Capital Projects and Bond Oversight Committee




<MeetMDY1> October 16, 2006


The<MeetNo2> Capital Projects and Bond Oversight Committee met on<Day> Monday,<MeetMDY2> October 16, 2006, at<MeetTime> 1:30 PM, in<Room> Room 169 of the Capitol Annex. Senator Elizabeth Tori, Chair, called the meeting to order.


Present were:


Members: Senator Elizabeth Tori, Co-Chair; Representative Mike Denham, Co-Chair; Senator Tom Buford; and Representatives Robert Damron, Paul Marcotte, and Jim Wayne.


Guests testifying before the Committee:† Larry Owsley, University of Louisville; Bob Wiseman, University of Kentucky; Ken Walker, Bruce Bailey, and Gary Cloyd, Kentucky Community and Technical College System; James Zabawa, Lora Snider, Terry Gray, and James Street, Eastern Kentucky University; John Hicks, Governor's Office for Policy and Management; Jim Abbott and Nancy Brownlee, Finance and Administration Cabinet; Terri Fugate, Office of Financial Management; Dennis Humble and Walter Clare, Kentucky Housing Corporation; and Sandy Williams, Kentucky Infrastructure Authority.


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


Senator Tori began the meeting by congratulating Shawn Bowen on her promotion to Committee Analyst. She noted that Ms. Bowen earned her Bachelor of Science degree in 1988, came to LRC in 1997, and has provided excellent service to the Committee as its assistant for nine and a half years. Committee members joined in congratulating Ms. Bowen on her promotion.


Senator Tori then called on Nancy Osborne, Committee Staff Administrator, to review the correspondence and information items. Ms. Osborne first discussed the quarterly status reports on authorized capital projects from the Finance Cabinet, Murray State University, the University of Kentucky, the University of Louisville, Western Kentucky University, and the Administrative Office of the Courts. She noted that the goal for the quarterly report system is to achieve consistency amongst the agencies and for access to eventually be provided through the LRC website.


Ms. Osborne briefly discussed information items included in members' folders. The first information item was the Office of Financial Management's annual report of bonds outstanding. As of June 30, 2006 the Commonwealth had approximately $5.14 billion of appropriation supported debt outstanding, compared to $4.7 billion on June 30, 2005. The 2006 amount does not take into account all authorized but not yet issued debt from the last two budget bills.


The second information item Ms. Osborne discussed was a report of a one-year extension of an Economic Development Bond (EDB) grant agreement for the Southern Kentucky Economic Development Corporation. She said the $1.4 million EDB grant to construct a 16,400 square foot (SF) facility in Somerset was conditioned upon creation of forty jobs. The facility is in operation, but a delay in receiving federal homeland security grant funds impacted the timely creation of the new jobs. The federal funds have now been released.


The final information item Ms. Osborne discussed was the monthly staff update on various capital projects. She noted the retirement of the state librarian, Jim Nelson, who was very involved in seeking funds for an addition to the state library. Also noted from the staff update was an article regarding a bond upgrade for Eastern Kentucky University's outstanding housing and dining revenue bonds of $10 million from BBB+ to A- by Standard & Poor's, a Bowling Green newspaper article discussing the federal funding of Veterans' nursing homes, and an article on the proposed federal IRS guidelines governing the application of tax-exempt proceeds to facilities used dually by governmental and private business entities.


Representative Marcotte asked what was the current status of the Davis v. Department of Revenue case. Mr. John Hicks, Deputy Budget Director, Governor's Office for Policy and Management, said it was his understanding that the current method of taxation will remain in effect during litigation. He said the Finance Cabinet intends to seek review by the U.S. Supreme Court. [At the Committee's October meeting, there was a discussion of the Kentucky Supreme Court's decision not to review a lower court ruling, 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. It was indicated that the Finance and Administration Cabinet has decided to ask the U.S. Supreme Court to review the case by the November 15 deadline.]


