The Challenges and Opportunities of the “New” Municipal Marketplace

1. The Challenges and Opportunities of the “New” Municipal Marketplace Prepared and Presented By:

2. Learning Objectives • The Participant will be able to identify key events that created the “New” Municipal Marketplace. • The Participant will be able to compare alternative financing vehicles, including: • Privately Placed Bank Loans. • Negotiated Sale of Public Securities. • Competitive Sale of Public Securities. • The Participant will be able to recognize the importance of Credit Ratings in the “New” Municipal Marketplace. • The Participant will be able to explain the Characteristics of Highly Rated Credits. • The Participant will be able to consider approaches to strengthen their own Unit’s credit rating.

3. Events that Shaped the “New” Municipal Marketplace August 2007: Bear Stearns Hedge Fund Collapse September 2008: FNMA/FHLMC Takeover / Lehman Files for Bankruptcy October 2008: DOW Jones drops 22% in one week. April 2010: Moody’s & Fitch Recalibrate Ratings Scale February 2009: American Recovery and Reinvestment Act Signed Into Law 2007 2008 2009 2010 July 2009: First NC BABs Issued (Negotiated) August 2009: First NC GO BABs (Competitive) January 2008: AMBAC Downgraded, beginning a string in Municipal Bond Insurer Downgrades October 2008: Municipal Rates Spike Municipal Variable Rate Market struggles due to a lack of liquidity Municipal Fixed Rate Market “Frozen” to many issuers

4. Bank Marketplace

5. The Bank Marketplace • Bank financing can be an attractive alternative to the public markets depending on the specific needs of the locality. • Generally, bank financing is most effective when the debt can carry the Bank-Qualified designation. • Bank financings can accommodate most any funding need and can provide many of the same “options” as are typically found in a public offering: • Wide range of credit pledges including General Obligation, Installment Purchase, Revenue, and Asset Backed /Subject to Appropriation. • Fixed or variable rate structures. • Short-term or long-term financing. • Various amortization options including capitalized interest, interest only and most any principal structure.

6. The Bank Marketplace • Bank financings can provide an issuer with a number of benefits and advantages as compared to the public markets: • Streamlined issuance period – typically about 60 days from start to finish – can be done more quickly if needed. • Less cumbersome issuance process – no ratings required and less extensive offering documents – minimal staff time and resources are required. • Financing terms and related documentation requirements are generally more favorable – shortened pre-payment lock-out term, if any at all, upfront and on-going fees are minimized by comparison and minimal on-going disclosure requirements.

7. The Bank Marketplace • Bank financing has not been spared the effects of recent financial turmoil. That said, many banks are still on solid footing and actively participate in municipal finance. • Perhaps the greatest change we’ve seen in the bank funding environment over the last year 1-2 years is the heightened level of loan-related credit analysis and due diligence. • Essentiality of asset pledge is key. • Increased documentation. • Demonstrated ability to manage budget. • Ability to repay planned debt from current or future sources. • In today’s market, Banks are also not as willing to extend credit to longer term financings. While 20-year final maturities are available from some Banks, many have limited terms to 5 or 10 years.

8. The Bank Marketplace • Based upon our experience with the bank funding process, Davenport recommends the following strategies to help insure a successful effort: • Develop a competitive process through a formalized RFP solicitation including all pertinent deal-related details: • Project overview. • Loan security and source of repayment. • Desired bond structure, term and repayment schedule. • Include as many banks in the RFP process as you can – local, regional and national entities – different banks have different lending capacities and needs at any given time. • Provide audited financials to all RFP recipients and be prepared for a series of due diligence inquiries.

9. Indicative Bank Rates Items of Note Indicative Bank Rates • Receive less of a yield curve benefit. • Instead fixed rate loans are often priced at one rate associated with the average life or final maturity.

