THE 2010 FINANCIAL ADVISORY COMMITTEE REPORT ON

REVIEW OF THE COLUMBIA ASSOCIATION'S FISCAL TARGETS

COMMITTEE MEMBERS
Chair: James P. Howard, II, Long Reach
Vice-Chair: Alan Romack, Owen Brown
Ed Coleman, Long Reach
Roger Hultgren, Harper's Choice
Ryan McCarthy, Wilde Lake
Dan Woodruff, Dorsey's Search

COLUMBIA, MARYLAND
FEBRUARY 22, 2010
 The 2010 Financial Advisory Committee

Cynthia Coyle
Chair, Planning and Strategy Committee
Columbia Association, Inc.
10221 Wincopin Circle
Columbia, Maryland 21044

February 22, 2010

Dear Ms. Coyle:

Please accept the attached report from the 2010 Financial Advisory Committee on “Review of
the Columbia Association's Fiscal Targets.”

As always, members of the Financial Advisory Committee are available for future consultation
regarding this report or other matters the Board of Directors or the Planning and Strategy
Committee require. The other committee members and I sincerely appreciate the opportunity to
have served the Columbia Association and residents as members of the Financial Advisory
Committee and on their behalf, I remain,

Respectfully,

James P. Howard, II
Chair, Financial Advisory Committee
 Review of the Columbia Association's Fiscal Targets 1

Charge
To develop a successor to the current Financial Management Program. The current Financial
Management Program is a ratio-based tool that is intended to analyze fiscal health. It has been
used for the past 5 years and is up for review. The PSC is asking that the FAC benchmark best
practices to create a successor program which may include these ratios, but which will not be
limited to them.

Recommendation
The Financial Advisory Committee recommends the Columbia Association adopt the Low Range
as specified as targets for financial health for the coming decade. These targets have been met
mostly under the current financial management plan and could be completely attainable with a
measure of fiscal discipline. Meeting these targets will help satisfy investor concern over the
long-term viability of CA's debt and encourage bond ratings agencies to continue classifying CA
debt at the upper range of investment grade.
 Review of the Columbia Association's Fiscal Targets 2

Introduction
The Financial Management Program (FMP) is a plan developed by the Columbia Association
(CA) to provide targets for financial health of the organization. The previous FMP will soon be
expiring and the charge asks the Financial Advisory Committee (FAC) to provide a new program
consisting of targets for several financial measurement ratios. These ratios are used to measure
the debt of the CA and provide insight into its long-term capacity to repay its obligations.

The CA uses debt financing to pay for new and existing programs and has done so since its
inception. In general, while the CA does separate its capital and operating expenditures for
budgetary purposes, the CA does not tie specific debts to specific programs nor physical plant.
The CA has pledged the income from its assessment lien income against the senior secured
bonds issued over the previous decades. The CA also maintains revolving credit which is
available to finance continuing activities. As a result, the CA's debt is similar to general
obligation debt in the parlance of municipal finance.

Much of the CA's debt is issued through the municipal bond market. The CA maintains a
revolving line of credit of $20 million and taps that credit line on an as-needed basis to fund
current activities. When that revolving line of credit is exhausted, the CA is able to issue
marketable securities and uses the proceeds of that sale to extinguish the line of credit and the
cycle begins anew. This can happen every two to four years depending upon the specific
financial needs of the CA. Additionally, market conditions, including prevailing interest rates,
may make it prudent to shorten or lengthen the cycle.

Using debt to fund CA operating and capital has both advantages and disadvantages. On the
positive side, the costs of facilities that are used for years or decades can be spread across the
entire time period for which the facility is in use, reducing the up front cost of a facility.
Negatives, however, are the increased cost due to interest payments and the questionable logic of
spreading the cost of operating expenses over a period of years. The core issue at hand, however,
is the inherent risk associated with debt management. By incurring long-term liabilities, the CA
and residents assume the risk that the CA might default and not meet its obligations.