Senator Tori introduced Mr. Bob Wiseman, Vice President for Facilities, University of Kentucky (UK), to discuss two project reports. Mr. Wiseman first reported a ground lease of 3.491 acres on the main campus with the U.S. Department of Agriculture. Federal funds will be used to build and operate a 55,000 SF Forage Animal Production Research building and 20,000 SF of greenhouses to be located behind the Plant Sciences Building off Cooper Drive. He said the lease, which has an initial term of 50 years with a 25-year renewal option, was approved by the UK Board of Trustees. Since the facility is to be owned, maintained, and operated by a non-state entity, no further Committee action was required.


Mr. Wiseman then discussed the University's rebidding of the construction contract for the Patient Care Facility (the hospital). A year ago, UK notified the Committee that it intended to use the construction manager at-risk (CM-at-risk) project delivery method using a guaranteed maximum price (GMP) approach, whereby the GMP is set by the CM-at-risk prior to the bidding process.


Mr. Wiseman said the hospital project will be completed in five subprojects. The first subproject was the parking garage replacement and the second was the Huguelet Road extension. Mr. Wiseman said the GMP method worked well for these subprojects, but for the infrastructure subproject, the contractor quoted a GMP $250,000 higher than the initial estimate. University officials determined that for this multiple-phase, multiple-year project that is being built in a period of high commodity market volatility, the contractor was setting an inflated GMP to avoid taking on too much risk. Mr. Wiseman said the University declined the contractor's request to increase the amount of the contract. Subsequently the contractor asked to terminate the contract, and the University concurred.


Mr. Wiseman said a Request for Proposals (RFP) was issued for a new CM-at-risk with construction management services to be a "pure agency relationship" compensated on a fee-basis through the bidding of each bid package, and then to be converted to a "lump sum at risk" contract. The University selected Turner Construction and is negotiating the final contract terms.


Mr. Wiseman then passed out a newsletter describing the new hospital project, and how it will look once construction is complete. He said this newsletter was also distributed to the UK Board of Trustees, faculty, staff, and to neighborhoods surrounding the University.


In response to a question from Representative Wayne, Mr. Wiseman responded that the first contractor, Gilbane Construction, will continue to manage the garage and road projects, and Turner Construction will manage the hospital construction. He said other institutions around the country that have utilized a CM-at-risk with a GMP for their construction projects had also experienced over-inflated construction contract quotes due to the market volatility.


Representative Wayne asked if the University is taking more or less risk under the new arrangement. Mr. Wiseman said under the GMP approach, the contractor quotes a price and then works with University purchasing officials to bid the job. He said with this approach, the contractor was at risk that the bids he received from all the subcontractors would be over what he had quoted to the University. He explained that Turner Construction does not have to quote a GMP prior to the bid, but the procurement process remains the same. Mr. Wiseman said the ultimate risk in terms of the bids is the same, but what the University gains from this change is that Turner Construction will be more of a consultant to the University as they try to manage the project and keep it within budget.


Chairman Tori asked Mr. Wiseman to describe the hospital project. Mr. Wiseman said the new hospital will be approximately one million square feet, and cost approximately $450,000,000 to build, including roads and infrastructure. At least 60% of the space will be finished out under this project, with the remainder to be done at a later date. He explained that the University opted to build shell space so that over time it could just have interior fit-up as opposed to the heavy construction around the hospital.

In response to a question from Representative Wayne, Mr. Wiseman said the procurement code is being followed and prevailing wage does apply to this project. Senator Tori said this item was an information report, and no Committee action was required.


Senator Tori noted that a quorum was now present and asked that the secretary to call the roll. Representative Wayne said the minutes of the September 19, 2006 meeting did not include a list of the members present at the meeting. He asked that the minutes be corrected, and then made a motion to approve the minutes as corrected. The motion was seconded by Representative Marcotte and passed by voice vote.


Senator Tori invited Larry Owsley, Vice President of Business Affairs, University of Louisville, to present a project report for the University. Mr. Owsley said the Inhalation Chamber is being built with a grant from the National Institute for Health to research the impact of various pollutants on research mice.


Mr. Owsley said after construction was started, there was an outbreak of Parvo Virus among the mice, and to protect the integrity of the research, it was necessary to enlarge the autoclave. A project scope increase of $293,500 (80% from restricted funds and 20% from clinical funds) is needed to cover the cost of construction. If approved, the revised project scope will be $2,410,000.


Senator Buford made a motion to approve the scope increase. The motion was seconded by Representative Wayne and passed by unanimous roll call vote.


