M E M O R A N D U M To: Jim Moncur and Jennifer Olenick, City of Houston Department of Finance From: Bank of America Merrill Lynch TeamDate: December 21, 2010Purpose: Market UpdateIn February 2010, the City of Houston selected Bank of America Merrill Lynch to underwrite a financing f or the Combined Utility Sy stem. The deal was scheduled to price in May 2010, with funds delivere d around June. Due to a v alidation suit the bond sale has been delayed, forcing the City to draw from its Commercial Paper program over the last seven months and putting the City at considerable risk for h igher financing costs. This is largely attributed to a dramatic increase in long- term interest rates during the past two months (please see accompanying chart) and the potential loss of the Build America Bonds financing program. The BABs pro gram was a temp orary program that was scheduled to expire on December 31, 2010 and has not been extended. As a result of these market conditions , the City’s cost of financing has increased dramatically. This memo is in response to your request for us to provide an estimate of how much the change in interest rates has cost the City and the ratepayers of the CUS when compared to the market in May 2010. To simplify our analysis, we focused on a $300 million CP program; however, it is fair to say that the City could have executed a larger transaction back in May, which means that the dissavings we calculate below are arguably understated. Due to the delay, the City has funded its capital e xpenditures using CP, which has been relatively cost-effe ctive due to historically low short-term rates. The interest cost savings from issuing CP over the past seven months are factored into our analysis 1 . If the City had issued long- term debt in May, the all-in cost would have been approximately 4.22%. The table below summarizes the results of our analysis. By not being able to sell the bonds in May 2010, the delay has cost the City and Houston ratepayers an estimated $37.72 million over the life of the issue 2 . This represen ts an average cost of $1.26 milli on per year over the next 30 years. 1 Assumes CP all-in cost of 1.00% (inclusive of credit fees) versus bond yield of 4.15% for seven months 2 Present Value dissavings amount to approximately $21.07 million assuming a discount rate of 4.15% Tax-Exempt Bonds Today Tax-Exempt/BABs in May Delivery Date 2/1/2011 6/1/2010 First Principal Payment Date 11/15/2016 11/15/2016 Par Amount $297, 54 0,000 $30 2, 57 5,000 Construction Fund $300,000,000 $300,000,000 Arbitrage Yield 4.864422% 4.150109% All-in-T.I.C. 4.931910% 4.216970% Average Annual Debt Service $20,479, 083 $18,690, 324 Gross Savings ($) $37,719,610 Average Annual Savings ($) $1,257,320 ↑ 62 bps ↑ 66 bps 3.00% 3.50% 4.00% 4.50% 5.00% 0 5 / 1 4 / 1 0 0 6 / 1 4 / 1 0 0 7 / 1 4 / 1 0 0 8 / 1 4 / 1 0 0 9 / 1 4 / 1 0 1 0 / 1 4 / 1 0 1 1 / 1 4 / 1 0 1 2 / 1 4 / 1 0 20y MMD 30y MMD ↑ 62 bps ↑ 66 bps 3.00% 3.50% 4.00% 4.50% 5.00% 0 5 / 1 4 / 1 0 0 6 / 1 4 / 1 0 0 7 / 1 4 / 1 0 0 8 / 1 4 / 1 0 0 9 / 1 4 / 1 0 1 0 / 1 4 / 1 0 1 1 / 1 4 / 1 0 1 2 / 1 4 / 1 0 20y MMD 30y MMD
To: Jim Moncur and Jennifer Olenick, City of Houston Department of Finance
From: Bank of America Merrill Lynch Team
Date: December 21, 2010
Purpose: Market Update
In February 2010, the City of Houston selectedBank of America Merrill Lynch to underwrite afinancing for the Combined Utility System. The
deal was scheduled to price in May 2010, withfunds delivered around June. Due to a validationsuit the bond sale has been delayed, forcing theCity to draw from its Commercial Paper programover the last seven months and putting the City atconsiderable risk for higher financing costs. Thisis largely attributed to a dramatic increase in long-term interest rates during the past two months(please see accompanying chart) and the potential
loss of the Build America Bonds financingprogram. The BABs program was a temporaryprogram that was scheduled to expire onDecember 31, 2010 and has not been extended. As a result of these market conditions, the City’s cost offinancing has increased dramatically.
This memo is in response to your request for us to provide an estimate of how much the change ininterest rates has cost the City and the ratepayers of the CUS when compared to the market in May 2010.To simplify our analysis, we focused on a $300 million CP program; however, it is fair to say that the City
could have executed a larger transaction back in May, which means that the dissavings we calculatebelow are arguably understated. Due to the delay, the City has funded its capital expenditures using CP,which has been relatively cost-effective due to historically low short-term rates. The interest cost savingsfrom issuing CP over the past seven months are factored into our analysis 1. If the City had issued long-term debt in May, the all-in cost would have been approximately 4.22%.
The table below summarizes the results of our analysis. By not being able to sell the bonds in May 2010,the delay has cost the City and Houston ratepayers an estimated $37.72 million over the life of theissue2. This represents an average cost of $1.26 million per year over the next 30 years.
Tax-Exempt Bonds
Today
Tax-Exempt/BABs
in May
Delivery Date 2/1/2011 6/1/2010
First Principal Payment Date 11/15/2016 11/15/2016
Average Life (years) 19.630Duration of Issue (years) 12.324
Par Amount 297,540,000.00Bond Proceeds 302,233,612.45Total Interest 292,030,050.00Net Interest 288,824,137.55Total Debt Service 589,570,050.00Maximum Annual Deb t Service 21,289,250.00Average Annual Debt Service 20,479,083.17
Par Average Average PV of 1 bpBond Component Value Price Coupon Life change
Serial Bonds 143,235,000.00 106.765 5.000% 13.714 120,258.80Term Bond due 2035 77,115,000.00 97.223 5.000% 22.889 104,876.40Term Bond due 2039 77,190,000.00 96.301 5.000% 27.351 111,153.60
297,540,000.00 19.630 336,288.80
All-In ArbitrageTIC TIC Yield
Par Value 297,540,000.00 297,540,000.00 297,540,000.00+ Accrued Interest+ Premium (Discount) 4,693,612.45 4,693,612.45 4,693,612.45- Underwriter's Discount -1,487,700.00 -1,487,700.00- Cost of Issuance Expense -743,850.00- Other Amounts
Target Value 300,745,912.45 300,002,062.45 302,233,612.45
Target Date 02/01/2011 02/01/2011 02/01/2011Yield 4.911311% 4.931910% 4.864422%
