Utility Financing 101 Presented by PFM Public Power Group

PFM

Utility Financing 101

Presented by PFM Public Power Group

September 14, 2009

PFM Introduction

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• Public Financial Management

- Offering financial and investment advice to governments & not-for-profits

- 400 professionals in 30+ offices throughout the US

- Two separate operating companies

- No bond underwriting or trading for our own account

- Helping our clients maximize financial value

- Within risk tolerances consistent with public sector objectives

Public Financial Management

Financial Advice & Strategic Consulting

$50+Bn/Yr Capital Markets Transactions

10 Person Public Power Group

PFM Asset Management

Investment Management & Consulting

SEC Registered & Regulated

Managing $35+ Billion of Client Assets

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I. Why Do Utilities Issue Debt?

II. Basic Terminology

III. Debt Financing Process

Table of Contents

3Public Financial Management , Inc.

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Why Do Utilities Issue Debt?

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► New Money• New generation or transmission needs

• Capital improvements

► Refinancing• Current interest rates are lower than rates on outstanding bonds (high-to-low)

► Debt Restructuring• Match life of the asset (license extended)

► Meet Immediate Cash Needs• Unforeseen market events (ARS meltdown)

► Why not just pass through new money needs to the rate payers?

Why do utilities issue debt?

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Last Month

Current Month

$100.00 $750.00

ACME POWER

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Development, 1.8%

Education, 20.4%

Electric Power and Utilities, 13.2%

Environmental Facilities, 1.7%

Health Care, 13.5%Housing, 4.0%

Public Facilities, 3.4%

Transportation, 11.0%

General Purpose, 17.9%

Overview of Municipal Market (2008)

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Source: The Bond Buyer 2009 Yearbook

Public Financial Management , Inc.

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Basic Terminology

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► Nominal or Coupon rate• Interest rate paid periodically on the

loan

• Usually expressed as a percentage of par amount

► Price• Amount a lender will lend in

consideration of future receipt of principal and interest payments

► Yield• Single rate that sets the PV of the

principal and interest payments equal to the price

► Simply put – a bond is a loan.• Buyer of the Bond is the lender or

investor

• Seller of the Bond is the borrower or the issuer

► Principal or Face Amount or Par Amount• Amount of loan

► Maturity date• Repayment date of loan

What is a bond?

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Maturity

PrincipalAnnuity of Interest

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► Fixed Rate Bonds – bonds whose interest rates remain constant over the life of the issue. These rates are determined on the date the bonds are priced.

► Variable Rate Bonds (VRDBs, ARS): bonds whose interest rates change at specified intervals over the life of the issue. They may be adjusted on a daily, weekly, monthly, annual or longer-term basis

Types of Bonds

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► Current Interest Bonds (CIBs) : pay interest periodically from the date of issue

► Capital Appreciation Bonds (CABs): or zero coupon bonds pay interest at maturity.

► Convertible CABs/Deferred Interest Bonds (DIBs): pay interest beginning at a date later than issuance, but prior to maturity.

When is interest paid?

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► All or a portion of an issue with stated maturities in consecutive years.

Serial Bonds


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2

4

6

8

10

12

14

16

18

20

2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

Mill

ion

s Serial Bond Structure

Maturity Principal Coupon Interest Debt Service2010 7,950,000 5.00% 5,000,000 1,486,111 2011 8,350,000 5.00% 4,602,500 14,070,000 2012 8,765,000 5.00% 4,185,000 14,066,500 2013 9,205,000 5.00% 3,746,750 14,070,500 2014 9,665,000 5.00% 3,286,500 14,070,500 2015 10,145,000 5.00% 2,803,250 14,070,500 2016 10,655,000 5.00% 2,296,000 14,069,250 2017 11,185,000 5.00% 1,763,250 14,065,500 2018 11,745,000 5.00% 1,204,000 14,068,000 2019 12,335,000 5.00% 616,750 14,070,000

Totals 100,000,000 29,504,000 128,106,861

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• What are the implications if you are selling 30-year bonds and investors are only interested in years 1-24 and year 30?