Senator Tori then invited Ken Walker, Vice President of Finance, Kentucky Community and Technical College System (KCTCS), Gary Cloyd, System Director of Facilities Management, KCTCS, and Bruce Bailey, Project Manager, Department of Facilities Management, KCTCS, to discuss the proposal to modify the lease-purchase agreement for the KCTCS System Office property in Versailles.


Mr. Walker said this Committee approved the original lease-purchase agreement between KCTCS and the City of Versailles (City) in November 2002. At that time, the City agreed to secure $6.3 million in funding to renovate 86,700 SF of a 130,000 SF facility that had at one time been the Texas Instruments, Inc. plant.


Mr. Walker said programs transferred by the 2006 General Assembly created the need to renovate an additional 15,000 SF of space in the Versailles facility. Some space will be fit-up to address needs created by staff increases due to some grant-funded projects received since moving to Versailles in 2003. The renovation will create an additional 13,000 SF of open office space and 2,000 SF of meeting room space. The City will issue $1,910,000 in bonds to fund the renovation project, and KCTCS will increase its lease-purchase payment to the City by an annual amount of $168,000 to correspond to the required debt service payments. This modification will not increase the time period of the original lease-purchase agreement and will be primarily supported by reallocating funds the Board of Emergency Medical Services is now paying for leased space. The remaining costs will be funded by reallocating current system office operating budgets. The additional lease-purchase payment will begin in Fiscal Year 2007-08, which will allow ample time for budget reallocations.


Mr. Walker said the KCTCS Board of Regents approved the modification and the Council on Postsecondary Education (CPE) supported it. KCTCS also secured two appraisals, for $10,500,000 and $11,500,000, that were submitted to the Finance Cabinet on September 29. The Finance Cabinet in turn sent a letter of support for this project on October 9. The renovation project will begin as soon as possible and is scheduled to be complete in fall 2007.


Representative Damron asked if the debt for this lease-purchase contract is being converted to a mortgage. Ms. Osborne responded that the staff analysis included information about the third-party financing of the project. She said the initial bond issue in 2003 was a general obligation of the City of Versailles, and this past June, the City refinanced the debt and structured it as mortgage revenue bonds. The savings from the June refinancing were passed on to KCTCS.


In response to a question from Representative Denham, Mr. Bailey said there is adequate square footage available at KCTCS' facility if they need to expand in the future.


Representative Damron asked why KCTCS is paying a one-time lump sum payment of $105,000 to reimburse the City the cost of debt issuance. Mr. Bailey said KCTCS has the cash, and it was their preference to limit the monthly lease-purchase payment. Representative Damron said he thought the $105,000 issuance cost seemed high and inquired as to the cost components. In response, Mr. Bailey said the underwriter's discount was two percent, but he was not sure who the underwriter was, or whether it was competitively bid by the City of Versailles.


Representative Damron asked why KCTCS is capitalizing interest for $34,000. Mr. Bailey said the original information submitted to the Committee had changed, and the new issue will not include capitalized interest.


Representative Damron said if the General Assembly would allow KCTCS and postsecondary institutions some flexibility in their bonding, the issuance costs for such bonds would decrease. He commented that the approach taken by KCTCS is not the best way to finance a project, but it may have been the only option they had.


Senator Buford said he agreed with Representative Damron in regard to allowing postsecondary institutions the flexibility to issue agency bonds.


In response to a question from Representative Wayne, Mr. Walker said this project did not require approval from the Finance Cabinet or CPE. He explained that the lease-purchase agreement was in place and authorized by the 2006-08 budget, and it was a reportable item and not one that required their approval. He added that had KCTCS sought approval from CPE or the Finance Cabinet, those agencies had indicated they would have responded affirmatively.


Senator Buford asked if KCTCS anticipates a large capital need since the escrow for this project by was raised $5,250. Mr. Walker said there was no known large capital need. He explained that the escrow was raised to ensure that an adequate capital renewal fund was associated with the project. He said KCTCS does not want the facility to be in a state of disrepair when ownership reverts to KCTCS at the end of the lease-purchase period.


