People. Ideas. Success. Guggenheim Partners, LLC Association of Defense Communities – 2012 Conference Financing Privatization Projects: Capital Markets.

People. Ideas. Success.

Guggenheim Partners, LLC

Association of Defense Communities – 2012 Conference

Financing Privatization Projects: Capital Markets Considerations

August 7, 2012

Prior to privatization:

o The Department of Defense (DoD) owned and operated on-base housing facilities for military service members and their families

o Funds for new construction, renovation and maintenance for the housing was part of the installation’s overall operating budget

o This practice placed base commanders in the role of landlord in addition to overseeing their mission-driven responsibilities

o This resulted in the quality of government-owned housing to deteriorate

o By 1995, the average military housing unit was about 40 years old and had typically received minimal updates and maintenance

o The generally poor condition of military housing was forcing service members to search off-base for adequate housing

o Housing became a major issues as troop retention suffered in an all volunteer force

Privatization Initiative:

o In 1996, Congress enacted the Military Housing Privatization Initiative (MHPI) legislation

o MHPI allowed the military to partner with private developers to build and operate modern and attractive on-base housing

o Private capital and leveraging government funds has proved to be a more efficient use of limited resources

o Key structuring point is the securitization of rents provided through the service members’ Basic Allowance for Housing (BAH)

o BAH is a key part of a military service members’ compensation

o Since 1996, $24 billion in private capital has been raised in building and renovating over 204,000 housing units

o The DoD provides the private developer a 50-year ground lease for existing housing that will be rebuilt or renovated

o Under privatization the DoD has extracted itself from the housing business and vastly improved the quality of the housing

o The DoD estimates that an additional $30 billion in private financing is still needed to complete the goals of the MHPI program.

Overview of the Military Housing Privatization Initiative

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Ground Lease:

o Financing is modeled after a traditional mortgage loan

o Security of the financing is based on several market and base mission factors with no implicit Government Guaranty

o The DoD partners with a private developer by entering into a 50-year ground lease between the two parties

o The ground lease require no rent and is renewable with mutual consent for an additional 25 years

o The ground lease obligates the developer to operate the housing and all associated improvements based on the lease terms

o The developer is not granted ownership of the land or improvements as those assets are returned to DoD at the end of the lease

Source of Revenue:

o The service members housing allowance or Basic Allowance for Housing (BAH) is the main revenue source

o The intent/purpose of the BAH program is to provide military families with a fair and equitable housing allowance

o The allowance is comparable to costs for housing in the market or private sector

o BAH rates are set so that military families can afford suitable rental housing located a reasonable distance from their bases

o BAH rates are set annually and are based on local submarket rents, utility costs and renter’s insurance

Partnership:

o To facilitate the financing through the private debt markets the developer and the DoD create a public-private partnership

o The two entities form an Limited Liability Corporation (LLC) to issue bonds for the ensuing construction and rehabilitation

o The bonds are secured by the assignment of the leases and the rents

Overview of the Military Housing Privatization Initiative

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Military Housing – Historical Issuance by Service

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All data compiled above from following sources: Guggenheim Partners, LLC database, Dept. of Defense, Moody’s, S&P, National PFG and Ambac.

9454.68; 39%

6737.655; 28%

5548.05; 23%

2215; 9%

Army Air Force

Navy Marines

Military Housing – Historical Issuance

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All data compiled above from following sources: Guggenheim Partners, LLC database, Dept. of Defense, Moody’s, S&P, National PFG and Ambac.

96-00 01 02 03 04 05 06 07 08 09 10 11 12

Series1 421 587 668 2266 1750 5802.65 3887 5804.2 1216.83 207 437 396 512.705

$500

$1,500

$2,500

$3,500

$4,500

$5,500

$6,500

Military Housing Issuance $mm (1996-2011) Total $23.436mmMilitary Housing Issuance $mm (1996-2012) Total $24 Billion

Military Housing – Historical Issuance

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All data compiled above from following sources: Guggenheim Partners, LLC database, Dept. of Defense, Moody’s, S&P, National PFG and Ambac.