– Debt service structure will not be level

– Yields may have to increase in order to interest buyers in years 25-29 (increased cost to you)

• To mitigate this, underwriters may spread out the 30 year par amongst the 25-30 year maturities as mandatory sinking funds. All maturities will be priced to the 30 year period.

Term Bonds

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1 24 30

1 24 30

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Debt Financing Process

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Overview


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Date Action

Prior to Week 1 ● Determine Type of Sale and Select Financing Team

Week 1 ● Kickoff meeting to discuss timing ,structure and drafting of disclosure documents

Week 2 ● Draft bond documents circulated: POS, Resolutions

Week 3-12 ● Continuous review and revisions to bond documents

Week 5 ● Credit Packages prepared and distributed to Rating Agencies

Week 6 ● Rating agency meetings on-site or in NYC

Week 7 ● Financing approved by Board/Commission

Week 8 ● Receive ratings

● Finalize, print and mail POS

Week 9 ● Pre-marketing of bonds

Week 10 ● Pre-pricing call

● Retail order period

● Bond pricing

● Final cash flows distributed

● Bond Purchase Agreement signed

Week 12 ● Bond Closing - Proceeds delivered

Post-Pricing ● Investment of Bond Proceeds

Timeline of a Bond Issuance


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Date Action













● Bond pricing







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► Negotiated• Identified underwriting team prior to sale date

• Negotiated underwriting spread

• Pro-active marketing campaign

• Assistance in developing plan of finance and legal framework

► Competitive• Underwriting team selected based on bid rate/spreads (TIC)

• Less pre-sale marketing

• FA and Client staff jointly develop plan of finance

What type of sale should I use?

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Who is involved?

ACME POWER

FinancialAdvisor

BondCounsel

Tax Counsel

SpecialCounsel

Underwriter

UW CounselTrustee

TrusteeCounsel

Rating Agencies

CreditEnhancersBond

Insurers

VerificationAgent /Accountant

RegistrarPaying AgentEscrow Agent

LOC/Liquidity

Providers


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► Before issuance:• Select financing team: Bond Counsel, Financial Advisor and Underwriter

• Understand the financing plan and chooses the financing structure

► After issuance:• Supervising, investing and administering the expenditure of bond proceeds

• Collecting, or monitoring the collection of revenues (taxes)

• Use of revenues to pay operating expenses and debt service

• Compliance with all undertakings, covenants and agreements

• Management of any enterprise funded by the debt

• Filing of any required reports with various governmental regulators, a bond insurer or other credit enhancement provider, if any, and credit rating agencies

• Addressing any problem that may arise with respect to the bonds, such as a shortfall in revenues, a tax audit or a regulatory issue

• Preparing, reviewing, and filing Annual Reports and Listed Event Notices under SEC Rule 15c2-12

Responsibilities of the Issuer

*Certain information taken from the CDIAC Primer of 2006


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► The financial advisor is a professional consultant retained to advise and assist the issuer by:• Determining financing needs and preparing analyses and plans

• Evaluating financing options (long-term vs. short-term debt) and different types of securities under difference scenarios

• Recommending negotiated or competitive sales

• Assisting in underwriting selection for negotiated sale

• Assisting in preparation of documents (official statement and notice of sale) for competitive bonds sales

• Preparing for and participating in rating agency presentations

• Giving advice during pricing and sale of bonds

Financial Advisor


*Certain information taken from “The Fundamentals of Municipal Bonds”

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► General Request for Proposal (RFP) Format• Turnaround time: 1-2 weeks

• Page/ font size limitation

• Questions:- General firm information (i.e., history, managerial organization, etc.)

- Local Office

- Team/Resumes

- Applicable Transactional History (i.e., negotiated, lease revenue, higher education, general obligation, etc.)

- Structuring Discussion (i.e., suggested structures for new debt, re-organization of old debt, incorporation of new products, etc.)

- Fees

Selection of the Financial Advisor

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► Bond Counsel is a lawyer who opines upon the security, legality, and tax-exemption of an issue.

