Resolution No. 90531
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RESOLUTION NO. 9053
A RESOLUTION OF THE CITY COUNCIL OF THE CITY OF
VERNON AMENDING ITS INTEREST RATE SWAP POLICY
WHEREAS, the City of Vernon (the "City") is a municipal
corporation and a chartered city of the State of California organized
and existing under its Charter and the Constitution of the State of
California; and
WHEREAS, the City is authorized pursuant to the provisions
of its Charter and the City of Vernon Municipal Facilities Revenue
Bond Law, constituting Chapter 2, Article XI, of the Vernon City Code,
to issue bonds, notes and other obligations payable from the Net
Revenues of the Electric System (capitalized terms used herein and not
otherwise defined shall have the meanings given such terms in the
Indenture mentioned below) to finance the Costs of improvements and
additions to the Electric System and to refund such bonds, notes and
other obligations; and
WHEREAS, on July 12, 2005, the City Council of the City of
Vernon adopted Resolution No. 8808 adopting Guidelines for Utilization
of Interest Rate Swaps & Other Derivative Products; and
WHEREAS, the City Council desires to approve amended
guidelines to provide procedural direction regarding the future use,
procurement and execution of interest rate swaps, options, and similar
contractual agreements ("interest rate swaps") in an effort to
integrate interest rate swaps into the City's overall debt and
investment management efforts; and
WHEREAS, the City Council does not intend the amended
guidelines to relate to other derivative products that the City may
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(consider, including but not limited to, those related to currency,
fuel, power, or energy -related derivatives and the guidelines are not
intended to require the City to modify or terminate existing interest
rate swaps; and
WHEREAS, interest rate swaps can be an effective interest
rate management tool to assist the City in achieving its financial
objectives, increase financial flexibility in addressing changing
market conditions and overall City circumstances, manage interest rate
risk, provide opportunities for interest rate savings, enhance
investment yields and aid the City in managing its balance sheet
through better matching of assets and liabilities.
NOW, THEREFORE, BE IT RESOLVED BY THE CITY COUNCIL OF THE
CITY OF VERNON AS FOLLOWS:
SECTION 1: The City Council of the City of Vernon hereby
finds and determines that the recitals contained hereinabove are true
and correct.
SECTION 2: The City Council of the City of Vernon hereby
approves and adopts the amended Guidelines for Utilization of Interest
Rate Swaps & Other Derivative Products, a copy of which is attached
hereto as Exhibit A and incorporated by reference.
SECTION 3: The Acting City Clerk, or his authorized
designee, is hereby authorized to make whatever nonsubstantive
changes, upon advice of counsel, to the Guidelines and all related
documents that become necessary to implement and carry out the
purposes of this resolution.
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SECTION 4: The Acting City Clerk of the City of Vernon
shall certify to the passage of this resolution, and thereupon and
thereafter the same shall be in full force and effect.
APPROVED AND ADOPTED this 24th day of May, 2006.
IATTEST:
BRUCE(V. LKENHORST, JR.
Acting y Clerk
LEONIS C. BURG, Mayor
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STATE OF CALIFORNIA )
) ss
COUNTY OF LOS ANGELES )
I, BRUCE V. MALKENHORST, JR., Acting City Clerk of the City of
Vernon, do hereby certify that the foregoing Resolution, being
Resolution No. 9053, was duly adopted by the City Council of the City
of Vernon at a regular meeting of the City Council duly held on
Wednesday, May 24, 2006, and thereafter was duly signed by the Mayor of
the City of Vernon.
(SEAL)
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BRUCE1.LKENHORST, JR.
Actin C' y Clerk
EXHIBIT
The City of Vernon, California
Guidelines for Utilization of
Interest Rate Swaps &
Other Derivative Products
Authorized upon motion carried at the May 24, 2006 meeting of the
City Council of the City of Vernon, California and
the Redevelopment Agency of the City of Vernon, California.
THE CITY OF VERNON, CALIFORNIA
Interest Rate Swap & Other Derivative Products Guidelines
I. INTRODUCTION
The guidelines outlined herein are intended to provide procedural direction regarding the future
use, procurement and execution of interest rate swaps, options, and similar contractual
agreements (hereafter, "Interest rate swaps"). These guidelines are not intended to relate to other
derivative products that the City or its departments may consider, including but not limited to, those
related to currency, fuel, power, or energy -related derivatives. These guidelines are not intended
to require the City to modify or terminate existing interest rate swaps.
