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Current Debt Policy - 3-22-04 DEBT MANAGEMENT POLICY 3/22/04 METROPOLITAN ST. LOUIS SEWER DISTRICT Table of Contents Introduction.....................................................................................................................1 Policy Statement.............................................................................................................2 Formulating Rates and Charges......................................................................................3 Types of Debt..................................................................................................................4 Purpose of Debt..............................................................................................................5 Types of Products ...........................................................................................................7 Structural Features........................................................................................................11 Funds and Accounts......................................................................................................13 Credit Objectives...........................................................................................................14 Method of Bond Issuance..............................................................................................14 Use and Investment of Bond Proceeds .........................................................................16 Documentation of Transactions.....................................................................................17 Market Relationships.....................................................................................................17 Consultant & Investment Banking Firm Selection..........................................................17 Glossary of Terms.........................................................................................................21 Metropolitan St. Louis Sewer District – Debt Management Policy - 1 - Metropolitan St. Louis Sewer District Statement of Policy Debt Management & Formulation of Rates and Charges March 22, 2004 Introduction In 2000 the Metropolitan St. Louis Sewer District (“MSD”) began a comprehensive review of capital infrastructure needs, directing the preparation of several studies and plans as follows: “Program Planning of the District’s Capital Improvement and Replacement Program”, prepared by Sverdrup/Kwame/Metcalf & Eddy Joint Venture, September 2002; “Strategic Five-Year Business Plan—2002-2007”, initially prepared in 2001 by MSD with participation of a citizens group. The Strategic Plan is updated annually. “Report on Revenue Requirements, Costs of Service, and Rates for Wastewater Service”, prepared by Black & Veatch, April 2002; “Stormwater User Charge Study,” prepared by Camp Dresser & McKee Inc., (In Process). As a result of this planning process MSD identified wastewater system capital needs totaling $3.7 billion and storm sewer system capital needs totaling $1.0 billion (in 2002 dollars) to be completed over an eighteen year period. A November 2000 voter referendum approved amendments to MSD’s charter, or “Plan of the Metropolitan Sewer District” to enhance accountability to the public and broaden MSD’s authorization to access debt financing. Key provisions of the 2000 MSD Charter amendment included the following: Establishment of a Rate Commission to review proposed rate changes and advise the MSD Board of Trustees, (the “MSD Trustees”) regarding proposed rate changes; Creation of the position of Internal Auditor appointed by the MSD Trustees; Instituting a requirement for a Management Audit to be completed every five years: Instituting a requirement for preparation of a continuing Five-Year Strategic Plan to be updated and approved annually; Instituting term limits for the members of the MSD Trustees; Permitting the issuance of district-wide revenue bonds to fund capital projects, subject to a voter approval requirement based on a simple majority; and Metropolitan St. Louis Sewer District – Debt Management Policy - 2 - Providing for the sale of bonds by negotiated, as well as competitive, sale. Based on engineering studies and reports, the MSD Board of Trustees (the “MSD Trustees”) identified Phase One Capital Improvement and Repair Program (the “CIRP’) totaling $647 million to be funded by a combination of bond proceeds and revenues to be generated by an increase to sewer rates and charges. A proposal was forwarded to the Rate Commission on May 16, 2002 for a multi-year increase to rates and charges that would facilitate the funding of approximately $147 million in capital projects on a pay-as-you-go basis (“PAYG”), and fund the repayment of $500 million in MSD Sewer Revenue Bonds. The Rate Commission approved the rate proposal in October 2002 and approved an amendment to the rate proposal in May 2003. The initial rate increase was adopted by the MSD Trustees and became effective August 1, 2003. A District wide referendum was held February 3, 2004, with voters authorizing the issuance of $500 million in MSD Wastewater System Revenue Bonds. Policy Statement The purpose of the Debt Management Policy is to guide current and future decisions related to the formulation of rates and charges and the issuance of debt to fund capital projects identified in the CIRP, and authorized by the MSD Trustees. Rates and charges for wastewater service will be established at levels adequate to ensure both the timely payment of all debt to be issued and to provide adequate surplus revenue to maintain the fiscal integrity of utility operations and fund a portion of the long-term CIRP. This Debt Management Policy confirms the commitment of the MSD Trustees to sound financial management practices. It is MSD’s policy to: Undertake a multi-year planning approach to facilitate both timely and equitable changes to rates and charges, and actively communicate information to MSD ratepayers and stakeholders regarding the financial health of MSD and forecasts of future funding needs; Maintain a strong financial foundation for MSD operations and completion of the CIRP; Assure access to the capital credit markets; Establish and maintain high credit quality for MSD debt; and Achieve the lowest aggregate CIRP financing costs consistent with a prudent degree of risk and the recognition of ratepayer affordability. The Debt Management Policy incorporates elements and information from a number of sources, including existing MSD practices and procedures, national credit agency guidelines, national and industry policies and best practices employed by high performing public entities. The MSD Trustees recognize that the Debt Management Policy may be amended or modified from time to time and reserves the right to waive or modify any of the policies and guidelines included Metropolitan St. Louis Sewer District – Debt Management Policy - 3 - herein if, in its judgment, doing so advances the MSD’s objectives and is deemed fiscally prudent. Funding the Long-Term CIRP In accordance with MSD’s Strategic and Operating Plan for 2002-2007, the Executive Director will ensure the completion and timely updates of a comprehensive capital improvement program including the preparation of a 15- year CIRP. Stormwater projects and wastewater infrastructure projects will be financed by separate funding sources. Stormwater projects will be financed through stormwater