APPA National Conference:
Financing Capital Projects in Difficult Market
Conditions
Panelists:
Michael Mace, Managing Director, Public Financial Mgmnt.
John Murphy, Sr. Research Analyst, Fidelity Investments
Karl Pfeil III, Managing Director, Fitch Ratings
Financing Capital Projects in Difficult Market
Conditions
Karl H. Pfeil III, Fitch Ratings
June 15, 2009
The Credit Drivers of the Current Market Environment
>
The Basic Pillars of Public Power Credit
>
New Rating Considerations:
– Economic Issues
– Financial Considerations
– Environmental Credit Considerations
>
Fitch Ratings’ Public Power Outlook - How Does it Stack to other Sectors?
www.fitchratings.com
3
Primary Credit Factors
1. Mgmt
5. Financials
And
Legal’s
2. Service
Territory
Utility’s
Credit
4.Cost
Structure
www.fitchratings.com
3. Assets &
Operations
4
Location, Location, Location
>
Each region has distinct
characteristics affecting the utilities’
credit profile:
— Fuel supply
— Water supply
— Environmental
— Regional politics
— Service territory characteristics
— New developments
www.fitchratings.com
5
US Annual Real GDP Change - History + Projections
25
20
Annual % Change
15
10
201
5
1.0
0
2010
2005
2000
1995
1990
1985
1980
1975
1970
1965
1960
1955
1950
1945
1940
1935
1930
-3.4
-5
2009
-10
-15
Gross domestic product
www.fitchratings.com
Fitch Baseline Proj
Bloomberg Median Proj
6
Average Annual US Unemployment Rate
12
10
10.0
2010
9.0
% Unemploymed
8
2009
6
4
2
0
2010
2008
2006
2004
2002
2000
1998
1996
1994
Fitch Baseline Proj
1992
1990
1988
1986
1984
1982
1980
www.fitchratings.com
1978
1976
1974
1972
1970
Unemployment
Bloomberg Median Proj
7
Annual Change in Personal Consumption Expenditures
15
10
% Change
5
2010
0
0.0
2008
2005
2002
1999
1996
1993
1990
1987
1984
1981
1978
1975
1972
1969
1966
1963
1960
1957
1954
1951
1948
1945
1942
1939
1936
1933
1930
-3.3
-5
200
9
-10
Personal consumption expenditures
www.fitchratings.com
Fitch Baseline Projection
8
Financial Considerations
www.fitchratings.com
9
Financial Ratios
>
Coverage (How much cash flow cushion is there to pay the utility’s fixed obligations?)
— Debt service coverage
— Debt/funds available for debt service
>
Liquidity (how much cash does the utility have relative to its operating expenses?)
— Days cash on hand
— Days liquidity on hand (includes CP capacity & lines of credit)
— Free liquidity to support variable rate debt
>
Leverage (how much equity has the utility built up relative to its asset base?)
— Equity/capitalization
— Debt/funds available for debt service
>
Other
— Variable rate exposure as % of capitalization
— Annual capital additions
— Five-year capital improvement plan and financial projections
www.fitchratings.com
10
www.fitchratings.com
11
Gross Variable Rate Debt/Capitalization (%)
(2006-2008)
100
90
80
70
FY 2006
%
60
FY 2007
50
FY 2008
40
30
20
10
0
www.fitchratings.com
Issuers
12
Greenhouse Gas/Carbon Reductions
CO2 Regulation: Not if but when
>
Fitch Ratings believes that there will be a carbon law at the federal level
>
Increasing number of state regulators are placing a cost on carbon in rate
making proceedings
>
More traditional Wall Street investors are now looking at carbon issues
www.fitchratings.com
13
Public Power Outlook
www.fitchratings.com
14
For a Stable Sector – The Issues Are Very Complex
Increasing
Capital Costs
Fuel
Costs
Environmental
Regulation
New Generation
Rates /
Regulation
www.fitchratings.com
Economy
and
Housing
Declines
15
Fitch Ratings’ Public Power Credit Outlook for 2009
>
The Outlook into 2009 is Stable with near-term pressures on individual credits that
could result in increased negative rating actions
>
The longer-term Outlook reflects increasing negative cost pressures
>
While our near-term outlook for the sector is stable, if current pressures such as
limited capital market access together with increasing economic stress that persists
long into 2009, a change in Outlook to Negative may be warranted
>
Public power has historically proven itself to be a very solid investment despite past
complexities facing the industry such as deregulation, fuel price volatility, and the