While adherence to these guidelines is required in applicable circumstances, the City recognizes
that changes in the capital markets, City programs, and other unforeseen circumstances may from
time to time produce situations that are not adequately addressed by these guidelines and that will
require modifications or exceptions to achieve City financial and policy objectives. In these cases,
flexibility to deviate from these guidelines is appropriate provided City Council authorization is
obtained and City Council approval of any transaction shall constitute approval of any deviation
from these guidelines. Any determination or other action of the City referred to in these guidelines
may be accomplished by [an authorized officer.]
The City maintains the right to modify these guidelines and no party shall have any right or remedy
solely as result of the City's failure to comply in any manner with these interest rate swap
guidelines.
11. APPROACH AND OBJECTIVES
Interest rate swaps can be effective interest rate management tools in helping the City to achieve
its financial objectives. Properly used, these instruments can increase the City's financial flexibility
in addressing changing market conditions and overall City circumstances, manage interest rate
risk, provide opportunities for interest rate savings and enhanced investment yields, and help the
City to manage its balance sheet through better matching of assets and liabilities. Interest rate
swap usage is to be integrated into the City's overall debt and investment management efforts.
This arguably describes most if not all derivatives.
Options granting the right to commence or cancel an underlying swap may be used to the extent
the swap itself is consistent with these guidelines and the City determines, after identifying and
evaluating all the associated benefits and risks, that granting or purchasing the option is
advantageous.
Rationales for Utlllting Swaps and Options
1. Optimize capital structure; Including schedule of debt service payments and/or fixed vs.
variable rate allocations.
2. Achieve appropriate asset / liability matching.
3. Manage risk, including:
a. Interest rate risk;
b. Changes in federal and state tax policy; or
c. Liquidity facility renewal risk.
4. Improve flexibility to respond to changing circumstances.
5. Generate interest cost savings.
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DOCSSF1:825096.1
41987-1 EHC
6. Enhance investment yields.
7. Manage exposure to changing markets in advance of anticipated bond issuances (e.g.,,
through the use of forward hedging Instruments).
III. PERMITTED INSTRUMENTS
The City may utilize the following financial products on a current, or forward basis, after identifying
the objective(s) to be realized and assessing the attendant risks.
1. Interest rate swaps, including fixed, floating and/or basis swaps.
2. Interest rate caps/floors/collars.
3. Options, either embedded in an interest rate swap or other permitted instrument or on a
stand-alone basis, including swaptions, caps, floors, collars and/or cancellation or index -
based features.
4. Forward hedging instruments.
IV. PROCEDURE FOR PROCUREMENT AND EXECUTION
Swaps may be procured via a competitive bid or through negotiation with one or more prospective
counterparties. The City's staff (the "Staff") will determine on a case -by -case basis which
approach best addresses the City's long-term financial objectives. Regardless of the method of
procurement, the City shall obtain a finding from a qualified and independent firm that the terms
and conditions of any transaction entered into reflect a fair market value of such transaction as of
the date of its execution.
V. ELIGIBLE COUNTERPARTIES
The City shall enter into interest rate swap transactions only with qualified swap counterparties.
The City shall not have an immutable credit standard with respect to counterparty credit ratings,
however, the City will attempt to do business with counterpartles rated at least "AA-" or "Aa3" or
equivalent by any two of the three nationally recognized rating agencies i.e., Moody's, Standard
and Poor's, and Fitch) or whose obligations are guaranteed by an entity satisfying such criteria at
the time the City enters into the agreements contemplated herein. In addition, the counterparty
must have a demonstrated record of successfully executing interest rate swap transactions.
VI. SWAP REVIEW AND EVALUATION
In connection with any swap, Staff shall review the proposed transaction and outline any
considerations associated with the transaction to the City Council. Such a review should include
the following:
1. Identification of the expected benefit and potential risks, which shall include, but not
necessarily be limited to, those risks and benefits outlined below.
2. Analysis of expected benefit versus potential risks, including preparation of any so-called
"sensitivity" and "breakeven" analyses necessary to conclude that (a) the expected
benefits of the transaction outweigh the reasonably expected risks and (b) the
contemplated transaction does not impose risks that threaten the City's ability to
undertake its core functions.
3. Analysis of resulting net variable rate interest exposure from the contemplated transaction
and any potential budgetary impact.
4. Resulting net termination exposure for each counterparty for all existing and any proposed
transactions.