► Essential every municipal security is accompanied by an opinion of bond counsel, who represents the legal interests of the bondholders. That opinion addresses that:• The bonds constitute legal, valid and binding obligations of the issuer

• Interest on the bonds is exempt from federal income taxation under applicable tax laws

The bond opinion does not make financial recommendations or represent a financial judgment as to the acceptability of the bond for the investor

► Other responsibilities of bond counsel:• Prepares and supervises bond proceedings

• Obtains necessary approvals from governmental authorities

• Discloses and examines litigation that may jeopardize the validity of the offering

• Interprets arbitrage regulations and tax law and provides guidance on structuring

• Drafts key financing documents

► Bond Counsel May NOT be Underwriter’s Counsel

Bond Counsel

*Certain information taken from “The Fundamentals of Municipal Bonds”


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► An underwriter is a securities dealer who helps government entities bring bond issues to market by purchasing a bond from an issuer and reselling it to investors.• Sets prices and yields on new issues, working closely with traders and salespeople to

determine the right price

• May act together or with more firms through a syndicate

• Ensures that appropriate continuing disclosure undertakings are entered into by the issuer to show compliance with SEC Rule 15c2-12

• After sale, confirms orders, delivers and pay for bonds, and meets various legal requirements

► In a negotiated sale, the issuer, prior to the sale date, selects a lead underwriter(s), who coordinates and manages the financing through all of its stages:• Leading up to the bond sale the underwriter is a critical member of the finance team,

opining on how various legal and structural decisions will impact the marketability of the eventual bond issue.

• Obtains agreement from the underwriting syndicate to the interest rates and terms of sale for the bonds

Underwriter


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Underwriter RFP Process

► Client issues Underwriter RFP• Similar to FA RFP:

- Lead, Co-manager, Selling Group role selection (vs. sole vs. joint)

- List of transactional experience (i.e., roles, size, etc.)

• FA usually maintains responsibility of summarizing RFP responses

• Client and FA develop “short-list”

► Underwriter Short-List Presentation*• Client Staff and Financial Advisor Panel

• 30-45 minute presentations

• 10-15 minute Question and Answer period

► Underwriter Selection

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► Using a syndicate of underwriters can greatly improve the sale of bonds• Individual firms may lack the ability to underwrite entire transactions on their own

• Multiple firms can be strategically organized to garner broader retail interest

Syndicate of Underwriters


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► Underwriter's counsel is customarily selected by the underwriter to:• Represents the underwriter and its interests in a negotiated sale

• Competitive sales generally do not require the retention of underwriter’s counsel

► Underwriter’s counsel customarily review, from the underwriter’s perspective, the documents prepared by bond counsel and negotiate matters relating to those documents on behalf of the underwriter.

► Underwriter’s counsel conducts a thorough due diligence analysis of the issuer.• Due diligence involves questions the issuer and important related parties about their

financial conditions, plans, reports, and other factors that are important for the purchaser to know in order to make an investment decision.

► Underwriter’s counsel also prepares the bond purchase agreement of contract , pursuant to which the debt is sold to the underwriter.

Underwriter’s Counsel


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► Credit rating agencies are firms that analyze the probability of the debt instrument returning all of the principal to the investor

► Municipal credit ratings are opinions of the relative investment quality of issuers and issues in the municipal and tax-exempt markets• Underwriters and investors rely upon the credit quality judgment made by the rating agencies

► The municipal bond market has slightly different

rating criteria from the corporate debt market owing

to the unique characteristics inherent in public debt

► Credit considerations may include:• Management, governance and business strategy

• Market position

• Service area

• Financial position

• Debt and capital plan

• Legal framework

Rating Agencies

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INVESTMENT GRADE RATINGS

MOODY’S S&P FITCH

Aaa AAA AAA

Aa1 AA+ AA+

Aa2 AA AA

Aa3 AA- AA-

A1 A+ A+

A2 A A

A3 A- A-

Baa1 BBB+ BBB+

Baa2 BBB BBB

Baa3 BBB- BBB-


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► The trustee is responsible for carrying out the administrative functions that are required under the bond documents, which may include:• Establishing and holding the funds and accounts relating to the bond issue

• Authenticating the bonds

• Paying principal and interest on the debt

• Protecting the interests of bondholders by monitoring compliance with covenants and acting on behalf of bondholders in the event of default

► The trustee generally acts as the liaison to the bondholders, particularly when a decision needs to be made about restructuring the debt or making only a partial repayment.

