Capital Projects and Bond Oversight Committee




<MeetMDY1> September 19, 2006


The<MeetNo2> Capital Projects and Bond Oversight Committee met on<Day> Tuesday,<MeetMDY2> September 19, 2006, at<MeetTime> 1:00 PM, in<Room> Room 169 of the Capitol Annex. Representative Mike Denham, Chair, called the meeting to order, and the secretary called the roll.


Present were:


Members:<Members> Representative Mike Denham, Co-Chair; Senator Elizabeth Tori, Co-Chair; Senator Tom Buford; Senator Jerry Rhoads; and Representatives Robert Damron and Paul Marcotte.


Guests testifying before the Committee: John Hicks, Ken Marks, and Nancy Brownlee, Finance and Administration Cabinet; Katie Smith, Economic Development Cabinet; Sandy Williams, Kentucky Infrastructure Authority; Tom Howard and Terri Fugate, Office of Financial Management; and John Egan, Attorney, Frost-Brown-Todd.


LRC Staff:† Nancy Osborne, Pat Ingram, Bart Hardin, Kristi Culpepper, and Shawn Bowen.


Representative Denham welcomed Representative James Bruce who was attending the meeting. He then called on Ms. Nancy Osborne, Committee Staff Administrator, to review correspondence and information items included in members' folders. Ms. Osborne said the folders included two items of correspondence:† the Annual Report for the Court Facility Use Allowance Contingency Fund for Fiscal Year 2006 submitted by the Administrative Office of the Courts (AOC), and the Kentucky Lottery Corporation's monthly financial report for July 2006.


Ms. Osborne briefly discussed the Court Facility Use Allowance Contingency Fund report. She said at the end of Fiscal Year 2006, AOC reported a positive balance of $443,900 in the Fund. The Fund balance reflects the use allowance allocation of $89,100 for the Johnson County Court facility project, which was approved by the Committee in November 2003. She said the allocation for Johnson County marks the first time the Fund has been utilized since 2002. Ms. Osborne said in May 2006, the Committee approved an allocation of up to 15% for a cost overrun for the Bullitt County Court Facility. Depending upon the facility's actual construction costs and recovery of claims from contractors, there is the potential expenditure of up to $172,000 from the Fund that may occur in Fiscal Year 2009.


Ms. Osborne noted the 2005 General Assembly provided line-item authorization for 15 new court facilities with total use allowance payments of $19.5 million, and the 2006 General Assembly authorized 18 new court facilities with total use allowance payments of $23.7 million.


In response to a question from Senator Tori, Ms. Osborne said the Court Facilities Contingency Fund received an appropriation of $553,000 in the 1998-2000 Judicial Budget. She said AOC has not had to use the Fund because the court facility construction projects have been completed within their authorized budgets.


Ms. Osborne said three information items were also included in members' folders:† Executive Order 2006-1016 relating to the reorganization designation for administration of 2006-08 enacted budget capital projects, the monthly staff update on various capital projects, and the updated monthly and weekly debt issuance calendar.


Ms. Osborne then discussed items contained in the monthly staff update. She noted the Department of Parks has taken over operation of some of the attractions in the Benham-Lynch area of Eastern Kentucky, and plans to make $1 million in capital improvements to the Benham School House Inn. The State Fair Board has issued a Request for Proposal to solicit private sector interest to develop a hotel to be located near the Kentucky Exposition Center in Louisville at the former site of the District 5 Transportation facility that has been relocated. Ms. Osborne said the staff update also included an article regarding the Kentucky Supreme Court's decision not to review a lower court ruling in the Davis v. the Department of Revenue case, therefore letting stand the decision that Kentucky's method of taxing out-of-state municipal bonds while exempting in-state municipal bonds violated the Commerce Clause of the U.S. Constitution. The article indicated that the Finance and Administration Cabinet has decided to ask the United States Supreme Court to review the case.


