CDIAC Workshop: February 1, 2011

Current Short Term Financing Options

Richard HiscocksOrrick, Herrington &

Sutcliffe(415) 773-5416rhiscocks@orrick.com

Eileen GallagherStone & Youngberg(415) 445-2311egallagher@syllc.co

m

2

Introduction: Short Term Financing Options

What is “short-term”? less than 120 days? within a fiscal year? 3-5 years?

a period less than the economic useful life of the asset?

For what purpose is short-term debt issued? Cash flow financing

Provide working capital to pay operating expenses

Examples: tax and revenue anticipation notes (TRANs), working capital notes

Bridge financings Provide interim short term financing for capital projects

Examples: bond anticipation notes (BANs), commercial paper (CP)

Permanent financings Provide long-term project funding at short-term interest rates

Examples: variable rate demand obligations (VRDOs), floating rate notes

3

Short-Term Interest Rates Tend to be Lower

Illustrative Rates

by Maturity

6-month:0.30%

1 year:0.46%

2 year:0.79%

5 year: 1.75%

10 year:3.44%

30 year:4.90%

Source: Bloomberg.

4

Short vs. Long Term Interest Rates Over Time

Source: Bloomberg. RBI: Long Term Tax-Exempt Bonds Maturing in 30 Years with Average Rating of A1/A+. SIFMA: All bonds in Index must be tax-exempt, non-AMT, have $10mm or more

outstanding and the highest short-term rating by Moody’s or S&P, and pay interest monthly with interest rate resets occurring on Wednesdays.

Comparative Tax-Exempt Municipal Interest Rates25-Bond Revenue Bond Index (RBI) vs SIFMA Index of Weekly Resets

January 1990 - December 2010

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

Jan-90 Jan-92 Jan-94 Jan-96 Jan-98 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10

RBI: 20-yr Average: 5.70%

12/29/10: 5.38%

SIFMA: 20-yr average: 2.80%

12/29/10: 0.34%

Interest Rate %

Financial market panic in wake of Lehman collapse,

fall 2008

Spread between short and long maturities is particularly wide in current market

5

Why Issue Short-Term Debt?

Access lower short term rates

Avoid locking-in long-term rates in unfavorable market conditions

Align short term or variable revenues with short term or variable liabilities

Defer full debt service payments until project is completed

Restructure debt to postpone payments, relieve near-term financial stress

Retain variable rate debt compatible with an outstanding swap

6

Who Buys Short Term Debt?

Money Market Funds Must keep investments very short to provide liquidity to investors

Investors expect “check book” access to funds

Seek high quality credits to preserve Net Asset Value (NAV) Investors expect $1 for $1 valuation, no principal risk

Regulations limit maturity of investments to less than 397 days Additional limits on credit quality and concentration of portfolio

Short, Intermediate and Long Term Bond Funds Have ability to purchase longer-dated maturities for particular funds

More flexible investment parameters

Long term fund participation in limited circumstances

Unlikely in current very low short term rate environment

Some Individual “Retail” Participation Depends on investment goals, sophistication and means of investor

Many short-term debt issues have $100,000 denominations that limit participation

7

Short Term Debt Alphabet Soup

Revenue and Grant Anticipation Notes (RANs, TRANs and GANs)

Working Capital Notes

Commercial Paper (CP)

Bond Anticipation Notes (BANs)

Auction Rate Securities (ARS)

Variable Rate Demand Notes (VRDOs)

Credit Enhancement and Liquidity (LOCs, SBPAs)

Interest Rate Derivatives (Swaps, Locks, Caps)

Floating Rate Notes (FRNs, SIFMA-Index notes, LIBOR-index notes)

8

RANs, TRANs and GANs

Tax Revenue or Grant Anticipation Notes (RANs or TRANs or GANs) Purpose: used for cash flow or capital projects

Benefit: smooth out inconsistent revenue streams like property tax receipts or grants

