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HomeMy WebLinkAboutMinutes - Investment & Finance - 5/25/05CITY OF PALM DESERT FINANCE DEPARTMENT INTEROFFICE MEMORANDUM TO: RACHELLE KLASSEN, CITY CLERK FROM: NIAMH ORTEGA, RECORDING SECRETARY K" DATE: JULY 5, 2005 SUBJECT: APPROVED MINUTES OF THE MAY 25, 2005 INVESTMENT & FINANCE COMMITTEE MEETING Please find attached the Minutes of the Investment & Finance Committee meeting which took place on Wednesday, May 25, 2005, and were approved by the Committee at the meeting of June 22, 2005. A memorandum has also been included as part of the Minutes packet for Council review. Please include on the upcoming agenda for review and acceptance by City Council. Please feel free to contact me at Ext. 382 if you have any questions. Thank you. nmo Attachment (as noted) G Tinanceftamh 0rtega\Wpdocs\1nvestment CommitleeWemostrklassenOt2605 wpd MINUTES REGULAR MEETING OF THE PALM DESERT INVESTMENT & FINANCE COMMITTEE Wednesday, May 25, 2005 CALL TO ORDER Chairman Gibson called to order a regular meeting of the Palm Desert Investment & Finance Committee at 10:30 a.m. II. ROLL CALL Present: Paul Gibson, Chairman Buford Crites, Mayor Jim Ferguson, Mayor Pro-Tempore Carlos Ortega, City Manager Justin McCarthy, ACM/Redevelopment Thomas Jeffrey, Deputy City Treasurer Dave Erwin, City Attorney Russ Campbell, Member Bill Veazie, Member Everett Wood, Member Also Present: Absent: Thomas Lee Wormley, Member Mike Cavanaugh, Wedbush Mortgage Securities Dennis Coleman, RDA/Housing Finance Manager Luis Espinoza, Assistant Finance Director Niamh Ortega, Recording Secretary Rodney Young, Desert Willow Golf Resort ORAL COMMUNICATIONS None. IV. APPROVAL OF MINUTES A. MINUTES OF THE REGULAR MEETING OF APRIL 27, 2005 MOTION was made by Mr. Wood and seconded by Mr. Campbell to approve the Minutes of the April 27, 2005 regular meeting. Motion passed; Mr. Ortega abstained. INVESTMENT & FINANCE COMMITTEE MINUTES V. NEW BUSINESS MAY 25.2005 A. CITY AND REDEVELOPMENT AGENCY INVESTMENT SCHEDULES AND SUMMARY OF CASH REPORTS FOR APRIL 2005 Mr. Jeffrey submitted the report for April 2005, and highlighted the following areas: For the month ended April 30, 2005, the book value of the City Portfolio was approximately $146.3 million. Interest earnings were approximately $321,000. Yield -to -maturity was approximately 2.94%. For the month ended April 30, 2005, the book value of the RDA Portfolio was approximately $125.2 million. Interest earnings were approximately $283,000. Yield -to -maturity was approximately 2.80%. Mr. Jeffrey pointed out that the RDA Portfolio reports a significant drop due to the maturation of a $23 million treasury note that was used to refund a project area, and approximately $9 million in debt service. Mr. Ortega referenced the Ford report included in the agenda packet, and stated that he agreed with staffs analysis and recommendation. B. LOCAL AGENCY INVESTMENT FUND (L.A.I.F.) ACCOUNT STATEMENTS FOR APRIL 2005 The reports were reviewed and placed on file. C. CALIFORNIA ASSET MANAGEMENT PROGRAM (C.A.M.P.) ACCOUNT STATEMENTS FOR APRIL 2005 The reports were reviewed and placed on file. D. CITY AND REDEVELOPMENT AGENCY FINANCIAL REPORTS FOR APRIL 2005 The reports were reviewed and placed on file. Mr. Gibson emphasized that the State's payment of sales tax has not yet been received. Year-to- date expenditures are similar to last year's expenditures. Mr. Gibson also informed the Committee that the State is in the process of changing the method for calculations of DMV increases. The same increase percentage will be applied to DMV fees as to property tax fees rather than basing the calculation on the auto volume and value within the City. 2 G.TinancelNiamh OrtegalWpdocs1investment Committee120051MOOesMinutes 052505 final.doc INVESTMENT & FINANCE COMMITTEE MINUTES MAY 25.2005 Mr. Coleman highlighted that supplemental income in the amount of $1.527 million was received. The most significant expenditures occur in capital projects, a large portion being for Wallaroo Childcare