corporate credit crisis
www.fitchratings.com
16
Fitch Ratings
www.fitchratings.com
Fitch Group
New York
One State Street Plaza
New York, NY 10004
+1 212 908 0500
+1 800 75 FITCH
Fitch Ratings
Fitch Solutions
London
101 Finsbury Pavement
London
EC2A 1RS
44 20 7417 4222
Algorithmics
Singapore
6 Temasek Blvd.
#35-03/04/05
Suntec Tower Four
Singapore 038986
+65 6336 6801
What Investors Really Want!
John M. Murphy, Research Analyst
Fidelity Investments
APPA National Conference
June 2009
19
What Investors Really Want!
 Research
 Trading & Markets
 Portfolio Management
www.fitchratings.comFidelity
Management & Research Co.
20
What Research Really Needs!
 Research
 Security
•
•
•
•
•
•
First Mortgage
Gross vs. Net Revenue Pledge
Liquidity Facilities
Market Access Alone is NOT a Security Interest
Access to All Pertinent Deal Documents
Covenants
 Disclosure
•
•
•
More Frequent Release of Financial Results
Derivative and Counterparty Exposures
Material Events
 Transparency
•
•
Semi-Annual Conference Calls or Internet Road Shows
Access to Management via Conferences, Calls or Meetings
www.fitchratings.comFidelity
Management & Research Co.
21
What Traders Really Need!
 Trading & Markets





D ate
05/14/09
05/14/09
05/14/09
05/14/09
05/14/09
05/14/09
05/14/09
05/14/09
05/14/09
05/14/09
05/14/09
05/14/09
05/14/09
05/14/09
05/14/09
Surveillance, Primary and Secondary
Appropriate Spread
Structure: Fixed vs. Floating
Duration / Maturity
Dealer Support
C usip
927675AC
927675AD
658196S8
56036YBF
79575DVC
542690U3
575765M Y
02765UBC
02765UBC
02765UBC
033177XH
052414CG
052414EU
052474LF
076099AW
D escriptio n
VIRGIN IS PUB(HOVENSA LLC) 5.87% 07/01/22@
VIRGIN IS PUB(HOVENSA LLC) 4.70% 07/01/22@
NC E M UNI(AGC) 5.25% 01/01/19
GA GAS PROJ(JPM C CO) 5.00% 03/15/22
SALT RIVER AZ 5.00% 01/01/37
LIPA NY 5.75% 04/01/39
M A M UNI WHSL(AM BAC) 5.31% 07/01/18
AM ERICAN M UN OH 5.00% 02/15/38
AM ERICAN M UN OH 5.00% 02/15/38
AM ERICAN M UN OH 5.00% 02/15/38
ANCH AK EL M BIA 5.125% 12/1/25
AUSTIN TX ELEC(AM BAC) 5.50% 11/15/14
AUSTIN TX ELEC(FSA) 5.00% 11/15/26
AUSTIN TX USR(AM BAC) 6.75% 11/15/11
BEDFORD VA IDA 6.55% 12/01/25@
www.fitchratings.comFidelity
Management & Research Co.
