State of Texas Debt – An Overview

1. State of Texas Debt – An Overview January 2011 Texas Bond Review Board Texas Public Finance Authority Bob Kline, Executive Director Dwight Burns, Executive Director kline@brb.state.tx.usdwight.burns@tpfa.state.tx.us 512-463-1741 512-463-5544 www.brb.state.tx.us www.tpfa.state.tx.us

2. Introduction

3. BRB vs. TPFA Bond Review Board – Oversight Agency • Board: Governor, Lt. Governor, Comptroller and Speaker (non-voting) • Approves state debt and lease purchases greater than $250,000 or a term longer than 5 years • Collects, analyzes and reports information on state and local debt - website • Administers the state's Private Activity Bond Allocation Program Texas Public Finance Authority – Issuing Agency • Board: Appointed by the Governor • Issues state debt as authorized by the legislature • Issues for 23 state agencies including 3 universities • Administers the Master Lease Purchase Program

4. Texas Debt Issuers

5. TPFA Client Agencies • Adjutant General/Military Facilities Commission • Cancer Prevention and Research Institute of Texas • Department of Aging and Disability Services • Department of Agriculture/Texas Agricultural Finance Authority • Department of Public Safety • Department of State Health Services • Health and Human Services Commission • Midwestern State University • School for the Blind and Visually Impaired • School for the Deaf • State Preservation Board • Stephen F. Austin State University • Texas Department of Criminal Justice • Texas Department of Transportation/Office of the Governor (Colonias Roadway Grant Program) • Texas Facilities Commission • Texas Historical Commission • Texas Military Preparedness Commission (Texas Military Value Revolving Loan Fund) • Texas Parks and Wildlife Department • Texas Southern University • Texas Windstorm Insurance Association • Texas Workforce Commission • Texas Youth Commission • TPFA Charter School Finance Corporation *TPFA gained authority by the 81st Legislature to issue debt on behalf of TAFA

6. 2. Debt Instruments

7. What is a Bond? A bond is a contract for a loan between a lender and a borrower specifying: • the due date for the loan called the term or maturity, e.g., 20 years; • the interest rate on the bond, e.g., 5%; • the debt service (repayment) schedule, e.g., monthly, semi-annually or annually; and • the revenue source pledged to repay the loan.

8. Common Terms for Debt Securities • Par – Face value of a security • Coupon – Interest rate paid on a security • Discount or Premium – Amount the price of a security is less than or exceeds par value • Fixed rate – Interest rate that does not fluctuate during the life of the security • Variable Rate -Interest rate that resets at fixed intervals based on a predetermined index or formula • Yield – Investor rate of return • Liquidity Provider – Financial intermediary that facilitates the remarketing of variable-rate debt at reset dates

9. Terms - Example General Obligation Refunding Bonds, Series 2010 Underwritten on 7/1/2010

10. Debt Maturities • Bonds: Long term (5+ years), fixed or variable rate • Notes: Short Term (<5 years), fixed or variable rate • Commercial Paper: (maximum maturity of 270 days), variable interest rate

11. Commercial Paper • Secured by general obligation pledge or a specified revenue source • Variable interest rate – usually much lower than long term interest rate • Maturity ranges from 1 to 270 days • Rolled-over (reissued) or refunded (repaid) with long-term debt at maturity

12. Municipal (Tax-Exempt) Interest Rates

13. Fixed Rates vs. Variable Rates Bond Buyer Index vs. SIFMA Index vs. TPFA CP(as of 11/30/10)

14. Taxation on Interest Earnings • Taxable - On federal (and some state and local) tax returns • Tax-Exempt – Exempt from taxation • Investors will accept a lower interest rate because earnings are exempt from taxation • $1.00 (taxable) - $.25 (taxes) = $0.75 (tax-exempt) • Federal tax law limits issuance, investment and use of proceeds of tax-exempt debt

15. 3. Types of Texas Debt

16. General Obligation (GO) Debt • Constitutional Pledge: Legally secured by a constitutional pledge of the first monies coming into the State Treasury that are not constitutionally dedicated for another purpose • Approvals: Requires 2/3 vote of both houses of the legislature and majority of the voters • Examples: Debt for prisons (TDCJ), mental health facilities (TDSHS), parks (TPWD)

17. Revenue Debt • Legally secured by a specific revenue source • Does not require voter approval • Examples: Veterans Land Board bonds, some Water Development bonds, college and university debt

18. Lease Purchase • TPFA issues revenue debt to finance a purchase of personal property or equipment under its Master Lease Program (MLPP) • TPFA holds the title to the property and leases the property to the client agency • Client agency makes lease payments to TPFA from general revenue appropriated to the client agency • TPFA uses the lease payments to pay debt service

19. Tax and Revenue Anticipation Notes (TRAN) • Issued by the Comptroller (CPA) to address the cash flow mismatch between tax revenues and expenditures from the general revenue • Repaid by the end of the biennium but are usually repaid by the end of the fiscal year • Repaid with tax receipts and other general revenue

20. Debt Issued by Universities • Revenue Debt: Revenue financing system debt finances permanent improvements and is repaid from system-wide revenue (except legislative appropriations) • Tuition Revenue Bonds: Legislature may authorize “tuition revenue bonds” (TRBs) and appropriate general revenue to offset the institution’s debt service • PUF: Pursuant to the Texas Constitution, only institutions within The University of Texas and Texas A&M Systems may issue obligations backed by income from the Permanent University Fund (PUF) • HEAF: Pursuant to the Texas Constitution, certain institutions, including some within The University of Texas and Texas A&M Systems, may issue Higher Education Assistance Fund debt (called HEAF or Constitutional Appropriation Bonds)