Center. Mr. Coleman also informed the Committee that in response to a query at the previous meeting, College of the Desert has retained approximately $1 million in non -obligated funds over the past five years. Approximately $1.924 million remains outstanding. E. PARKVIEW PROFESSIONAL OFFICE BUILDINGS FINANCIAL REPORT FOR APRIL 2005 The report was reviewed and placed on file. Two tenants are vacating and an item is being placed on the Council agenda to discuss prospective tenants. CVAG has the option to take part of the space formerly occupied by UCR, and Virginia Waring is being considered for the remainder of the space. F. PALM DESERT GOLF COURSE FACILITIES CORPORATION FINANCIAL REPORT FOR APRIL 2005 Mr. Young reported that the course continues to do well, as evidenced by its cash flow of $1.8 million, $815,000 more than last year. 85,000 rounds of golf were sold this year, as opposed to 81,000 last year and 72,000 two years ago. The good weather in March and April compensated for poor weather at the beginning of the year. Group business has doubled for June, and the course is within 15,000 rounds of capacity. Broker rates will be increased next year. Mr. McCarthy asked how many of the 85,000 rounds would be considered low -value capacity that could be offset by captive demand rounds. It was estimated that about 50% were lower -paying rounds, and about 70% of those are non-resident players. It was agreed that the Senior Financial Analyst would conduct additional research with Mr. Young to evaluate the uses at Desert Willow. VI. CONTINUED BUSINESS None. VII. OLD BUSINESS A. PUBLIC AND PRIVATE PARTNERSHIP BACKGROUND CHECKS No report. 3 G:1FinanceWiamh OrtegalWpdocsllnvestment Committee120051MInuteslMinutes 052505 final.doc INVESTMENT & FINANCE COMMITTEE MINUTES MAY 25. 2005 B. PALM DESERT FINANCING AUTHORITY BOND ISSUANCE Requests for Qualifications (RFQ) were received on May 13, 2005. A meeting has been scheduled for June 7, 2005 to review the RFQs. Vill. ADJOURNMENT Mr. Gibson adjourned the meeting at 10:55 a.m. Niamh Ortega, Reco ing Secretary 4 GAFinanceWiamh OrtegalWpdocsllnvestment Committee12005WinuteslMinutes 052505 frnal.doc 'V CITY OF PALM DESERT OFFICE OF THE CITY TREASURER STAFF REPORT TO: Investment and Finance Committee DATE: May 25, 2005 SUBJECT: S&P Downgrade of Ford Motor Credit Corporation Bonds to High -Yield CONTENTS: Exhibit "A": Comparative Credit Ratings of FMCC as of 5-18-05 Exhibit "B": Merrill Lynch Credit Monitor Report dated 5-12-05 On May 5, Standard and Poors ("S&P") downgraded Ford Motor Credit Company's ("FMCC") long-term debt one notch from "BBB-" to "BB+" ("high yield" or "junk"). Although the timing of the action came as a surprise, the action itself did not. FMCC is still considered to be "investment grade", however, since Moody's and Fitch continue to rate it as such. Ford has two core businesses: Ford Motor Company ("FMC"), the carmaker, and FMCC, the captive finance arm. Over the last few years, FMC's profitability has been mediocre, while FMCC's profitability has been excellent (the corporate "cash cow"). In 2004, FMCC accounted for 80% of Ford's $3.5 billion after-tax profit. As a Finance Committee member noted, "Ford is a finance company that sells cars to raise debt." The City owns FMCC bonds. On April 8, 2005, Ford reversed an earnings guidance affirmation that it had made two weeks earlier, and announced that it was abandoning its target of $7 billion of pretax profit in 2006 ($4 billion from FMC; $3 billion from FMCC). This target was the centerpiece of Ford's five-year recovery plan, and was considered non-negotiable. It was intended to restore car making as Ford's most profitable core business. Although Ford had made a $1.2 billion profit in 1Q2005 (GM, in contrast, lost $1.1 billion), profits were down 38% from prior year due primarily to plunging large SUV sales. The trigger for the downturn was spiraling gasoline prices caused by high Chinese oil demand. Ford was caught transitioning from large SUVs to smaller, more fuel -efficient, crossover