Risks: short term and fixed repayment require careful forecasting of future cashflow

Interest rate: fixed at time of note sale

Requirements: Government Code and federal tax requirements

Example: City relies heavily on property tax receipts due in December and April while expenses

are fairly evenly spread throughout year

With diminished reserves in current economic climate, cash flow shortfall peaks after early December payroll payment

TRAN proceeds bolster cash position in July to cover peak deficits in fall; balances are restored and funds are set aside to repay TRANs throughout winter and spring, before June TRAN maturity

Credit rating is based on predictability of revenues, accuracy of projections, expected liquidity (and alternatives) at maturity and ability to withstand less favorable results

9

Deficit Borrowings

Working Capital Note (“deficit borrowing”) Purpose: used for cash flow to address a deficit

Benefit: provides near term cash relief from cash flow pressures

Challenges: requires accelerated repayment from all free cash flow beyond a modest reserve; can be difficult to market to investors

Constraints: federal tax law limitations for tax-exempt issue

Example: City committed cash to a capital project in expectation of reimbursement from

CalTrans

Delayed reimbursements created cash flow strain on city’s operations

Working capital note provides financial breathing room

Repaying notes over 10-year horizon

10

Commercial Paper

Commercial Paper (CP or TECP) Purpose: may be used for capital projects or cash flow

Benefit: offers flexibility to create template for borrowing program and then draw down project funds as needed with streamlined approvals

Maturity: less than 270 days; a true maturity

Interest rate: set at time of CP draws

Liquidity requirements: third party (bank) liquidity or (rarely) self-liquidity

Example: Transportation authority with large capital program

May use CP draws to fund interim, initial project funding

One large, long-term financing issued to fund balance of project and pay off CP

Credit rating based on credit quality of liquidity bank, not borrower

11

Bond Anticipation Notes

Bond Anticipation Notes (BANs) Purpose: capital projects

Benefit: can provide seed financing in advance of a planned long-term financing

Interest rate: fixed at time of note sale

Requirements: statutory and tax limits

Example: Sales tax authorization approved by voters but revenue collections begin in 2 years

Transportation authority can issue BANs now to tap future debt capacity

BANs are repaid with long-term financing after collections begin

Credit ratings are based on expected terms of future take-out and assessment of future market access

12

Variable Rate Debt: VRDOs

Variable Rate Demand Obligations (VRDOs or VRDBs) Purpose: used for capital projects

Benefit: access rates on the short end of the yield curve, retain flexibility to pay off or restructure debt at any time

Maturity: principal amortization may be scheduled over the life of the bonds, typically 30 years, or structured as lump sum term maturity

Interest rates: variable rate may be reset daily, weekly, monthly or other periodic basis

Most debt issued is in 7-day mode

Assuming 7-day reset mode, interest payments are made on a monthly basis

Remarketing agent resets the interest rate based on market conditions on each rate reset date

Liquidity requirements: third party (bank) liquidity or (rarely) self-liquidity

13

VRDO Liquidity Requirements

Liquidity is necessary for traditional VRDOs VRDO’s generally have a “demand” feature

Investors can “put” the bonds back to the issuer/remarketing agent at each rate re-set period; this feature makes VRDOs appealing to money market funds

Necessitates a bond structure enhanced with liquidity, usually by a commercial bank Provided for a specific time period, typically 1 to 5 years, subject to renewal Annual fees can range from .25% to 2% (or more) of principal depending on term,

credit, etc.

