Southeast Wisconsin Professional Baseball Park District Note Buy Back

General Provisions

Southeast Wisconsin Professional Baseball Park District (Stadium District) is contemplating a purchase of the Foundations $20,000,000 note for a purchase price of $5,000,000 with a closing date of September 1, 2001. The Stadium District's justification of the $5,000,000 offer is a financial rate of return analysis using an assumed 12% as the alternative investment rate the Foundation could earn if it had the $5,000,000 to invest today. Their analysis showed that the value of the assumed investment would have a current value of $4,235,600. Since the current value of $4,235,600 does not match $5,000,000 exactly, the true rate would be something less than 12%. The analysis completed by the financial staff shows a rate of return closer to 8.3%.

Davis & Kuelthau Analysis

Per a conversation with Norman Mater at Davis & Kuelthau, they made assumptions on returns and simplified the original repayment schedule in order to develop a proposed payout number. Using a bond table, they developed various scenarios and agreed upon a middle ground number. The methodology used was to determine how much an investor would pay today to obtain a 12% yield on a 30-year bond paying a 2% coupon. They referred to a bond table and found that the present value is $4,235,600. Other assumptions they made were as follows:

Yield	Years	Coupon	Present Value (rounded)

12%	30	2%	$4.2 million (the amount used in the memo)

12%	30	3%	$5.8 million

8%	30	2%	$7 million

12%	30	4%	$7 million

The $5,000,000 was proposed as a compromise between a 2% and 3% coupon. The 12% yield was chosen as an assumed number since they did not know what rate of return the Foundation actually received on investments and they needed to pick a number to begin the calculation.

Return on Foundation Investments

Since 1986 the Foundation has earned returns through July 2001 of:

Total portfolio 11.78%

Equity portfolio 13.31%

Fixed portfolio 7.59%

If we looked at past performance, the yield assumption of 12% made by Davis & Kuelthau is fairly close to the rate of return earned on the total portfolio since inception. The analysis completed by the financial staff shows that the rate proposed on the $5 million pay off is closer to 8.3%, which is close to the return on the fixed income portfolio. Based on past performance, the proposed payoff appears to be reasonable. However, past performance is not indicative of future performance. Past performance includes the most recent decade of unprecedented high returns that should be factored out of the analysis of what the future returns will include. According to the Grantham, Mayo, Van Otterloo (GMO) forecasts, returns over the next 10 years will generally be lower as inflated values are squeezed out of market prices. Using their forecast, the analysis above should use a lower rate of return. Using the assumption that the $5,000,000 would be invested in fixed income securities, the highest expected return would be 6.3%. Using this rate, the principal payment should be approximately $6,000,000.

Other Risks

There may be other risks that have not been factored into the calculations. One of the risks not factored into the above calculations is a default rate. The extended payment period for the loan infers a higher probability of default. The discount to mitigate the risk of loss by receiving an accelerated payment is not included in the calculation. There is also a risk not quantified for a change in inflation rates over a 30-year period. The Foundation will have lost opportunities for reinvestment at higher interest rates should the economy face higher inflation rates in the future. Aside from economic issues, there are programmatic considerations. The question should be raised on whether the Foundation will now have the opportunity to fund new initiatives that may not have been considered.

Closing Date

The closing date in the Business Proposal is September 1, 2001. Norman Mater believes there is flexibility in this date.

Tax Considerations

Repayment of the loan requires analysis of tax considerations. The $5,000,000 repayment would be added back to the asset base for the payout calculation and it would also be added back to the required distribution in the year of repayment. The financial staff estimated the effect on current year taxable income and found that it would increase excise taxes paid by about $100,000 this year. This estimate was based on an assumed excise tax rate of 2%.

One benefit to receiving the repayment this year is that net investment income and net assets are down from last year so the total dollars paid will be much lower than last year. The excise tax owed in 2000 is around $1,100,000 vs. $187,000 estimated for 2001 (without the repayment.) Another benefit is a reduction in qualifying distributions to bring down the Foundations average distribution ratio.

Pending legislation may reduce the Foundations excise tax rate to 1% or 0% in 2002. The Foundation may save $50,000 to $100,000 by deferring the payment until next year. The tax savings would ultimately be distributed to grantees vs. paid to the government.

Recommendation

Considering the analysis above, the Foundation should accept a proposal for repayment by the Stadium District. Based on an assumed rate of return of 6.3% the Foundation should negotiate a $6,000,000 repayment. Factoring in a risk of default, the Foundation may accept less than $6,000,000 for the assurance of repayment. The Foundation should not accept less that $5,000,000 based on the probability that return on investments will not exceed 8.3% in the future. The timing of the payment will be dependent on the negotiation process with the Stadium District.