charges, with some current funding derived from subdistrict specific property taxes. The issuance of Stormwater Revenue Bonds may be considered at a later date. Wastewater infrastructure projects will be funded by wastewater charges and Wastewater System Revenue Bonds. Appropriate ranking systems for stormwater and wastewater infrastructure projects will be utilized to develop the CIRP. The ranking process for both categories of CIRP projects will reflect the following parameters: Capital projects that are necessary to ensure compliance with Federal Environmental Protection Agency and State of Missouri Department of Natural Resources rules and regulations and that protect the health and safety of MSD customers will be given the highest priority. Capital projects will be consistent with MSD’s long-term goals and mission and reflect a well-conceived plan to address infrastructure needs. Capital projects will be consistent with regulatory trends, including existing and future permit requirements and evolving Sanitary Sewer Overflow, Combined Sewer Overflow, Total Maximum Daily Load, flow blending, and storm water regulations. It is anticipated that the Long-Term CIRP will be funded with a combination of PAYG and debt financing, with debt issuance subject to voter authorization. To the extent Federal, State or other sources of grant revenues are available MSD will appropriately consider and pursue such funding sources. Given the uncertain nature of such grant sources, however, the Executive Director will include in the long-term CIRP a plan of finance for funding the CIRP that reflects PAYG and debt financing funding sources. The mix of PAYG and debt financing should balance concerns regarding the affordability of rates and charges as well as the impact of debt burden on MSD ratepayers. Formulating Rates and Charges Rates and charges will be established at levels to generate sufficient revenues to support the full cost (direct and indirect) of operations including ongoing and preventive maintenance, to ensure the timely payment of debt, to provide debt service coverage and meet other Master Bond Ordinance, provisions as applicable, and to ensure adequate and appropriate levels of liquidity and emergency reserves. Rates and charges shall be reviewed at least annually. Metropolitan St. Louis Sewer District – Debt Management Policy - 4 - Each year, at the time the annual operating and capital budget is presented for the consideration of the Trustees, the Executive Director will report to the Trustees regarding the adequacy of rates and charges to meet all legal obligations as well as the broader goals and mission of MSD. Types of Debt The MSD Trustees shall authorize and approve all debt issued for the purpose of financing a portion of MSD’s CIRP, as well as debt that may be issued for the purpose of refunding any MSD debt outstanding. The MSD Trustees may employee a Financial Advisor to assist MSD with a capital financing strategy and the evaluation or analysis of specific relevant debt management matters. When the MSD Trustees determine that the use of debt is appropriate, the following criteria will be utilized to evaluate the type of debt to be issued. Long-Term Debt MSD may issue long-term debt (general obligation or revenue bonds) where it is deemed that capital improvements should not be financed from current revenues. Long-term borrowing will not be used to finance current operations or normal maintenance. Long-term debt will be self-supporting and structured such that the weighted average maturity of the debt does not exceed the expected useful life of the capital project. Short-Term Debt Short-term borrowing may be utilized as authorized by MSD Charter, Article 3, Section 3.020(13), for the temporary funding of capital projects or for operational cash flow deficits subject to the following policies: MSD may issue short-term debt when there is a defined and adequate repayment source. Lines of Credit may be considered as an alternative to other short- term borrowing options if it is determined to be more cost-effective. Other Short-Term Debt, including commercial paper notes, may be used when it provides an interest rate advantage or as interim financing until market conditions are more favorable for long-term debt issuance. Lease Purchase Debt Lease purchase debt, including certificates of participation, shall be considered as an alternative to long-term vendor leases. Such debt shall be subject to annual appropriation. In order to reduce the cost of lease borrowing and to improve control over leases MSD may implement a master lease program. Variable Rate Debt To maintain a predictable debt service burden, MSD may give preference to debt that carries a fixed interest rate. MSD, however, may consider variable rate debt to diversify its debt portfolio, reduce interest costs and match the durations of assets and liabilities. Prior to issuing variable rate instruments, MSD Staff and Metropolitan St. Louis Sewer District – Debt Management Policy - 5 - the Financial Advisor will analyze the savings available in comparison to fixed rate instruments and evaluate and quantify the risks associated with the variable rate debt. The most recent five-year average of the BMA Index may be used as a benchmark for determining variable rate debt cost. Ancillary costs for remarketing, liquidity, or broker-deal and tender agent fees should also be reflected in the analysis. As long as variable rate debt is outstanding, MSD will actively monitor and evaluate market conditions and shall determine if it is appropriate and cost efficient to convert the variable rate debt to fixed interest rates. Consistent with rating agency guidelines, the percentage of unhedged variable rate debt outstanding at the time of any debt issuance shall not exceed the upper limit for such debt specified by the rating agencies. Unhedged variable rate debt representing 15 to 20 percent of MSD’s total outstanding debt is an acceptable upper limit. For purposes of this limitation, variable rate debt is considered hedged if it is subject to an interest cap, has been synthetically converted to a fixed rate, or if short-term investments offset variable rate debt exposure. Short-term MSD investments for purposes of this limitation shall include monies invested and maintained for working capital and liquidity purposes. MSD may use contracts that limit exposure to interest rate volatility, such as interest rate Caps and Collars, to hedge interest rate fluctuations. Variable rate bonds may be used in conjunction with a financial strategy, which results in long-term synthetic fixed rate debt. Prior to using synthetic fixed rate debt to fund authorized capital expenditures, MSD will require that the interest rate cost is at least 20 basis points lower than traditional fixed rate debt, based on projections provided by MSD Staff and the Financial Advisor. Any risks associated with the utilization of a synthetic fixed rate debt structure will be identified and evaluated by the Financial Advisor in a written recommendation to the MSD Trustees. The risk analysis will be consistent with the provisions of this Debt Management Policy. Purpose of Debt Long-term debt may be issued to finance authorized CIRP projects, or to refund, on a current or advanced basis, outstanding debt obligations. New Money Bonds New money issues are those financings that generate additional funding to be available for expenditure on capital projects. These