The last item from the staff update Ms. Osborne discussed concerned the Department of Public Protection, Department of Insurance. She said the Department of Insurance has contracted with an outside vendor to review 22 state-owned facilities to determine if they are being insured at the appropriate amount. She said in the past, the Committee has raised concerns about whether state facilities are adequately insured.


Representative Denham then introduced Ms. Nancy Brownlee, Director for the Division of Real Properties, to discuss two emergency leases. Ms. Brownlee reported that the Department of Parks (PR-4787) in Spencer County has initiated an emergency lease to acquire suitable living space for the park manager of Taylorsville Lake State Park. She explained that the park manager's on-site residence was deemed unfit for habitation due to dampness and mold. The Department requested temporary replacement housing for the park manager, and ads were placed in local newspapers. However, no responses were received. As a result, the Finance Cabinet declared an emergency and a two-bedroom apartment in Taylorsville at a cost of $625 monthly was rented.


Ms. Brownlee said when funding is available, the Department of Parks anticipates construction of replacement housing on-site for the park manager, and this lease will no longer be needed.


Ms. Brownlee then reported an emergency lease for the Department of Corrections (PR-4784) in Sandy Hook, Kentucky. She explained that an electrical fire at the Little Sandy Correctional Complex in November 2005 rendered the Deputy Warden homeless. Since November, the Deputy Warden has resided in the homes of two different agency employees. He is now requesting that temporary housing be provided for the duration of the time it will take to repair his on-site residence. Ms. Brownlee said the Department has leased a two-bedroom apartment in Sandy Hook at a cost of $500 monthly. Ms. Brownlee said the lease will be needed for at least 90 days until the repairs at the complex are complete.


Representative Denham asked what the length of term is for this lease. Ms. Brownlee said the lease was initially effective from June 26, 2006 until June 30, 2006, the end of the fiscal year. She said the lease was renewed July 1, 2006 for a one-year period. She said the lease also contains a 30-day cancellation clause.


These leases were procured by emergency order, and did not require action by the Committee.


Representative Denham said a quorum was now available at the meeting and asked for the roll call and approval of the minutes. Representative Marcotte made a motion to approve the minutes of the August 22, 2006 meeting. The motion was seconded by Senator Tori and approved by voice vote.


Representative Denham asked Mr. John Hicks, Deputy State Budget Director, Governor's Office for Policy and Management, and Mr. Ken Marks, Deputy Commissioner, Department for Facilities and Support Services, to present the Finance Cabinetís monthly report to the Committee. Mr. Hicks first reported an allocation of $651,900 from the Capital Construction and Equipment Purchase Contingency Account for the Kentucky State University Young Hall Dormitory project. After a review of the project by the Finance Cabinet, the Department for Facilities and Support Services, and the University, it was determined that there was a best and final bid of $9,048,000, and a 6% scope increase would be necessary to meet the low bid.


Mr. Hicks said this is one of the final projects at Kentucky State University associated with the partnership agreement the Commonwealth entered into with the U.S. Department of Education's Office of Civil Rights.


Representative Denham asked what the balance in the Contingency Account will be after this allocation. Mr. Hicks said the account has a balance of approximately $9.7 million, assuming the state receives the $1 million allocation back from the Louisville Arena project.


[In September 2005, the Committee approved an allocation of $1 million from the Contingency Account to the Commerce Cabinet to finance a feasibility study for the Louisville Arena project. The Contingency Account was to be reimbursed when financing for the project was accomplished.]


Senator Rhoads made a motion to approve the allocation from the Contingency Account for the Young Hall project. The motion was seconded by Senator Tori and passed by unanimous roll call vote.


Mr. Hicks then reported a correction to the project scope for the Bluegrass Station Building 101 Warehouse Replacement project. This project is administered by the Department of Military Affairs and was reported to the Committee as an emergency project in July 2006 at a scope of $3,151,089. Mr. Hicks said additional funds in the amount of $369,011 should have been included as part of the original project scope, however, due to a communications error, funds for the architectural and construction contingency were inadvertently omitted. The funding source for the scope increase is Bluegrass Station's 2006-2008 Major Maintenance Pool.


