Investing Bond Proceeds

1. Investing Bond Proceeds • CDIAC @ Inland Empire Association of Government Accountants • Hilton San Bernardino • San Bernardino, California • October 8, 2008

2. Investing Bond Proceeds The Bonds Have Been Issued ... Now What? • Congratulations! • Months of careful planning are over • At last, the Bonds have been issued • You’ve locked in at a low cost of funds • Now it’s time to get back to your regular duties • Do Not Forget About the Bond Proceeds • Probably on your “To Do List” • Typically are forgotten • Are unique assets considering the arbitrage rebate and yield restriction requirements - you want to owe rebate

3. Investing Bond Proceeds Why Bother Worrying About Investments? • Costs • Interest costs accrue on bonds immediately so... • Negative carry (i.e., negative arbitrage) on investments increases financing cost • Improved investment performance will... • Reduce negative carry, and even lower overall borrowing costs • Typical Funds • Project Funds • Net funding + more earnings = smaller bond issue • Gross funding + more earnings = more project funds • Reserve Funds • Earnings will offset debt service costs • Higher earnings here can offset costs of negative carry in Project Funds • Debt Service Funds • More earnings = less net debt service (this is a good thing!)

4. Investing Bond Proceeds Formulating an Investment Strategy - General Principles • Public Funds Investing Oath of Responsibility • Bond proceeds are actually the public’s assets • Safety • Protect your principal by minimizing credit risk • Liquidity • Ensure that funds are available when needed • Too long...market price risk • Too short...reinvestment rate risk • Matched to expectations...just right • Yield • Matching liabilities and assets • Floating or fixed rates • Generate consistent risk-adjusted returns • Arbitrage rebate requirements may prohibit you from retaining additional earnings from higher yielding investments (i.e. riskier)

5. Investing Bond Proceeds Formulating an Investment Strategy - Practical Considerations • When Do I Start? • Once the structure and sizing of the debt is known • If you plan on using an investment advisor, do so at the beginning of your debt issuance, not at the end. • And it shouldn’t cost you anything more • Add investment advisor to the “Financing Team” • Integral Part of Debt Strategy • Do you net fund or gross fund? • Surety or cash-funded DSR? – Example • Can’t I wait for rates to go higher, it seems like a good bet? • Yes....No....Maybe.... Did you say “bet?”

6. Investing Bond Proceeds Formulating an Investment Strategy - Practical Considerations - continued • Case Study • $50,000,000 new money financing • 25 year amortization • Bond yield = 4.67% • Construction Fund = 4.44% • Total debt capacity may determine whether to purchase a surety bond or fund a Reserve Fund

7. Investing Bond Proceeds Formulating an Investment Strategy - Arbitrage Rebate Requirements • Recalling the Implications of the Arbitrage Rebate Requirements • Goal: Positive arbitrage without compromising safety or liquidity • Prepare prospective arbitrage rebate models for competing investment alternatives • If positive arbitrage is attainable, consider enhancing safety and liquidity • Consider expenditure exceptions if positive arbitrage can be achieved in the project funds

8. Investing Bond Proceeds What other issues do I need to consider? • As Glenn mentioned, rebate expectations • Positive vs. Negative Arbitrage • Confidence in expenditure schedule • Good estimate vs. Level Draws • Risk tolerance / comfort with investment options • Conservative vs. Less risk adverse • Market outlook

9. Investing Bond Proceeds Investment Approaches & Options • “Passive” Approach • Local Government Investment Pool (e.g. San Bernardino County Pool) • Money Market Mutual Fund • Asset/liability matched strategy using portfolio of securities • Investment Agreement • “Active” Approach • Managed Portfolio of Securities

10. Investing Bond Proceeds Passive Investment Approaches • LGIP or Money Market Fund • Advantages: Daily liquidity, stable NAV, low credit & market risk • Disadvantages: Fluctuating interest rates, opportunity cost • Asset/Liability Matched Portfolio • Advantages: Liquidity, manage reinvestment risk, manage market risk, lock-in interest rates • Disadvantages: Potential losses if securities need to be liquidated, non-IRS subsidized fees • Investment Agreement (e.g., Flex-Repo, GIC, FDA) • Advantages: Liquidity, eliminate reinvestment risk and market risk, lock-in interest rate • Disadvantages: Opportunity costs if rates subsequently increase, reinvestment risk if proceeds remain unspent after agreement matures

11. Investing Bond Proceeds Active Investment Approaches • Managed Investment Portfolio • Interest rate view: Rates expected to rise more than is forecasted by current shape of the yield curve • And/or • Project Expectations: Draw schedule uncertain and likely to significantly change • Advantages: Flexibility to adjust strategy, lock-in rates, liquidity • Disadvantages: Lower returns / opportunity cost, non-IRS subsidized fees

12. Investing Bond Proceeds How do I make my decision? • In addition to safety and liquidity considerations….. • Arbitrage Considerations - degree of expected arbitrage position may broaden or narrow options • Draw schedule – Maintain flexibility if draws are less certain • Risk Tolerance / Investment Comfort – Ok to stay within your “comfort zone”, but consider alternatives, particularly if they may make sense • Interest Rate Outlook – Do current interest rates reflect rational expectations?

13. Investing Bond Proceeds • Questions?