Because the lien against homeowners is structurally similar to an ad valorem property tax and the
CA is a unique organization, the models of credit measurement available to cities and small
governments provide the best lens with which to view the CA. The FAC and its predecessors
have historically used the model of municipal debt when evaluating the CA's debt management
and believes this approach is also used by credit ratings agencies.

This model does have shortcomings, however, as it is predicated on the ability of a jurisdiction to
institute a tax on personal income. While many local governments engage in some enterprise
activities, unlike many cities, the CA receives approximately half of its income from enterprise
activities. As a result, the CA is subject to both cyclical and counter-cyclical market forces. If
the organization is fiscally prudent, under these circumstances, it can effectively hedge against
the broader market, providing significant protection to its credit standing, without regard to the
macroeconomic climate.
 Review of the Columbia Association's Fiscal Targets 3

The Financial Model of the Columbia Association

Because the CA is effectively modeled as a municipality, and there is evidence to suggest this is
the model used by the the credit ratings agencies, 1 this is the approach the Financial Advisory
Committee will take. Though this model suffers from drawbacks previously mentioned, it
effectively relates the ability of the CA to repay its obligations based on its assessment income
through the analogy to ad valorem taxes. In this regard, the CA is likened to a small city, with
approximately 100,000 residents, in a generally prosperous region. The FAC has historically
used this approach to understanding the CA's financial health.

The financial health ratios are important to the CA because some ratios are important for
maintaining the CA's debt rating, ensuring cost effective debt placements. Creditors look for
guidance from credit ratings agencies and if a ratings agency should consider the CA to be
higher risk than a similar sized city, the CA would be forced to pay a higher rate of interest for its
debt.

Additionally, some ratios, CA 2 and CA3, must be maintained at specified levels by the current
bond trust agreement. Failure to maintain those ratios can constitute technical default allowing
the bondholders to seize CA assets. The FAC has noted previously that a default by the CA is
not similar to a default by a local government given that a local government would likely survive
bankruptcy proceedings and bondholders would be disadvantaged in such a proceeding
compared to a private organization.

As CA income from both assessments and enterprise activities changes, along with expenses and
debt, the financial ratios can vary. For instance, an increase in expenses will cause the ratio of
income to expenses to decrease and may signal a potential problem. It is best to consider the set
of ratios holistically and not focus on individual measures.

The FAC recommends using the four ratios recommended for observation by the Municipal
Bond Association,2 according to their designations by the Budget Committee in 2007: 3

R1=total debt /assessed value

R2=total debt / population

R3= per capita debt / per capita income

CA1 =debt service / revenues

For reference, the Budget Committee also considered two other ratios, but because these are
required by the bond trust agreement, the FAC will not recommend targets for those ratios:

1. Columbia Association Budget Committee, “Measuring the Financial Health of the Columbia Association,”
(Columbia, MD: Columbia Association: 2007).
2. Judy Wesalow Temel, The Fundamentals of Municipal Bonds, (New York: John Wiley & Sons, 2001): 176.
3. See note 1.
 Review of the Columbia Association's Fiscal Targets 4

CA2=debt service /annual charge revenue

CA3 =operating expenses /revenues

The required target for CA2 is 67% and for CA3 is between 65% and 70%.4 The current FMP
also includes references to other ratios that the FAC believes should no longer be considered.

Criteria for Policy Evaluation

In evaluating a potential change in ratio targets, this Committee will consider four questions:

1. Bond Rating–How does this affect the bond rating? Will changing a given target alter
how credit ratings organizations view the Columbia Association?

2. Solvency–How does this affect the solvency of the corporation? This is closely related
the first question, but is subtly different in extremity.

3. Cash Flow–How does this affect the cash flow? Will a specified target impact cash flow
positively or negatively?

4. Assessment–How would this affect the assessment lien? Some changes may be best
implemented by changing the assessment lien rate.