Trustee


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► Entities that guarantee or insure in one form or another the sufficiency of revenues to pay the bonds

► In each case the purpose of the credit enhancement is to provide:• Additional security for the

bonds that improves the credit rating of the bonds

• Lower borrowing cost to the issuer

Credit Enhancement


Insurance Company

S&P Moody's Fitch S&P Moody's Fitch

AmbacAAA Aaa AAA CC Caa2 n/a

AssuredAAA Aaa AAA AAA Aa2 AA

Berkshire Hathaway AAA Aa1 n/a

XLCA/SyncoraAAA Aaa AAA n/a Ca n/a

CIFGAAA Aaa AAA CC Caa2 n/a

FGICAAA Aaa AAA n/a n/a n/a

FSAAAA Aaa AAA AAA Aa3 AA+

MBIA/NPFGCAAA Aaa AAA A Baa1 n/a

Previous Ratings (December 2007)

Current Ratings

not in market

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► Bond registrar - maintains a list of the names and addresses of all registered owners of the bonds and recording transfers and exchanges of the bonds

► Authenticating agent - authenticating bonds upon initial issuance or upon transfer or exchange

► Paying agent - paying interest on the bonds by check or wire to the respective registered owners, and paying principal of the bonds to the registered owners upon surrender of the bonds at maturity or upon earlier redemption

► Escrow agent - holding the investments acquired with the proceeds of an advance refunding and using payments on those investments to pay debt service on the refunded bonds

► Dissemination agent - acting on behalf of the issuer or other obligated person to disseminate annual reports and event notices to repositories under SEC Rule 15c2-12

Others


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Date Action













● Bond pricing







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“Kick-off” Meeting

► Working Group:• Client staff

• Financial Advisor

• Bond Counsel

• Lead Underwriter

• Underwriter’s Counsel

• Trustee

• Trustee Counsel

► Agenda• Roles and Responsibilities

• Financing Timetable (approximately 8-12 weeks)- Documents (i.e., Indenture, Supplemental Indenture, POS, Official Statement, Bond

Purchase Agreement, Verification Agent Report, Investment Agreements, etc.)

- Meetings with Rating Agencies

- Printing

- Mailing POS (i.e., pre-marketing)

- Pre-Pricing/Pricing

- Closing

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Date Action













● Bond pricing







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► Official Statement• Similar to a prospectus for investors

• Purpose of the issue

• Description of the bonds

- Security

- Debt Service Reserve Requirements

- Additional Bonds Test

- Optional/Mandatory Redemptions

• Description of the Issuer

• Tax Opinion

What goes into Bond Documents?

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Mandatory Redemption Provisions


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Mandatory Redemption Provisions (cont’d)


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► An optional redemption (or call) provision allows the issuer to redeem bonds on a date prior to final maturity at a pre-set price (usually par).

► The call provisions are described in the bond resolution and official statement.► A series of call dates may be specified for different lengths of time.► If the bonds are to be called on the first call date at a premium to par, bonds called

on subsequent call dates will generally be redeemed at descending prices.► For example:

Optional Redemption Provisions

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OPTIONAL REDEMPTION

The Bonds maturing on or before November 1, 2010 shall not be subject to redemption prior to maturity. The Bonds maturing on or after November 1, 2011 shall be subject to optional redemption by the City on or after November 1, 2010 in whole at any time or in part from time to time in such order as determined by the City and by lot within a maturity (if less than a full maturity is to be redeemed) at the respective prices which are expressed as percentages of the principal amount of the Bonds to be redeemed, together with the interest accrued thereon to the date fixed for redemption:

Period During Which Redeemed Redemption

(Both dates are inclusive) Price November 1, 2010 through October 31, 2011 101.0% November 1, 2011 through October 31, 2012 100.5 November 1, 2012 and thereafter 100


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Date Action













● Bond pricing







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► Work with FA and underwriter to prepare presentation for meeting with the rating agencies• Organization and management

• Financial condition

- Debt service coverage, fixed charge coverage, liquidity

• Service area

• Rate competitiveness

• Top power purchasers

• Specifics of upcoming deal

• Other changes?

