April 21, 1998

 To:Strategic Policies and Priorities Committee

 From:City Clerk

 Subject:Toronto Transit Commission Five-Year Capital Subsidy Agreement - Prepayment of Subsidy in Exchange for Release

 Recommendations:

 The Budget Committee on April 20, 1998, recommended to the Strategic Policies and Priorities Committee, and Council:

 (1)the adoption of the report (April 20, 1998) from the Chief Financial Officer and Treasurer; and

 (2)that the City and the Toronto Transit Commission enter into a surviving agreement that requires the City to match the provincial funding over the life of the agreement and permits the City the flexibility contemplated in the report (April 20, 1998) from the Chief Financial Officer and Treasurer.

 Background:

 The Budget Committee on April 20, 1998, had before it the following:

 (a)Report (April 20, 1998) from the Chief Financial Officer and Treasurer regarding prepayment of all remaining Provincial subsidy obligations under the TTC Five-year Capital Subsidy Agreement;

 (b)Communication (April 9, 1998) from the General Secretary, Toronto Transit Commission forwarding Toronto Transit Commission Report No. 1 dated April 8, 1998, regarding the Provincial/Municipal/TTC Capital Subsidy Agreement;

 (c)Communication (March 31, 1998) from the Minister of Transportation regarding the cancellation of the TTC Capital Subsidy Agreement; and

 (d)Communication (April 17, 1998) from the General Secretary, Toronto Transit Commission regarding the five-year TTC/Provincial/Municipal Capital Subsidy Agreement.

 The following Members of Council appeared before the Budget Committee in connection with the foregoing matter:

 -Councillor Howard Moscoe, Chair, Toronto Transit Commission; and

-Councillor Rob Davis, Vice Chair, Toronto Transit Commission

 City Clerk

 Barbara Liddiard/rc/kd

Item No. 9

Attachment

 c.Chief Financial Officer and Treasurer

Chief Administrative Officer

General Secretary, Toronto Transit Commission

Commissioner of Urban Planning and Development Services

Mr. Rob Hatton, Finance Department

(Report dated April 20, 1998, addressed to the

Budget Committee from the

Chief Financial Officer and Treasurer)

  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

 (Communication dated April 9, 1998, addressed to the

City Clerk from

the General Secretary, Toronto Transit Commission)

 At its meeting on Wednesday, April 8, 1998, the Commission considered the attached report entitled, AProvincial/Municipal/TTC Capital Subsidy Agreement.@

 The Commission amended Condition #1 and #5 noted on page 3 of the report to read as follows:

 (1)two reserve funds or trust funds (if it can be accommodated without any adverse tax implications) be established - one for the Sheppard Subway project and one for the Commission=s base capital program; and

 (5)new projects not included in Schedule A of the 1998-2002 Capital Budget will require specific Commission and Council approval.

 The Commission then approved the following:

 (1)the execution of an agreement to release the Province from the Provincial/Municipal/TTC Capital Subsidy Agreement in consideration of their prepaying their obligation under the agreement, subject to the conditions set out in this report, as amended.

 (2)that this report be forwarded through the City Urban Environment and Development Committee to City of Toronto Council for approval.

 The Commission also requested that when staff reply back to the Minister regarding the

release that the letter include reference to the fact that the Province does not have unilateral power to cancel the contract.

 The foregoing is forwarded to the City of Toronto Council for approval.

 (Toronto Transit Commission Report No. 1

dated April 8, 1998)

 Recommendation

 It is recommended that the Commission approve:

 (1)the execution of an agreement to release the Province from the Provincial/Municipal/TTC Capital Subsidy Agreement in consideration of their prepaying their obligation under the agreement, subject to the conditions set out in this report; and

 (2)that this report be forwarded (through the appropriate standing committees) to the City of Toronto for approval.

 Funding

 If the proposed financial settlement of $828.2 million offered by the Province is properly protected in reserve funds and is appropriately invested to obtain a return at least equal to the discount factor applied by the Province, there should be no impact on the capital program for either the City of Toronto or the TTC from a funding perspective.

 Background

 On June 6, 1996, the Minister of Transportation announced wide-ranging changes to Provincial subsidy for transit projects including dropping traditional funding from 75% Provincial share to 50% for transit capital projects and disallowing certain overhead costs previously charged against the TTC capital program. A copy of the announcement is attached. Subsequently, TTC, Metro and Provincial staff met to work out the details of an agreement to provide flexibility and security of capital funding to the TTC. This resulted in a five year Provincial/Municipal/TTC Capital Subsidy Agreement which was approved by the Commission on September 17, 1996 and by Metro Council on September 25,1996.

 The Capital Subsidy Agreement (CSA) agreement provides for provincial funding of $511 million for the Sheppard Subway project and $915 million for the Commission's base capital program for the years 1996-2000 (contingent upon matching funding from Metro - now the

City of Toronto). The CSA reflects Provincial subsidy eligibility rules and rates (reduced from 75% to 50%) and it includes various capital envelopes (groupings of like projects) and provides for benchmarking of projects or components of projects (eg. overheads). Other key features of the agreement include:

 (1) The establishment of a credit account to permit money saved on a project to be re-invested in other transit projects and to allow timing differences in cash flow on an individual project to be recognized.