Policy Alternatives
The Committee will consider four potential targets for financial planning. The first option is to
maintain the current situation and keep the existing targets. The first alternative is an array of
low-range targets, exemplified by low debt and a push for expenses drawing from current
income. The second alternative is an array of mid-range targets, showing a middle-ground
approach. The third alternative is an array of high range targets, exemplified by higher debt.
There are infinite possibilities within the spectrum of options. However, the Committee believes
these four options present a simple but broad picture of the effects of the entire spectrum. The
target ranges are:

Alternative R1 R2 R3 CA1
Current FMP N/A N/A N/A 25.00%
Low Range 1.00% $750 1.00% 5.00%
Middle Range 2.00% $1,300 3.00% 10.00%
High Range 3.00% $2,000 5.00% 15.00%

The CA currently only has targets for the final metric, CA 1.

4. Columbia Association Budget Committee, Report on the FY2006 Budget, (Columbia, Maryland: Columbia
Association, Inc., January 27, 2005).
 Review of the Columbia Association's Fiscal Targets 5

Comparison of Alternatives by Criteria

The comparison matrix for the effect of each alternative on each criterion the Financial Advisory
Committee deemed important is as follows:

Alternative Bond Rating Solvency Cash Flow Assessment

Current FMP Neutral Neutral Neutral Neutral
Low Range Positive Positive Positive Negative
Middle Range Negative Neutral Neutral Neutral
High Range Negative Neutral Negative Positive

This analysis is subjective and can be interpreted in a variety of ways. It is the FAC's best guess
as to how altering the targets would affect the CA's financial condition. However, the FAC is
comfortable making this judgement due to its current and past analyses of the CA's and local
governments' financial conditions.
Recommendation
The Financial Advisory Committee recommends the Columbia Association adopt the Low Range
as specified as targets for financial health for the coming decade. These targets have been met
mostly under the current financial management plan and could be completely attainable with a
measure of fiscal discipline. Meeting these targets will help satisfy investor concern over the
long-term viability of CA's debt and encourage bond ratings agencies to continue classifying CA
debt at the upper range of investment grade.
 Review of the Columbia Association's Fiscal Targets 6

Appendix 1: Ratio Comparison for Selected Cities Nationwide

Beaverton, OR Boulder, CO Fargo, ND Kenosha, WI Las Cruces, NM
FY 2008 Figures
Founded 1893 1859 1871 1835.00 1907
General Obligation Debt $14,190,063 $60,120,000 $174,922,478 $8,236,434 $173,357,114
Debt Service $2,299,897 $12,883,000 $10,087,666 $7,499,567 $262,549
Assessed Value $7,000,000,000 $2,416,542,000 $3,201,497,937 $6,341,813,300 -
Revenue $60,605,037 $174,794,000 $108,246,514 $71,561,315 $84,539,359
Property Tax $28,131,042 $21,865,000 $17,269,481 $42,822,076 $7,777,195
Operating Expenses 58,252,893 $154,896,000 $97,307,824 $64,061,748 $70,995,143
Population 85,560 94,171 93,531 96,950 89,722
Per Capita Income - $28,976 $37,553 $27,237 24293
Key Ratios
CA1—debt service / revenues 3.79% 7.37% 9.32% 10.48% 0.31%
CA2—debt service / annual charge rev. 8.18% 58.92% 58.41% 17.51% 3.38%
CA3—operating expenses / revenue 96.12% 88.62% 89.89% 89.52% 83.98%
R1—total debt / assessed value 0.20% 2.49% 0.05 0.13% -
R2—total debt / population $166 $2,075 $4,658 $302 $1,932
R3—per capita debt / per capita income - 7.16% 12.40% 1.11% 0.08
Source: Committee Compilation
 Review of the Columbia Association's Fiscal Targets 7

Appendix 1: Ratio Comparison for Selected Cities Nationwide (continued)