ST
VI
VI
NC
GA
AZ
NY
MA
OH
OH
OH
AK
TX
TX
TX
VA
Secto r
IDB
IDB
JOIN
SGAS
E&G
E&G
JOIN
JOIN
JOIN
JOIN
E&G
E&G
E&G
E&G
IDB
IN S
CP N
5.88
4.70
AGC
5.25
5.00
5.00
5.75
AM BAC 5.31
5.00
5.00
5.00
M BIA
5.13
AM BAC 5.50
FSA
5.00
AM BAC 6.75
6.55
M AT
07/22
07/22
01/19
03/22
01/37
04/39
07/18
02/38
02/38
02/38
12/25
11/14
11/26
11/11
12/25
OIY P arD ate
5.88
07/14
4.70
01/15
4.40
01/18
4.21
4.75
01/16
5.87
04/19
0.00 07/07
5.36
02/18
5.36
02/18
5.36
02/18
4.24
12/15
4.28
4.52
11/16
6.20
6.55
12/11
M o o dy B idYield
OfferYield
B idYSOfferYS
M ullerYieldSize
Baa3
9.92
Baa3
9.95
6.46
9.73
Aa2
4.20 4.05 1.20 1.05 4.47 10,000
Aa3
5.55 5.48 2.06 1.99 5.64 4,000
Aa1
4.70 4.70 0.06 0.06 4.72 10,000
A3
5.01
0.33 5.12
635
#Aaa
A1
5.15
0.50 5.11
330
A1
5.13
0.48 5.11
330
A1
5.15
0.50 5.11
340
A1
125
A1
2.98
640
Aa3
4.55
0.39
90
WR
2.67
25
B2
9.50
5
D ealer Initial
FAKE
FM R Bid
M SCO Cu/O
SBHU M KT
SBHU Cu/O
M OTC Inven
FAKE
LOOP VB Ofr
M NGT M C Ofr
WCHV BDSK Ofr
BLBG BW
BLBG BW
DRAU Inven
BLBG BW
BLBG BW
22
Evaluating Structural Relationships Over Time
Increased focus on quantitative infrastructure is necessary because
municipal bond valuations are influenced by many variables.
www.fitchratings.comFidelity
Management & Research Co.
23
What PM’s Really Need!
 Portfolio Management
 Sector Weights
 Index Weighting
 Security Selection
PMV Difference View
State GO
Local GO
Special Tax
Lease
Electric
Health Care
Housing
Education
IDB
Water
Transportation
Resource Rec
Pool
PreRe
Escrow
XOver
Tobacco
Other
S MUN F MUN
-5.39 -5.16
-1.81 -4.33
-2.19 -2.33
-0.73 -2.29
-0.59 -1.55
-0.89 -1.06
-0.37 -0.54
-0.21 -0.21
-0.13 -0.11
0.32 -0.11
-0.88
0.15
0.21
0.29
0.19
0.33
-0.58
0.47
0.61
2.42
0.71
0.91
1.16
4.24
3.10
www.fitchratings.comFidelity
Management & Research Co.
AZ
MA
-3.98 -11.14
-1.75
4.81
-1.39 -4.12
1.66 -6.19
-0.49
6.45
1.75
0.94
-0.24
6.03
0.67
-0.23
1.51
-0.11
4.07
-4.38
-6.59
-0.21
-0.70
1.84
0.36
1.27
-0.08
0.63
0.86
0.88
3.20
MN
-4.69
-1.71
1.06
-0.56
-3.20
-6.74
-0.92
1.52
4.15
4.57
11.67
0.68
1.95
-7.97
TFR
CA
CA SI
MI
NJ
-5.17 -10.21 -13.34 -11.04 -12.11
-4.89 -3.77 -2.90 -12.07 11.38
-1.18
5.68 -2.22 -6.24 -11.04
0.13 -0.26 -1.45 -0.55 -0.58
-3.61 -3.23 -1.26 -1.21
2.29
-1.33 -3.04 -0.19
2.23
2.21
-0.64 -0.98 -0.07 -0.99 -1.06
-1.28 -0.92 -0.03 -0.89 -0.85
0.42
1.88
0.22
-0.42
-0.07
2.90
1.15
0.11 -0.78
-0.19 -0.04
1.19
3.59
0.13
0.07 -0.51
1.41 -1.54
2.53
0.96
0.64
1.73
0.27 -0.23
0.46
0.60
1.77
1.95 -0.93
3.95
3.21
3.26
10.42
4.10
4.82 -1.38 -0.49
4.41
7.65
5.24 27.81
5.95
-0.23
0.46
-0.64
OH
-5.06
-7.58
-2.62
0.35
1.03
-1.18
-4.30
-0.50
-0.19
0.93
6.10
-1.16
0.70
EIM
-8.75
-8.37
2.16
-0.35
-3.92
-2.85
-1.24
-0.17
0.29
-0.83
1.28
-1.48
-0.26
-0.72
0.29
11.92
0.74
12.46
11.32
-0.21
INT
SHT
CT
-8.03 -27.68
0.17
-7.70 -1.26 -20.51
0.12 -0.25 -9.59
-0.36
0.64
1.75
-1.00 -0.03
-0.98 -0.53
0.43
-0.60 -0.04
-0.36 -0.83
1.90
0.94 -0.04
0.14