funds will be used for acquisition, construction and major rehabilitation of capital assets identified in the CIRP. The structure for any financing shall be recommended by the Financial Metropolitan St. Louis Sewer District – Debt Management Policy - 6 - Advisor based on the composition of MSD’s outstanding debt and market conditions at the time of the sale for the new money issue. Refunding Bonds MSD may undertake a refunding of outstanding debt for the purpose of capturing interest rate savings, to restructure debt, change the type of debt instruments being used, or to retire a bond issue and indenture in order to remove undesirable covenants, based on the recommendation of MSD’s Financial Adviser. Refunding outstanding bonds for debt service savings may be undertaken on a current basis; i.e., the optional call date for the bonds to be redeemed is within 90 days of the dated date of the new refunding bonds. Before MSD undertakes a current refunding, its Financial Advisor will analyze the contemplated refunding and opine to MSD Staff that the economic benefit of such refunding will achieve a total projected net present value savings in an amount equal to or exceeding three percent of the total par amount of the bonds to be refunded. The refunding of outstanding bonds for debt service savings may be undertaken as an advanced refunding; i.e., the optional call date for the bonds to be redeemed is at least 90 days after the dated date of the refunding bonds. The refunding may reflect a net cash or crossover refunding structure. Before MSD undertakes an advanced refunding its Financial Advisor will analyze the contemplated refunding and opine to MSD Staff that the economic benefit of such refunding meets the following two-part criteria: Each maturity to be advance refunded will produce a three percent minimum present value savings; and The total present value savings for all maturities to be advanced refunded will result in a net present value savings equal to or exceeding four percent of the total refunded par amount. The present value analysis of savings may be supplemented by utilization of a call-option-pricing model to measure the potential savings that may be generated for individual bond maturities. The call-option-pricing model computes the maximum possible refunding value of an outstanding bond and then computes the savings under current market conditions as a percentage of the maximum value. The target savings from any particular refunding candidate shall be a minimum of 75 percent of the expected value of the call option, net of all transaction expenses. At the recommendation of MSD Staff and the Financial Advisor, individual refunding candidates that are above or below the savings objective may be included in order to optimize MSD’s financial objectives for any given refunding issue. If the structure of an advanced refunding transaction incorporates an interest rate swap or other hedging agreement, the transaction must generate demonstrable additional savings as compared to the relevant traditional net cash or crossover Metropolitan St. Louis Sewer District – Debt Management Policy - 7 - refunding approach. The amount of additional savings demonstrated should be commensurate with the additional risk assumed by MSD in the transaction. Recognizing that are a multiplicity of possible such transaction structures, with different and varying sources of risk, no specific savings criterion are specified. Prior to proceeding on such an advanced refunding, MSD’s Financial Advisor must undertake an analysis of the risks associated with the interest rate swap or hedging agreement, estimate the additional savings to be realized and provide a written recommendation to the MSD Finance Committee that such additional savings is commensurate with any risks associated with the proposed transaction. The identification of risks associated with the transaction shall be consistent with the “Interest Rate Swap Risk Analysis” section of this Debt Management Policy. Escrow Structuring MSD shall utilize the least costly securities available in structuring refunding escrows. The Secretary-Treasurer may authorize the Financial Advisor or a qualified third party agent, who is not a broker-dealer, to assist with the structure of the escrow and procurement of securities for refunding transactions. The Secretary-Treasurer shall require the Financial Advisor or qualified third party agent to provide a Fair Market Opinion that shall state that the securities were procured through an arms-length, competitive bid process (in the case of open market securities), that such securities were more cost effective than State and Local Government Obligations (SLGS), and that the price paid for the securities was reasonable within Federal guidelines. MSD shall take all necessary steps to optimize escrows and to avoid negative arbitrage in its refundings. Any resulting positive arbitrage will be rebated as necessary according to Federal guidelines. Types of Products MSD may utilize financial instruments that lower its interest expense, manage its financial risk, and improve its financial condition. MSD may not use financial instruments that create extraordinary leverage or financial risk, lack adequate liquidity to terminate at fair market value, or whose value cannot be determined easily from available market information. The use of derivative financial products should produce a result not otherwise available in the cash market (e.g., lack of advance refunding/non-callable debt) or provide a higher level of savings or benefit commensurate with any risks associated with the derivative financial product. Current Coupon Bonds Current coupon bonds are bonds that pay interest periodically and principal at maturity. They may be used for both new money and refunding transactions. Current coupon bonds may be structured to meet the demands of the investor and thereby reduce the cost of borrowing. Features such as annual principal maturities, the use of discounts, maturity of the debt, parameters of the call provisions, bond insurance and cash funded or surety debt service reserve fund may be adjusted based on the market conditions at the time of sale. Metropolitan St. Louis Sewer District – Debt Management Policy - 8 - Zero Coupon and Capital Appreciation Bonds Zero coupon bonds and capital appreciation bonds have principal amortization that is much slower than level debt service with coupon bonds, resulting in increased interest expenditure over the life of the bonds. Zero coupon and capital appreciation bonds shall only be recommended in limited circumstances. Interest Rate Swaps and Hedging Agreements Any utilization of interest rate swaps, or hedging agreements is subject to Missouri statutory authorization and limitations. To the extent permitted by law, MSD may utilize the following financial products after identifying the specific financial objective to be realized and assessing that product’s attendant risks: Interest Rate Swaps Options on Interest Rate Swaps Swaptions Caps/Floors/Collars Interest rate swaps and hedging agreements will be considered where appropriate in the issuance of or management of debt only in instances where it has been demonstrated that the swap or agreement will either provide a hedge, which reduces risk of fluctuations in expense or revenue, or alternatively, where it will reduce total project cost. Swaps and hedging agreements will only be utilized with prior approval of the MSD