5. An analysis of any credit -related impact that the proposed transaction would have, or
could reasonably be expected to have, on the City's credit ratings.
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Swap Risks
1- Counterparty Risk — The risk of a payment default on an interest rate swap by the City's
Counterparty.
2. Termination/Replacement Risk - The risk that an interest rate swap must be terminated
prior to its stated final cash flow date and that the City cannot obtain a replacement
transaction with substantially similar terms. In such circumstance, the City could owe a
potentially large termination payment and/or find the resulting capital structure to be
undesirable (q&, contain excessive variable rate debt exposure).
3. Tax Risk — Generally, in the context of a "synthetic fixed rate bond issue" an unexpected
adverse discrepancy between the rate paid by the City to the holders of its underlying
bonds and the rate received on the associated interest rate swap caused by a reduction or
elimination in the benefits of the tax exemption for municipal bonds, (eg., a reduction in
the highest marginal tax rate that causes an increase in the ratio of tax-exempt to taxable
Yields).
4. Basis Risk — Generally, in the context of a "synthetic fixed rate bond issue" an
unexpected adverse discrepancy between the rate paid by the City to the holders of its
underlying bonds and the rate received on the associated interest rate swap, (e.g„ a tax-
exempt variable rate issue paying bondholders an average of 68% of LIBOR while the City
receives only 65% of LIBOR pursuant to the associated swap.)
5. Tax Exemption Risk — The risk that the transaction may make the City's related bonds
taxable.
6. Liquidity / Remarketing Risk — The risk that the City cannot secure a cost-effective
renewal of a Letter or Line of Credit or suffers a failed auction or remarketing with respect
to its variable -rate bonds.
7. Impact On The City's Credit Rating.
For purposes of calculating net exposure to identified risks, credit shall be given to any fixed
versus variable rate swaps that offset termination exposure for a specific Project or bond
transaction. For assessing risks associated with variable rate transactions (e.g., a fixed receiver
swap), credit may also be given for any assets that are used to hedge a transaction as long as in
the City's judgment such assets are reasonably expected to remain in place on a coterminous
basis with the swap.
Benefit Expectation
A synthetic fixed rate bond issuance (or other transactions resulting in the City having a fixed pay
obligation) should be expected to generate material savings versus the comparable cash flows
resulting from a traditional cash -market bond offering or lock in attractive rates in anticipation of
future City funding needs. The City will determine materiality on a case -by -case basis and may
waive such requirement if, in its judgment, the contemplated transaction helps to meet any of the
other objectives outlined herein.
For variable rate or other swap transactions that do not result in a fixed interest rate, the City will
evaluate any additional value generated through the transaction in assessing the benefits of
proceeding, including the ability to meet the broad objectives outlined herein. These benefits
include, for example, reducing interest rate or tax risk, optimizing the City's capital structure, or
further reducing reasonably expected interest expense.
VII. LEGAL AND CONTRACTUAL REQUIREMENTS
In connection with each interest rate swap, the City and Counterparty must (1) receive a legal
opinion acceptable to the market to the effect that the interest rate swap is a legal, valid and
binding obligation of the City. Such opinion must set forth the statutory and/or other provisions
that grant the City the capacity and authority to enter into the interest rate swap and (ii) a
certificate of the City's [financial/swap] advisor as to compliance of such swap with these
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guidelines or, if applicable, describing any respect in which such swap does not comply with these
guidelines.
Unless otherwise recommended by the Staff and approved by the City Council, the City will use
swap documentation based on published ISDA standards, including the Master Agreement,
Schedule to the Master Agreement and a Credit Support Annex. The City may modify these
standard forms and use additional documentation as, on the advice of counsel and/or its other
advisors, it deems necessary and appropriate.
Terms and Notional Amount of Swap Agreement
The City shall determine the appropriate term for an interest rate swap agreement on a case -by -
case basis. In connection with the issuance or carrying of bonds, the outstanding notional amount
of a swap agreement should relate to the amortization of the related existing or anticipated debt of
the City on the related Project.
Subject to the provisions contained herein, the City swap documentation and terms should include
the following:
1. Downgrade provisions triggering termination shall, absent extraordinary circumstances, be
no worse than those affecting the counterparty.
2. Governing law for swaps will be New York law, but should reflect California authorization
provisions.
3. Collateral thresholds should reflect counterparty credit ratings and overall termination
exposure to each counterparty (see "Collateral" under Section VII. Limitation on
Countemarty Default and Termination Exposure below).