10. Public Markets

11. Competitive vs. Negotiated Sales • Competitive Sale – Bids accepted for purchase of bonds by underwriters at a time and date certain. • Traditional issuance method of General Obligation Bonds in North Carolina. • Competitive process can help to achieve low rates. • Size, timing, and structure determined at least 1 week prior to sale of bonds. • Negotiated Sale – Underwriters are selected prior to the sale at an agreed upon fee. Underwriters then market bonds to the public at an opportune time and offer to purchase bonds from the Unit at negotiated rates and terms. • Traditional issuance method of Revenue Bonds and Certificates of Participation in North Carolina. • Provides flexibility as to size, timing, and structure of bond issuance up to and through day of pricing. • In 2009, the North Carolina General Statutes were amended so as to permit negotiated sales of General Obligation bonds in circumstances beyond refunding transactions – primarily for issues in which a federal subsidy was available.  • This year the General Assembly further amended this provision so as to eliminate the expiration date. 

12. NC G.O. Issuance: Competitive vs. Negotiated Items of Note North Carolina G.O. Bond Issuance June 2009-June 2010 Competitive Transactions • 41 issues totaling $1.4 billion. • 20 New money issues • 3 taxable (2 stimulus) • 21 Refunding issues. Negotiated Transactions • 33 issues totaling $1.3 billion. • 14 New money issues • 8 taxable (7 stimulus) • 19 Refunding issues 83%, of Negotiated Transactions were Refunding or Taxable Issues. 58% of Competitive Transactions were Refunding or Taxable Issues

13. Municipal Market Issuance Volume Items of Note Municipal Issuance ($ Billions) • Since April 2009, the issuance of BABs has lowered the supply of tax-exempt debt in the marketplace. • The reduction in supply of tax-exempt bond has helped compress tax-exempt yields during this period. • Since April 2009, BABS have comprised 25% of the municipal market supply.

14. Long-Term Borrowing Rates: ARRA Options Items of Note 30-Year Borrowing Rates • ARRA programs expire at the end of CY 2010. Discussion continues that some programs will continue beyond 2010. • Qualified School Construction Bonds • At or near zero interest loan. • Recovery Zone Economic Development Bonds (RZEBs) • 45% interest rate subsidy of taxable bonds. • Build America Bonds (BABs) • 35% interest rate subsidy of taxable bonds.

15. Competitive Issuance: BAB/TE Hybrid Items of Note Parity Summary of Bids • The competitive bid offering platform, PARITY, has made adjustments to allow for a combined issuance of tax exempt and BABs. • It is important to verify every bid received to confirm accuracy of Parity calculations.

16. Competitive Issuance: BAB/TE Hybrid Items of Note Parity Bid Detail • As shown in the bid to the right, bidders have the option to choose which maturities they choose to issue as BABs.

17. Update on Municipal Rates

18. Long-Term Borrowing Rates Items of Note Historic Bond Buyer 20-Bond Index • 20-Bond Index Matures in 20 years and is rated ‘Aa2’/‘AA’ by Moody's and S&P. • Historical Statistics: • Average: 5.38% • Max: 7.56% • Min: 3.94% • Current: 4.37%

19. Long-Term Borrowing Rates Items of Note ‘AAA’ MMD • The Municipal Market Data Daily Rate Publication (MMD) is the benchmark for municipal yields. • Municipal borrowers who issue public securities receive the benefit of the yield curve. • Current municipal rates are lower across the board (i.e. years 1-30) than the same period over the previous five years.

20. Credit Spreads Items of Note 30-Year MMD • The spread between ‘BBB’ and ‘A’ rated bonds has increased: June ‘03 – Sept. ‘08 • Average: 0.28% • Minimum: 0.07% • Maximum 0.51% Sept. ‘08 – Present • Average: 1.78% • Minimum: 0.79% • Maximum 2.58% • On a $25,000,000 borrowing, a difference of 1.0% in rates could equate to an increase of $3.4 million in total debt service. Due to the Absence of ‘AAA’ Bond Insurers and a Flight to Quality by Municipal Investors, Strong Credit Ratings are more important now than ever before.