SUVs (where future demand will be). -Staff Report S&P Downgrade of Ford Motor Credit Corporation Bonds to High Yield May 25, 2005 Page 2 of 3 All three rating agencies (S&P, Moody's, and Fitch) reacted by putting Ford on "Negative Outlook," thereby signaling a likely downgrade. This caused Ford to become one of the most heavily traded names for a week. The City Treasurer's Office discussed whether to reduce the City's position in Ford, and concluded that it would not be prudent, due to market volatility. Subsequent conversations with brokers confirmed that this was a sound decision (Ford bonds were trading hundreds of basis points over the average high -yield level). S&P's rating action on Ford was not based upon management fraud or any specific event. S&P had reviewed Ford's operations, and competitive market conditions over the next two years, and had concluded that if current trends continued, then there would be an increased risk that Ford might default on intermediate- and long-term bonds (maturing in 5+ years). S&P expressed "skepticism about whether management's strategies will be sufficient to counteract mounting competitive challenges." These challenges included intensified market competition, continued market share loss, and increased health care costs. S&P noted, however, that Ford currently had good liquidity, and that FMCC would probably generate $3 billion in pretax profit for 2005. Ford has completed 50-75% of its funding requirements for 2005, and can finance the remainder by issuing asset -backed securities that will carry a "AAA" rating. The S&P downgrade has effectively precluded Ford from issuing unsecured debt, however, due to the high interest rates that would be required. Accordingly, Ford now issues debt exclusively through the asset -backed securities market. MGM, AT&T, Xerox, Georgia Pacific, J.C. Penny, Lucent Technology, and General Motors are other well-known names that have had high -yield downgrades. The Bottom Line [1] Majority View: Still Investment Grade. Two of three major credit agencies still rate FMCC as "investment grade" (see Exhibit "A"). Moody's rates FMCC long-term debt at "Baa2" (two notches above high yield, after a two -notch downgrade on May 12); Fitch rates Ford at "BBB" (two notches above high yield, after a one -notch downgrade on May 19). S&P's BB+ high -yield rating is the minority view. The Lehman bond indexes are used by 90% of institutional investors. Due to S&P's action, Ford will move to the Lehman high -yield index in June 2005, oniv to return to the Lehman investment grade index in Julv 2005, when Fitch ratings are included, and an average is taken. [2] Strong Balance Sheet. According to Merrill Lynch (see Exhibit "B"), Ford has one of the strongest balance sheets in the auto industry. Ford's bank lines have no ratings triggers or other financial covenants. Ford has only $3.2 billion of debt maturing within the next 10 years. Ford continues to pay $2 billion in dividends to its shareholders annually. Staff Report S&P Downgrade of Ford Motor Credit Corporation Bonds to High Yield May 25, 2005 Page 3 of 3 FMC has cash and cash equivalents of $22.9 billion; net liquidity of $5.2 billion; and $7.2 billion of committed bank lines. FMCC has cash and cash equivalents of $13.1 billion; $13.8 billion of global credit lines; and $18 billion of committed liquidity facilities. FMCC could raise additional cash by either: 1) continuing to shrink its receivables base; or 2) selling Hertz Rent-A-Car (a non -core business), which would eliminate $8 billion of debt from Ford's balance sheet, and generate $6-8 billion in cash. [3] Good Pay. The City's Ford position will completely mature within 25 months (June 2007). Staff has talked to two of the top analysts in the securities industry: Mary Rooney, Director of Credit Analysis for Merrill Lynch, and Girard Miller, a noted economist, former CEO of ICMA Retirement Corporation, and the current COO of Janus Capital Group. Both have studied Ford, and have confirmed that it will be able to pay off its debt within