Standby purchase agreement (SBPA) Provides liquidity to repay an investor who wants to liquidate his/her holdings (exercise

the “put”) when another investor can’t immediately be found Can be terminated in certain circumstances if issuer’s credit deteriorates

Direct-pay letter of credit (LOC) Provides liquidity and credit enhancement to ensure repayment of debt service in

certain circumstances Irrevocable commitment through term of agreement

14

Variable Rate Market Stress

Rating downgrades of banks and bond insurers began in late 2007 Credit enhancer’s rating and credit affects issuers’ interest rates at remarketing

Affected many VRDOs and insured ARS

Triggered termination events and “penalty” interest rates in some cases

Culminated in ARS market collapse and liquidity crisis in February 2008 Left ARS investors with no liquidity

Resulted in sharply higher rates for issuers in most cases

Many VRDOs and ARS were subsequently restructured Some issuers retained variable rate exposure to keep interest rates low and/or to

avoid termination of overlapping interest rate swap structures

Market collapse changed perception of risk Strategic reassessment of business by liquidity providers

Many liquidity banks retreated from sector

Triggered new regulatory pressures

15

Update on the Liquidity Landscape

The field of credit enhancers has declined from 15+ to less than 10 active participants Major providers: BAML, Barclay’s, JP Morgan, Lloyd’s, US Bank, Wells Fargo

Second tier: Bank of the West, City National, Northern Trust, RBC, Scotia, Sumitomo

Capacity and saturation pressures mounting

Short-term market for credit enhancement remains scarce

Source: Thomson, as of 12/31/10

Top 10 Domestic LOC Banks

Par (Millions)

# of Issues

Top 10 Domestic LOC Banks

Par (Millions)

# of Issues

JP Morgan Chase 3,738$ 61 JP Morgan Chase 2,942$ 36Wells Fargo Bank 2,825 64 Bank of America 2,568 35U.S. Bank 2,812 67 Wells Fargo Bank 928 27Bank of America 2,758 64 PNC Bank 737 10SunTrust Bank 1,065 16 Barclays Bank 484 5BB & T 942 35 TD Bank 479 6TD Bank 654 21 Bank of Montreal 450 1RBS Citizens 444 7 Citibank 365 5PNC Bank NA 380 15 Union Bank 283 6Citibank 366 4 RBS Citizens 193 2

Major Types of Credit Enhancement

Major Types of Credit Enhancement

Total Domestic LOCs 18,236$ 437 Total Domestic LOCs 9,353$ 207Total Foreign LOCs 2,050 46 Total Foreign LOCs 1,864 18Standby Purchase 4,021 38 Standby Purchase 3,469 19

2009 2010Changing Credit Enhancement Landscape

16

New regulatory pressures Money market reforms: greater liquidity, higher credit quality, shorter average maturities

Basel III reforms: higher capital requirements for banks => more competition, higher cost

Diminished supply at time of considerable demand for liquidity renewals Facilities scheduled to expire (as of June 2010): $94 billion in 2011 and $45 billion in 2012

Pricing and terms Much more challenging to secure credit approval for “weaker” credits

Pricing spiked post-crisis, has since moderated, but nowhere near pre-crisis levels

Changing Liquidity Regulation and Pricing

Municipal Letters of Credit & Standby Purchase Agreements:Schedule of Expirations by Dollar Volume

0

2

4

6

8

10

12

14

16

July 2010 Feb 2011 Sep 2011 April 2012 Nov 2012

$ B

illio

ns

SBPALOC

Municipal Letters of Credit & Standby Purchase Agreements:Schedule of Expirations by Number of Facilities

0

100

200

300

400

500

600

700

July 2010 Feb 2011 Sep 2011 April 2012 Nov 2012

# of

Fac

ilitie

s

SBPALOC

Source: SIFMA, as of June 30, 2010

17

Emergence of Alternative Variable Structures

Floating Rate Notes Benefit: can be used to create or retain variable rate debt without third-party bank

liquidity

Interest rates: set at a fixed spread to variable weekly index (i.e. SIFMA or LIBOR)

Liquidity requirements: No liquidity required, essentially “self-liquidity” Risks: Exposure to future short-term yields, market access and interest rate risk at

maturity

Structuring considerations: amortization, put timing, call features, target investors

Fixed-Rate Notes Benefit: accesses lower short term rates, may retain an outstanding swap

Interest rates: fixed rate based on maturity

Liquidity requirements: None, investors evaluate prospects for take-out at maturity

Risks: Issuer exposed to market access and interest rate risk at take-out

Dearth of liquidity spurs development of new approaches

18

Variable Rate Issuance Volume

Source: Thomson Reuters. SIFMA

Source for CA Issuance Data: Thomson Reuters and Ipreo. As of 12/27/2010.