21. Rating Agency Considerations

22. Ten Characteristics of Highly Rated Credits • Resilient Economy • Diverse Tax Base • Affluent Population • Established Financial Policies • Effective Management Practices Strong Reserves Financial Flexibility Affordable Debt Burden Balanced Capital Plan Long-range Planning

23. 1. Resilient Economy Highly rated credits have a diverse, resilient economy that exhibits steady growth or renewal • Multiple industry clusters. • Economic resilience in recessionary environment. • Industrial/commercial growth and reinvestment in community. • Transportation links within region. • Unemployment consistently below state, regional, and national averages. • High proportion of knowledge based jobs/industries. • Few sectors in decline. Resilient Economy Employment by Industry

24. Resilient Economy (continued) Highly rated credits have a diverse, resilient economy that exhibits steady growth or renewal Unemployment Rate Poverty Rate

25. 2. Diverse Tax Base Highly rated credits’ Ad Valorem tax base exhibit commercial and industrial diversity, not just residential growth • Market value of taxable property per capita is above average. • No concentration among top ten taxpayers (less than 10% of total assessed value). • Tends to be successful in redevelopment projects. • Underscores demand and desirability of community. Diverse Tax Base Assessed Value Per Capita

26. Diverse Tax Base (continued) Highly rated credits’ Ad Valorem tax base exhibit commercial and industrial diversity, not just residential growth • No concentration among top ten taxpayers (less than 10% of total assessed value). Diverse Tax Base Top 10 Tax Payers

27. 3. Affluent Population Highly rated credits tend to be affluent areas in or adjacent to core cities • Have a solid, independent job base. • Number of jobs tends to be a high percentage of the Labor Force. • Wealth and income indicators above State and U.S. Averages (student population or governmental presence may temper income levels, but are stable). Affluent Population Per Capita Income

28. Affluent Population (continued) Highly rated credits tend to be affluent suburbs adjacent to core cities • Steadily growing or stable population. • Educated labor force with high portion of employees in executive and professional occupations. Affluent Population Regional ‘AAA’ Communities Washington, DC* • Arlington, VA • Fairfax, VA • Loudoun, VA • Montgomery, MD • Prince George’s, MD • Calvert, MD • Charles County, MD • Bowie, MD • Frederick, MD • Talbot, MD • Falls Church, VA • Herndon, VA City of Baltimore* • Howard, MD • Baltimore, MD • Annapolis, MD • Carroll, MD • Harford, MD City of Richmond* • Chesterfield, VA • Hanover, VA • Henrico, VA • Albemarle, VA • Charlottesville, VA Virginia Beach, VA • James City, VA City of Raleigh/Durham • Durham, NC • Wake, NC • Cary, NC • Chapel Hill, NC • Apex, NC • Wake Forest, NC City of Charlotte • Mecklenburg, NC • Cornelius, NC City of Winston-Salem • Forsyth, NC City of Greensboro • Guilford, NC • High Point, NC City of Wilmington* • New Hanover, NC *Not rated ‘AAA’

29. 4. Established Financial Policies Highly rated credits have formally adopted a broad spectrum of state of the art fiscal and debt management policies that are adhered to • Reviewed / discussed with Elected Officials and adopted, if possible. • Fund Balance. • Reserve policies establish minimum reserve level and conditions for use and replenishment. • Non Recurring Funds. • Policy regarding use, and may prohibit use in some operations. • Investment Management Policy. • Debt Capacity. • Debt to assessed value target and/or maximum limit. • Debt Service to expenditures target and/or maximum limit. • 10-year Payout Ratio target and/or minimum limit. • Amount of cash funding of CIP. • Policies need to allow for responsible future growth, not limit it.

