1. Debt Capacity and Affordability California Debt and Investment Advisory Commission Municipal Debt Essentials – Accessing the Debt Market February 2, 2011

2. Topics and Presenters  Legal limitations on debt capacity David Glasser, Finance Manager Bay Area Air Quality Management District 415.749.4771 dglasser@baaqmd.gov  Debt and affordability as a credit factor Karen Ribble, Senior Director Fitch Ratings 415.732.1756 karen.ribble@fitchratings.com  Analysis of debt affordability to determine debt capacity Mike Kremer, Senior Vice President First Southwest Company 310.401.8050 michael.kremer@firstsw.com 1

3. Legal limitations on debt capacity

4. General limitations Legal limitations on debt capacity  Proposition 13 (1978) Article XIIIA (Tax Limitation) Article XIIIB (Spending Limitation: Proposition 4) Article XIIIC (Voter Approval for Tax Levies) Article XIIID (Assessments and Property Related Fees)  Proposition 218 (1996)  Proposition 26 (2010) 3

5. Other debt capacity limitations Legal limitations on debt capacity  Limitations on annual increases CPI Adjustments Cost of service restrictions  Restricted use funds 4

6. Debt and affordability as a credit factor

7. Analysis of an entity’s debt profile is one of Fitch’s key rating factors Debt and affordability as a credit factor  Tax-supported debt (e.g. GO bonds and lease obligations)  Extent and nature (fixed or variable for example) of the entity’s current debt level  Outlook for future debt level  Focus on affordability and flexibility  Overlapping debt and its role in an entity’s debt profile  Includes debt issued by overlapping taxing entities  Self-supporting debt (e.g. water and sewer revenue bonds) 6

8. Trends and debt ratios Debt and affordability as a credit factor  Trends Relationship of debt/debt service to available resources and economic growth  Do fixed costs like debt service increase steeply while the economy is shrinking or growing slowly?  Debt ratios as a measure of relative affordability Debt as a percentage of taxable market value  5% is above average Debt per capita  $4,000 is above average Debt service as a percentage of general and debt service fund spending  > 10% of general and debt service fund spending is above average 7

9. Future capital and debt needs Debt and affordability as a credit factor  Significant infrastructure needs and debt plans can weaken an otherwise strong debt profile  Comprehensive five-year capital improvement plan Standard among highly rated local governments Effective tool to prioritize projects recognizing limited resources Fitch evaluates changes over time in the size and scope of the CIP to gauge future demands for capital funding Ability to meet capital needs where there are debt issuance restrictions (e.g. voter approval requirements) 8

10. Debt structure and amortization Debt and affordability as a credit factor  30-year amortization is typical, matching the useful life of the project 25% amortized in 5 years and 50% in 10 years is average and a neutral credit factor Above 65% in 10 years is considered rapid and a credit strength Below 40% in 10 years is considered slow and a credit weakness  Variable rate obligations 15%-20% is a prudent range for most issuers in at least the ‘AA’ category. Below ‘AA’, more than 15% of variable rate debt and/or derivatives is considered a risk 9

11. Pension and other post-employment benefits Debt and affordability as a credit factor  More flexible commitment to future payments than publicly issued debt – i.e. can be influenced by a variety of actuarial, accounting, investment or other policy decisions  Focus on the size of the liability, funded ratio, measures of affordability (annual cost as percent of spending), and actuarial assumptions.  Review actions to reduce large liabilities  Pension or OPEB debt obligations 10

12. Revenue-supported debt analysis Debt and affordability as a credit factor  Purpose  Justified by capacity constraints, projected market growth, or competitive opportunities  Demonstrable need for CIP (e.g. through econometric analysis and consultation with regional and economic development and planning agencies)  Ability to service planned debt from existing operations  Magnitude  Actual and expected amount of outstanding debt service compared to historical and expected revenue streams  Structure  Fixed rate bonds with amortizing principal within the assets expected life  For variable rate issuers, ability to manage interest rate and liquidity risk  Legal Provisions  Security pledges, rate covenants, events of default, additional bonds test, reserve requirements, and bank bond provisions for variable rate bonds 11

13. Analysis of debt affordability to determine debt capacity

14. Reasons for debt financing capital projects relative to the PAYGO alternative Analysis of debt affordability to determine debt capacity  Intergenerational equity Spread costs over the long-term life of the debt financed asset  Timely compliance with regulatory mandates Wastewater treatment plant  Expand infrastructure to provide service or facilitate economic growth School, streets and sewers, and redevelopment of blighted areas  Expedite operational date of revenue generating facilities Power plant, airport terminal, etc.  Manage other long-term liabilities Pension obligations and other post-employment benefits  Match grant funds from intergovernmental and private sources State of CA School Facility Program 13

15. Debt affordability analysis is as much an art as a science Analysis of debt affordability to determine debt capacity  Debt affordability analysis is used to establish spending priorities, maintaining a balance between capital needs and fiscal resources  Debt burden metrics (compared to historic and peer group levels) are tools employed to gauge the capacity for new debt issuance  Tax-supported debt ratios – transforming sources of wealth into revenues through taxation makes these sources good indicators of a borrower’s ability to repay its obligations Debt as a percentage of assessed value Debt per capita Debt as a percentage of personal income  Revenue supported debt ratios – the budgetary resources of general fund and self- supporting enterprises are used to measure debt capacity Debt service as a percentage of general fund expenditures (or revenues) Coverage of debt service by net revenues, typically defined as pledged revenues net of operating expenses (excluding non-cash charges like depreciation) 14

16. Example 1: Capacity of AA rated school district to issue additional GO bonds Analysis of debt affordability to determine debt capacity  School district has $5.52 billion of outstanding GO bonds at June 30, 2010  Debt as a percentage of assessed value metric is utilized to gauge debt capacity -- 2.5% ratio is selected as policy maximum (legal debt limit) Ratio at June 30, 2010 is 1.70% Assessed valuation projections should be reasonable $3.35 billion is total amount of affordable additional GO bonds over five years (subject to voter authorization) 15

17. Example 2: Capacity of AA rated school district to issue additional GF debt Analysis of debt affordability to determine debt capacity 16  School district as $218.6 million of outstanding lease obligations at June 30, 2010  Debt service as a percentage of general fund expenditures is utilized to gauge debt capacity -- 1.5% ratio is selected as policy maximum  Ratio at June 30, 2010 is 0.27%  Budget projections should be reasonable  $1.131 billion is total amount of affordable additional GF lease obligations over five years

18. Example 2: Capacity of AA rated school district to issue additional GF debt Analysis of debt affordability to determine debt capacity 17

19. Example 3: Capacity of AA- rated utility to issue additional revenue obligations Analysis of debt affordability to determine debt capacity 18  Water utility has $209.0 million of outstanding installment sale COPs at June 30, 2010  Coverage of debt service by net revenues is utilized to gauge debt capacity - - 1.75x ratio is selected as policy maximum Debt service coverage ratio at June 30, 2010 is 2.56x Budget projections should be reasonable $52.27 million is total amount of affordable additional installment sale COPs over five years

20. Example 3: Capacity of AA- rated utility to issue additional revenue obligations Analysis of debt affordability to determine debt capacity 19