-0.65
0.35
0.93
1.06
0.66
1.71
2.71
0.54
0.52
0.91
5.51
0.03
2.91
0.19
0.53
2.63
1.98
9.81
2.14 -2.01
4.82
0.50
6.45
-0.17
7.32
4.44
MD
0.21
-9.62
-9.13
-1.89
-0.24
0.90
1.47
2.64
2.06
9.93
0.76
3.67
5.25
2.57
-0.62
NY
PA
-1.81 -6.11
7.81 -20.10
-1.69 -3.79
-4.76
5.65
-1.68
-0.06
0.28
-2.56
-1.46
1.50
-0.84 -0.13
0.42 -0.27
0.88
-2.77
-0.28
0.56
5.14
0.39
0.35
4.97
4.67
-1.01
4.66
4.09
-2.21
-3.16
24
The Answer is….
Everything!
www.fitchratings.comFidelity
Management & Research Co.
PFM
Information Prepared for the
Annual Meeting
Challenges & Uncertainty
vs.
Solutions & Opportunity
The PFM Group
Mike Mace
Managing Director
Public Financial Management
June 15, 2009
Public Power Finance in a Challenging Environment
PFM
• Introduction
• Impacts of the Financial Crisis
• Current Challenges
• The Solutions
• Preparing for the Next Challenges
26
Introduction
PFM
• 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
Public Financial Management
PFM Asset Management
Financial Advice & Strategic Consulting
Investment Management & Consulting
$50+Bn/Yr Capital Markets Transactions
SEC Registered & Regulated
10 Person Public Power Group
Managing $35+ Billion of Client Assets
-
No bond underwriting or trading for our own account
-
Helping our clients maximize financial value
-
Within risk tolerances consistent with public sector objectives
27
Crisis… What Financial Crisis?
PFM
•
Borrowing Costs Under /Around 5.00%, Short-Term Rates Almost Zero!
•
Investment Rates are Up, Stock Market Has Been Strong
•
Natural Gas and Commodity Prices Beginning to Make Sense Again
Rates %
Long Term Rates Over the Past Year
8.00
AAA GO
A ELEC REV
TREASURY
7.00
6.00
5.00
4.00
3.00
2.00
28
More Good News Than We Have Time For
•
•
•
PFM
Retail Investors Have Been Big Buyers of Public Power Bonds
-
LIPA in January
~$250 MM Retail Orders for $435 MM Bonds
-
SRP in January
~$300 MM Retail Orders for $744 MM Bonds
-
JEA in February
$71 MM Retail Orders for $129 MM Bonds
-
Energy Northwest in March
-
JEA in April
$98 MM Retail Orders for $64 MM Bonds
-
CMEEC in April
$68 MM Retail Orders for $38 MM Bonds
~$270 MM Retail Orders for $370 MM Bonds
Taxable Build America Bonds Have Been a Huge Success
-
SMUD sells $200 MM long-term bonds at a net rate of 4.11%
-
CPS Energy sells $375 MM long-term bonds at a net rate of 3.89%
-
Both issues receive investor orders ~4+ times their size
MEAG Power & CPS Energy Projects Atop DOE Nuclear Guarantee List
29
More Good News Than We Have Time For
•
PFM
MEAG Power Finances Initial Stage of Vogtle Expansion
-
Tax-exempt, 13-month notes ranging from 0.47% to 0.85%
Taxable, 13-month notes at 1.90%
Total of ~$500 MM averaging 0.84%
•
OUC Sells $200 MM One-Year Notes at 0.45%
•
SRP Rolls 30- and 60-Day Commercial Paper at 0.23% and 0.28%
•
JEA Short-Term Bonds Reset at 0.23%
•
MMWEC “Failed” Auction Rate Bonds Reset at 0.06% (not a typo!)