30. 5. Effective Management Practices Highly rated credits exhibit best industry practices in managing their affairs • Demonstrate willingness to maintain structural balance in difficult economic environments: • Revenue adjustments. • Expenditure/program reductions. • Operating surpluses are the norm. • Strong disclosure practices. • Interim financial reporting is common. • Stability of key personnel and informed elected officials. • Regular financial performance monitoring and reporting to elected officials. Effective Management Practices GFOA Awards

31. 6. Strong Reserves Highly rated credits have a strong fund balance that consistently meets or exceeds internal targets • Depending on diversity and dependability of revenues, unreserved general fund balance for a Highly Rated Credit can range widely from as low as 10% of Budget to as high as 60%. • Excellent liquidity across all major funds. • No need for cash flow borrowing. • Enterprise, internal service funds, and pension funds are healthy. Strong Reserves Unreserved / Undesignated GF balance as % of Budget

32. 7. Financial Flexibility Highly rated credits have solid overall fiscal flexibility • Regular pay-as-you-go funding for Capital. • Competitive tax rates. • Rapid debt retirement. • Diversity of revenue sources is typical: • Property tax. • Lesser taxes/fees available have been implemented. • Conservative budgeting. • Positive fiscal relationships with related jurisdictions. Flexibility Tax Rates of Local / Regional Units

33. Financial Flexibility (continued) Highly rated credits have solid overall fiscal flexibility • The Payout Ratio measures how quickly a Credit pays down its debt. • The industry standard is to analyze the 10-year payout ratio, or the percentage of the principal paid back over the next 10 years. Flexibility 10-Year Payout Ratio

34. 8. Affordable Debt Burden Highly rated credits regularly measure debt affordability and policies are in place to control amount and timing of debt issuance to meet policy targets • Low to moderate debt ratios measured by: • Debt to assessed value. • Debt service to expenditures. • 10-year payout ratio. • Strong record of pay-as-you-go funding. Affordable Debt Burden Debt Service vs. Expenditures

35. 9. Balanced Capital Plan Highly rated credits typically have a well-defined 5 or 10 year capital improvement plan (CIP) • Balanced sources and uses/ • Minimal use of “To Be Determined” funds. • Highest priority projects are identified. • Incremental operating costs associated with CIP are clearly identified. • Reviewed and updated at least annually. Balanced CIP CIP Planning

36. Debt Capacity Analysis DS vs. Expenditures 10-year Payout Debt to AV Debt Affordability 10. Long Range Planning Long term planning is a hallmark of highly rated credits • Emphasis on internal planning; early issue identification. • Tend to be “first implementers” for new standards. • External planning and cooperation with other entities to tackle regional issues. • Multi-Year financial planning discipline is in place and updated regularly. Long Range Planning Planning Process Annual CIP Review / Update Implementation

37. Long Range Planning Existing and Proposed Debt • Review Existing Debt Profile. • Layer proposed CIP debt on top of exiting debt profile in order to: • Measure Debt Capacity. • Measure Debt Affordability. • Evaluate alternative debt structures to alleviate any potential problems. Long Range Planning Existing and Proposed Debt

38. Long Range Planning Key Debt Ratios • Review how proposed debt impacts key debt ratios. Long Range Planning Debt to Assessed Value

39. Long Range Planning Key Debt Ratios • Review how proposed debt impacts key debt ratios. Long Range Planning Debt Service to Expenditures

40. Long Range Planning Key Debt Ratios • Review how proposed debt impacts key debt ratios. Long Range Planning 10-Year Payout Ratio

41. Long Range Planning Debt Affordability • Review how proposed CIP / Plan of Finance impacts cash flows available to pay for debt service. • Evaluate all potential costs associated with projects • Debt Service • Operating Impacts • Evaluate potential sources of payment • Debt Service Budget • Sales Tax • Capital Reserves • Other Long Range Planning Affordability

42. Contacts • If there are any questions about the material presented today, please feel free to contact anyone from the Davenport Team. • Raleigh Office Bob High 919-571-6547 rhigh@investdavenport.com • Charlotte Office Walter Goldsmith Patrick Smith 704-998-5396 704-375-0550 wgoldsmith@investdavenport.com psmith@investdavenport.com • Richmond Office Ted Cole Mitch Brigulio 804-697-2907 804-697-2903 tcole@investdavenport.com mbrigulio@investdavenport.com