Livonia, MI Macon, GA Roanoke, VA Sandy, UT Waukegan, IL Wilmington, NC
FY 2008 Figures
Founded 1950 1823 1882 1893 1859 1739
General Obligation Debt $63,070,804 $67,452,000 $275,531,207 $2,425,000 $94,565,307 $29,655,000
Debt Service $2,818,271 $4,963,690 $31,165,398 $1,779,700 $8,306,966 $7,388,341
Assessed Value $5,209,000,000 $1,895,364,925 $7,407,774,726 $8,834,376,909 - $13,643,490,563
Revenue $127,400,000 $104,892,000 $287,996,553 $70,491,195 $89,250,643 $80,730,676
Property Tax $58,381,619 $17,814,000 $98,714,420 $7,233,667 $17,356,638 $41,472,281
Operating Expenses $123,100,000 $93,964,000 $306,874,197 $65,334,719 $87,873,000 $69,638,456
Population 91,220 90623 93504 96660 89877 100192
Per Capita Income $27,923 32619.00 33358.00 49151.60 - 32800.91
Key Ratios
CA1—debt service / revenues 2.21% 4.73% 10.82% 2.52% 9.31% 9.15%
CA2—debt service / annual charge rev. 4.83% 27.86% 31.57% 24.60% 47.86% 17.82%
CA3—operating expenses / revenue 96.62% 89.58% 106.55% 92.68% 98.46% 86.26%
R1—total debt / assessed value 1.21% 3.56% 3.72% 0.03% - 0.22%
R2—total debt / population $691 $2,068 $2,947 $49 $1,052 $904
R3—per capita debt / per capita income 0.02 6.34% 8.83% 0.10% - 2.76%
Source: Committee Compilation
 Review of the Columbia Association's Fiscal Targets 8

Appendix 2: Historical Ratio Comparison for Selected Counties in Maryland

Anne Arundel Baltimore Co. Howard Montgomery Columbia Assn.
FY 2006 Figures
Founded 1650 1659 1851 1776 1965
General Obligation Debt $875,982,000 $752,245,000 $541,323,315 $1,493,888,054 $63,035,000
Debt Service $104,580,589 $68,084,000 $67,132,766 $215,372,072 $12,703,000
Assessed Value $43,802,722,000 $48,292,908,000 $29,852,994,080 $110,529,249,116 $8,034,858,000
Revenue $1,047,237,963 $1,389,453,000 $996,345,521 $3,410,462,595 $52,923,000
Property Tax $411,488,309 $588,640,000 $353,894,412 $1,073,936,688 $26,060,000
Operating Expenses 924,028,630 $1,325,854,000 $931,195,501 $3,273,734,293 $30,775,000
Population 511,549 786,650 276,287 953,000 98,383
Per Capita Income $44,927 $39,478 $54,924 $61,805 $54,924
Key Ratios
CA1—debt service / revenues 9.99% 4.90% 6.74% 6.32% 24.00%
CA2—debt service / annual charge rev. 25.42% 11.57% 18.97% 20.05% 48.75%
CA3—operating expenses / revenue 88.23% 95.42% 93.46% 95.99% 58.15%
R1—total debt / assessed value 2.00% 1.56% 1.81% 1.35% 0.78%
R2—total debt / population $1,712 $956 $1,959 $1,568 $641
R3—per capita debt / per capita income 3.81% 2.42% 3.57% 2.54% 1.17%
Source: Committee Compilation
 Review of the Columbia Association's Fiscal Targets 9

Addendum 1
Per the request of the Columbia Association's Planning and Strategy Committee, the FAC
provides a time table for reduction of CA 1:

Fiscal Year CA1

2011 16%
2012 18%
2013 15%
2014 12%
2015 11%
2016 6%
2017 5%
2018 5%
2019 5%
2020 5%

The values for fiscal year 2011 through 2016 are based upon the existing and proposed debt as of
April 30, 20125 and assumes a 3.0% increase in income from all sources for each year.

5. Columbia Association, Operating and Capital Budget (Draft), (Columbia, Maryland: Columbia,
Association, Inc., December 17, 2009).
 Review of the Columbia Association's Fiscal Targets 10

Addendum 2
The Columbia Association's Planning and Strategy Committee asked the FAC to consider the
impact of a proposed new headquarters building on the targets recommended in this review. The
FAC recognizes that a proposed building project will be expensive and impossible to fund from
current revenues. Borrowing will be necessary. However, these recommendations are based on
best practices and it is incumbent upon the Columbia Association's Board of Directors to balance
the value of a new facility with the costs of building it.