the next two years. [4] Successful New Product Models. Ford's April 2005 sales numbers indicated that F-series pick-up truck sales had increased 2% over prior year, after dropping in the first quarter (F-series trucks are the best-selling vehicles in the U.S.). The restyled Mustang is currently selling so rapidly that Ford is having trouble restocking inventory. The Five Hundred Sedan, and the Mercury Montego, after a slow start, are beginning to gain in popularity. The Ford Escape is the second-best selling crossover SUV, and is more fuel efficient than its Japanese counterparts. [5] Majority of Creditors Standing Firm. A May 5 survey of Ford creditors (Bloomberg News Service) revealed that the majority planned to hold onto their Ford bonds, despite the S&P downgrade. The only forced selling over the next few months will come from private and public pension funds, mutual funds, and insurance companies that are prohibited from owning high - yield bonds. Hedge funds and high -yield investors will be the buyers. In summary, Ford remains an investment -grade credit that has sufficient cash to redeem its debt through June 2007. As a short-term creditor, the City is indifferent to Ford's long-term debt ratings. While the California Government Code prohibits local agencies from acquiring bonds that do not have a "A" credit rating, it is silent on the treatment of legally acquired bonds that have been downgraded below "A". Consequently, the City has the flexibility to hold the bonds to maturity. Staff is currently tracking Ford's balance sheet on a quarterly basis in order to identify any significant erosion of liquidity, should it occur. Submitted By: r�-�'1 om o►a .ul . Thomas W. Jeffr put City Treasurer EXHIBIT "A" 5/19/05 FORD MOTOR CREDIT CORPORATION 2:03 PM COMPARATIVE CREDIT RATINGS FOR LONG-TERM DEBT AS OF MAY 19, 2005 DESCRIPTION HIGHEST QUALITY VERY HIGH QUALITY HIGH QUALITY GOOD QUALITY SPECULATIVE HIGHLY SPECULATIVE HIGH DEFAULT RISK DEFAULT FITCH AAA AA+ AA AA- A+ A A - BBB+ BBB - BB+ BB BB- B+ B B- CCC+ CCC CCC- CC C DDD DD D STANDARD & POORS AAA AA+ AA AA- A+ A A - BBB+ BBB BBB - BB BB- B+ B B- CCC+ CCC CCC- CC C D MOODY'S Aaa Aal Aa2 Aa3 Al A2 A3 Baal Baa3 Bal Ba2 Ba3 Bl B2 B3 Caa Ca C CLASSIFICATION INVESTMENT GRADE HIGH YIELD ("JUNK") FOOTNOTES: "LONG TERM DEBT" IS DEFINED AS BONDS HAVING A MATURITY OF 5 YEARS OR MORE, FROM TIME OF RATING. RATING AGENCIES DO NOT RATE BONDS BY INDIVIDUAL MATURITY. SO, A FORD BOND MATURING IN 2 YEARS WILL CARRY THE SAME CREDIT RATING AS A FORD BOND MATURING IN 10 YEARS, EVEN THOUGH THE RISK OF DEFAULT FOR FORD IS MUCH GREATER OVER TIME. "SPECULATIVE" MEANS THAT CREDIT RISK MIGHT DEVELOP DUE TO ADVERSE ECONOMIC CHANGE OVER TIME. BUT FINANCIAL MEANS MAY BE AVAILABLE TO ALLOW FINANCIAL COMMITMENTS TO BE MET. EXHIBIT "B" W Merrill 6ywA Table 1). While some bonds have cheapened due to fundamentals (e.g. Morgan Stanley, Viacom, Albertson) many, especially those of higher quality should be mean reverting. Also, comparing to CDS mitigates fundamental steepening as 5YR CDS/5 Year Cash bonds beta is typically greater than 1. Pension Reform may quell Treasury Steepening. But Benefit High Quality Corporates There is some debate as to how much more the Treasury curve will steepen if the proposed pension reform is passed. It is quite possible that demand for long dated assets will exceed any incremental supply. However, if Pension reform were to become reality, it is also true that long dated Corporates should benefit even more. Recall that in the proposed legislation pension liabilities will be discounted by Single A Corporate curve. Single A Corporates should be the hedge asset of choice and thus benefit in either a treasury steepening or a pension -driven flattening environment. Changing Index Rules Confusing the Auto Migration to High Yield ML Takes the Average ML index criteria is based upon an average of the Moodys, S&P and Fitch numerical ratings (where AAA=1, AA1/AA+ = 2, Aa2/AA = 3, etc.). A composite rating of 10.5 or higher falls below investment