Trustees. Interest Rate Swap Risk Analysis MSD shall evaluate all financial products with respect to the unique risks they each create. The analysis and recommendation of the Financial Advisor should establish that the risks to MSD are justifiable. A specific determination must be made that the projected benefits exceed the identified risks by an adequate margin over a comparable cash market transaction, if available. At a minimum, MSD and the Financial Advisor should perform a risk evaluation of the following factors and questions: Market or interest rate risk—Does the transaction hedge or create interest rate volatility? Tax risk--Is the value of the instrument subject to a future change in federal income tax policy? Termination risk—Under what circumstance might the transaction be terminated? At what value? Risk of uncommitted funding or “put risk”—Does the transaction create an additional financing obligation dependent upon third party participation? Metropolitan St. Louis Sewer District – Debt Management Policy - 9 - Credit risk--How would the transaction be impacted by a change in MSD’s credit ratings? Liquidity renewal risk--What is the impact on the transaction of higher liquidity charges upon renewal of the liquidity facility? What actions can mitigate the risk of liquidity renewal? Counterparty risk--What is the creditworthiness of the counterparty? What downgrade and collateral provisions mitigate this risk? Basis risk--Do the anticipated payments MSD receives match the payments it makes? Interest Rate Swap Procurement MSD’s preference is that the procurement of interest rate swaps be undertaken on a competitive bid basis. MSD prefers the utilization of interest rate swap contracts that have strong price transparency and which are of a type referred to as “plain vanilla,” e.g., a percentage of LIBOR and BMA interest rate swaps. On a product-by-product basis, MSD will consider a negotiated procurement of financial instruments that have customized or specific attributes benefiting MSD, provided that justification of the benefit is documented. To the extent MSD procures an interest rate swap through a negotiated process, the Financial Advisor or other qualified advisor will provide a Fair Market Opinion letter to the Treasurer that includes a certification that the interest rate swap pricing reflects fair market value of the transaction. Interest Rate Swap Counterparty Requirements MSD will only enter into interest rate swap agreements with highly rated financial institutions. Credit criteria for financial institutions are as follows: The institutions’ long term, unsecured and unsubordinated obligations are rated at the time of execution of the interest rate swap agreement by at least one rating agency at least “Aa3” by Moody’s Investors Services, Inc. (Moody’s) or “AA” by Standard and Poor's Ratings Services, a division of McGraw-Hill Companies, Inc. (“S&P”), or FitchRatings “Fitch”) and by at least one other rating agency at no lower than an “A2” by Moody’s or “A” by S&P or FitchRatings; or The institutions’ obligations under the interest rate swap agreement and the Credit Support Annex are unconditionally guaranteed by a bank or non-bank financial institution the long-term, unsecured and unsubordinated obligations of which are rated at the time of execution of the interest rate swap agreement by at least one credit agency at least “Aa3” by Moody’s or “AA” by S&P or FitchRatings and by another rating agency not lower an “a2” by Moody’s or “A” by S&P or FitchRatings. Metropolitan St. Louis Sewer District – Debt Management Policy - 10 - Financial institutions seeking to act as an interest rate swap counterparty must agree to one-way collateral and ratings downgrade provisions that provide additional protection for MSD. Interest Rate Swap Documentation MSD will use standard International Swap Dealer Association (ISDA) interest rate swap documentation including the Schedule to a Master Agreement and a Credit Support Annex thereto. Interest Rate Swap documentation should include the following terms and provisions: Downgrade provisions triggering termination should be bilateral; Governing law for interest rate swaps may be New York, but should reflect Missouri’s authorization provisions; The language related to credit events in the master agreement should be narrowly drafted with regards to MSD credit downgrade events and specify downgrade trigger events and remedies for the counterparty; Eligible collateral should be limited to Treasuries and Federal Agencies; Collateral thresholds should be set on a sliding scale reflective of counterparty credit ratings. Termination value should be set by the “market quotation” methodology. Interest Rate Swap Contract Limitations MSD may enter into interest rate swap contracts, provided that the cumulative total of all Interest Rate Swap contracts at any one time shall not exceed 10 percent of the then outstanding long-term debt, adjusted for the amount of any authorized new money bonds not yet issued. MSD will avoid incurring significantly more than $100,000,000 of exposure to any single counterparty. For the purpose of this size limitation, a counterparty is considered to include all affiliated or syndicated entities to the same transaction. Benefit Expectation from use of an Interest Rate Swap Financial transactions using interest rate swaps or other hedging agreements that are intended to produce the effect of a synthetic variable rate debt or synthetic fixed interest rate debt must generate demonstrable additional savings as compared to alternative traditional variable or fixed rate financing approaches. Target savings should reflect the greater complexity and higher risk of derivative financial instruments. The savings threshold should increase with the complexity and risk features of the specific proposed interest rate swap. In calculating the prospective savings derived from use of an interest rate swap, all applicable remarketing credit and liquidity fees must be added to variable rate debt cost, utilizing the five-year historic average of comparable variable rate securities. Metropolitan St. Louis Sewer District – Debt Management Policy - 11 - Prior to executing any interest rate swap transaction, MSD’s Financial Advisor shall undertake an analysis of the proposed transaction, compare the interest rate swap proposal to a more traditional financing approach, if available, review any all risks associated with the interest rate swap transaction, quantify the reasonably expected economic benefit to be derived from the transaction. The advisor shall also advise the Treasurer that the economic benefits either are or are not commensurate with any risks to MSD regarding the transaction so analyzed. Collateral Requirements for Interest Rate Swap Agreements MSD shall not provide collateral to secure its obligations under interest rate swap agreements. Collateral posted by counterparty shall consist of cash or U.S. Government securities deposited with a third party trustee. Structural Features MSD bonds will be structured consistent with requirements specified in the Plan of the Metropolitan Sewer district and applicable Missouri statutes. Bond issues will be structured to optimize the cost of funds while recognizing the debt affordability targets discussed in the Debt Management Policy. Debt structure decisions must recognize the impact on MSD ratepayers, and such impact will be communicated in appropriate public forums prior to