George Majors Thomas Huestis Kelly McGary

1. George Majors Thomas Huestis Kelly McGary

2. 2 Presentation Outline

3. 3 Exposure to interest rate risk caused by the structure of assets and liabilities can have significant budget impacts Most tax-exempt entity asset/liability profiles are characterized by long-term fixed rate liabilities and short-term assets In general, debt for capital projects is amortized over the projects useful life (20 years or longer) Public policy objectives Budgetary certainty Investment assets are generally short-term Safety, Liquidity, Return State Statutes Investment policy - WAM/duration limits Interest earnings fluctuate with short-term rates Correcting Asset/liability imbalances Extend asset duration w/in liquidity needs (GIC, longer maturity bonds) Shorten debt duration w/in credit standards (FRN�s, VRDB�s, swaps) Match variable rate debt exposure to �core� asset balances Consider how assets and liabilities function together (�Net Interest Expense�) Asset/Liability Mismatches

4. 4 Net Interest Expense (�NIE�) is the difference between the interest expense incurred on debt-type obligations and interest income earned on investments It is Net Interest Expense, rather than either (a) debt expense or (b) interest income alone that impacts the budgetary bottom line The objective is to integrate debt and investment strategies toward minimizing both the absolute level of NIE and volatility in NIE �Net Interest Expense�

5. 5 Capital Funding Alternatives

6. 6 Historical Net Interest Expense Comparison

7. 7 Shortening Liabilities vs. Extending Assets

8. 8 Historical Costs and Cyclical Lows

9. 9 Issue additional floating rate debt Swap existing fixed rate debt to floating Refinance existing fixed rate debt with floating rate debt when existing debt becomes subject to optional redemption Increasing Floating Rate Exposure

10. 10 Management Considerations Short-term investment yields have averaged approximately 1.40% over the BMA Index. Active management of portfolio duration and asset allocation can add significant value when applied in a disciplined manner within pre-established guidelines. Short-term asset duration reduces exposure to repricing risk Shortening of debt duration hedges short-term interest rate exposure of asset portfolio Establishing A Duration Strategy

11. 11 Common Terminology Repricing Risk: The risk that arises when assets and liabilities are repricing at different time intervals Asset Sensitive: Portfolio with assets repricing earlier than liabilities (Reinvestment rate risk) Liability Sensitive: Liabilities repricing earlier than assets (market price and interest rate risk) Basis Risk: Risk that arises from changes in the relationship between interest rates for different market sectors (i.e. taxable & tax-exempt) Duration of asset portfolio is shortened to hedge against floating rate debt exposure (i.e. BMA Index) Matching of asset and liability duration reduces exposure to repricing risk Establish target duration and acceptable degree of duration mismatch As interest rates decline, reduced interest income is off-set by reduced borrowing costs As interest rates rise, higher borrowing costs are off-set by greater investment income Provides high degree of near-term budgetary predictability (i.e. Net Interest Expense) Short Duration Strategy

12. 12 Management Considerations By establishing management constraints and operating parameters, an optimal portfolio can be established which maximizes the expected spread between the asset portfolio and variable rate tax-exempt interest costs (BMA). For example, subject to the following portfolio constraints; 1) Average maturity <=180 days 2) Portfolio/BMA Correlation =.90 3) Treasuries >= 35% 4) Agencies <= 65% 5) Corporate = 0%, The following portfolio results in the greatest expected spread to BMA Sample Short Duration Portfolio

13. 13 Short Duration Strategy

14. 14 Common Terminology Scenario Analysis: Simulation of several different interest rate scenarios (flattening, inverted, steepening, parallel shift, etc) and the effect on assets and liabilities Book Value Perspective: Perceives risk in terms of it�s effect on accounting and earnings. Market Value Perspective: Perceives risk in terms of it�s effect on the market value of a portfolio Duration of asset portfolio may be extended in effort to maximize expected spread to variable rate debt costs Longer duration portfolio may generate greater expected spread over time Less near-term budgetary predictability due to repricing risk that results from duration mismatch Establish acceptable degree of duration mismatch Manage portfolio duration and structure to capitalize on relative value opportunities and manage risks Must consider tolerance for unrealized losses (market price risk) Scenario analysis and stress testing can help quantify exposure Intermediate Duration Strategy

15. 15 Interest rate risk is best addressed by focusing on net interest expense, rather than gross interest expense Must consider interest earned on asset portfolio as well as interest payable Using all variable rate debt represents risk that rates will rise in future Using all fixed rate debt represents risk that rates will decline in future Both scenarios expose issuer to interest rate risk and will impact budget An Integrated asset/liability management approach reduces balance sheet risk and speculation regarding future interest rates Coordinated investment and borrowing strategy hedges rate movements Analyzes how both asset and debt portfolios will perform in future interest rate environments and what impact on budget will be over time Net interest expense may be forecast with relatively high degree of accuracy End result is better net economics and less volatility of NIE Questions or Comments? Summary/Q&A

16. 16 Presentation Outline

17. 17 Portfolio management and implementation Variable rate debt Investment management Implementation of an integrated approach Analyses are consistent with an integrated approach Policies and procedures are consistent with an integrated approach Education and communication are consistent with an integrated approach Education and communication Key Implementation Issues

18. 18 Variable rate debt is a powerful debt management tool for the right issuer for the right purposes Reduction in overall cost of capital Historically lower average cost compared to fixed rate debt Maintenance of future flexibility for change in outstanding debt Provides cost effective flexibility to restructure or pay down debt in future May allow for flexibility in timing of fixed rate issues Risks and costs need to be considered Variable Rate Debt � Is it Good Idea?

