P1247676900zwpUY

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J U L Y   1 6 ,   2 0 0 7
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What's Happening in Public Finance
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 C O N F I D E N T I A L
Robert Dailey Manager, East Region Tax-Exempt
Capital Markets JPMorgan
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Tremendous Increase in the Sophistication and
Breadth of Public Finance Problem-Solving

• Issuers have a broader array of products and
  strategies available to them than ever before
• Bonds that achieve fixed rate as well as floating
  rate exposure
• Derivative products dramatically increase
  flexibility to manage debt
• Structured finance enables efficient financing
  from dedicated revenue streams
• Asset-backed
• Tax-increment financing
• More need and opportunities to leverage assets
• Increasingly sophisticated analysis
• Increasing precision and flexibility to test
  outcomes
• Asset/liability management
• Optimizing debt structure
• Encourages more and quicker decision-making
• Closer integration of the municipal market to
  other markets, and closer integration of public
  finance bankers with peers in corporate and other
  markets

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Non-Traditional Buyers Can Drive Pricing
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Higher Ratings for Municipal Credits
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Strong Appetite for High Yield Municipals
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The Burden of Other Post-Employee Benefits
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The Rise and Scope of Privatization
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Non-Traditional Investors Now Account for a Large
Percentage of New Issue Purchases

• Class continues to grow in number and asset size
• Portfolios are underweighted in many municipal
  credits
• JPMorgans multi-product platform offers risk
  management products for these investors
• BMA Swaps
• LIBOR Swaps
• MMD Rate Locks

JPMorgan Swap Transactions with Investors (bn)

• Swaptions
• Credit Default Swaps
• Futures

Par Amount of Fixed Rate Bonds Held in JPMorgans
Tender Option Bond (TOB) Program
TOB Growth Weekly Volume (mm left axis) and
Running Total (bn right axis) of Client TOB
Securitizations
Running total
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 C A N   D R I V E   P R I C I N G
New issues
YTDQ22007
Annualized
Unwinds
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Higher Ratings for Municipal Credits
Non-Traditional Buyers Can Drive Pricing
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4
Strong Appetite for High Yield Municipals
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The Burden of Other Post-Employee Benefits
10
The Rise and Scope of Privatization
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Higher Credit Ratings in the Municipal Market
Moodys US Municipal Bond Rating Changes Since
2005
H I G H E R   R A T I N G S   F O R 
 M U N I C I P A L   C R E D I T S
Source Moodys

• Special tax obligation bonds have received
  particular focus
• Structuring features can achieve ratings higher
  than general obligations

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Moody's Rated Municipal Bonds 10-year Cumulative
Default Rate is Lower Than That of Aaa-rated
Corporate Bonds
Default Rates of Moodys Rated Investment Grade
Municipal Bonds (Excluding GO and Water Sewer)
vs. Corporate Default Rates
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 M U N I C I P A L   C R E D I T S
Source Mapping of Moodys U.S. Municipal Bond
Rating Scale to Moodys Corporate Rating Scale
and Assignment of Corporate Equivalent Ratings to
Municipal Obligations, June 2006
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Strong Appetite for High Yield Municipals
Non-Traditional Buyers Can Drive Pricing
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Higher Ratings for Municipal Credits
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The Burden of Other Post-Employee Benefits
10
The Rise and Scope of Privatization
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The Current High Yield Market Environment

• The high yield municipal bond market represents
  62 billion as of June 20, 2007, and has been
  steadily growing over the past decade
• Increased proprietary trading by major
  broker/dealers
• Increased activity from non-traditional buyers
  (i.e., crossovers and hedge funds)

Total High-Yield Assets Held Under Management
S T R O N G   A P P E T I T E   F O R   H I G H 
 Y I E L D   M U N I C I P A L S
Source AMG Data Services
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Credit Spreads Have Been at an All Time Low
10 Yr Baa-Aaa Credit Spreads (bps)
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 Y I E L D   M U N I C I P A L S
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The Burden of Other Post-Employee Benefits
Non-Traditional Buyers Can Drive Pricing
2
Higher Ratings for Municipal Credits
4
Strong Appetite for High Yield Municipals
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The Rise and Scope of Privatization
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Other Post-Employment Benefits

