Debt ManagementAn issuer’s and an investor’s point of view

Stifel Nicolaus

Jones Hall Franklin Templeton

City of San José

Sara BrownManaging Director

Steve MelikianPartner

Jennifer JohnstonAnalyst, Municipal Bonds

Peter DetlefsDebt Administrator

Market We Work In:General Fund Financings in a Bankruptcy World

A Word About Lease Financings•COPs / Lease Revenue Bonds were created

to circumvent statutory limitations on debt issuance▫ Not considered “debt” because of judicially recognized

exception to debt limit for leases•Obligation to budget and appropriate the

lease payment so long as city has use/possession of an identified asset ▫ Because the lease payments must be appropriated annually,

they are not binding on future councils ▫ Market perceives a difference among city-owned assets:

essentiality

Credit Market Concerns Reflect the Inherent Structure of this “Debt”

•No clear prioritization of debt repayment vs. other general fund expenditures

•Possible unwillingness to repossess the leased asset

•Possible inability to re-let the leased asset

Rating Agencies React•Moody’s recently increased its differential

between a city’s GO bonds and its general fund obligations, because leases:▫are highly exposed to city’s general

finances▫compete with other city funding priorities▫For most cities, the result is a 2-notch

differential •S&P has traditionally concluded on a 1-

notch differential

Best of Times // Worst of Times•Best of Times:

1. Interest rates in general are extremely low

•Worst of Times:1. Relative to the general market, interest

rates for general fund leases are higher Wider spreads to MMD

2. Concerns about future downgrades

Investor Reaction •Several large institutional funds will no

longer purchase lease-backed obligations▫Insurance provides no value

•For the most part, individual retail investors will not purchase lease transactions▫Just too much risk▫Maybe insurance will resurrect interest

Concerns Lead to Bifurcated Market• Issuance w/ Relative

Ease▫Large transactions

> $50 million ▫Well-known

municipality▫Frequent participant

in market

→ more secondary market liquidity

•Issuance w/ Market Challenges▫Small transactions

<$30 million▫Less-known

municipality▫Infrequent issuer

→ less secondary market liquidity

Black & White:Bond Counsel “Clarifies” Bankruptcy Law

POTENTIAL AREAS OF SAVINGS IN BANKRUPTCY•Labor Contracts•Pensions (?)•Retiree Health Care•Bond Debt Service•Constitutional Limitation on Debt

Prevents Other Long-term General Fund Liabilities

Labor Contracts•Cut Pay

•Cut Benefits

•Cut Employees

Pensions (?)•Are Pensions protected in Bankruptcy?•Two arguments against changing:

▫ Pensions are contracts and have special statutory protection under State law that cannot be impaired

▫ California courts have continually upheld the primacy of pensions, which should be honored by a Federal bankruptcy judge

•“Impairment” requires:▫ a legitimate fiscal crisis or emergency;▫ that the proposed solution is reasonable and necessary to

address the fiscal crisis or emergency; and▫ That there is not a less intrusive way to accomplish the same

result

Retiree Health Care•Appears to have no similar (to Pensions)

protection under California Law

•Stockton has reduced its payments for Retiree Health Care

Bond Debt Service•Revenue Bonds with statutory liens are

protected in a Chapter 9 Proceeding•Sentiment is that G.O. Bonds are similarly

protected since tax overrides can only be used for G.O. Bond Debt Service

•General Fund Obligations –COPs, Lease Revenue Bonds & POBs– are at risk

•Asset Essentiality becomes important as the bankrupt entity seeks to “walk away” from the lease

Creditor’s Commentary:An Investor Explains It’s Decision Tree

Decision-Making Process•Bond Security•Issuer Credit

Quality▫ Legal/structural

framework▫ Financial position▫ Debt & pension burden

•Disclosure•Market

▫ Supply of alternative bonds

▫ Retail•Buy – Sell - Hold

Bond SecurityIssuer Credit Quality

▫ Demographics, economy & wealth indicators

▫ Discussion with management

Disclosure•Market

▫ Rates▫ Daily pricing of the funds

Buy – Sell - Hold

How Have Things Changed?•Insurance

•Ratings

•Media / Headline Risk

•Disclosure

Challenges•Decision-making in a political

environment•Pensions, unions, long-term liabilities•Bankruptcy•Appropriation risk•Essentiality•Headlines/Media•Partnerships between issuers and buyers

Speaking to the Market:An Issuer Explains It’s Debt Management Procedures

Primary Disclosure•Development of an Official Statement

•Appendix A – general City information prepared and updated by City staff

•Actively engage more staff in disclosure process▫ Budget Office▫ Retirement Staff▫ Public Works▫ City Attorney’s Office

Evolving Pension Disclosure•Growth in sheer volume of pension

disclosure▫ Between 2003 and 2013, increased from 2 pages to 40

pages

•Extensive review, each and every time enter the capital markets by: ▫ Plan Actuary▫ Retirement Staff▫ City Attorney’s Office▫ Disclosure Counsel

Secondary Market Disclosure•Annual Report pursuant to requirements

of Continuing Disclosure Agreement

•Rating Agencies’ Periodic Review

•Comprehensive Annual Financial Report

•Material Event Notices

Reporting•Publically available reporting and periodic

education with City Council on matters related to disclosure and finances▫ Quarterly investment and debt reports▫ Comprehensive annual debt report▫ Monthly financial reports▫ Comprehensive staff reports highlighting key disclosure

issues▫ City Council study sessions

•CAFR presented to City Council within 5 months after end of Fiscal Year

Key Points We ALWAYS Remember•Disclosure is the CITY’S responsibility

•Cannot solely rely on consultants▫ Be active and INVOLVED in the process

•Disclosure is hard work and is NEVER done

•Disclosure is CRITICAL to the city’s success in the marketplace