 (2) Allowance for the carry forward of unspent capital funds to future years.

 (3) Immediate Provincial project approval for all items set out in Schedule A of the agreement.

 It was anticipated that these features would provide the Commission with the flexibility to better manage and deliver its Capital Program through the recognition of the Commission's long-term capital needs as defined and prioritized in the capital program.

    Discussion

 In a letter dated March 31, 1998 to the Mayor of the City of Toronto and the Chair of the TTC (copy attached), the Minister of Transportation advised that the Province intends to make a one-time payment of $828,200,100 to discharge its responsibilities flowing from the Provincial/Municipal/TTC Capital Subsidy Agreement. The $828.2 million payment represents the discounted value of payments not yet received under the CSA and will be made in exchange for a full release, signed by the TTC and the City of Toronto, of any future claims under the agreement. City of Toronto staff are currently reviewing the discount factors (based on Provincial bond zero coupon curves), however, it is believed that they are reasonable.

 Staff from both the TTC and the City have met with representatives of the Province to discuss the details of this announcement. While it is understood that the Provincial proposal is not intended to place the Commission at any disadvantage compared to the current arrangement, the proposed settlement is being made without any Provincial conditions other than the requirement that a release be signed before any monies are paid. While the Province wishes to prepay its obligations and withdraw from any future involvement in municipal transit matters, the principles of the Capital Subsidy Agreement (noted above) must continue in force under the agreement between the Commission and the City of Toronto. This can be facilitated through the establishment of reserve funds for the $828.2 million, with the following conditions:

 (1)two reserve funds should be established - one for the Sheppard Subway project and one for the Commission's base capital program,

 (2)joint approval from both the TTC and the City will be required to draw funds from the reserve accounts and the City of Toronto will be required to provide matching funds. This approval would be provided through the annual budget process and will include an updated Schedule A to the agreement. The current version of Schedule A is as approved by the Commission along with the 1998-2002 Capital Program at its meeting of November 18, 1997 (see copy attached). This Schedule A must be updated to reflect 1997 actuals, the slippage of bus deliveries from 1998 into 1999 and, the proposed reallocation of future bus purchase funds to a subway car purchase order to replace the H2 subway cars.

 (3)since the Province's one-time payout covers their obligation discounted, the funds in reserve must be in income earning investment vehicles and the earnings must accrue to the fund in order to ensure sufficient funds are available for the Commission's capital program, and

 (4)any underruns, cost savings or slippages must remain in the funds,

 (5)new projects will require specific Commission and Council approval,

 (6)additional contributions to the reserves should be accepted (eg. through the sale of surplus assets).

 In addition to the foregoing, based on discussions with Provincial staff, the following conditions should be included in the release agreement:

 (1)there will be no further Provincial capital subsidy compliance audits (post-1996),

 (2)there will be no future Provincial recapture or clawback of funds received from the sale/disposition of assets,

 (3)the Province will no longer establish municipal transit policies.

 Once the Commission and City of Toronto Council approve the Province's proposed settlement, TTC and City legal staff will meet to develop appropriate documentation to conclude a release agreement in exchange for the $828.2 million.

 Justification

 The TTC's Capital Program represents the Commission's prioritized needs. Long-term, comprehensive, reinvestment plans and multi-year budgets are included based on life-cycle replacement programs, implementation of necessary safety improvements and the need to overcome the effects of previously deferred maintenance/investment. The Province and Metro Council recognized the Commission's needs through the provision of $915 million under the Capital Subsidy Agreement for the base capital program. In order to ensure that the Commission's requirements can be met, it is essential that the $828.2 million settlement be set aside and utilized only for the Commission's capital program to ensure that the transit system is restored and maintained in a state of good repair.

 (Communication dated March 31, 1998, addressed to

Mayor Mel Lastman and Councillor Howard Moscoe, Chair, Toronto Transit Commission

from the Minister of Transportation)

As part of the realignment of provincial and municipal services, the government has given municipalities full control and autonomy over the operation and financing of their respective transit systems. Municipalities now have the discretion necessary to make local transportation decisions, unfettered by the provincial government.

 In the context of these service realignments, we believe that a continued direct Ministry of Transportation management role in the TTC capital program is no longer warranted. To this end, effective March 31, 1998, I am cancelling the TTC Capital Subsidy Agreement (CSA) entered into with the Municipality of Metropolitan Toronto and the Toronto Transit Commission on October 3, 1996. We are making a one-time payment of $828,200,100 to discharge our responsibilities flowing from the cancellation of the CSA. The payment of $828,200,100 will be made in exchange for a full release, signed by the City and the TTC, of any future claims under the CSA.

 Staff from the Ministries of Transportation and Finance have already met with Mr. Michael Garrett, Chief Administrative Officer, City of Toronto, and Mr. David Gunn, Chief General Manager, TTC, to discuss how we calculated the $828,200,100, and any other equitable estimate of the costs flowing from the cancellation of the CSA.

 This decision signals a new era for municipal transit planning in Toronto: an era where, together, the City and the TTC can fund, plan and implement the transit needs of the City of Toronto.

 I look forward to meeting with you to discuss any matters relating to the above.