96-00 01 02 03 04 05 06 07 08 09 10 11 12

Insured 252 421 585 2266 402 4478.65 3419 5804.2 486.83 0 0 0 0

Uninsured 169 166 83 0 1348 1324 468 0 780 157 437 396 512.705

$500

$1,500

$2,500

$3,500

$4,500

$5,500

$6,500

Uninsured

Insured

Military Housing Issuance $mm (1996-2011) Total $23.436mmMilitary Housing Issuance $mm (1996-2012) Total $24 BillionMilitary Housing Issuance $mm (1996-2011) Total $23.436mmMilitary Housing Issuance $mm (1996-2012) Total $24 BillionMilitary Housing Issuance $mm (1996-2011) Total $23.436mmMilitary Housing Issuance $mm (1996-2012) Total $24 Billion

Phase 1

Phase 2 Phase 3

Phase 4

Military Housing – Structuring Dynamics

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Changes in Structuring Dynamics

Four distinct eras in a relatively short time frame (1998 – 2012)

Phase 1: 1998-2003

Phase 2: 2004-2005

Phase 3: 2006-2008

Phase 4: 2008-present

Phase 11998 – 2003

Phase 22004 – 2005

Phase 32006 – 2008

Phase 42008 – present

Credit Execution Insured Senior / Sub Insured Uninsured

Min. Underlying Rating A BBB BBB AA

Stabilized DSC Ratio 1.25x 1.10x 1.15x 1.50x

Growth 5-years 3% / 3% 3% / 3% 2% / 2% Mkt. DependentMax 2% / 2%

Primary Structured Developer/ Credit Enhancer

Investment Banker/

Rating Agency

Investment Banker/ Rating

AgencyInvestor

Military Housing – Historical Issuance & Spreads

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All data compiled above from following sources: Guggenheim Partners, LLC database, Dept. of Defense, Moody’s, S&P, National PFG and Ambac.

96-00 01 02 03 04 05 06 07 08 09 10 11 12 $-

$1,000

$2,000

$3,000

$4,000

$5,000

$6,000

$7,000

$421 $587 $668

$2,266 $1,750

$5,803

$3,887

$5,804

$1,217

$207 $437 $396 $513

00 01 02 03 04 05 06 07 08 09* 10* 11* 12*0

50

100

150

200

250

300

350

400

450

175

125100

7050 50 40 30

400

350

250275

365*Underlying AA-rating

Military Housing – Historical Issuance

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All data compiled above from following sources: Guggenheim Partners, LLC database, Dept. of Defense, Moody’s, S&P, National PFG and Ambac.

18114.68; 76%

5840.705; 24%Insured

Uninsured

Military Housing – Historical Issuance

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All data compiled above from following sources: Guggenheim Partners, LLC database, Dept. of Defense, Moody’s, S&P, National PFG and Ambac.

9683.68; 40%

7753; 32%

540; 2%

138; 1%

5840.705; 24%

MBIA/National

Ambac Assurance Corp.

CIFG

XL/Syncora

Uninsured

Military Housing – Color on Issuance History

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Military housing market was highly fragmented in the beginning as credit and political risks were being scrutinized by the credit enhancers, rating agencies and investors.

By the end of 2007 ~85% of the overall market was credit enhanced by either MBIA/National or Ambac.

In 2008 issuance dropped by 80% as the loss of the AAA-rated credit enhancers was the key culprit.

In addition to the lack of credit enhancement, the market has had to adjust to wider spreads and the loss of Fannie Mae and Freddie Mac as key market participants.

Beginning in 2008 transactions are now structured to a AA-level as investors require high investment grade ratings on all new issues.

The lower leverage has further reduced the debt capacity of issuers and hampering the ongoing project development.

Recently investors have lightened up their holdings in the sector and most have stopped adding new paper due to negative headlines about the Defense budget.

Other Issues

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Disclosure is very limited.

Insured deals have impaired ratings due to DSRF Surety or lack of ratings.

FY13 DOD budget. Current mark-up only has $32bb of mandated $48bb reductions per Budget Control Act of 2010. Beginning Jan. 2013 additional $50bb in savings to be enacted per sequestration.

Per announcement by Administration on August 1st – Military personnel accounts exempt from Sequestration cuts.

Limited liquidity in sector.

Most secondary trades are for small lots of high quality AA-rated paper. Most new deals have yields approaching 7% with a AA-rating.

With long term Treasury rates at historical lows our view is to be cautious when looking at long duration paper in this sector.

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Disclosure and Legal Notices

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