debt issuance. Term of Debt The weighted average maturity of the debt issue will not exceed the useful life the project(s) to be financed. Final maturity of the bonds will not exceed 30 years from the date of issuance. Debt Service Structure Combined principal and interest payments for any bond issue will be structured in consideration of existing debt outstanding and to achieve approximately equal annual debt service requirements over the life of the bonds. Exceptions will occur for refunding bonds that may have varying principal repayments structured to fill in gaps created by refunding specific principal maturities. The objective is to achieve level debt service in aggregate for each lien, with the debt service trailing off as bonds mature. Lien Levels Senior and junior liens for debt issues may be utilized if the resulting debt structure optimizes certain critical debt constraints, typically either cost or capacity. Capitalized Interest Certain types of financings such as certificates of participation, lease-secured financings, and certain revenue bonds may require that interest on the bonds be paid from capitalized interest until MSD has constructive use of the capital infrastructure funded by the bond proceeds. In order to avoid unnecessarily increasing the bond size MSD will minimize its use of capitalized interest. Metropolitan St. Louis Sewer District – Debt Management Policy - 12 - Premium and Discount Bonds While premium and discount bonds may reduce the interest cost of the bonds they should only be used when economically justified and upon recommendation by the Financial Advisor. Bifurcated Coupons Bifurcated coupons for individual maturities may be utilized if the Financial Advisor provides a written recommendation to MSD Staff confirming that the coupon bifurcation will enhance the pricing of the bonds by optimizing interest from both institutional and retail investors. Debt Service Reserve Fund A Debt Service Reserve Fund will be established in an amount equal to the lesser of (1) the maximum amount of principal of and interest due in any MSD fiscal year on all outstanding parity debt obligations, (2) 125 percent of the average annual debt service on Parity Debt Obligations, or (3) an amount not in excess of 10 percent of the sale proceeds of the Parity Debt Obligations. A surety bond insurance policy may be used if such use is not expected to impair the marketing of the bonds and only upon the written recommendation of the Financial Advisor. Amortization MSD will seek to achieve overall level annual debt service for all debt outstanding. Amortization of principal for debt issues will reflect this objective. Call Provisions In general, MSD’s debt instruments will include a call provision for maturities longer than 10 years. Prior to issuing bonds without a-call provision, MSD will evaluate expected interest savings, based on the theoretical value of the call option. Credit Enhancement Bond insurance will be used when it provides an economic advantage to a particular bond maturity or entire issue. The decision to use bond insurance shall be based upon the value it adds to a specific transaction. The analysis of that value shall compare the present value of the prospective interest savings produced due to the insurance to the cost of the insurance premium. Insurance may be purchased when the premium cost is less than the projected interest savings. Bond insurance may be purchased for the entire par amount of an issue or for specific maturities thereof, based on a recommendation to the Secretary-Treasurer from the Financial Advisor regarding the most cost-effective approach. For MSD bond issues sold on a negotiated basis, quotations for bond insurance will be solicited from at least three providers. In the case of a competitive bond sale, MSD will solicit applications for pre-qualification of insurance from at least three qualified providers. The winning underwriter in a competitive sale will Metropolitan St. Louis Sewer District – Debt Management Policy - 13 - determine whether it will purchase insurance for the issue. For a negotiated issue, the MSD Trustees will authorize the purchase of bond insurance if it is deemed prudent and reasonable. Letters of Credit may be considered as an alternative approach to credit enhancement. If a letter of credit is proposed, MSD will select the provider pursuant to a competitive procurement process and taking into account bank or provider ratings and any impact on marketing the bonds. Liquidity Facility Liquidity may be necessary and prudent to ensure the marketability of certain short-term financing instruments such as commercial paper, variable rate demand obligations or auction rate securities. MSD may select a liquidity facility through a competitive procurement process. Provider selection criteria will include but not be limited to the following: Only those banks with long-term ratings greater than or equal to that of MSD, and short-term ratings of “P-1” and “A-1+,” by Moody’s and S & P, respectively, will be solicited. Providers must agree to terms and conditions acceptable to MSD and as recommended by the Financial Advisor. MSD will provide a term sheet along with the request for qualifications to which the banks will highlight modifications; Providers must demonstrate experience and credibility in the market by providing representative list of clients for whom the bank has provided liquidity facilities; and Fees, including upfront and annual charges, will be evaluated, taking into account differential trading costs as appropriate. Funds and Accounts MSD has established and will maintain Wastewater Revenue and Stormwater Revenue Funds to facilitate the separate accounting of all cash receipts of fees, charges, licenses, and permits for sanitary sewer and stormwater services. MSD has established and utilizes the General Fund to finance the ordinary operations of the District and to account for revenues and activities of the District that are not provided for in any other fund. The Operating, Maintenance and Construction Improvement (OMCI) Funds account for the expenditure of subdistrict property tax receipts and Construction Funds are established for the Sanitary Replacement and Stormwater Replacement projects funded through the annual CIRP. The Capital Improvement Trust Fund accounts for the expenditure of capital improvement surcharge moneys collected between 1988 and 1995. Metropolitan St. Louis Sewer District – Debt Management Policy - 14 - Debt Service Funds account for the principal and interest due on short-term financing and the planned Wastewater Revenue bonds as well as the Debt Reserve Account to be established as part of the Master Bond Ordinance for the Wastewater Revenue Bonds. Special Funds include the Improvement, Real Property Improvements and Alterations Fund, the Water Backup Insurance and Reimbursement Fund and the Emergency Fund and are established to account for distinct purposes and programs as established by the MSD Trustees. The Master Bond Ordinance, to be approved by the MSD Trustees, together with Supplemental Bond Ordinances that may be authorized from time to time by the MSD Trustees will establish a flow of funds for application of revenues pledged to the repayment of bonds issued by MSD. The Finance Director will direct and ensure that the funds and accounts established by the Master Bond Ordinance are maintained and that the revenues are allocated consistent with the pledges and