California 2010 variable rate issuance down 30% from 2009

2010: 45 issues totaling $2.6 billion

2009: 57 issues totaling $3.7 billion

0

20

40

60

80

100

120

140

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

($ B

illion

s)

Auction RateLinked RateVariable Rate

Municipal Variable Rate Issuance2001-2010

380

390

400

410

420

430

440

450

460

Q2 2009 Q3 2009 Q4 2009 Q1 2010 Q2 2010

$ B

illio

ns

Outstanding Municipal Variable Rate Demand Obligations by Par

2009 Q2 through 2010 Q2

Diminished volume of issuance and outstanding variable rate debt

19

Fixed Rate Note Issuance Volume

Source for Charts: Thomson Reuters.

Source for CA Issuance Data: Thomson Reuters and Ipreo. As of 12/27/2010.

0

10

20

30

40

50

60

70

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

YT

D

($ B

illio

ns)

California Issuance Volume Up 11% increase in 2010 over 2009

2010: 107 issues totaling $19 billion

2009: 96 issues totaling $17.3 billion

TRAN issuance Increased in 2010 due to financial

pressures

Season peaks in summer

National Municipal Fixed Rate Note Issuance2001-2010

20

Strategies for Issuers of Short-Term Products

Continue to monitor cash positions and revenue trends Developing a strategy early on for TRAN issuance helps better position issuers

Evaluate Self-Liquidity Structures Market has proven that capacity exists for issuer-balance sheet secured obligations

Significant cost advantage for strong credits

Requires indenture flexibility for principal coming due (and put bonds)

Proven market access required for structures that are remarketed

Continue to solicit new entrants to the credit market Fees have declined from peak, but remaining active participants face challenges

Large market participants face credit capacity with large issuers and market saturation with investors

Smaller players can only take on $50-$75mm of any given credit

A

B

C

Appendices

22

Short-Term Interest Rates and Fed Policy

2-Year Treasury & Fed Funds Target Rate1

(1) Source: Federal Reserve & Bloomberg. As of 1/3/2011.

Fed’s easy monetary policy keeps short-term rates near historic lows

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

Jan-01 Jan-03 Jan-05 Jan-07 Jan-09 Jan-11

(%)

2-Year U.S. TreasuryFed Funds Target Rate2-yr avgff avg

Average = 2.39%

Average = 2.72%

23

1-Month LIBOR : 20-Year History

1-Month LIBOR1

(1) Source: Bloomberg. LIBOR is short for “London Inter-Bank Offered Rate”. As of 1/3/2011.

Bank-to-bank borrowing rates fell to new lows in 2010

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

Jan-91 Jan-95 Jan-99 Jan-03 Jan-07 Jan-11

Average = 3.85%

Max = 8.75%Min = 0.23%

Current = 0.26%

0.0%

0.2%

0.4%

0.6%

Jan-09 Jul-09 Jan-10 Jul-10 Jan-11

Average = 0.30%

24

SIFMA Index: 20-Year History

Securities Industry & Financial Markets Association (SIFMA) Index1

(1) Source: SIFMA. All bonds in Index must be tax-exempt, non-AMT, have $10mm or more outstanding and the highest short-term rating by Moody’s or S&P, and pay interest monthly with interest rate resets occurring on Wednesdays. As of 1/3/2011.