Representative Wayne asked why the state did not purchase this facility from the City as opposed to leasing it. Mr. Bailey said at the time, KCTCS did not have the funds to purchase the building. He said they requested funding in the last budget to purchase the facility, and he predicted that KCTCS would continue to request funding for this purpose until they own the facility.


Chairman Tori said the topic of how postsecondary institution projects are authorized for bond funds would be a good item for future discussion.


Representative Denham made a motion to approve the KCTCS lease-purchase modification. The motion was seconded by Representative Wayne and passed by 5-1 roll call vote. Representative Damron explained his no vote by saying that the method KCTCS used to finance this project was ineffective. He said the professional bond services were not competitively bid, and the cost of issuance is excessive. He said while he could not support the financing mechanism for this project, he supported the KCTCS Central System Office project.


Representative Wayne said he voted to approve this project because he understood KCTCS is in a bind and part of that bind was created by the General Assembly's failure to raise the money to properly fund schools of higher learning.


Senator Tori then asked James Zabawa, Assistant Director of Purchasing, Eastern Kentucky University (EKU), to discuss a project report for the University. Mr. Zabawa introduced other EKU staff joining him at the table for the presentation: James Street, Director of Facility Services; Lora Snider, Director of Purchasing; and Terry Gray, Director of the Manchester campus.


Mr. Zabawa reported a lease of property for the University's extended campus center at Manchester. The University is leasing 13,000 SF at an annual cost of $123,804 ($9.50 per SF). He said the Manchester Center is highly utilized and serves over 350 students and offers over 90 classes. A new $12.5 million facility authorized for state bonds in the last two budgets is in design and will serve as the new center when finished. Mr. Zabawa said this lease was competitively bid, and can be extended through 2009 if the need arises.


Representative Denham made a motion to approve the new lease for EKU. The motion was seconded by Representative Wayne and passed by unanimous roll call vote.


Senator Tori invited John Hicks, Deputy State Budget Director, Governor's Office for Policy and Management, and Jim Abbott, Commissioner, Department for Facilities and Support Services, to present the Finance Cabinet's monthly report. Mr. Hicks reported a $129,300 allocation from the Emergency Repair, Maintenance and Replacement fund for the Cabinet for Health and Family Services Oak and Acorn Intergenerational Center in Louisville. The facility is leased to a private non-profit organization that operates a senior center and a day care center. Funds will be used to repair the HVAC and associated problems. Senator Tori said Emergency Fund allocations must be reported to the Committee within thirty days, and no further Committee action was needed.


Senator Tori then called on Nancy Brownlee, Director, Division of Real Properties, to present three lease modification reports. Ms. Brownlee first reported a lease modification for the Department of Corrections, Probation and Parole Office (PR-4725) in Campbell County. She said this lease with EGC Construction was originally processed and awarded as an emergency lease, and approved by the Committee in June 2006. The lease execution was temporarily placed on hold in July due to the filing of a lawsuit in federal court by EHI, an unsuccessful bidder to the project objecting to the lease award. [After the lease was awarded to EGC Construction Corporation, one of the competing vendors, EHI, filed a lawsuit in U.S. District Court seeking an injunction. EHI claimed the state violated its civil rights in the way the lease was procured and that the state violated KRS 56.803 in how the procurement was conducted. In August, a hearing was conducted and the court denied EHI's motion for an injunction. At the same hearing, the state filed a motion to dismiss the case.]


Ms. Brownlee said the Probation and Parole Office continues to experience unsanitary office conditions due to sewage discharge from the detention center located above them. However, the new lessor, EGC, was unwilling to begin the renovations to the new property required by the state in light of the risks associated with the pending litigation. To offset the risk of starting the renovation work while the court case remains undecided, EGC initially requested a non-refundable deposit, but the state denied that request. The state then offered and the lessor accepted an adjusted lease payment schedule which would offset the risk associated with this project, and at the same time, allow the agency to move to the new facility. The lease was modified as follows: in Fiscal Year 2007 the annual payment will increase from $139,531 to $195,343; and thereafter, for the next six years, the lease will cost $130,228 annually. The lessor also agreed to add one additional year to the lease, and the annual cost at that time will return to the original amount of $139,531.