covenants included in the Master Bond Ordinance. Liquidity MSD will accumulate and maintain cash-on-hand for liquidity purposes and as a source of unrestricted operating reserves in an amount equal to 45 days operating expenses (excluding depreciation). The liquidity requirement will be reviewed from time to time and the Executive Director is expected to offer recommendations for adjustments to the requirement as appropriate to maintain prudent ongoing operating reserves. Surplus revenue in excess of this liquidity requirement may be allocated to PAYG CIRP projects. Credit Objectives MSD will actively seek to maintain and improve the credit ratings of its outstanding debt obligations through the highest quality fiscal management and adherence to prudent investment and debt management policies, including debt affordability benchmarks. Credit objectives, together with the relative cost of debt, will be considered in the structure of any junior or subordinate lien debt. MSD will maintain ongoing communications with all three national credit rating agencies and, at a minimum, provide annual credit updates to credit analysts. Method of Bond Issuance MSD may consider selling its bonds on either a competitive or negotiated basis. MSD shall utilize a sale method to achieve the lowest debt cost depending on the size and characteristics of the proposed issue and the applicable market conditions at the time of sale. MSD Staff and the Financial Advisor will provide a written recommendation to the Finance Committee regarding the method of sale for each proposed bond issue. The conditions, which indicate the appropriate method for selling a particular bond issue, are generally described below. Metropolitan St. Louis Sewer District – Debt Management Policy - 15 - Competitive sale methodology: Bond prices are stable and/or demand is strong; Market timing and interest rate sensitivity are not critical to the pricing; Participation from Disadvantaged Business Enterprises (DBE / Small Business Enterprises (SBE) firms is best efforts; MSD has a well established credit rating and is a recognized issuer in the market; There are no complex explanations required during marketing, regarding: issuer’s projects, media coverage, political structure, political support, funding, or credit quality; The bond type and structural features are conventional; Bond insurance is included or pre-qualified (available); and The transaction size is manageable Negotiated sale methodology: Bond prices are volatile and/or demand is weak and/or the supply of competing bonds is high; Market timing is important, such as for refundings; Coordination of multiple components of the financing is required; Participation from DBE / SBE firms is enhanced; MSD has lower or weakening credit rating; MSD is not a well known issuer to investors; Sale and marketing of the bonds will require complex explanations about the issuer’s projects, media coverage, political structure, political support, funding, or credit quality; The bond type and/or structural features are non-standard, such as for a forward bond sale, issuance of variable rate bonds or where there is use of derivative products; Metropolitan St. Louis Sewer District – Debt Management Policy - 16 - Bond insurance is not available or not offered; Early structuring and market participation by underwriters desired; MSD has selected a group of qualified investment banking firms through a competitive procurement process with lead bankers for specific issues chosen from the pre-qualified banking pre-qualified underwriters pool; Large transaction size; and Strong retail participation is desired and expected to enhance pricing efforts. Use and Investment of Bond Proceeds The Secretary-Treasurer shall comply with all applicable federal, State, and bond ordinance restrictions regarding the use and investment of bond proceeds. Any Investment of bond proceeds shall be executed in accordance with MSD’s Investment Management Policy. Net bond proceeds will be deposited in the Construction fund only be used to reimburse qualified capital expenditures funded on an interim bases and to fund the costs of capital projects authorized by the MSD Trustees. Diversification The Secretary-Treasurer shall diversify invested bond proceeds in order to reduce risk exposure to single issuers (other than Treasuries and Agencies), types of investment products and types of securities held. Competitive Bidding of Investments The Secretary-Treasurer shall competitively bid and or use the services of the Financial Advisor, or qualified Investment Advisor, to bid the purchase of securities, investment agreements, float contracts, forward purchase contracts and any other investment products use to invest bond proceeds. Underwriters of MSD’s bonds may bid on the sale of investment products for the bond proceeds. The Financial or Investment Advisor shall document the bidding process and results thereof and shall certify in writing that MSD received a competitive and fair market price on all investments purchased based on the bidding process. Disclosure The Secretary-Treasurer will require a full disclosure of all fees charged for investment services or the sale of investment products to MSD to ensure that a provider of investment products has no conflict of interest and all investments are purchased at a fair market price. Metropolitan St. Louis Sewer District – Debt Management Policy - 17 - Documentation of Transactions The decision processes used in each financing transaction shall be fully documented. The documentation will capture information regarding the recommendations of the Financial Advisor, selection of the financing team, decisions on product selection and structuring features, sizing, timing, selection of vendors providing ancillary services and selection of investment securities or products. This information will be compiled into a post-pricing book, “bond transaction file,” which will be prepared and delivered to the Secretary-Treasurer by the Financial Advisor for each financing. MSD shall keep on permanent file the post-pricing book. Market Relationships The Secretary-Treasurer and the Director of Finance shall be primarily responsible, along with the Executive Director, for maintaining MSD’s relationships with Moody’s Investors Service, Standard & Poor’s, and FitchRatings as well investors and bondholders. In addition to general communication, the Secretary-Treasurer and Director of Finance, or their appropriate designees, shall: 1) meet, either in person or telephonically, with each agency’s analysts at least once each fiscal year, and 2) communicate with each agency’s analysts prior to each competitive or negotiated debt transaction. Continuing Disclosure MSD shall comply with U.S. Securities and Exchange Commission Rule 15c2-12 by filing with each Nationally Recognized Municipal Securities Information Repository its annual financial statements and other financial and operating data for the benefit of its bondholders no later than six months after the end of the MSD’s fiscal year. The inability to make timely filings must be disclosed promptly. Rebate Reporting The use and investment of bond proceeds shall be monitored continuously to ensure compliance with arbitrage restrictions. Existing regulations require that issuers calculate annual rebate requirements related to any bond issues and pay any required rebate every five years. Therefore, MSD Staff shall ensure that bond proceeds and investments