April 20, 1998

 To:Budget Committee

 From:Chief Financial Officer and Treasurer

 Subject:TTC Five-Year Capital Subsidy Agreement

Prepayment of Subsidy in Exchange for Release

 Purpose:

 To arrange for the discounted prepayment of all remaining Provincial subsidy obligations under the TTC Five-year Capital Subsidy Agreement.

 Funding Sources, Financial Implications and Impact Statement:

 Prepayment of the subsidy into an interest bearing capital reserve fund is designed to have no financial impact on the City. The release of the Province from the Capital Subsidy Agreement and the prepayment of all outstanding subsidies under the agreement in no way alleviates the fiscal difficulties arising from the elimination of capital subsidies for transit purposes. At an estimated impact of $180 million per year, the subsidy loss is the single largest budget pressure the City has ever faced. The Budget Committee has requested a report in September 1998 outlining a strategy to address this issue, which is also discussed in a separate report to this Committee on a proposed capital financing management plan.

 Recommendations:

 It is recommended that:

 (i)in exchange for prepayment to the City by the Province of an amount of $828,200,100 adjusted as necessary for changes in the prevailing interest rates and any undue delays in the receipt of payment:

 (a)the City, TTC and the Province execute a mutual release from the Five-year Capital Subsidy Agreement;

   (b)a by-law be introduced to create two interest bearing Reserve Funds entitled AThe TTC Capital Subsidy Reserve Fund@ and AThe Sheppard Subway Project Capital Reserve Fund@ to be established with the proceeds of the prepayment, to be expended solely for the purposes of funding TTC capital projects in accordance with the subsidy assumptions in the 1998 capital program;

 (c)the TTC report entitled AProvincial/Municipal/TTC Capital Subsidy Agreement@ be received for information; and

 (ii)appropriate staff be authorized to undertake any necessary actions to implement these initiatives.

 Council Reference/Background:

 On September 25, 1996 Metro Council authorized the execution of a five-year tripartite capital subsidy agreement with the Ministry of Transportation and the Toronto Transit Commission . The agreement set the terms for continued capital subsidy for the completion of the Sheppard Subway project and other TTC capital works through to the year 2000. The agreement was executed on October 5, 1996.

 Discussion:

 The Five-year Capital Subsidy Agreement (CSA) was instrumental in the decision of Metro Council to complete the Sheppard Subway project. The agreement provided assurances that subsidies for the project and the rest of the TTC capital program would continue, at least through to the year 2000. Shortly afterward the Province announced that it was discontinuing transit subsidies across the Province as of January 1, 1998, confirming the benefit of the agreement, but leaving the City exposed to the full downloading impact culminating in 2001.

  A.Potential Benefits of Prepayment

 The Province's proposal, as suggested by the attached correspondence from the Minister of Transportation, is to prepay all outstanding subsidies provided by the agreement, presumably for the purposes of reducing the Ministry's administration costs. As long as the payment is sufficient to fund the remaining subsidies obligations, the proposal has the following benefits:

 (i)Guaranteed Receipt of Subsidy - under the CSA, subsidy availability is subject to the Legislature allocating adequate funding to the Ministry of Transportation. Therefore, the risk exists that we would not receive the full subsidy as set out in the agreement.

 (ii)Administrative simplicity - the release as proposed in this report reduces the need to process and account for subsidy claims to the Province, eliminates uncertainty about cash flow of subsidies due to payment processing delays and ineligibility rulings, and eliminates the opportunity for Provincial intervention into purchasing decisions through subsidy eligibility restrictions.

 (iii)Financial flexibility - the reserve funds, as proposed in this report, would provide the opportunity to partially defer the use of debt financing for TTC projects, depending on prevailing capital market conditions.

 (iv)Potential Financial Gains - under the proposed lump sum prepayment of the subsidy, the City assumes all the benefit and risk associated with gaining an investment return on the funds. The Province has suggested that it could guarantee a rate of return on the funds if they are held by the Ontario Financing Authority and metered out in annual payments to the City, however, such a safeguard is not deemed necessary. An additional benefit of the release is that surplus property used for TTC purposes, previously subject to partial claw back of the proceeds of disposition by the Province of between 16 percent and 75 percent on the grounds that either the purchase or maintenance of the assets had been subsidized, will no longer be subjected to this treatment.