•
SMMPA Renews Two-Year Credit Facility at 0.70%
30
Public Power Financing – Challenges Remain
PFM
• #1: Change - Dramatic, Fast-Paced & Unprecedented
THEN
NOW
commonplace
non-existent
– Auction Rate:
solution
problem
– Bank Letter/Lines:
cheap → expensive → unavailable
– Bond Insurance:
– Gas Prepays:
– Bond Market:
huge savings
huge headaches
good → volatile → closed → wide open
– Derivatives:
free money
&*$%#@!
– Fuel/Energy Hedging:
saving money
just a hedge
Last Year’s Solutions Became This Year’s Problems
Fortunately, the Problems Have Been Manageable
Public Power Fares Better Than Most Market Sectors
31
Public Power Financing – Challenges Remain
•
PFM
#2: Long-Term Planning in a Time of Uncertainty
-
Resource decisions: WHAT?, WHEN?, IF?
-
The high cost of risk aversion and mitigation
-
When does “normal” return and what does it look like?
-
How do you make 40+ year decisions in a 12-month window of turmoil?
•
#3: Managing Environmental Alternatives, Impacts & Costs
•
#4: The Economy vs. Credit Strength
-
High credit ratings have never been more valuable
-
Your customers are under considerable pressure
-
Local governments have significant needs
-
Where is the proper balancing point?
32
Public Power Financing – Challenges Remain
•
•
PFM
#5: Liquidity Concerns
-
Fuel and purchased power contract collateral postings
-
Interest rate swap collateral postings and termination payments
-
Revenues falling or failing to rise
-
Rating agency scrutiny of bank letter/line of credit repayment provisions
-
The business is more volatile, and requires more reserves
-
Yet liquidity is more expensive than in the past
#6: Reduced Competition on the Financial Playing Field
-
Fewer Underwriters, Insurers, Commercial Banks
-
Staffing has declined at remaining firms
-
Fees have increased
-
Bank Letter/Line capacity and pricing will remain a problem
-
Short-term program fees are up to 6X the actual short-term interest rates
33
Public Power Financing – The Challenges
PFM
• How Are We Doing So Far?
→
34
Public Power Financing – The Solutions
•
PFM
The Stimulus Bill and Build America Bonds
-
Taxable bond with a 35% Issuer Interest Subsidy from Treasury
Provides theoretical full value for tax-exemption, resulting in ~4.00% net rate
Public power is well positioned to enter the taxable market
Taxable investors understand utility credits and can compare you to IOUs
Spread to
30YR Treas
4.00%
Build America Bond Initial Treasury Spreads
NY MTA
AA-
3.50% NJ TPK
A
CAL GO
A
3.00%
UVA
AAA
2.50%
SMUD
A+
2.00%
ILL Toll
AA-
CPS
AA+
1.50%
1.00%
4/15
4/20
4/23
4/28
5/1
5/6
5/11
5/14
5/19
5/22
5/27
6/1
6/4
35
Public Power Financing – The Solutions
•
PFM
The Stimulus Bill and Build America Bonds, Examples:
Selected Build America Bond Results
Date
04/22/09
05/05/09
06/02/09
-
Issuer
CAL GO
SMUD
CPS Energy
Rating
A2/A/A
A1/A+/A
Aa1/AA/AA+
Rate
7.43%
6.32%
5.98%
Treas
Spread
3.65%
2.25%
1.45%
Net Rate
4.83%
4.11%
3.89%
Savings vs Tax Savings vs Tax
Exempt
Exempt
~0.60%
~1.15%
~0.90%
~ $60 MM
~ $90 MM
And positive side effects from $10+ Billion reduction in tax-exempt volume
Rates %
Long Term Rates In Recent Months
5.00
Reduced
Volume Helps
Muni Market
4.75
4.50
4.25
4.00
AAA GO
TREASURY
3.75
3.50
4/15
4/22
4/29
5/6
5/13
5/20
5/27
6/3
36
Public Power Financing – The Solutions
•
PFM
However, No Good Deed Goes Unpunished by the Financial Media
Taxpayers Lose $328 Million in Build America Profits
By Darrell Preston and Bryan Keogh
May 4 (Bloomberg) -- State and local public finance officials from New Jersey
to California rewarded investors with $328 million of instant profit by selling
debt through the federal government’s Build America Bonds program.