19. 19 Funding types: Interim (Construction) funding Permanent (Long-term) funding Multitude of products and programs available: Variable Rate Bonds � tax-exempt and taxable Commercial Paper � tax-exempt and taxable Auction Rate � tax-exempt and taxable Variable Rate Loan Programs � tax-exempt and taxable Bank Loans � tax-exempt and taxable For some issuers, derivatives can be used to create synthetic variable rate exposure Not covered in this presentation Overview of Variable Rate Financing Vehicles

20. 20 Overview of Variable Rate Financing Vehicles

21. 21 For larger issuers, direct issuance of variable rate debt can be the most cost effective Florida variable rate debt pools and programs: Florida Municipal Loan Council (League of Cities) Sunshine State Florida Association of Counties Others Issuer options

22. 22 Challenges to Utilizing Variable Debt Identifying and evaluating new risks Tax reform risk Credit enhancement and liquidity facility renewal risk Refinancing risk if using for interim financing Budgetary Risk �appropriately budget for annual debt service payments Arbitrage rebate requirements Higher administrative costs More time consuming to manage Must be active in daily management Monitoring and reporting Requires skilled staff Communication and education Convincing yourself Convincing others

23. 23 Overview of Variable Rate Financing Vehicles

24. 24 Objective: minimize programmatic impact by making a reasonable interest rate assumption Annual debt service = principal x interest rate Future interest rates are unknown for variable rate debt Assume average rate in effect through next budget period Assume too high: decrease budgetary resources available for other purposes Assume too low: diverts resources from other purposes late in the fiscal year Variable Rate Challenge � How to Budget?

25. 25 Make sure that variable rate debt and investment earnings budget estimates are not inconsistent Historical and Current Interest Rates are useful for �Rule of Thumb� estimation Understanding the Fed�s objectives and policy drivers helps refine estimate. Funds Rate is a driver Read what are the various economists saying and predicting regarding short-term rates Keep database of rates Fed Funds LIBOR Investment benchmarks BMA Your variable rate debt performance Variable Rate Challenge � How to Budget?

26. 26 Exceptions to rebate requirement for new money transactions Six month spending exception Eighteen month spending exception Two-year spending exception Debt service reserve funds Computation periods Administrative considerations Variable Rate Challenge � Arbitrage Rebate Considerations

27. 27 Need to convince yourself first that adding variable rate debt makes sense Projections: Project monthly cash flows for the major funds considered Look at minimum and maximum investment balances Look at your investment practices Determine a target variable rate debt component for major fund(s) Historical analysis: Review historical interest earnings and average rates Map an investment proxy against variable debt index Opportunity cost analysis Policies and procedures consistent with an integrated approach Communication and Education

28. 28 Concerns that need to be addressed regarding �Why Now?� Short-term rates have risen Long-term rates are low Lose up-side in a rising rate environment Financing community pressures Political pressures Additional Analyses Review of historical rate trends Calculate break-even rates for variable rate debt to fixed rate alternative (recognizing this looks at only one-side of the balance sheet) Considerations Issue additional variable rate bonds Phase in new variable rate exposure Issue variable rate bonds as fixed rate bonds become currently refundable Opportunity Cost Analysis

29. 29 Opportunity Cost

30. 30 Debt Policy Provides for variable rate debt Parameters for the amount of variable rate debt Government Finance Officers Association Recommended Practices �Using Variable Rate Debt Instruments� Investment Policy Maintain investment portfolio consistent with variable rate debt exposure Reserve Policy Protection that investment balances will remain stable to continue to act as a hedge for variable rate debt Policies and Procedures

31. 31 Variable rate debt is powerful debt management tool for the right issuer for the right purposes Even with integrated Asset/liability management programs, variable rate debt creates new risks and additional costs An issuer should use a comprehensive approach, considering the asset side of its balance sheet, when deciding on variable rate debt exposure Communication and education is key for successful implementation Summary � Variable Rate and an Integrated Asset/liability Management Approach?

32. 32 Presentation Outline

33. 33 Appropriate Use of Variable-Rate Debt Operating Flexibility Capital Access Asset/Liability Balance Financial Management Capabilities

34. 34 Operating Flexibility Stable reserves, operating margins Revenue-raising/rate-setting flexibility Capital Access Debt levels, access to additional capital Credit Considerations

35. 35 Asset/Liability Balance Appropriate match of short term assets with short term debt Financial Management Capabilities Asset and Liability Management Policy Ability to respond to unexpected changes in the asset balance Financial management and systems able to monitor variable rate exposure and regularly assess risk Credit Considerations (continued)

36. 36 Limited management capabilities Lack of financial flexibility Volatile cash and short term investment balances, historically Potential Risk Factors That May Warrant Further Review