are traced in a manner that facilitates the completion of accurate rebate calculations, and rebate payments, if any, are made in a timely manner. Consultant & Investment Banking Firm Selection MSD will select its Financial Advisor, investment banking firms and its bond counsel by a competitive-negotiated process through a Request for Proposals (RFP) pursuant to the procurement authority of the Secretary-Treasurer. All then applicable MSD contracting policies will apply to all contracts with finance professionals. Selection may be based on a best value approach for Metropolitan St. Louis Sewer District – Debt Management Policy - 18 - professional services or the lowest responsive cost-effective bid based upon pre- determined criteria. Financial Advisor Selection MSD will select an independent financial advisor (or advisors) to assist with the issuance of all debt and debt administration processes. The financial advisory services may include, but shall not be limited to, the following: Providing recommendations to the MSD staff & Trustees; Evaluating risks and opportunities associated with debt issuance; Monitoring marketing opportunities; Evaluating proposals submitted to MSD by investment banking firms and providing coordination with the banking team; Advising on investment banking firm selection for debt transactions; Advising on structuring and pricing of bond issues; Preparing requests for proposals for other financial services (trustee and paying agent services, printing, credit facilities, remarketing agent services etc); Educating MSD personnel on relevant financing topics; Providing advice, assistance and preparation for presentations with rating agencies and investors; Providing post-transaction analysis. Financial Advisor Selection Criteria Selection of MSD’s financial advisor(s) should be based on the following criteria: Experience in providing consulting services to complex issuers; Knowledge and experience in structuring and analyzing complex issues; Experience and reputation of assigned personnel; and Fees and expenses. Investment Banking Firms MSD may select a group of investment banking firms to underwrite debt issues on a negotiated basis. MSD will select a senior manager (or co-senior managers) Metropolitan St. Louis Sewer District – Debt Management Policy - 19 - for each negotiated sale from among the qualified banking firms based on the following criteria: The firm’s ability and experience in managing complex transactions similar to this Debt to be issued; Prior knowledge and experience working with transportation issuers; The firm’s willingness and ability to risk capital to underwrite MSD debt obligations; Quality and experience of personnel assigned to MSD’s engagement; Proposed management fees and expenses; The proposed marketing plan; and The ability to sell bonds to Missouri retail investors. Co-manager Selection Co-managers will be selected utilizing the same criteria as used for the senior manager. In addition to their individual qualifications, co-managers appointed to specific transactions shall depend upon of the transaction size and the necessity to ensure maximum distribution of MSD’s debt obligations. Syndicate Policies MSD will approve syndicate policies and designation priorities prior to the issuance of debt. MSD may periodically reassess and recommend changes at any time the composition of the investment banking firms underwriting MSD’s debt issues. Bond Counsel MSD debt shall be issued with a written opinion by legal counsel affirming that MSD is authorized to issue the proposed debt, that MSD has met all constitutional and statutory requirements necessary for issuance, and a determination regarding the proposed debt’s federal income tax status. MSD shall select a nationally recognized bond counsel firm with extensive experience in public finance and tax issues through a competitive request for proposal process. Bond counsel will prepare an approving opinion and other documents relating to the issuance of debt. Disclosure Counsel MSD shall hire, when appropriate, Disclosure Counsel to prepare official statements in the event of a competitive sale. Disclosure Counsel will be responsible for ensuring that the official statement complies with all applicable rules regulations and guidelines. Disclosure Counsel will be a nationally Metropolitan St. Louis Sewer District – Debt Management Policy - 20 - recognized firm with extensive experience in public finance. The counsel will be selected base on a competitive procurement process. Special Counsel MSD shall hire, when appropriate, Special Counsel to provide assurance that MSD is compliant with all applicable statutory, regulatory and contractual provisions of bond issues. Disclosure by Financing Team Members Finance Team Members will be directed at the time of selection to provide written disclosure of any conflicts of interest that may relate to their ability to represent MSD, to disclose any relationships with MSD Trustees, to disclose any current investigative action of any federal or state regulatory agencies, and to establish their compliance with rules promulgated by the Municipal Securities Rulemaking Board as applicable. Team members will be obligated to disclose promptly any material changes to the disclosure provided in the selection process or in this Debt Management Policy. Metropolitan St. Louis Sewer District – Debt Management Policy - 21 - Glossary of Terms Arbitrage . The difference between the interest paid on the tax-exempt securities and the interest earned by investing the security proceeds in higher-yielding taxable securities. IRS regulations govern arbitrage on the proceeds from issuance of municipal securities. Bond Anticipation Notes (BANs). These notes are re-paid from the proceeds of the issuance of long-term debt. Typically issued for capital projects. Call Provisions. The terms of the bond giving the issuer the right to redeem all or a portion of a bond prior to its stated date of maturity at a specific price, usually at or above par. Caps (Interest Rate). The purchase of this product allows an issuer selling variable rate debt (see definition below) to hedge against high interest rates by setting a limit above which the interest costs cannot rise. Capitalized Interest. A portion of the proceeds of a bond issue that is set aside to pay interest on the same bond issue for a specific period of time. Interest is commonly capitalized for the construction period of the project. Collars (Interest Rate). This product is a combination of an interest rate cap and an interest rate floor. The variable rate issuer purchases a cap to limit the maximum interest rate costs, and sells the floor option (the least amount of interest expense an issuer can expect to pay) to obtain a premium that will be used to pay for the cap. These events create a band of interest rates between the floor and the cap that will serve as the upper and lower limits within which the issuer’s interest rates may fluctuate. Commercial Paper. Very short-term, unsecured promissory notes issued in either registered or bearer form, and usually backed by a line of credit with a bank. Competitive Sale. A sale/auction of securities by an issuer in which underwriters or syndicates of underwriters submit sealed bids to purchase the securities. Contrast to a negotiated sale. Continuing Disclosure. The principle that accurate and complete information material to the transaction which potential investors would