Representative Denham noted that the Department of Military Affairs is using a large portion of its maintenance pool for this project. He asked if this has impacted the Department's ability to address other maintenance needs at Bluegrass Station. Mr. Hicks said Bluegrass Station keeps a good list of its deferred maintenance needs, and they believe this allocation of funds will not impact their ability to address other maintenance needs. He said this project is a high priority for Bluegrass Station. He added that if Bluegrass Station has the need for maintenance projects that exceed its maintenance pool, there is the capability to increase maintenance expenditures for projects under $600,000 if Bluegrass Station has the cashflow.


In response to a question from Senator Tori, Mr. Hicks said they believe this is the final scope increase for this project. He said a construction contract has been awarded, and the amount being allocated today for the construction contingency is typical in construction projects.


Senator Tori made a motion to approve the project scope increase. The motion was seconded by Representative Marcotte and approved by unanimous roll call vote.


Mr. Hicks next reported a $1,036,950 privately-funded scope increase for the Runway/Taxiway/Apron Rehabilitation project. The additional funds will be used to correct a design flaw on the 500-foot runway extension at the Capital City Airport in Frankfort. Mr. Hicks said the design firm, HMB, discovered a design error in the runway extension earlier this year, and as a result of that error, the consultant architect and its insurer has paid to the Commonwealth $1,036,950, which represents the approximate value of the necessary remediation work.


Mr. Hicks said the Transportation Cabinet, which now has responsibility for this project due to a June 2006 executive reorganization order, has worked closely with the Finance Cabinet to move forward in as timely a way as possible. He said the construction contractor has also been cooperative in that it has been willing to maintain its bid, given the delay in the construction resulting from the remediation work.


In response to a question from Representative Denham, Mr. Hicks said the remediation work will correct the design flaw, and all Federal Aviation Administration standards will have been met after this correction.


Representative Marcotte made a motion to approve the scope increase for the project. The motion was seconded by Senator Rhoads and passed by unanimous roll call vote.


The final item Mr. Hicks reported was a $1,220,700 project for the Department of Fish and Wildlife Resources to be funded from the Fees-in Lieu of Stream Mitigation Projects Pool. The project, Laurel Fork (Guy Cove) in Perry County, will repair damage to the property caused by mining. Representative Denham said no action was required on this project which is being reported from an authorized pool at a cost of over $400,000.


Representative Denham next asked Ms. Katie Smith, Deputy Commissioner for the Department of Financial Incentives, Cabinet for Economic Development, to report on a proposed Economic Development Bond (EDB) grant.


Ms. Smith reported a proposed grant of $200,000 to the Louisville/Jefferson County Metro Government to benefit NHK Spring Precision of America, Inc. The grant will be used to offset the cost of construction for a 91,328 square foot building in the Jefferson Riverport of Metro Louisville.


Ms. Smith said the EDB grant agreement stipulates that NHK will create 79 new full-time jobs for Kentucky residents within three years of occupancy of the facility, and the company will be required to pay the new employees an average wage of $18.12 per hour. NHK will also be required to maintain these jobs for an additional three years. If the company fails to meet these requirements, it must pay the Louisville/Jefferson County Metro Government $1,013 per job not created or maintained.


Representative Denham asked if NHK received any state grant funds for the construction of its other facilities. Ms. Smith said the company has affiliate locations in Bowling Green and Franklin. She said these companies may have received tax incentives under one of the tax incentive programs, but she was not completely sure.


In response to questions from Representative Denham, Ms. Smith said NHK hires a lot of skilled and technical positions. She said the new facility is not open yet, but they anticipate opening before the end of this year.


Senator Tori asked if it is standard operating procedure to require in the EDB contract the number of people to be employed. Ms. Smith said this is standard procedure for EDB grants. She explained that by requiring a specific number of employees, the Cabinet is able determine if the company is in compliance with the grant and whether the company will have to pay back a portion of the grant based upon those numbers.


