|Half Moon Bay Concludes Bond Audit|
Half Moon Bay Concludes Bond Audit
City Council Reaches Closing Agreement with IRS over Audit of Build America Bonds
HALF MOON BAY, CA – The City Council approved an agreement with the Internal Revenue Service, bringing to closure the IRS audit process concerning the City’s $10,915,000 Judgment Obligation Bonds Series 2009B (Federally Taxable, Direct Payment, Build America Bonds, or “BABs”). These bonds financed a portion of the Yamagiwa v. Half Moon Bay settlement resulting in the City’s ownership of approximately 25 acres of property along Cabrillo Highway.
The agreement provides clarity and flexibility for the City Council to determine the best use of the property and avoids additional legal costs. “I am glad this resolution allows us to move forward determining the best future use for the property and am appreciative to legal counsel and staff that such a complex tax matter has been resolved without a protracted court battle,” says Mayor Allan Alifano.
Bond Issuance Background
To finance the $18,000,000 Yamagiwa settlement, in 2009 the City issued $16,680,000 in bonded indebtedness in two parts: (1) $5,765,000 in conventional tax free municipal “judgment obligation” bonds; and (2) $10,915,000 in federally taxable “Build America Bonds.” Build America Bonds were created under the American Recovery and Reinvestment Act that President Obama signed into law in early 2009, and were a component of the Federal Government’s stimulus package designed to spur state and local government investment in new capital infrastructure. By the Federal Government reimbursing a portion (35%) of the interest paid by the City to investors, the Build America Bonds program allowed participating agencies to finance projects at a slightly lower cost than conventional tax-exempt financing.
The decision to issue Build America Bonds was based on recommendations of the City’s bond counsel and underwriters, and was made during the worst financial crisis experienced by the City of Half Moon Bay since its incorporation. Build America Bonds allowed the City to finance a portion of the Yamagiwa settlement at the lowest possible cost for Half Moon Bay residents yet the decision to issue judgment obligation bonds also restricted the use of the property to narrowly-defined public uses such as a corporate yard for storage of public works equipment or new administrative buildings. Given the court’s determination that wetlands caused by human activities rendered the parcel largely unusable and without significant value, additional property uses at the time of the bond issuance seemed unlikely.
Since the time of the Yamagiwa settlement and the issuance of BABs, additional research and analysis has been conducted, which indicates that the City may be able to make more productive use of the property than was anticipated at the time of the bond issue. In the Yamagiwa case, both the plaintiff and the City were operating under the assumption that the City’s Local Coastal Program requires a 100 foot development buffer around all wetlands. This was based upon an expansive interpretation of Half Moon Bay Municipal Code Section 18.38.080 which establishes a 100 foot buffer requirement for wetlands that constitute “lakes, ponds or marshes.” More recent analysis suggests that for degraded wetlands that are not classified as “lakes, ponds or marshes” (such as those present on the property site), a less stringent 50 foot buffer applies. This increases the amount of useable land.
Also since the original settlement, the City received an unexpected and generous land donation from Ronald and Patricia VandenBerghe, principals of Merit Manor, LP. The property, often referred to as “Glencree,” is approximately 12 acres and is immediately adjacent to the former Yamagiwa property. The two properties are collectively known as the “Cabrillo Highway Properties” and have a combined land area of approximately 37 acres. The acquisition of Glencree increases the viability of the potential development of the combined acreage.
In addition, while the City remains financially unable to build a community facility, the economy is slowly starting to turn in a positive direction. The private sector may once again have the ability to finance certain developments and be interested in investing in Half Moon Bay.
IRS Bond Audit Background
The Build America Bond program was new in 2009. In late 2010, the Internal Revenue Service began auditing many issuers of Build America Bonds, including the City of Half Moon Bay, to verify compliance with applicable regulations. An IRS field agent met with City staff, visited the property, and obtained pertinent information and background documentation related to the bond issue. In late 2011, IRS field office staff informed the City that the IRS questioned whether the 2009 issue qualified under the requirements of the program. The IRS questioned whether the property transfer that occurred as part of the Yamagiwa settlement qualified as a “capital acquisition” under the Build America Bonds program, as well as whether it was reasonably likely, at the time of the issue, that the property would be devoted to a public use for the life of the bonds. As a way to resolve its concerns, the IRS proposed reducing the amount of the interest subsidy from 35% to 29%, thus placing the City in basically the same position with the Build America Bonds as the simultaneously issued tax-exempt bond issue.
Closing Agreement Advantages
After carefully considering all options, the City Council has determined that a negotiated closing agreement provided the most advantageous outcome for the City and its residents. It provides the City with additional flexibility in considering options for maximizing the use of the Cabrillo Highway Property for the benefit of Half Moon Bay and its residents. In turn, the City will accept a lower interest subsidy from the Federal Government on the BABs, resulting in a cost that will be roughly proportionate to the City’s cost of financing $5,765,000 in conventional tax free municipal “judgment obligation” bonds that were issued simultaneously with the BABs. The additional annual cost to the City resulting from the lower interest subsidy is approximately $56,000 in the first year, and will be gradually reduced as interest payments decline over the life of the bonds. In addition, there will be a one-time repayment of the difference in the subsidy payments received to date by the City of approximately $174,000. The one-time payment will come from existing risk management reserves.
While the City Council is confident, based on the advice of its bond counsel, that it would ultimately have prevailed in a legal challenge to the IRS position, the approved closing agreement provides certain advantages that more than offset the reduction in interest payment reimbursements. Advantages include:
The City Council is pleased to close this latest chapter in the Yamagiwa story that continues to visit the consequences of errant decisions of the past on the current City Council, staff and members of the public. The City Council looks forward to exploring options for the property that make the most of this important community asset.