Investing Bond Proceeds

1. California Municipal Treasurer’s Association Investing Bond Proceeds Lauren Brant Senior Managing Consultant PFM Asset Management LLC Lester T. Wood Managing Director Bond Logistix, LLC April 20, 2004

2. Noticing the Obvious FINISHED FILES ARE THE RE- SULT OF YEARS OF SCIENTIF- IC STUDY COMBINED WITH THE EXPERIENCE OF MANY YEARS

3. Investing Bond Proceeds • Financial Requirement • P & I Payments • Earning Assets • BondProceeds • Use ofEarnings • Debt Service • Objective • Reduce Borrowing Costs

4. Overview • Who’s Involved in the Decision Making Process? • Arbitrage Considerations. • Fun with Funds! • Mixing and Matching Investments. • Case Study.

5. Who’s Involved?

6. Arbitrage Considerations • What is arbitrage? • Exceptions, Exemptions, Elections • How does arbitrage factor into the investment strategy for my bonds? • How will I keep track of the arbitrage of my bond issue? • Planning Ahead

7. What is Arbitrage? 9.0 Positive Arbitrage 8.0 Yield 7.0 Bond Yield (tax-exempt) 6.0 Investment Yield (taxable) Negative Arbitrage 5.0 4.0 1993 1994 1995 1996 1997 1998 • 100% tax on earnings in excess of bond yield

8. Loopholes • Exceptions • Project fund spending • Exemptions • Small issuer • Elections • Penalty in lieu of rebate

9. Investment Strategy • Factors to consider prior to issuance: • IRS regulations • Marketplace vs. arbitrage yield • Interest rate trends • Ongoing strategy considerations: • Arbitrage is cumulative from day one, across all funds

10. Netting Effect

11. How do I Keep Track? Transaction Transaction Transaction Future Value Future Value Date Days Type Amount Factor Cash Flow --------------- -------- ------------------ --------------------- ------------------ ----------------------- 5/12/98 1800 Deposit 236,491,000.00 1.29199835 305,545,981.15 5/12/98 1800 Withdrawal (39,947,000.00) 1.29199835 (51,611,457.98) 6/30/98 1752 Withdrawal (25,949,000.00) 1.28320184 (33,297,804.46) 9/30/98 1662 Withdrawal (14,175,000.00) 1.26686948 (17,957,874.92) 12/31/98 1572 Withdrawal (20,475,000.00) 1.25074500 (25,609,003.95) 3/31/99 1482 Withdrawal (20,100,000.00) 1.23482575 (24,819,997.66) 6/30/99 1392 Withdrawal (19,050,000.00) 1.21910912 (23,224,028.78) 9/30/99 1302 Withdrawal (19,050,000.00) 1.20359253 (22,928,437.66) 12/31/99 1212 Withdrawal (19,600,000.00) 1.18827343 (23,290,159.16) 3/31/00 1122 Withdrawal (20,650,000.00) 1.17314930 (24,225,533.12) 6/30/00 1032 Withdrawal (19,600,000.00) 1.15821768 (22,701,066.49) 9/30/00 942 Withdrawal (12,200,000.00) 1.14347610 (13,950,408.41) 12/31/00 852 Withdrawal (5,150,000.00) 1.12892215 (5,813,949.06) 3/31/01 762 Withdrawal (1,000,000.00) 1.11455344 (1,114,553.44) --------------- -------- ------------------ --------------------- ------------------ ----------------------- 15,001,706.05 Calculation Date 5/12/03 Days Since Inception 1800 Earnings Yield 5.600000% Arbitrage Yield 5.190000% Future Value at Earnings of 5.19% $15,001,706.05 Future Value at Earnings of 5.60% $16,486,923.58 Arbitrage Rebate Liability 5/12/03 $1,485,217.53

12. Planning Ahead At Issuance • Calendar of Important Dates • Expenditure benchmarks • Yield restriction • 5-year payment date • Filing • Data Collection • Segregated funds • Refunding issues • Transferred proceeds

13. Fun with Funds! • Project (Acquisition/Construction) • Match to Draw Schedule • Debt Service Reserve • Covenant to Maintain Fixed Amount • Semi-Annual Availability • Capitalized Interest

14. Fun with Funds! • Debt Service Principal & Interest • Capitalized Interest • Cash Flow Thereafter • Escrows

15. Surety Bonds or L.O.C. • Insurance with Recourse • Replace Cash Funded DSR • Debt Cap Problem at Time of Issuance • Over Budget on Project Costs After Issuance

16. Cost of Surety or L.O.C. • Premium Cost • Lost Ability to Earn Positive • Current/expected arbitrage position

17. Mixing & Matching Investments • Typical bond proceeds investments: • Liquidity Pools • Structured Portfolios • Investment Agreements

18. Considerations • Liquidity requirements • Yield objectives (arbitrage yield vs. market) • Purpose of funds • Agency’s tolerance for risk • Bond document investment language (boilerplate) • Net/Gross funding for construction fund

19. Liquidity Pools • Money market funds • County pool • Local Agency Investment Fund (LAIF) • Joint powers authority Features • Liquidity within restrictions of investments • Ease in administration Issues to consider • Variable investment rate • No customization to draws

20. Structured Portfolios Features • Customized investment strategy • Portfolio initially structured to match expected draw schedule • Active trading can improve yield • Portfolio restructured as draw schedule changes and to adjust for market changes • Ability to lock in higher yield on longer-term funds Issues to consider • Can be time consuming to monitor and manage • Slightly higher transaction costs may be incurred • Mark-to-market risk for Reserve Fund • Reduced liquidity

21. Investment Agreements • Guaranteed Rate • Withdrawals at Par • Shift Reinvestment and • Market Rate Risks to Provider • Issuer Assumes Credit Risk on IAs

22. Investment Agreement Providers • Banks • Primary Dealers • Private Placements • Insurance Companies

23. Investment Agreements • Standard With Collateral • Downgrade • Collateralized • Puts • Forward Delivery

24. Uses of Investment Agreements • Construction / Acquisition • Full flex draws • Debt Service Reserves • Semi-annual draw • Debt Service Float • Monthly window

25. Conclusion • Consider the risks/rewards of all options. • Develop an investment strategy for all proceeds prior to issuance. • Revisit each fund’s strategy on a frequent basis. By doing these things, you increase your chances of reducing your borrowing costs.