► Meeting can take place on-site, in NYC, or via conference call

► Rating process typically takes 3-4 weeks

What do the rating agencies need to know?

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Date Action













● Bond pricing







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► Posting of the POS• Typically 1 – 2 weeks prior to pricing

• Allows potential investors to do their “homework” on the credit

► Underwriter communication to investors• Internet Roadshow

- Issuer summarizes their current financial position and the transaction via conference call and webcast to potential investors

- Gives investors the opportunity to ask questions

- Puts the deal on the calendars

► Local newspaper, bond buyer advertisements

► Time is more important than ever

Pre-marketing of the bonds

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► Three classes of investors dominate the municipal market.

1. Households, consisting of individuals acting directly or through investment counsel

2. Household proxies – bond funds such as mutual funds, money market funds, bank personal trusts and investment trusts

3. Institutions, particularly commercial banks and property and casualty insurance companies.

Who buys tax-exempt bonds?

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Households, 34.99%

Mutual funds, 14.20%

Money market funds, 18.09%

Closed-end funds, 3.50%

Nonf inancial corporate businesses, 1.53%

Nonfarm noncorporate businesses, 0.22%

Government-sponsored enterprises, 1.27%

State & local gov't general funds, 0.21%

Rest of the world, 1.26%

Commercial banks, 7.35%

Savings institutions, 0.40%Property & casualty insurance, 13.43%

Life insurance companies, 1.46%

State & local gov't retirement funds, 0.03%

Brokers & dealers, 2.06%

Source: The Bond Buyer Yearbook 2007

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Investor Preferences


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Date Action













● Bond pricing







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► Market update► Initial price views from underwriters

► Internal discussion with FA

► Decisions made regarding designation and liabilities

Pre-Pricing Call

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1 2 3 4

MaturitySenior

Manager Co #1 Co #2 Co #3 Co #4 Min Max Avg

2010 75 80 75 63 175 63 175 942011 80 85 80 70 180 70 180 992012 85 90 85 75 185 75 185 1042013 85 90 90 80 185 80 185 1062014 85 90 90 85 185 85 185 1072015 95 95 100 90 195 90 195 1152016 98 100 105 95 198 95 198 1192017 98 100 105 95 198 95 198 119

ACME PowerSeries 2009Price Views

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► Pricing: Where the Fun Part Begins► Pricing Is a Function of Everything

• Underwriters canvas the market and develop a recommended scale

• Provide the consensus views of the other underwriting group member

• FA provides market comparables that are an essential tool (just use the favorable ones)

• Other supply in the market is important

• Market tone and economic announcements come into play

• Some bonds have narrow pricing expectations, others are more of a fishing expedition

• Release a Preliminary Pricing Wire to Investors (9-10AM)

• Investors place orders (9-12 Noon)

• Issuer, Underwriter, FA review the order book (Noon-1PM)

• Adjustments to rates to reflect either strength or weakness of demand

• Upon agreement, underwriter makes formal offer to buy bonds on behalf of the group

• FA takes credit for success or blames underwriter for any problems (Ongoing)

Day of Pricing

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Date Action













● Bond pricing







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What do you do at closing?

► Pre-closing/Closing Includes:• Documentation requiring Client signatures

• POS/OS

• Closing memorandum- Wiring Funds: Underwriter to Trustee, Escrow Agent, Insurer (up-front premium), Client (costs of

issuance)

• Indenture

• Supplemental Indenture

• Bond Purchase Agreement

• Verification Agent Report

• Escrow Report

• 8038 Form (Arbitrage yield)

• Final numbers

• Costs of Issuance

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Date Action













● Bond pricing







Utility Financing 101 Presented by PFM Public Power Group

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Transcript of Utility Financing 101 Presented by PFM Public Power Group