 (v)The City Finance Department has reviewed the outstanding subsidies with TTC staff. The assumptions used to derive the net present value of all remaining subsidy payments and the proposed payment of $828.2 million are deemed to be fair and reasonable subject to the following conditions:

 (a)changes to the prevailing interest rates at the time of the transfer of the funds or significant delays in the payment after Council approval of the prepayment could result in the need for adjustment to the amount of the payment;

 (b)the Province will not impose any expenditure eligibility criteria on the funds; and

 (c)there will be no further claw back on the proceeds of future asset sales as described above.

 Full prepayment of the discounted value of future subsidy obligations will place all responsibility on the City to plan for full funding of TTC capital expenditures, and to invest the funds in such a way as to ensure that the funds generate a rate of return sufficient to provide a cash flow comparable in value to that the Ministry of Transportation was compelled to provide under the agreement.

 B.The TTC Position

 The TTC has reviewed the proposal and approved execution of a release at the April 8 Commission meeting as described in the accompanying transmittal, subject to certain conditions, such as the funds being set aside in two (one for the Sheppard Subway) separate interest accruing reserve funds. In general, these conditions are consistent with standard financing procedures followed by the City or as proposed in this report.

 The TTC report also proposes that the funds be set aside in a trust, to ensure that the funds are used only for TTC purposes as would have been the case under the subsidy agreement. This option has been considered by the City's legal department. In the opinion of the legal department, as supported by Finance, a trust fund is a disadvantageous mechanism for the City to employ, primarily because:

 (1)it would transfer beneficial ownership of the funds to the TTC, e.g. surplus returns on investment; and

 (2)it would create restrictions on the use of and access to the funds by the City to reduce its financing costs.

 Consequently, it is recommended that the TTC report AProvincial /Municipal/TTC Capital Subsidy Agreement@ be received for information.

  C.The Recommendations of this Report

 The release of the Province from future obligations under the Capital Subsidy Agreement should be constructed in such a way as to:

 (1)terminate all obligations under the capital subsidy agreement;

 (2)provide for a lump sum payment from the Province of Ontario of $828.2 million or the equivalent adjusted for changes in interest rates and undue delays in payment; and

 (3)terminate any rights of the Ministry to audit TTC capital expenditures, claw back subsidy payments, or claim any portion of proceeds from sale of TTC assets or assets used for TTC purposes.

 In order to safeguard the funds for their intended purpose and protect fiscal integrity of the City, it is recommended that two interest accruing reserve funds (one for the Sheppard Subway Project) be set up for TTC capital financing purposes only and that the proceeds from the release be contributed to such reserve upon receipt. Normal budget procedures and Council by-laws are sufficient to guide the use of these funds until they are fully depleted. If the funds are placed in a reserve fund as recommended in this report, a motion in Council to reopen the enabling by-law would require a majority before use of the funds for any other purpose could be considered.

 The release of the Province from the Capital Subsidy Agreement and the prepayment of all outstanding subsidies under the agreement in no way alleviates the fiscal difficulties arising from the elimination of capital subsidies for transit purposes. At an estimated impact of $180 million per year, the subsidy loss is the single largest budget pressure the City has ever faced. Staff have been asked to report back to the Budget Committee in September on a fiscal strategy to address the elimination of the TTC capital subsidy, which is also discussed in a separate report to this Committee on a proposed capital financing management plan.

 Conclusion:

 The proposal from the Province to prepay all future TTC capital subsidies required under the capital subsidy agreement in exchange for release from the agreement has certain policy, administrative and financial advantages for the City. Subject to approval of this report, two interest accruing reserve funds will be set up so that the funds will be available when required to finance budgeted TTC capital expenditures.

 Contact Name:

 Rob Hatton, telephone: 392-9149, fax: 392-3649

Interim Budget Lead, Urban Environment and Development Committee

Internet: robert_hatton@metrodesk.metrotor.on.ca

     W.A. Liczyk

Chief Financial Officer and Treasurer