COG Comprehensive Annual Financial Report

a. Hedging Derivative Instruments Objective of the Interest Rate Swaps

As a means to convert variable rate obligations to synthetic fixed rate obligations to reduce the overall variable rate exposure of the City, the City entered into an interest rate swap agreement with Bank of America Merrill Lynch in October 2002, in connection with its $5,700,000 Series 1998 Variable Rate General Obligation Bonds. The intention of the swap was to effectively change the City’s interest rate on the bonds to a synthetic fixed rate of 3.46%. Swap Terms The bonds and the related swap agreement will mature on April 1, 2020. At inception, and at June 30, 2018, the swap notional amount of $5,700,000 matched the $5,700,000 variable-rate bonds outstanding. Starting in Fiscal Year 2019, the notional value and the principal amount of the associated debt declines. Under the swap, the City pays the counterparty a fixed payment of 3.46% and receives a variable payment computed as 67% of 1 Month London Interbank Offered Rate (LIBOR). The bonds’ variable rate coupons are closely associated with the Securities Industry and Financial Markets Municipal Swap Index Because interest rates were lower on June 30, 2018 than at the date of the execution of the swap, the swap had an estimated fair value as of June 30, 2018 of ($136,592). The mark-to-market valuation was established by market quotations from the counterparty representing estimates of the amounts that would be paid for replacement transactions. Credit Risk As of June 30, 2018, the City is not exposed to credit risk of the counterparty given the derivatives’ negative fair values. The counterparty was rated Aa3 by Moody’s Investors Services (Moody’s), A+ by Standard and Poor’s (S&P) and AA- by Fitch Ratings (Fitch) at June 30, 2018. No collateral or other security is required to support the hedging derivative instruments’ credit risk. No master netting arrangements are maintained as there is only one counterparty to the transactions. Interest Rate/Basis Risk As noted above, the swap exposes the City to basis risk should the relationship between 67% of 1 Month LIBOR and SIFMA diverge, changing the synthetic rate on the bonds. The effect of this difference in basis is indicated by the difference between the intended synthetic rate of 3.46% and the actual synthetic rate as of 2018 of 3.55%. As of June 30, 2018, the rate on the City’s bonds was 1.54% whereas 67% of 1 Month LIBOR was 1.40%. Termination Risk The derivative contract uses the International Swap Dealers Association Master Agreement, which includes standard termination events, such as failure to pay and bankruptcy. The City will have the right to terminate the swap at any time over the life of the swap at the current market value on short-term notice. The respective Schedule to the respective Master Agreement includes an “additional termination event.” That is, the swap may be terminated by the counterparty if the outstanding debt of the City, secured by its faith, credit and taxing power, ceases to be rated at least A3 by Moody’s or any successor thereto, A- by S&P or any successor thereto, or A- by Fitch, or any successor thereto or shall fail to be rated by at least one of Moody’s, S&P, and Fitch. The City or the counterparty may terminate the swap if the other party fails to perform under the terms of the contract. If the swap is terminated, the variable-rate bonds would no longer carry a synthetic interest rate. Termination will result in the City either making or receiving a termination payment based upon the market value on the date of termination. Market Access Risk/Roll Over Risk The City’s swap is for the term (maturity) of the bonds and therefore there is no market-access risk or rollover risk. (SIFMA). Fair Value

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