Senator Rhoads made a motion to approve the EDB grant. The motion was seconded by Senator Buford and approved by unanimous roll call vote.


Ms. Smith said also in members' folders was the Annual Report on Economic Development Bond Pool Program/Monitoring of Jobs Creation/Payback Requirements. She said during Fiscal Year 2006, three new economic development projects were approved:† Hydro-Gear Limited Partnership, Webasto Roof Systems, and UGN, Inc. She said she would be happy to answer any questions the Committee may have regarding this report. Representative Denham said no Committee action was required for this report.


Next, Ms. Sandy Williams, Financial Analyst, Kentucky Infrastructure Authority (KIA), reported the execution of assistance agreements for a number of line-item Coal/Tobacco Development Grants approved in previous sessions of the General Assembly. Representative Denham said no further action was required on the report.


Representative Damron said during the budget discussions this year concerns were raised that bond proceeds allocated for water and sewer projects were not being spent down so as to avoid arbitrage penalties. He said budget language allowed the advance funding of projects from future bond pools. He asked how the spend-down provisions are working for pool programs, and if these projects are being monitored to make sure the state is not in violation of federal spend-down regulations. Ms. Williams said KIA has hired an arbitrage firm to calculate any arbitrage issues KIA may have from bonds it has issued. She said the firm has not started its work, but she would be happy to report back to the Committee when it does. Representative Damron said he recognized that projects sometimes take a while to start, and he said he was concerned that money allocated for water and sewer projects in the budget was not being drawn down in a timely manner.


Representative Damron asked how KIA decides which projects to advance fund if they are not scheduled to be bonded until later in the year. Ms. Williams said they have the ability for the non-coal producing counties receiving water and sewer appropriations to advance fund projects out of previous bond issues. She said in order for a project to be advance funded, the county needs to complete its paperwork and submit it to KIA. After that, the project must be reviewed by this Committee before it is eligible to receive funding. She noted that the Green County sewer project on the Committee's agenda today is an example of a project authorized by the 2006 General Assembly that is being advanced pursuant to the 2006 HB 380 budget language.


In response to another question from Representative Damron, Ms. Williams said KIA has three financial analysts that assist local communities with processing their grant applications in a timely manner. She said KIA is focusing on some of the projects that are more stagnant than others, and have been in contact with those communities.


Representative Damron asked that a report be provided to the Committee once the firm studying the arbitrage issue calculations has completed its study. Ms. Williams said she was not involved with that project, but she would make that request.


The next report was provided by Mr. Tom Howard, Executive Director, Office of Financial Management (OFM), and Ms. Terri Fugate, Deputy Executive Director, OFM. Mr. Howard first introduced Mr. Clay Owen, Treasurer, University of Kentucky (UK), and Mr. Marc Mathews, Controller, UK.


Mr. Howard first discussed the new UK bond issue report to the Committee this month:† Kentucky Asset/Liability Commission University of Kentucky General Receipts Refunding Project Notes 2006 Series A, Taxable Refunding Project Notes 2006 Series B, and Project Notes 2007 Series A, $166,095,239. The proceeds from this bond issue will be used to refund and defease all outstanding UK Housing and Dining System Revenue Bonds, and to provide financing for one-half ($75 million) of the agency fund supported bonds authorized by the 2006 General Assembly for the next phase of funding for the UK hospital.


In response to a question from Representative Denham, Mr. Howard said the true interest cost of a bond issue includes all the expenses associated with the transaction, which is 4.49% for the UK transaction.


Representative Denham noted that interest rates have dropped over the last few weeks. He asked if the state would get a better interest rate if they held the bond issue. Mr. Howard said they would like to issue these bonds as quickly as possible. He said they are trying to get through the financial statements for UK as quickly as possible in order to get those out, to be able to get into the market price, and to take advantage of these low rates, not only for the refunding but for the forward delivery piece as well.


