will start at approximately $1.4M per year, will escalate by 2.5% year over year in order to retire the full amount of the loan within the 30 year period.

With respect to the Client Service Centre (CSC), Mr. Chartrand confirmed that part of the agreement reflects a decision made by the last term of Council. When staff presented to Committee and Council last fall, the disposal of the CSC was one of the incentives put forward as part of this public, private partnership in order to see some town centre development. He explained that the transfer of the CSC enables the City to fund part of the Orléans Arts Centre facility. The City will be leasing the facility back for a firm period of 25 years. He maintained the benefit was the town centre development, which was the very strong second objective approved by Council for this public, private partnership.

Responding to questions from Councillor Bloess, Mr. R. Chartrand, Director of Economic Development and Strategic Projects, confirmed that as part of the agreement, the City has step-in rights specifically for the Orléans Arts Centre in the event of a default. However, he felt that was virtually no risk of the partner defaulting because he was setting up a special purpose corporation specifically for that loan. With respect to the rest of the development, he indicated the City had performance security of $2.5M for 2 major developments; a seniors’ residence and a hotel. Furthermore, he noted there was also land reversion as an underlying performance security.

Subject to Council adopting the Policy on Debt and Financing, that Corporate Services and Economic Development Committee recommend Council approve:

2. Authorize the City Solicitor and the City Treasurer to bring forward a by-law as required for this lease financing agreement for execution by Council.

CARRIED

* This amount includes interest accrued during the construction period and added to the amount of financing while a typical City debenture does not include this interest. With a City debenture payments during construction are funded from the City’s cash flow.