Utility Financing 101 Presented by PFM Public Power Group

1. Utility Financing 101Presented by PFMPublic Power Group September 14, 2009

2. Introduction • 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 PFM Asset Management Investment Management & Consulting SEC Registered & Regulated Managing $35+ Billion of Client Assets Public Financial Management Financial Advice & Strategic Consulting $50+Bn/Yr Capital Markets Transactions 10 Person Public Power Group 1

3. Table of Contents Why Do Utilities Issue Debt? Basic Terminology Debt Financing Process Public Financial Management , Inc.

4. Why Do Utilities Issue Debt?

5. Why do utilities issue debt? ACME POWER • 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?

6. Overview of Municipal Market (2008) Source: The Bond Buyer 2009 Yearbook Public Financial Management , Inc.

7. Basic Terminology

8. What is a bond? • 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 Principal Annuity of Interest Maturity • 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

9. Types of Bonds 0 0 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 Public Financial Management , Inc.

10. 0 When is interest paid? 0 0 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. Public Financial Management , Inc.

11. Serial Bonds All or a portion of an issue with stated maturities in consecutive years. Public Financial Management , Inc.

12. Term Bonds • 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. 1 24 30 1 24 30

13. Debt Financing Process

14. Overview Public Financial Management , Inc.

15. Timeline of a Bond Issuance 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 Public Financial Management , Inc.

16. Timeline of a Bond Issuance 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 Public Financial Management , Inc.

17. What type of sale should I use? • 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

18. Who is involved? Financial Advisor Tax Counsel Verification Agent / Accountant Bond Counsel Special Counsel Registrar Paying Agent Escrow Agent ACME POWER Underwriter Credit Enhancers Bond Insurers UW Counsel Trustee RatingAgencies LOC/ Liquidity Providers Public Financial Management , Inc. Trustee Counsel

19. Responsibilities of the Issuer *Certain information taken from the CDIAC Primer of 2006 • 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 Public Financial Management , Inc.

20. Financial Advisor *Certain information taken from “The Fundamentals of Municipal Bonds” • 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 Public Financial Management , Inc.

21. Selection of the Financial Advisor • 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

22. Bond Counsel *Certain information taken from “The Fundamentals of Municipal Bonds” • 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 Public Financial Management , Inc.

23. Underwriter • 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 Public Financial Management , Inc.

24. 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

25. Syndicate of Underwriters • 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 Public Financial Management , Inc.

26. Underwriter’s Counsel • 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. Public Financial Management , Inc.

27. Rating Agencies • 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 Public Financial Management , Inc.

28. Trustee • 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. Public Financial Management , Inc.

29. Credit Enhancement • 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 Public Financial Management , Inc.

30. Others 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 Public Financial Management , Inc.

31. Timeline of a Bond Issuance 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 Public Financial Management , Inc.

32. “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

33. Timeline of a Bond Issuance 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 Public Financial Management , Inc.

34. What goes into Bond Documents? • 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

35. Mandatory Redemption Provisions Public Financial Management , Inc.

36. Mandatory Redemption Provisions (cont’d) Public Financial Management , Inc.

37. Optional Redemption Provisions 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: Public Financial Management , Inc.

38. Timeline of a Bond Issuance 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 Public Financial Management , Inc.

39. What do the rating agencies need to know? • 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

40. Timeline of a Bond Issuance 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 Public Financial Management , Inc.

41. Timeline of a Bond Issuance 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 Public Financial Management , Inc.

42. Timeline of a Bond Issuance 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 Public Financial Management , Inc.

43. Pre-marketing of the bonds • 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

44. Who buys tax-exempt bonds? Source: The Bond Buyer Yearbook 2007 • Three classes of investors dominate the municipal market. • Households, consisting of individuals acting directly or through investment counsel • Household proxies – bond funds such as mutual funds, money market funds, bank personal trusts and investment trusts • Institutions, particularly commercial banks and property and casualty insurance companies.

45. Investor Preferences Public Financial Management , Inc.

46. Timeline of a Bond Issuance 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 Public Financial Management , Inc.

47. Pre-Pricing Call • Market update • Initial price views from underwriters • Internal discussion with FA • Decisions made regarding designation and liabilities

48. Day of Pricing • 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)

49. Timeline of a Bond Issuance 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 Public Financial Management , Inc.

50. Timeline of a Bond Issuance 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 Public Financial Management , Inc.