Representative Wayne asked if there is a state precedent for accelerating lease payments to fund improvements. Ms. Brownlee said this is a unique case in that prior to declaring this lease an emergency in May, the state had advertised for replacement space for the Probation and Parole Office four times in three different counties and could not locate any suitable space. She said due to Probation and Parole's clientele, some commercial lessors were unwilling to lease space.


Ms. Brownlee said after the Division of Real Properties declared an emergency and alternative means were used to find suitable space, best and final offers were received from three lessors. She said by accelerating the lease payments with the new lessor the state was able give the owner some security should the lawsuit not be ruled in the state's favor.


Mr. Abbott added that in the past there have been instances where the state accelerated lease payments for leased properties in Franklin County, and to establish a lease at a higher rate and then discount that lease over a period of time is not unusual. He said what is unusual in this situation is that the initial bid on this property was negotiated due to the declaration of an emergency situation, and based on the initial bid, the state renegotiated with that lessor to establish a new modification because of the pending litigation. Ms. Brownlee added that the total cost of the lease ($976,717) over the seven-year lease term will remain unchanged.


In response to a question from Representative Wayne, Ms. Brownlee said Probation and Parole's clientele consists of individuals on parole. Representative Wayne told of a similar situation experienced in his district when Probation and Parole moved to an office in a public shopping center. The neighbors were initially reluctant about the agency locating in such a public place, but after a series of community meetings, the situation worked out when the neighbors realized there was a benefit to having the office there. He suggested that some creative marketing be done when advertising for this kind of lease. Mr. Abbott noted that this lease was advertised several times, but once the tenant was identified to the property owners, they withdrew their property from consideration.


Senator Tori asked if would it be necessary, depending on the federal court ruling, to rebid this lease. Ms. Brownlee responded that if the Courts do not rule in the state's favor, they will have to rebid the lease. She said the state's motion to dismiss is pending in the legal action, and the Cabinet is fairly comfortable that the court is going to rule in the state's favor.


Representative Damron asked who owned EGC and EHI. Ms. Brownlee said she did not have that information with her but she would provide that information to the Committee members.


Ms. Brownlee then presented a lease modification report for the Environmental and Public Protection Cabinet (EPPC) in Perry County (PR-2984). She said this lease modification is a consolidation of two EPPC leases, the Division of Forestry (PR-1061) and the Department for Environmental Protection (PR-2984).


Ms. Brownlee said a structural failure caused floor damage at the leased facility occupied by EPPC's Division of Forestry, and the City of Hazard ordered the building condemned. The state contacted another Perry County lessor that leased space to EPPC's Department for Environmental Protection, and the lessor advised that he was willing to lease additional space under the same terms and conditions as PR-2984. This modification will increase the leased space by 3,377 SF, and increases the annual lease cost of by $31,237 from $72,235 to $103,473 annually.


Representative Wayne noted that 15 staff are being relocated from a building that was approximately 7,800 SF to space that is 3,377 SF. He asked if this amount of space will be adequate. Ms. Brownlee responded that six of the 15 staff are part-time and work in the office one day per week. The Department for Environmental Protection has agreed to let Forestry staff utilize a conference room and two offices, and the remaining conference space will be shared with the Division of Forestry except during fire season.


Representative Denham made a motion to approve the two lease modification reports. The motion was seconded by Representative Marcotte and approved by unanimous roll call vote.


The final item Ms. Brownlee reported was a lease modification for the Department of Revenue (PR-3386) in Franklin County. The Department of Revenue has installed additional breakers and circuits in its leased facility in Franklin County. The modifications will cost $1,160, and will be amortized over the remaining lease term (June 30, 2008). Senator Tori said lease modifications of less than $50,000 are to be reported to the Committee within 30 days after execution, and no further action is needed.


The next report was provided by Terri Fugate, Deputy Director, Office of Financial Management (OFM), Dennis Humble, Chief Financial Officer, Kentucky Housing Corporation (KHC), and Walter Clare, Financial Management Sr. Director, KHC. Ms. Fugate reported one new bond issue: Kentucky Housing Corporation, Single Family Housing Revenue Bonds 2006 Series U, V, W, and Y (and additional series as necessary), $100,000,000. The bond proceeds will provide mortgage financing for first-time low and moderate income Kentucky homebuyers. The KHC board approved the issuance of bonds up to $200,000,000 in August. The transaction was approved by the State Property and Buildings Commission in September. She said the $200,000,000 is expected to be issued in two different pieces. The first issue of approximately $90,000,000 is to be sold on October 24 with closing on November 29.