21. College & University Debt Outstanding As of 08-31-10 (billions)

22. Refundings • Used to: • Refinance – Issue new debt to pay off old debt • Lower interest rates • Change bond covenants • Change repayment schedule (“Restructure”) • Can be a “current” refunding or an “advance” refunding • Federal tax law permits tax-exempt bonds to be advance refunded only once

23. 4. Debt Sale Mechanics

24. Debt Issuance Process • Legislative authorization and appropriation • Issuer Board approval • Bond Review Board approval • Sale (Negotiated/Competitive) • Attorney General approval • Closing • Ongoing Administration

25. Debt Administration • Timely debt service payments • Monitor expenditure of bond proceeds • Comply with federal tax law • use of facility • investment of bond proceeds • arbitrage rebate compliance • Legislative appropriations for debt service, if required • Continuing Disclosure

26. Finance Team Bonds and Notes: • Financial Advisor • Bond Counsel • Underwriter Commercial Paper Transactions also include: • Dealer • Paying Agent • Liquidity Provider

27. Methods of Sale Negotiated • Unusual financial or legal structure • Issuance timing important (e.g., refunding) • Requires more pre-marketing effort Competitive • Straightforward structure • Well-known credit and security pledge • Size and ratings often attract bidders

28. Negotiated • Pool of underwriters usually selected through issuer’s RFP process • Price, interest rates and other terms of the securities negotiated with underwriter on sale date • Advantages: Flexibility in timing, structure and composition of underwriting syndicate • Disadvantages: lack of competition in pricing, wider fluctuations in spreads

29. Competitive • Underwriter selected on sale date through competitive bid based on lowest True Interest Cost • Winning underwriter determines structure of underwriting syndicate – not the issuer • Advantages: competition in pricing, usually lower spreads and open process • Disadvantages: limited flexibility, limited pre-selling, minimum control over bond distribution and risk premium

30. Pricing/Trading • Underwriter, financial advisor and issuer closely check the market to agree on preliminary pricing scale • Preliminary scale is forwarded to the market for a “pricing period” during which orders are received • Preliminary scale may be revised depending on orders received • At the end of pricing period, the underwriter buys the debt at specific rates, terms and maturity structure • Debt trades in the secondary market based on issuer’s credit and prices related to relevant market indices

31. 5. General Revenue Impact Self-Supporting vs. Not Self-Supporting

32. Self-Supporting • Repaid with revenues other than general revenues, can be either GO or revenue debt • Examples: • GO: Water Development Board debt repaid from loans made to communities for water and wastewater projects • Revenue: University revenue financing system debt, Housing and Community Affairs debt

33. Not Self-Supporting • Repaid with state general revenues, can be either GO or revenue debt • Examples: • GO: HEAF Bonds, most TPFA Bonds, Water Development Bonds • Revenue: TPFA MLPP, Texas Military Facilities Commission/Adjutant General Bonds

34. Constitutional Debt Limit • Texas Constitution prohibits the issuance of additional state debt if the percentage of debt service payable by general revenue in any fiscal year exceeds 5% of the average of unrestricted general revenue for the past three years • At fiscal year-end 2010, Constitutional Debt Limit (CDL) was 1.36% for issued debt and 4.10% including issued and authorized but unissued debt

35. Calculating the Constitutional Debt Limit Maximum Debt Service = 5% of the Average of Unrestricted General Revenue for FY’s ’08, ’09 and ’10 Debt Service Debt Service for all in Peak Year + Unissued Debt 3 year moving average of unrestricted GR

36. Q & A

37. 6. Texas Debt

38. State Debt Outstanding

39. Historical State Debt OutstandingAs of 8/31/10 (billions)

40. Debt Service on State Debtas of 8/31/10 (millions)

41. Local Debt Outstanding($174.55 billion outstanding as of 8/31/2009)

42. State and Local Debt – 10 Most Populous States

43. BRB Local Debt Online Database Local government searchable databases and downloadable data available on the Bond Review Board’s web site: http://www.brb.state.tx.us/lgs/lgs.aspx

44. 7. State Credit Ratings, Debt Affordability and Swaps

45. Credit Ratings State Credit Ratings: • Moody’s Aaa • Standard and Poor’s AA+ • Fitch AAA Factors Considered: • Economy • Financial condition • Debt burden • General management practices

46. General Obligation Credit Ratings - 10 Most Populous States

47. Debt Affordability Study (DAS) • Published in February by the BRB in coordination with the LBB • Provides leadership with assessment of the general revenue impact of debt-service requirements for not self-supporting debt (NSS) over the next 5 years • Debt Capacity Model calculates five key debt ratios to measure state’s ability to pay annual NSS debt-service • Can be used to analyze various debt-service scenarios

48. Interest Rate Swap • Form of Derivative • Hedge against interest rate risks • Does not represent debt • 2 parties agree to exchange different forms of interest payments for a definite period • Achieves lower cost financing by using short-term interest rates rather than higher, long-term rates • Market of multiple $ trillions

49. Pay-Fixed, Receive-Variable Swap

50. Pay-Variable, Receive-Fixed Swap