COVENANT PLEDGE PROVIDES ADEQUATE BONDHOLDER PROTECTION Although non-ad valorem funds provide the basis of support for the current offering, the city's continually-weakened financial position placesstrain on the typical operating sources used for repayment of non-ad valorem obligations. Available gross non-ad valorem revenue of approximately $257.9 million ($219.9 million net of essential general government and public safety costs not paid from property taxes) in fiscal2010 appears significant in relation to the estimated $35 million in maximum annual debt service (MADS) on all non-ad valorem obligations(including the expected Series 2011B port tunnel bonds). However, since available revenues are also utilized for operating purposes, the city'sdeteriorating financial position lends little additional credit support to the bonds. Non-ad valorem funds are an important component of the city'soperating budget, supplementing property tax revenues used for basic essential general government and public safety expenditures, and areexpected to grow in importance given the depressed economic environment and property tax reform which will restrict property tax revenuegrowth going forward. Non-ad valorem revenues are diverse and include sales taxes, public service taxes, charges for services, licences andfees and other taxes. Net non-ad valorem revenues of $219.9 million in fiscal 2010 are down 20.5% from their fiscal 2006 peak of $276.6 million. About 35.5% of all covenant obligations (including the current 2011A and expected 2011B issues) are repaid within 10 years and all obligationsare scheduled for repayment within 29 years. Debt service requirements gradually decline from the $35 million peak in fiscal 2017 to below $20million in 2031 (through maturity in 2039).FISCAL OPERATIONS CHARACTERIZED BY CONTINUING STRUCTURAL IMBALANCE AND DETERIORATING RESERVESDespite the implementation of financial and debt principles, recent declines in revenues associated with property tax reform and a strugglingeconomy as well as rising fixed costs have posed significant challenges to maintaining structural balance and adherence to financial policies.The ability to achieve structural balance and replenish reserves to required levels in the prescribed timeframe appears remote.The city has recorded operating deficits in five of the last six fiscal years through fiscal 2010 due to a combination of overspending, revenueunderperformance and declines in property taxes related to property tax reform and the housing market correction. The use of reserves in fiscal2010 continues the multi-year trend of depleting General Fund balance almost 90% from $126.3 million in fiscal 2006 to $13.4 million at the endof fiscal 2010, in contrast to the $93.5 million requirement (in fiscal 2011) pursuant to a city ordinance formula based on 20% of the averageprior three year revenues. The fiscal 2010 total fund balance equates to a slim 2.7% of total General Fund revenues, with unreserved balance of $4 million equating to 0.8% of revenues. There is no undesignated balance, for the second consecutive year. Additionally, pension and healthcare costs total an appreciable $104.5 million, or 21% of the total $499 million fiscal 2011 operating budget, which inhibits financial flexibility.Finally, the city has increased contributions from the Parking Authority, which transfers excess funds to the city, to $7.5 million in fiscal 2010from $2.0 million in fiscal 2009, only partly with the benefit of a parking fee increase.The City of Miami's $499 million fiscal 2011 adopted operating budget closed a $105 million gap primarily by implementing $72 million in salaryand pension cuts, $15 million in fine and fee increases, a $10.4 million transfer from restricted Redevelopment Agency Funds, and budgeting for use of $23 million in reserves. Officials currently expect a roughly $5.5 million shortfall to be offset with funds that either have been budgeted or have already been set aside and they expect not to use any of the meager remaining reserves, although prior expectations as to the use of reserves were not met. For fiscal 2012, officials anticipate a $55 million gap and have thus far identified $35 million to $40 million of potentialcuts including a 10% cut in city departments.Pursuant to Ordinance, when reserves are below prescribed levels, a two-year replenishment plan must be adopted. Non-compliance occurredat the end of fiscal 2009 (September 30) and presumably the cure period would require increasing the reserve from $13.4 million to $93.5million by the end of fiscal 2011 (September 30), which appears highly unlikely. Officials, therefore, would likely have to consider options whichcould include lowering of the 20% requirement or extending the period in which it has to be replenished. Given the limited financial resources,even considering certain debt restructuring (see below) to achieve savings, reserve replenishment to such a degree is daunting. The city'soriginal financial forecast at the beginning of fiscal 2011 indicated growing General Fund deficits from $122.5 million in fiscal 2012 to $174.5million in fiscal 2015 based on spending patterns at that time and prior to declaring a "financial urgency" that reduced pension costs. Morecurrently, the fiscal 2012 gap is estimated at $55 million with expected pension savings of about $50 million.City police and fire fighters have filed an unfair labor practice lawsuit against the city for invoking a financial urgency statute that allowed cityofficials to rewrite union contracts. Further, the city has been involved in whistleblower and other class action lawsuits. Also, the city's internalauditor has questioned local option gas revenue transfers to the General Fund for the fiscal years 2008 through 2010 and their use for operatingpurposes, for which the city is in disagreement ($4.5 million, $5.0 million and $2.2 million in fiscal 2008, 2009 and 2010, respectively). Finally,the city is also the focus of a Security and Exchange Commission (SEC) investigation into the city's financial disclosure in relation to certainbond issuance and transfer of certain funds. The ultimate outcome of all or any of these events and the potential impact on the city's financialcondition is uncertain at this time. Actuaries have identified the city's other post employment benefit liability (OPEB) pursuant to GASB 45, at a substantial $521.9 million as of October 1, 2008, with the annual required contribution (ARC) at $43.8 million, in relation to the city's funding only the pay-as-you-go portion of about $12.9 million in fiscal 2010. The city has been contributing 100% of its ARC for pensions. General employee pensions are funded at82.7% as of September 30, 2009 and police and fire are funded at 59.8%. Also, in recent years, double digit increases in health care costsprompted changes in the city's health care plan which have now been implemented. The city's ability to contain and reduce fixed costs andenhance revenues are important considerations in restoration of structural balance.ECONOMY STRONGLY AFFECTED BY HOUSING CRISIS; LONG-TERM OUTLOOK FAVORABLEThe city has been strongly affected by the residential housing crisis, leading to significant foreclosure activity, significant fall-off in constructionactivity and persistent high unemployment. Foreclosed properties increased from 221 in 2007 to 917 in 2010, and are at 718 for the first fivemonths of 2011. Foreclosures have increased residential vacant inventory, and housing values have declined precipitously. Median single familyhome values declined 50.2% from their 2007 highs of $380,100 to $189,400 in 2010, with continued declines to $169,200 seen as of April 2011,while condominium values declined about 54.6% to $116,900 over the 2006 to 2009 period, with continued decline to $115,700 seen as of April2011. Unemployment is significant at 14.3% in April 2011 and high relative to both the state (10.4%) and nation (8.7%).The city's taxable base has declined 20% between fiscal 2008 and fiscal 2012 (preliminarily) to a still sizable $30.3 billion, with the greatestdecline (15%) occurring in fiscal 2010, and a more modest 3.8% in fiscal 2012. The city is mature with population increasing only marginally(1%) over the past decade through the 2000 census, but about 10.2% since that time (to 399,457 estimated in 2010) with redevelopment andnew construction having brought more residents into the city. A majority of city residents are foreign-born, and the 2000 census poverty level(28.5%) was more than twice that of the state (12.5%) and nation (12.4%). Unemployment, foreclosures and housing value declines willcontinue to weigh heavily on a poorer population base.