grade. (An average rating between 10.5 and 11.499 = BB+). GM falls to High Yie14 GMAC, F, FMC and Hertz all remain investment grade As shown in Table 2, GM's Baa3/BB/BBB- rating averages to 10.7, which rounds to 11 or BB+. Since GMAC's average rating is 10.3, its rating rounds to BBB-. Based on the ML scheme, both Ford and FMC have a decent cushion (5 and 7 notches, respectively) before falling to high yield. Table 2: ML index Rules and GM and Ford Complex: The "10.5" Cutoff Md value CrediU" Numerical Raft Average Index Bns GM (8aa3IB8lB8B-) AVG(10,12,10) 10.7 $12.2 GMAC (Baa2/BB/B8B•) AVG(9,12,10) _10.3 $31.0 F (BAA1iBB+/BB8+) AVG(8,11,8) 9.0 $16.6 FMC (A3/BB+/BBB+) AVG(7,10,8) 8.3 $24.9 HRTZ (8aaM8B•/8BB+) AVG(9,10,8) 9.0 $3.7 Source: Merrill Lynch. Left rasng aro mapped b ordinal numeric radnp: AAA -1, AA 2....B88-•10,88.12... Lehman Takes the Middle This contrasts to the Lehman index schema. It is our understanding that Lehman Brothers currently takes the "lower of Moody's and S&P, but commencing July 1, will use the middle or 2nd highest rating of Moody's1S&P\Fitch. Assuming no rating change by Credit Strategies - 10 May 2005 Moody's or Fitch by late June, GM, GMAC, F, and FMC will all fall out of Lehman's high grade index at the end of this month, only to return in July. Both F and FMC will likely go back to high grade in July while GM/GMAC has less margin for error for a return (basically, Fitch must not downgrade 1'/z months). NAIC Remains Unchanged at i Highest All Auto bonds will retain their current NAIC rating of "2". Recall, the NAIC recognizes four NRSROs (Moody's, Standard & Poor's, Fitch, and DBRS). When there is more than one NRSRO rating the second -highest rating is translated to an NAIC Designation (Similar to the new Lehman schema). For example, if the ratings are "A", "A", and "BBB" then highest rating is "A", and the second -highest rating is also "A" so the asset becomes NAIC I (the equivalent of "A"). The NAIC equivalents are: >:A- = 1;BBBt = 2; BBt = 3;Bf = 4;on down to in or near default = 6. Table 3: Summary of the Index Rules Index Rule GM Current Rating ML Average of Moodys, SP Fitch 10.7 - NY Lehman Current Lower of Moodys, SP 12 - HY Lehman starting 6/1 24d highest of Moodys, SP and 10 - IG Fitch NAIC Second Highest of Moodys, SR 2 - IG Fitch, and DBRS Source: ML Ford versus GM: Relative Value In the Curve Underweight GM, Marketweight F In the context of GM and F's new reality as high yield credits, we continue to favor F over GM. While the action from S&P on F came sooner than we had expected, bonds discount the fundamental and technical risks in our view. Despite wider trading levels at GM, we expect incrementally negative fundamentals and technicals to continue to pressure spreads. We believe F spreads fairly compensate investors for a traditional "5-B" credit. Liquid balance sheet. F maintains the strongest balance sheet in the sector with industrial cash of S23bn (incl. VEBA), and net liquidity of S5bn. This compares to GM's cash and S-T VEBA balance of S20bn, but a net debt balance of $12.5bn. Liquidity is substantial w/sizeable bank lines & minimal near -term industrial debt maturities. More operational flexibility. F's structural cost base affords it a relative advantage over GM, and we acknowledge the strides F has made toward its restructuring goals laid out in 2002. Given its smaller size and more moderate legacy obligations (pensions and OPEB), F can adjust its volume to focus on higher margin opportunities. GM must absorb the costs of carrying about 2.4 retirees for every active employee, whereas F's ratio is approximately 1.2:1. Refef to important disclosures on page 11. Credit Strategies - 10 May 2005 Product initiative. While not a distinct advantage for either company, we are modestly more positive regarding F's near term product momentum relative to GM. Both companies are getting hit hard by declines in overall market share, with particular weakness in SWs. GM has lost 1.6 points of share YTD, while F has lost 1.1 share points. For its part, GM will