Municipal variable rates remain near all-time lows

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

Jan-91 Jan-95 Jan-99 Jan-03 Jan-07 Jan-11

Average = 2.65%

Max = 7.96%Min = 0.15%

Current = 0.34%

0.0%

0.4%

0.8%

1.2%

Jan-09 Jul-09 Jan-10 Jul-10 Jan-11

Average = 0.34%

25

Variable Rate Investor Demand

Weekly Total Tax-Exempt Money Market Fund Flows

-25-20-15-10-505

10152025

Jan-

08

Mar

-08

May

-08

Jul-0

8

Sep

-08

Nov

-08

Jan-

09

Mar

-09

May

-09

Jul-0

9

Sep

-09

Nov

-09

Jan-

10

Mar

-10

May

-10

Jul-1

0

Sep

-10

Nov

-10

Jan-

11

($

Billi

ons)

Exceptionally low rates Money market returns barely cover

administrative costs, if at all

Diminished investable assets Investor panic abates

Investors withdraw funds to seek more attractive returns

Drop in money market assets

Portfolio investor preferences Sensitive to credit quality of banks

Seek diversity of issuer and liquidity bank names, can be “full” on some names

Concerns about interest rate trends drives interest in index rate bonds

Regulatory reforms SEC Rule 2(a)7 money market reforms

Basel III

Tax-Exempt Money Market FundsAssets and Fund Flows as of 1/3/2011

Source: Bond Buyer & Investment Company Institute. As of 1/12/2011.

Total Tax-Exempt Money Market Fund Net Assets

300

350

400

450

500

550

Jan-

08

Mar

-08

May

-08

Jul-0

8

Sep

-08

Nov

-08

Jan-

09

Mar

-09

May

-09

Jul-0

9

Sep

-09

Nov

-09

Jan-

10

Mar

-10

May

-10

Jul-1

0

Sep

-10

Nov

-10

Jan-

11

($

Billi

ons)

26

Variable Rate Debt: ARS

Auction Rate Securities (ARS) Purpose: used for capital projects

Interest rates: variable, reset through an auction based on bids of potential investors

Liquidity: did not require liquidity the way VRDOs typically do

Auction market collapsed in early 2008 No new ARS issuance since February 2008 market failure

Many ARS issues have been restructured to avoid penalty interest rates

Approximately $66.8 billion remained outstanding as of July 2010

27

Interest Rate Swaps Purpose: often used in combination with variable

rate debt to limit interest rate risk, create a “synthetic” fixed interest rate

Common structure: issuer issues variable rate debt, pays fixed-rate swap rate to counterparty, receives variable rate from counterparty

Interest Rate Derivatives

Issuer receives variable rate

Issuer pays fixed rate

Issuer pays variable rate

Counterparty

Investors

Issuer

Risks: Counterparty failure to perform, mismatch in basis of offsetting variable rate legs, liquidity renewal, termination events, etc.

Termination: Typically requires payment to terminate swap Termination payments can benefit either issuer or counterparty depending on value

Mark-to-market values and termination costs depend on swap terms and market conditions

Interest Rate Caps, Locks, Floors Purpose: varying tools to mitigate interest rate risk with variable rate debt

28

Example: SIFMA Indexed Bonds

Summary Statistics Pricing Summary

Dated Date: 5/20/2009

$104,180,000 Series A-2

Amortization: Matched to refunded ’03 bonds

Put maturity: 12 months

Call Lockout period: 6 months

Initial placement (5/2009): SIFMA +5 bps

First Remarketing (1/2010): SIFMA +0 bps

Second Remarketing (10/2010): SIFMA +0 bps

Next step: Expected to remarket 2Q 2011

Issue Date 180 Days:11/16/09

End Tender Period

Call Protection Period:Tender Period Halfway Date

7-25 days: Spread Determined

45 days: Notice of Remarketing

Structure: Metropolitan Water District of Southern CaliforniaSeries 2009 A-2 Index Tender Bonds

Six month call option provides the flexibility to determine the best time to go into the market