be likely to consider material in making investment decisions with respect to the securities be made available on an ongoing basis. Credit Enhancement. Credit support purchased by the issuer to raise the credit rating of the issue. The most common credit enhancements consist of bond insurance, direct or standby letters of credit, and lines of credit. Metropolitan St. Louis Sewer District – Debt Management Policy - 22 - Credit Support Provider. With respect to the ISDA Schedule any guarantor or contingent guarantor (e.g. a contingent swap counterparty) of a party’s obligations under the swap agreement. Current Coupon Bonds. Bonds that pay interest periodically and principal at maturity. Debt Service Coverage. Net Revenue available for debt service divided by debt service. Debt Service Reserve Fund. The fund in which moneys are placed which may be used to pay debt service if pledged revenues are insufficient to satisfy the debt service requirements. Deep Discount Bonds. These are bonds that are priced for sale at a substantial discount from their face or par value. Derivatives. A financial product whose value is derived from some underlying asset value. Designation Policies. Outline how an investor’s order is filled when a maturity is oversubscribed when there is an underwriting syndicate. The senior managing underwriter and issuer decide how the bonds will be allocated among the syndicate. There are three primary classifications of orders that form the designation policy: Group Net orders; Net Designated orders and Member orders. Escrow. A fund established to hold moneys pledged and to be used to pay debt service on an outstanding issue. Expenses. Compensates senior managers for out-of-pocket expenses including: underwriters counsel, DTC charges, travel, syndicate expenses, dealer fees, overtime expenses, communication expenses, computer time and postage. Interest Rate Swap. An agreement between an issuer and a counter-party in which one party exchanges a stream of interest computed on a notional amount for another stream of interest computed on that notional amount. Frequently, one party is exchanging a variable rate stream for a fixed rate stream of interest or vice versa. Letters of Credit. A bank credit facility wherein the bank agrees to lend a specified amount of funds for a limited term. Management Fee. The fixed percentage of the gross spread which is paid to the managing underwriter for the structuring phase of a transaction. Metropolitan St. Louis Sewer District – Debt Management Policy - 23 - Market Quotation. With respect to one or more terminated transactions and a party making the determination, an amount determined on the basis of quotations from four leading dealers in the relevant market (“Reference Market-makers”). Each quotation will be for an amount, if any, that would be paid to such party or by such party that would have the effect of preserving the economic equivalent of any payment(s) that would have been required under the terminated transaction. Members. These are underwriters in a syndicate other than the senior underwriter. Moral obligation bonds. Typically issued by a state agency or authority, these bonds are secured by revenues from the financed project, and an additional non- binding pledge that any deficiencies in the legally pledged revenues will be reported to state legislature, which may in turn appropriate state funds to make up the shortfall. Commonly, legislation that authorizes the issuance of such bonds provides that the state may apportion money to support debt service, but has no legal obligation to do so. Moody’s Median. Key financial, debt, economic and tax base statistics with median values for each statistic presented. Negotiated Sale. A method of sale in which the issuer chooses one underwriter to negotiate terms pursuant to which such underwriter will purchase and market the bonds. Net Revenue. Defined in greater detail by the Authority’s Indenture. Net Revenue is the difference between gross revenue and operating and maintenance expenses. Original Issue Discount. The amount by which the original par amount of an issue exceeds its public offering price at the time it is originally offered to an investor. Original Issue Premium. The amount by which the original par amount of an issue is below its public offering price at the time it is originally offered to an investor Pay-As-You-Go. An issuer elects to finance a project with existing cash flow as opposed to issuing debt obligations. Present Value. The current value of a future cash flow. Price Transparency. The availability of current pricing and trading information of securities. Private Placement. The original placement of an issue with one or more investors as opposed to being publicly offered or sold. Metropolitan St. Louis Sewer District – Debt Management Policy - 24 - Rebate. A requirement imposed by Tax Reform Act of 1986 whereby the issuer of tax-exempt bonds must pay the IRS an amount equal to its profit earned from investment of tax-exempt bond proceeds at rates exceeding the tax-exempt borrowing rate. The tax-exempt borrowing rate (or “bond yield”) is calculated pursuant to the IRS code together with all income earned on the accumulated profit pending payment. Second Method. With respect to one or more terminated transactions that the settlement amount will reflect full two-way payments of any amounts owed by one party (whether defaulting or otherwise) to another. Selling Group. The group of securities dealers who participate in an offering not as underwriters but rather who receive securities less the selling concession from the managing underwriter for distribution at the public offering price. Swaption. An option agreement granting the purchaser the right, but not the obligation, to enter into an interest rate swap at a later date. Syndicate Policies. The contractual obligations placed on the underwriting group relating to distribution, price limitations and market transactions. Threshold Amount. With respect to the ISDA Credit Support Annex, that Swap Termination Value amount above which a party is required to post collateral. For example, at a Threshold Amount of $10,000,000 if the Swap Termination Value equals -$15,000,000, KDOT would be required to post collateral of $5,000,000. Underwriter. A dealer that purchases new issues of municipal securities from the Issuer and resells them to investors. Underwriter’s Discount. The difference between the price at which bonds is bought by the Underwriter from the Issuer and the price at which they are reoffered to investors. Valuation Date. With respect to the ISDA Credit Support Annex, that date on which the Swap Termination Value will be calculated for purposes of determining any required collateral amount to be posted. Valuation Date is typically specified as any Local Business Day. Valuation Percentage. With respect to posted collateral under the ISDA Credit Support Annex, 100% minus any discount or “haircut” applied to eligible collateral. For example, eligible Federal Agency securities collateral typically has a Valuation Percentage of 95%, i.e. a 5% haircut. Thus, a party required to post $5,000,000 in collateral under the Credit Support Annex could provide $5,000,000 of Cash collateral or $5,263,158 of Federal Agency securities. Variable Rate Debt. This is debt with an interest rate that is re-set at intervals according to an index or a formula or other standard of measurement as stated in the bond contract.