CDIAC Workshop: February 1, 2011
Current Short Term Financing Options
Richard HiscocksOrrick, Herrington &
Sutcliffe(415) [email protected]
Eileen GallagherStone & Youngberg(415) [email protected]
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
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