Senator Buford made a motion to approve the new bond issue. The motion was seconded by Representative Marcotte and passed by unanimous roll call vote.


Mr. Howard then discussed the Second Supplement to the 2005 General Fund Second Series Project Notes trust indenture issued by the Kentucky Asset/Liability Commission (ALCo). These project notes are to be issued in an aggregate principal amount not to exceed $950 million. The Second Supplement will add 53 new projects authorized in HB 380 totaling $1,126,991,000. This amendment also will increase by $200 million the maximum amount to be outstanding at any time.


Mr. Howard said in August 2005, ALCo authorized up to $750 million of General Fund Project Notes to fund projects authorized by House Bill 267 of the 2005 Regular Session. In September 2005, the State Property and Buildings Commission (SPBC) issued $230 million in bonds to fund the various authorized projects from 2005, which included a portion of KIA projects. He said there remained $639 million of authorized but unissued debt which fell under the project notes program.


On November 2, 2005, ALCo issued $100 million of the $750 million in project notes to provide interim financing for projects that were moving forward from the 2005 session. To date, approximately $55 million of the $100 million has been spent.


Mr. Howard said in late December and early January interest rates dropped, and ALCo locked in some of the funding costs on these 2005 projects on a forward basis using interest rate swaps. He said they bid two $80 million interest rate swaps, one to mature in February 2007 and one in February 2008, to cover the future issuance of a total of $300 million of permanent bonds. Mr. Howard said the swaps reduced the debt service appropriation for approximately half of the authorized but unissued debt by over $4 million in the current budget.


Mr. Howard said the swaps are closely monitored and have been very effective. Taxable interest rates have increased 100 basis points since January 2006. Originally, because the relationship between tax-exempt and taxable bonds was so close, the swaps were based upon a London InterBank Offered Rate (LIBOR). Since then, the relationship between tax-exempt and taxable bonds has changed. To hedge the hedge and reduce the basis risks associated with the taxable hedging product, OFM just recently converted the swap from a taxable swap to a tax-exempt swap. This conversion of the swap, from LIBOR to BMA (Bond Market Association Municipal Swap Index), resulted in an additional $335,000 of annual debt service appropriation savings based on the current rates.


Mr. Howard said yesterday (September 18, 2006) ALCo added the remaining 2006 authorized projects from HB 380 to the ALCo 2005 General Fund Second Series indenture. He said the projects are now eligible to be funded through this program with the not to exceed amount increased from $750 million to $950 million. He said these notes will not all be sold at any given point in time, but periodically additional increments will be issued. He reminded the Committee that currently there is $100 million outstanding for the ALCo 2005 General Fund Second Series Project Notes program. This indenture basically will provide for all of the remaining 2005 and 2006 General Fund supported projects.


Representative Damron said historically some projects were initially advance funded before they were authorized by the budget bill. He asked if this will be the case now with all the projects in the 2006-08 budget. Mr. Howard said they will not issue bonds before they are authorized by the budget bill. He said the notes essentially provide a cashflow mechanism for those projects that are in the planning and design phase that need to move forward. These projects will now have access to funds.


In response to another question from Representative Damron, Mr. Hicks said for most of the projects, particularly the construction projects, a design phase is required. Through this financing method, they have been able to move forward with the acquisition of consultants, architects, and engineers on state funded projects. He said his office has requested that the Governor's Office for Local Development (GOLD) review its projects that have completed the application process for the project pools under KIA and GOLD. KIA has capital from the State Property and Buildings Commission last year. Additionally, $87 million in bonds from the Phase II Tobacco Settlement has been devoted to KIA projects. Mr. Hicks also noted the 2006 HB 380 budget provision allowing the utilization of certain 2004-2006 bond authorizations for 2006-2008 authorized KIA projects. Mr. Hicks said they are confident that by January they will be able to accommodate any KIA project through those vehicles.


