Investing Bond Proceedsand Capital Funds

Presented by Julio F. MoralesApril 24, 2006

2April 24, 2006

The Last Step in Financing ProcessDo not ignore the reinvestment of bond proceeds

Refunding with 3%savings on $10 million

= $300,000

Increase DSR earnings by 1.0% for 30 years:

($1 million DSR x 1.0% x 30) = $300,000

If you ignore the reinvestment of bond proceeds, you can effectively undo all your efforts

In comparison to

3April 24, 2006

Arbitrage Yield

IRS calculation of effective interest rate paid on a tax-exempt bond

IRR Calculation of Par Value vs. Adj. Debt ServicePrincipal & Interest+/- Premium / (Discount)- Bond Insurance

Arbitrage Yield4.85%

410,000 2.90%335,000 3.00%350,000 4.00%360,000 4.00%375,000 4.50%395,000 4.50%410,000 4.50%430,000 4.50%455,000 4.50%475,000 4.50%490,000 4.00%510,000 4.00%530,000 4.13%555,000 4.25%580,000 4.30%605,000 4.35%625,000 5.00%660,000 5.00%690,000 5.00%725,000 5.00%760,000 5.00%795,000 5.00%840,000 5.00%880,000 5.00%930,000 5.00%975,000 5.00%

1,020,000 5.00%1,070,000 5.00%1,130,000 5.00%1,185,000 5.00%1,240,000 5.00%

4April 24, 2006

IRS Arbitrage Regulations

Arbitrage Yield – the effective interest rate paid on a tax-exempt bond issue.

1. Yield Restriction Issuers are restricted from investing bond proceeds at a rate materially higher

than the arbitrage yield, except in the following case: Issuer “reasonably expects” to spent 85% of project fund or construction

fund monies) within a temporary period of 3 years. Bond proceeds held in a reasonably required reserve (i.e., DSR fund) De minimis amount = lesser of $100,000 or 5% of the bond issue.

2. Arbitrage Rebate The IRS requires an issuer to rebate excess interest earnings above the

arbitrage yield (i.e., rebate payments), generally every five (5) years.

There are three primary exemptions from rebate Proceeds spent within prescribed 6-month, 18-month, or 2-year schedule. Small issuer –expects to issue less than $5 million in a calendar year. Bond proceeds are invested in tax-exempt municipal securities.

5April 24, 2006

Goals: Maximize Earnings

You must perform rebate calculations

You get to keep all earnings up to the arbitrage yield

Goal is to invest at or above the arbitrage yield

“Opportunity Cost” if invested below the arbitrage yield

3.00%

4.00%

6.00%

Money Market=4.00%

Investment=5.00%

Opportunity Costs

Arbitrage Yield=4.85%

Subject to rebate

5.00%

6April 24, 2006

Investment ObjectivesInvestment Principles

Safety minimize chances

of issuer default Chance of decline

in market value

Liquidity Time constraint Function of cash

flow needs

Yield Risk/reward ratio

Portfolio Goals

Preservation of principal

Flexibility

Investment Return

Balance: Best return for lowest risk

7April 24, 2006

Permitted Investments Most investment policies address investment

options for operating funds. Typically, investment options for bond

proceeds are defined under “permitted investments” in the Trust Indenture / Fiscal Agent Agreement. Rating Agencies/Bond Insurers impose standard

investment guidelines.

8April 24, 2006

Investment Alternatives

1. Money Market Instrument or LAIF

2. Laddered Portfolio – Treasury / Agency Securities, Corporate Bonds, CDs

3. Investment Agreements – GICs, Repos, Forward Purchase Agreements

4. Combination of Above

9April 24, 2006

The Lottery

State of California offers payments of $5 million over 20 years or a single up front payment.

$-

$1,000,000

$2,000,000

$3,000,000

$4,000,000

$5,000,000

$6,000,000

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

Total over 20 years=$100 million

?One-time Payout

or

10April 24, 2006

The Lottery

$62.3 million

Total over 20 years

$-

$1,000,000

$2,000,000

$3,000,000

$4,000,000

$5,000,000

$6,000,000

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

Which would you choose? Depends on discount rate

Discount rate = 5.0%

11April 24, 2006

Advantages of Investment AgreementsMarket Risk –Investment Agreements are par instruments that eliminate the

potential market risk associated with most fixed income securities. Elimination of market risk is especially important for a long-term investment (e.g., DSR) or in a rising interest rate environment.

Asset / Liability Management – Investment Agreements can be structured to match cash flows, maturity dates, call provisions, etc. – allows issuer to match assets with liabilities.