(continued)…
37
Public Power Financing – The Solutions
•
•
PFM
Other Tax Credit Bonds Can Deliver Near 0% Financing
-
Renewable and conservation expenditures qualify for tax credit financing
-
Investor received a Federal tax credit instead of interest from borrower
-
Limited size and uncertain allocations are considerable drawbacks
-
The current program partially rewards, but does not incentivize, renewables
-
The tax credit market needs taxpayers
DOE Loan Guarantees and Other New Technology Incentives
-
Value and availability of guarantees are uncertain
-
DOE Nuclear Guarantees: from marginal, to valuable, to essential, to optional???
-
If administered properly, it can be a powerful program
38
Public Power Financing – The Solutions
PFM
• House Financial Services Committee Proposals
-
Municipal Bond Insurance Enhancement Act
Treasury Dept. Office of Public Finance to reinsure up to $50 BN annually
-
Municipal Bond Liquidity Enhancement Act
Federal Reserve/TARP to lend money for the purchase existing variable-rate debt
-
Municipal Financial Advisors Regulation Act
Financial Advisor standards and SEC-registration
-
Municipal Bond Fairness Act
Require credit ratings system to reflect comparable risks of default
Some or All of This Could be Helpful
Some or None of This Might Actually be Implemented
39
Public Power Financing – The Solutions
PFM
• Investors Still Have Money on the Sidelines:
-
Educated, credit-sensitive institutional investors can help public power
Retail investors must be willing to come out of their shells
Credit Crisis Sends
Investors Packing
40
Public Power Financing – The Solutions
PFM
• Preserving Credit Strength
-
Balance local, ratepayer and bondholder interests
-
Do what you can, but no downgrades
-
Credit spreads are higher than ever – Cost of Downgrade Studies
-
Avoid the Straw That Breaks the Camel’s Back
Incremental action leading to a downgrade is VERY expensive
Downgrades take many years to reverse
Borrowing the extra $50 MM may raise interest costs on future $Billions
• Educated and Informed Public Power Constituents
-
Work with the Board to make informed decisions
-
Helping ratepayers understand the value of their public power asset
41
Preparing for the Next Challenges
PFM
• Ongoing Concerns
– Federal Debt and the Impact on Interest Rates
– Economic Impact on Credit Ratings
– Headline Risk Effect on Investors
– Bank Credit Enhancement Market Taking Years to Normalize
42
Preparing for the Next Challenges
PFM
• Ultimately, There Will Be a Price for All the Federal Help
-
Drastically Climbing Federal Debt and Guarantees
- Debt Up 27% in past 18 months:
from $9.0 to $11.4 Trillion
43
Preparing for the Next Challenges
PFM
• We May Just be Starting to Pay the Price
-
Normalization, or the start of a trend?
Rates %
Sharply Rising 30-Yr Treasury Rates
5.00
4.50
4.00
3.50
3.00
2.50
2.00
Sep-08
Oct-08
Nov-08
Dec-08
Jan-09
Mar-09
Apr-09
May-09
Jun-09
44
Preparing for the Next Challenges
PFM
• What Will Help Us Meet the Challenges
– The Tax-Exempt Product Will be Essential to Investors
– Retail Investors are the Backstop to Higher Rates
– The Bond Market Will Remain Open and Provide Access to Capital
– Commercial Banks Will Recognize Public Power Value and Safety
– Public Power Will Continue to Outperform Other Sectors
45