Representative Damron asked if projects authorized in the 2006-2008 budget under GOLD now have access to funds. Mr. Hicks said they do have access to funds, and projects that are ready can move forward.


Representative Denham asked if this method of advance funding projects will result in any additional costs to the Commonwealth. Mr. Hicks said utilization of this financial mechanism will not result in any additional costs to the state. He explained that this method of funding projects will save the state money. He said OFM and the Finance Cabinet closely monitor each project's expenditures, and project notes will be issued and will provide cash flow to a project as its needs arise. Mr. Hicks said permanent debt can be issued at a later date, thereby allowing the state to save money by delaying debt service.


Mr. Hicks said in the past, when projects were ready to move forward, they would advance fund projects by interfund borrowing, meaning they would establish a receivable, and borrow the needed funds from the Capital Construction Investment Income Account. The problem with this method was the loss of interest income to the Account while waiting for the receivable to be reimbursed with bonds. He said by using project notes to provide interim financing, interfund borrowing as a method of advance funding a project is no longer needed, and the Capital Construction Investment Income Account can be used for maintenance projects as intended.


Senator Tori made a motion to approve the Second Supplement to the ALCo 2005 General Fund Second Series Project Note Trust Indenture. The motion was seconded by Senator Buford and passed by unanimous roll call vote.


Ms. Fugate next presented two follow-up reports for previously approved bond issues: Kentucky Housing Corporation Housing Revenue Bonds, 2006 Series K (Non-AMT), Series L (AMT), Series M (AMT) (Variable Rate), Series N (Taxable), and Series O (Taxable) (Variable Rate), $87,670,000; and Kentucky Higher Education Student Loan Corporation, Student Loan Revenue Bonds, Senior Series 2006 A-1 (Tax-Exempt), Senior Series 2006 A-2 through Series 2006 A-5 (Taxable), and Subordinate Series 2006 B-1 (Tax-Exempt), $350,000,000.


The last follow-up report Ms. Fugate discussed was Kentucky Economic Development Finance Authority Adjustable Rate Medical Center Revenue Improvement Bonds, Series 2006 (Ashland Hospital Corporation d/b/a King's Daughters Medical Center project), $40,000,000. She then introduced the bond counsel for this issue, Mr. John Egan with Frost-Brown-Todd, to further discuss the bond issue.


Mr. Egan said after the August Committee meeting, he submitted a letter to the Committee in which he further explained comments he made at that meeting when a question was raised as to whether the addition of two floors for a Cardiac and Vascular Center needed a new Certificate of Need (CON). Mr. Egan explained that a new CON was not needed for this project, which is a cardiovascular center expansion and an outpatient imaging expansion. He said there was some confusion because at the same time, the hospital had been trying to get a new CON. He cited the Ashland newspaper article that appeared the day after the Committee meeting stating that a new CON was denied to King's Daughter Medical Center (KDMC). The new CON had been denied, but he said KDMC does not need a new CON for the two-floor addition project. Mr. Egan said the hospital is appealing the Cabinet for Health and Family Services' decision denying the issuance of a new CON. If through the appeals process the hospital cannot get a new CON, the medical center will move some of its existing beds to the new facility. Representative Denham said no action was required for any of the follow-up bond issues.


Ms. Fugate next presented one new school bond issue with School Facilities Construction Commission (SFCC) debt service participation for the Madison County School District.


Senator Rhoads made a motion to approve the school bond issue. The motion was seconded by Senator Buford and passed by unanimous roll call vote.


Ms. Osborne said there was one locally-funded school bond issue submitted to the Committee for review this month for the Pikeville Independent School District in Pike County. She said all disclosure information has been filed, and no further action on the bond issue is required.


Representative Denham said the Committee's next meeting is scheduled for October 17 at Bluegrass Station in Lexington, Kentucky at 1:00 p.m.


With there being no further business, Representative Marcotte made a motion to adjourn the meeting. The motion was seconded, and the meeting adjourned at 2:00 p.m.