4. Eligible collateral as set forth under "Collateral" in Section VII. Limitation on Counterparty
Default and Termination Exposure below.
Vlll. LIMITATIONS ON COUNTERPARTY DEFAULT AND TERMINATION EXPOSURE
In order to diversify the City's counterparty credit risk, and to limit the City's credit exposure to any
one counterparty, collateralized and uncollateralized exposure limits will be established for each
counterparty based upon both the credit rating of the counterparty as well as the relative level of
market price volatility risk associated with each existing and projected swap transaction with that
counterparty.
A termination payment to or from the City may be required in the event of termination of a swap
agreement due to a default, a decrease in credit rating, or other agreed upon termination event of
either the City or the counterparty. In certain circumstances, the City may be required to make a
termination payment to a counterparty that does not meet its contractual obligations. Prior to
making any such termination payment, Staff shall evaluate whether it is financially or otherwise
advantageous for the City to obtain a replacement oounterparty (P. , through an assignment to
another dealer) rather than making such termination payment directly.
In general, the City shall have the right to terminate any interest rate swap agreement at the
market value thereof for the Counterparty at any time. To the extent practicable, the City should
have the right to assign its obligations to other counterparties.
Collateral
To protect itself further, as part of any swap agreement, the City may require collateralization or
other forms of credit enhancements to secure any or all swap payment obligations. As
appropriate, the City may require collateral posting or other forms of credit enhancement
consistent with the following:
1. Each counterparty to the City may be required to post collateral if the credit rating of the
counterparty (or guarantor) falls below the "Aa" (Moody's) or "AA" (Standard & Poor's and
Fitch) category (without regard to modifiers). Collateral shall be posted based on a
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schedule which is ratings -based and provides for lower thresholds of unsecured credit
exposure as the counterparty's rating decreases.
2. Threshold amounts shall be determined by the City on a case -by -case basis. The City, in
consultation with counsel and its financial advisor and/or swap advisor, will determine the
reasonable threshold limits for the initial deposit and for increments of collateral posting
thereafter.
3. Collateral posting requirements for each counterparty will take into consideration multiple
transactions with that counterparty, some of which may offset the City's overall exposure
to that counterparty.
4. If appropriate, Collateral provisions may be applicable to both the City and counterparty.
5. Collateral may be deposited with a third party trustee, or as mutually agreed upon
between the City and the counterparty.
6. A list of acceptable securities that may be posted as collateral and the valuation of such
collateral will be determined and mutually agreed upon with each counterparty.
7. The market value of the collateral shall be determined no less frequently than monthly, or
more frequently if the City determines that it is in its best interest given the specific nature
of the swap(s) and/or collateral requirements.
8. The City shall determine on a case -by -case basis whether forms of credit enhancement
other than collateral -posting are more beneficial.
IX. ONGOING MANAGEMENT
The City will seek to maximize the benefits and minimize the risks it carries by actively managing
its interest rate swap program. This will entail periodic monitoring of market conditions for
emergent opportunities and risks. Active management may require modifications of existing
positions including, for example:
1. Early termination;
2. Shortening or lengthening the term;
3. Sale or purchase of options; or
4. Use of basis swaps.
X. ONGOING REPORTING REQUIREMENTS
A report providing the status of all interest rate swap agreements entered into by the City will be
prepared no less frequently than semi-annually (or on such other basis directed by the City
Council) and shall include the following:
1. A description of all outstanding interest rate swap agreements, including Project and
bonds series, type of swap, rates paid and received by the City, total notional amount,
average life of each swap agreement, and remaining term of each swap agreement.
2. Highlights of all material changes to swap agreements or new swap agreements entered
into by the City since the immediately preceding report.
3. Market value of each of the City's interest rate swap agreements.
4. The credit rating of each swap counterparty or its credit support provider, if any.
5. For a swap transaction entered into to generate debt service savings, the City will
calculate on an annual basis the actual debt service requirements versus the projected
debt service on the swap transaction at the original time of execution. Such a calculation
shall include a determination of the cumulative actual savings (or, if applicable, additional
payments made by the City) versus the projected savings at the time the swap was
executed.
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6. Listing of any credit enhancement, liquidity facility or reserves and accounting of all costs
and expenses associated with the credit enhancement, liquidity facility, or reserves.
7. The marls to market value for each transaction and the aggregate for each counterparty.
8. Discussion of other risks associated with each transaction.
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