be experiencing somewhat of a product dry -spell until its GMT 900 platform (large SWs and pickups) ramps up in early 2006. Further, the success of this platform is hard to predict given (1) the secular shifts in the industry away from traditional SWs and (2) GM has not released design photos of the new products. F's recent car/CW launches have been building momentum, which is partly mitigating weakness in its light truck performance. Stronger credit medics. Across-the-board, F has stronger credit metrics. For FY05, we expect F to post an EBITDA margin of 5% versus GM's 4%. Interest coverage of 5.7x compares with GM's 2.3x. Debt-to-EBITDA is forecast at 2.5x, well below GM's 5.2x. Though global unfunded pensions total S 12bn at F versus S8bn at GM, F's OPEB obligation is effectively half the size of GM's. We also expect F to post close to breakeven cash flow this year, in contrast to a S5bn cash outflow expected at GM. Hertz sale would bepositive for fundamentals and technicals. We continue to expect F will move toward a separation of Hertz. While the company has not indicated what form a separation would take, management stated it would be done in conjunction with boosting liquidity. We believe a sale is most likely, and ML estimates the business could be worth over S6bn. Such a sale would be welcome news for the market, enabling the company to further strengthen its balance sheet (which may include further debt reduction) and/or offset the potential charges/cash outlays surrounding a further Visteon restructuring. Further, the technical implications are also favorable as almost S4bn of Hertz bonds are removed from the F ticker. We expect F to remain in the high grade indices this year (ex -June), while GM drops out Collectively, the rating agencies do differentiate between F and GM. Though S&P takes a harsher view, we believe Moody's and Fitch will be more tolerant of F's recent missteps and keep it at investment grade, allowing F to remain in the MULehman high grade indices for the near term (except for the month of June). That said, the pending Moody's review of F is expected to be concluded in the coming days, which may add some near term volatility. Conversely, we believe it is just a matter of time before GM is rated high yield at all 3 rating agencies, forcing it out of all major investment grade indices. FACZ Merrill Lynch Table 4: Auto Comparable Financial Summary FY05 Estimates ($s in mms) - ktdustrW Only F Gall Ratings 0ADYs1W1Fi1lcr) Bu11BB+IBBB+ Bat31BWBBB- Outlooks (MUSISVIFUN WL Negim NXN Total Net Sales and Revenues $148,028 $152,033 EBITDA 7,415 6,294 Depreciation and Amortization 6,340 8,008 EBIT (a) 1,075 (1,714) Interest Expense, Gross 1,300 2,785 Other Expenses Qncome) (255) 200 EBT Cam" 30 (4,699) j(ilfrat7�si`fiFil�' Cash and Equivalents - $19,492 $15,542 Total Debt 18,435 32,522 Total Shareholders' Equity (b) 17.539 27,772 Total Capitalization 35,974 60,294 EBITDA Margin 5.0% 4.1% EBITDA Coverage of Interest 5.7x 2.3x EBITDA- cap -ex Coverage of Interest 0.9x -0.6x Total Debt 1 Capitalization 51.2% 53.9% Net Liquidity (Cash - Debt) $1,057 ($16,980) Atfjusted Net Liquidity (c) $5,157 ($13,461) Total Debt I EBITDA 2.5x 5.2x Marra L**&xbdF&aian $12 $0 L#*ZrdadCM $32 $61 Sara: SEC dorarrnerm, FIGM, K es*nars. E�i1s Wusai O* tetanus present Aiwuiets br tlr industrial wwmt arty (ex*=e). foxes axwe e*wd wy bms. (a) Orr includes interest *boor. (M SooditWxY epndy br FIGM rWemm co w5dNed stainhaders' eWq. (c) Mos d no 4mity ntlrdes pre -handed VEB& vkkh is assumed to remain bt YoY. Chart 2: GNIAC vs FMC Credit Curves: Narrow Basis in'09s and '10s eoo - No 5W 4W .00 cPA a +as W•sae Teo Wa d 3W aso awn ,o. a47 17 • • Wea a"r21 • trio WSae Da♦� ,a ,,,.i. . .. F. • F' •am 31 CPAs 5175,� V Wa d • g,, nr W a,75 Sowce: Muni Lynch GPAC Fes ., v, •.n � • "MAW O.A. —c"M Cuw i —rec Fa v" What Looks Cheap: FMC 110s, FMC 109s in Z There are many factors affecting valuation at these levels: dollar price, liquidity and Repo dynamics. Dollar prices Refer to important disclosures on page 11. 4