• Other Post Employment Benefits (OPEBs) include
  the following non-pension benefits to retirees
• Medical (largest liability)
• Vision
• Dental
• Life insurance
• Payout patterns for OPEB liabilities are similar
  to those for pension liabilities, and last for
  decades
• OPEB payouts are more volatile, and have a
  slightly longer duration
• Inflation has been vastly higher for
  post-retirement medical expenses than for
  pensions during the last several years
• Unlike pensions, post-retirement medical expenses
  have no relation to salary
• While there is a wide degree of variation, most
  employers pay part or all of the post-retirement
  medical premiums
• It is impossible to buy insurance from carriers
  many years in advance
• Medical cost risk stays with employer

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Comparison of Nationwide Funding Shortfalls
Funding Shortfalls ( billions)
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The Rise and Scope of Privatization
Non-Traditional Buyers Can Drive Pricing
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Higher Ratings for Municipal Credits
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Strong Appetite for High Yield Municipals
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The Burden of Other Post-Employee Benefits
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Catalysts for the US Public Infrastructure Market

• Infrastructure has the potential to be the
  worlds largest capitalized asset class
• JPMorgan expects the infrastructure market to
  evolve similar to the real estate market

• Historical underinvestment in maintenance and
  expansion
• 1.6 trillion needed over next 5 yrs1
• Financing alternatives tapped
• High taxes
• High debt
• Increasing comfort with precedent domestically
  and internationally
• Enabling state and federal legislation
• Economic, social and environmental risks from
  road congestion more visible
• Understanding of use of proceeds

• Asset class well established overseas
• Long life, low volatility assets are very
  appealing to pension funds, life companies and
  specialist funds (both listed and wholesale)
• Equity and debt funds heavily capitalized but
  underinvested with a variety of mandates
• Attractive financing market conditions and
  receptivity to infrastructure assets

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1American Society of Civil Engineers Report Card
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Policy vs. Proceeds Trade-off
Lower policy risk, lower proceeds
Medium risk
Medium / high risk
Highest risk
Pay as you go
Tax-exempt alternatives
Add hybrid capital
Concession
Sale
IPO

• Partial or whole

• Significant releveraging
• Other funding sources?

• High yield or mezzanine capital

• Entire asset or a portion?
• Length of time?

• Minority sale
• Cornerstone investor

• No risk
• Are ongoing funds available?

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A Process to Understand Your Alternatives
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• Use of proceeds
• The critical starting point

• Policy objectives and financial analysis
• Pre-capital structure
• Tariff/fee regime and pricing power length of
  concessions?
• OM standards regime?
• Define scenarios to run and manage revenue
  consultant work critical to understand
• Output - financial forecast scenarios

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• Develop a menu of alternatives with financial and
  non-financial / policy metrics
• Use of proceeds
• Policy objectives
• Transaction alternatives

• Analyze transaction structure alternatives
• Maximize existing leverage tax exempt bonds
  high yield securitizations
• Concession structures availability payments to
  maximize flexibility and price refinancing and
  profit sharing
• IPO and asset sale alternatives

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Price vs. Policy trade-offs
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Transaction Preparation and Process is Critical
Effective Asset Preparation And Process
Management Is Key To Eliminate Constraints Seen
On Precedent Transactions That Have Limited
Competitive Tension And Reduced Valuation

• Eliminate the constraints seen on precedent
  transactions
• Revenue studies / construction plans must be
  prepared on a realistic basis in terms of pricing
  and term of agreements (not done in ITR)
• Create a stapled OM contract for equity
  investors (has been a constraining factor for
  financial investors in precedent deals)
• Provide a stapled debt financing package for
  equity investors
• Very common in corporate MA transactions to set
  a valuation floor and maximize competition
• Allow enough time in the process for financing
  completion and proper due diligence prior to
  final bids
• Understand valuation drivers, where value has
  been left on the table previously, and manage
  bidders to maximize value to the Client

The removal of these constraints dramatically
increases the ability of key financial buyers
(pension funds and life companies for example) to
participate in a process. In particular, the
opportunity for direct investment by pension
funds the lowest cost of capital investors
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Infrastructure Sector Observations
JPMorgan Infrastructure Sector Observations
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