Reinvestment Risk – Issuer can lock-in the reinvestment rate (on DSR) for the life of the investment.

Construction Risk – Full-flex GICs / Repos allow issuers to make withdrawals in any amount on any date. Investment Agreements providers assume construction risk – cash flow variances of withdrawal from project fund accounts.

Default Risk – Investment Agreements providers assume default risk on the bonds.

Flexibility – Investment Agreements are negotiated contracts. Issuers can structure options or contour cash flows to meet their needs.

12April 24, 2006

Limitations of Investment AgreementsLimited Market Trading – Since most Investment Agreements are

structured to meet the specifications of an individual issuer (bond deal), there is no secondary market for investment agreements.

Contracts can be structured with a market breakage fee (fixed income pricing)

Option to Terminate (at par).

Documentation – Investment Agreements require more than just a trade confirmation. Investment agreements are structured with unique provisions; and therefore require a negotiated contract (typically 7-10 days after bidding).

Broker / Bidding Agent - Investment agreements (like most securities) are often sold via GIC brokers or bidding agents. IRS excludes bidding fees from arbitrage calculations.

13April 24, 2006

Break-Even Analysis

DateInvested Balance

Withdrawals 7.8 Mo. Avg. Life

Required LAIF Rate

Interest Earnings

GIC Rate (LIBOR - 15bps)

Interest Earnings

Increased Earnings

PV Increased Earnings

3/1/2006 5.12%1 4/1/2006 20,000,000 1,873,086 4.25% 70,833 5.12% 85,362 14,528$ 14,468$ 2 5/1/2006 18,126,914 1,659,477 4.42% 66,745 5.12% 77,367 10,622 10,5343 6/1/2006 16,467,437 1,611,335 4.59% 62,947 5.12% 70,284 7,337 7,2464 7/1/2006 14,856,102 1,525,971 4.76% 58,874 5.12% 63,407 4,533 4,4585 8/1/2006 13,330,130 1,525,971 4.92% 54,699 5.12% 56,894 2,196 2,1506 9/1/2006 11,804,159 1,287,725 5.09% 50,095 5.12% 50,381 287 2807 10/1/2006 10,516,434 1,258,960 5.26% 46,107 5.12% 44,885 (1,221) (1,186)8 11/1/2006 9,257,475 1,132,732 5.43% 41,887 5.12% 39,512 (2,375) (2,297)9 12/1/2006 8,124,743 1,125,454 5.60% 37,903 5.12% 34,677 (3,226) (3,107)

10 1/1/2007 6,999,289 1,125,454 5.77% 33,635 5.12% 29,874 (3,762) (3,608)11 2/1/2007 5,873,835 1,048,020 5.94% 29,052 5.12% 25,070 (3,982) (3,803)12 3/1/2007 4,825,815 1,048,020 6.10% 24,546 5.12% 20,597 (3,949) (3,757)13 4/1/2007 3,777,794 887,394 6.27% 19,746 5.12% 16,124 (3,622) (3,431)14 5/1/2007 2,890,400 513,997 6.44% 15,513 5.12% 12,336 (3,177) (2,997)15 6/1/2007 2,376,403 513,997 6.61% 13,088 5.12% 10,143 (2,946) (2,767)16 7/1/2007 1,862,406 513,997 6.78% 10,519 5.12% 7,949 (2,570) (2,405)17 8/1/2007 1,348,408 180,233 6.95% 7,805 5.12% 5,755 (2,050) (1,910)18 9/1/2007 1,168,176 180,233 7.11% 6,926 5.12% 4,986 (1,940) (1,800)19 10/1/2007 987,943 180,233 7.28% 5,996 5.12% 4,217 (1,780) (1,644)20 11/1/2007 807,710 180,233 7.45% 5,016 5.12% 3,447 (1,568) (1,443)21 12/1/2007 627,477 180,233 7.62% 3,985 5.12% 2,678 (1,306) (1,197)22 1/1/2008 447,244 180,233 7.79% 2,903 5.12% 1,909 (994) (907)23 2/1/2008 267,012 133,506 7.96% 1,771 5.12% 1,140 (631) (573)24 3/1/2008 133,506 133,506 8.13% 904 5.12% 570 (334) (302)

20,000,000$ 671,494$ 669,564$ (1,930)$ 0$

*LAIF Published Daily Yield as of April 11, 2006

0.17% Required Increase in LAIF Rates (per Month)

3.88% Required Increase for LAIF to Break-Even

Invested in GICInvested in LAIF Break-Even Analysis