Senator Tori asked if the debt structure is expected to remain stable and unchanged. Mr. Clare responded yes, that each of their prior transactions were similar, and the only change one sees occasionally is when KHC is able to issue a small amount of non-alternative minimum tax (AMT) debt and AMT debt. He said each transaction may have some piece of taxable bonds that would be a mix of fixed rate and variable rate, and potentially swapped to fix rate. He said the general structure of close to 50% tax-exempt and 50% taxable, with a modest mix of variable rate and fixed rate, will be seen in the transactions ahead. This structure has been the case in the last three KHC bond issues and is fairly indicative of the future transactions.


Representative Denham asked what the projected interest rate is for these first time homebuyers. Mr. Clare said currently the interest rates range from 5.75% to 6.13% depending upon the points paid. The highest rate is 6.13% for government and FHA loans with no points, and a regular 30-year conventional rate is 6%. The rate goes down if a borrower pays points.


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


Ms. Fugate said also provided for the Committee's information was the Semi-Annual Report of the Kentucky Asset/Liability Commission (ALCo) and a follow-up report for a previously approved bond issue: KHC Single Family Housing Revenue Bonds, 2006 Series P, Q, R, S, and T, $110,000,000. Neither of these reports required Committee action.


Representative Denham asked if there had been any criticism from auditors or anyone reviewing the ALCo report. Ms. Fugate responded there had been no questions from any source. He further inquired as to whether the asset liability structure was on target with where it should be. Ms. Fugate said the report is an internal management report required by statute. She said no concern has been expressed by the rating agencies, which are always aware of the amount of outstanding debt the state carries and how it is managed.


Senator Tori next welcomed Ms. Sandy Williams, Kentucky Infrastructure Authority (KIA). Ms. Williams said KIA had three loans to present. The first loan request was from Sanitation District #1 of Boone, Campbell, and Kenton Counties to increase its KIA Fund A loan by $3,060,675 (10%) for changes to the Eastern Regional Wastewater Treatment Plant to have the effluent outfall flow to Brush Creek as opposed to the Ohio River. If approved, the new Fund A loan will be $33,667,425, to be combined with $5,360,652 local funds for a total cost of $39,028,077.


The next project was a Fund A loan request of $711,100 for Boyd County Sanitation District No. 2 to construct the Westwood/Fairview collection system. The loan is to be combined with federal and state grants and local funds, for a total project cost of $1,918,000.


The last project Ms. Williams presented was a request by the Northern Kentucky Water District for a Fund F loan of $4,000,000 to improve the drinking water treatment plant. The loan is to be combined with local funds of $2,865,000 for a total project cost of $6,865,000.


Representative Denham made a motion to approve the three loans. The motion was seconded by Representative Marcotte and approved by unanimous roll call vote.


Ms. Williams said membersí folders also included a report from KIA regarding 11 infrastructure for economic development fund grants for non-coal counties for the Committee's review. No further action was required on these projects.


Ms. Fugate next presented 13 school bond issues with School Facilities Construction Commission (SFCC) debt service participation: Butler County, Clinton County, Grant County, Graves County, †† Henry County, Lewis County (2), Madison County, Muhlenberg County, Paintsville Independent (Johnson Co.), Pike County, Pulaski County, and Simpson County.


Representative Marcotte made a motion to approve the new school bond issues. The motion was seconded by Representative Wayne and passed by unanimous roll call vote.


Ms. Osborne said there were seven locally-funded school bond issues submitted to the Committee for review this month: Boone County (2), Ft. Thomas Independent (Campbell Co.), Somerset Independent (Pulaski Co.), Henderson County, Jackson County, and Johnson County. All disclosure information has been filed, and no further action is required.


Senator Tori announced that the next Committee meeting will be Tuesday, November 21 at 1:00 p.m. There being no further business, there was a motion and second to adjourn. The meeting adjourned at 2:37 p.m.